Interest rate is a measure of the amount paid on a borrowed money or the amount received for saving money.
This means, if an amount of money is borrowed, the individual/entity is required to pay a percentage of the money within a specified period, based on the agreed term.
Similarly, if an individual or organization saves, a specific amount will be received – a bonus for not spending all your money.
However, we could have a high or low-interest rate and each of these categories have its pros and cons.
When the interest rate is low, citizens are encouraged to borrow. They buy cars, acquire homes, and travel because they pay little on the amount borrowed.
Also, people are willing to borrow to expand their businesses as they can pay back the miniature charges.
During this period, purchasing power is strengthened and organisations can afford to scale their businesses thereby contributing to the economy.
However, low-interest rate leads to more money in circulation as people will borrow than save. They will also have abundant money to spend. The low-interest rate can be a contributor to inflation in a country.
On the flip side, when this interest rate is high, people borrow less and may be willing to save more. Consequently, there is less demand for goods and services, as individuals may only spend on food items ignoring secondary needs like clothing, buying cars and even travelling.
Organizations will start laying off members of staff because of the drop in the demand for goods and services. Little wonder organisations like Twitter, Microsoft, etc are cutting down the number of employees.
An Increased interest rate could be a means to tackle inflation. This is what Nigeria is trying to do by increasing interest rates on a gradual basis. Nigeria wants to reduce the inflation rate.
If the high-interest rate lingers, it would weaken purchasing power over time. Businesses will keep being stagnant, individuals would hold back because they cannot afford to borrow.
Not all sectors of the economy will do well with a high-interest rate. According to Schwab Center for Financial Research, the sectors that can benefit from high-interest rates are communication services, Healthcare, utilities, energy, financial institutions, and information technology.
On the other hand, sectors like Consumer Discretionary, Industrials, and Materials, Consumer Staples, and Real Estate may not do well during this period.