How are interest rates used to control an economy

In free-market economies, consumers and businesses can do almost anything they want as long as they pay for it. Therefore, by controlling the cost of money - its interest rate - central banks are able to influence economic growth.

In a totalitarian country the government can simply tell its citizens what it wants them to do. But in free-market countries, consumers and businesses are encouraged to increase or reduce their economic activity through a variety of economic incentives. By increasing short-term interest rates, for example, a central bank discourages bank lending, reducing the amount of money available for business expansion and consumer spending. Likewise, by lowering these interest rates, a central bank acts to encourage economic activity.

Banks often borrow money from the central bank to lend to consumers and businesses. The interest rate charged by a central bank for loans of reserve funds to commercial banks and other financial intermediaries is called a discount rate. This charge originally was an actual discount (an interest charge held out from the amount loaned), but the rate is now a true interest charge, even though the term discount rate is still used.

The discount rate serves as an important indicator of the condition of credit in an economy. Because raising or lowering the discount rate alters the banks' borrowing costs and hence the rates that they charge on loans, adjustment of the discount rate is considered a tool to combat recession or inflation. The discount rate is also used to deal with balance-of-payments deficits—that is, to regulate international movements of capital.

All interest rates are linked, because money, like most commodities, is interchangeable. Banks and individuals will go wherever interest rates are lowest - basically, wherever money is cheapest - so a change in interest rates announced in Washington will affect interest rates in Singapore.

In the global village of the international money markets, interest rates have become the heartbeat of economic activity, regulating economic growth worldwide. A country's consumers and businesses, therefore can be directly affected by central bank decisions made on the other side of the world. Foreign investment money can come flooding in at a moment's notice, or be pulled out just as quickly if one country's interest rates are not kept in line with other countries in the world economy.

2. Выберите правильный вариант окончания предложения, используя информацию текста.

1. In free market economies consumers and businesses can do …

a) almost anything they want as long as they pay for it.

b) nothing.

c) everything without payment.

2. Banks often borrow money …

a) from other banks.

b) from the central bank.

c) from the government.

3. All interest rates are linked …

a) because money is interchangeable.

b) because they don’t encourage economic activity.