The Economic Implications of Government Control Over the Interest Rates Essay

Introduction

In several countries, governments embarked on structural reforms to the financial sectors in the specific countries. The structural reforms included regulation of interest rates that have been usually determined by the market. Interest rates are the charges that are charged when one borrows money from financial lending institutions or the amount paid by a financial institution to a depositor after a certain period. Interest rates are normally expressed as a percentage of the total amount borrowed or deposited over a period of time. Countries that have bodies and regulations to control the interests that are charged on deposits and lending include the United States, Kenya, Zambia just to mention a few. The main aim of regulating these interest rates is usually to ensure that the borrowers are protected from overwhelming high-interest rates. In general, decreasing the interest rates may bring about economic growth due to increased economic activities but this is not always the case. The goal of this paper is to determine the economic effects that brought about by the regulation of interest rates. This paper discusses the grieve effects of the regulation and the benefits and finally makes conclusions on whether regulation interest rates is better than leaving the market to decide the range of interest rates.

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Regulation of interest rates

Regulating interest rates refers to the act of controlling the extra amount charged by a creditor be it a financial institution or an individual on the amount that has been lent to an individual or institution over some period of time. This involves setting the maximum percentage and the minimum percentage of the principle that can be charged as interest.Economic limitations

The limitations of having regulated interest rates are adverse since most of the time the maximum rates that are set by the regulators are usually way below the market rates. The limitations include;

First, the regulations are made for the purpose of increase credit availability and make sure the low-income earners and small business institutions have access to affordable credits. This is not what happens, the restrictions have brought scarcity of the credit that is available for the essential activities in the economy. For instance, in the United States, the states had put some restriction on the interest rates that lowered the interest rates. The effect was the transfer of capital to other areas even though the locals had a high demand for credit. The restrictions mainly affected the construction industry in the state of Tennessee. The impact was immediately felt by a decrease in residential developments, increased unemployment in the construction industry, a reduction in the sale of building supplies and external individuals and businesses competed to acquire the financial resources that were available in Tennessee. An introduction of the interest rate regulation reduced the lending capability of several banks which lead to a drop in their stock prices for the banks that had been listed in the securities exchange. The effects on price were felt over a thirty-day period during which the regulation was introduced (Claessens et al, 2016). It is clear that limiting the maximum interest rates discourage investments in financial lending services within the area of application of the rule thus making credit unavailable which was not the intention of such restrictions.

Second, the regulation of interest rates makes it more difficult for the low-income groups to access credit (Claessens et al, 2016). When the interest rate maximum is restricted to low percentages the financial institutions tend to shy off from lending to low-income borrowers who have less adequate security and have limited ability to repay the amount. This means that the borrowers who have more assets for security and the capability of repaying back are given more consideration. The origin aim of providing affordable and available credit then fails since the low -income groups cannot get the credits (Claessens et al, 2016). The economic implication of this is that the low-income groups cannot invest due to lack of capital hence an imbalance in the economic setting.

Economic Benefits of interest rates regulation

On the other, hand the benefits that are brought by the regulation of interest rates is that the vulnerable in the economy are protected from exploiting lenders. The vulnerable in this case include the low-income earners, the minorities, and women. The borrowers who have low incomes are more likely not to see how the high-interest rate credits could harm them and therefore the government has to intervene and prevent these cases. The low-income earners borrow at high rates mainly because they are lured by the lender to get credits at high rates and therefore may find themselves in situations that they are in cycles of debt. The control of the interest rates discourages the lenders from luring the low-income earners to get credit thus preventing situations in which a person or a group is in deb cycles (Miller & Black, 2016). Therefore, interest rates regulation prevents the exploitation of the low income and desperate low-income earners from taking credits that they can't afford.

Conclusion

In conclusion, regulating interest rates and setting the maximum rates below the market rate prevents the exploitation of the vulnerable but has more adverse effects to the economy such as unavailability of credit for important developments such as residential buildings and the low-income earners get discriminated for having fewer assets for collateral.

References

Claessens, S., Coleman, N., & Donnelly, M., (2017). "Low-For-Long" Interest Rates and Banks' Interest Margins and Profitability: Cross

Miller, T., & Black, H., (2016). Examining Arguments made by Interest Rate Cap Advocates.