Consequential economic impacts of high and rising interest rates

  • Increased cost of public debt servicing – redemption of treasury bills and bonds by the government involves paying back the principle sum plus interest.
  • Non-performing loans/bad debts arising from existing loan agreements. This tends to cripple the liquidity status of institutions, leading to cash flow crisis and possibly of a complete collapse. We have seen in Kenya the Central Bank imposing statutory management of some commercial banks with a view to reviving them; with some of these banks being liquidated where revival trials fail. A bank collapse means a lot in terms of loss of deposits of those with accounts, unemployment, tax
    revenue to the government etc.
  • Disincentive to investment – increase in interest rate increases the cost of capital hence reducing capital formation, growth and development.
    Inflationary tendencies – a rise in interest rates tends to increase the general level of prices of goods and services, leading to reduced purchasing power and welfare standards.
    Rationalization of business operations with a view to cutting costs – one of the options taken is to retrench workers (the order of the day in Kenya), again increasing the general level of unemployment, poverty and purchasing power (effective demand)
    Credit squeeze – high and rising interest rates reduces the ability of banks and other financial institutions to create more credit (advance new loans from deposits net of the cash-ratio requirement) since the demand for loanable funds decreases.

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