Monday, September 3, 2007

Problems of Keeping interest Rates too High.

It is very well for economists to talk about the benefits of recessions - "creative destruction" but, recessions do create real personal hardships for individuals affected by unemployment, bankruptcy and falling incomes.

Problems of Recessions

Recessions don't necessarily weed out just the inefficient. Recessions can cause the bankruptcy of many good companies who just can't cope with the temporary downturn. This particularly applies to new companies.


Recessions create uncertainty which discourages investment. People dislike the uncertainty of fluctuations in the business cycle. Moderate steady growth helps encourage investment.


This suggests that high periods of unemployment tend to lead to higher unemployment rates in the future. Basically, if people are unemployed it becomes more difficult to get work in the future. This is because they become demotivated e.t.c.

High Interest Rates do not affect people equally.

Higher interest rates may be needed to discourage excess borrowing and inflationary pressures. However, people often forget that interest rates are an imperfect mechanism. They do not affect consumers equally. For example, new homeowners with a large mortgage will be heavily affected by a small rise in interest rates. The older generation who have paid off their mortgage may actually welcome rising interest rates. This is because it increases the income from their savings.

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