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Financial Literacy
Course: Financial Literacy > Unit 11
Lesson 3: Interest and debtWhy interest rates go up and down
Learn about the basic mechanisms that impact interest rates.
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Khan Academy doesn’t provide legal, tax or accounting advice. You should consult your legal and/or tax advisors before making any financial decisions.
The material provided on this website is for informational use only and is not intended for financial or investment advice. Khan Academy assumes no liability for any loss or damage resulting from one’s reliance on the material provided. Please also note that such material is not updated regularly and that some of the information may not therefore be current. Consult with your own financial professional when making decisions regarding your financial or investment options.
Khan Academy doesn’t provide legal, tax or accounting advice. You should consult your legal and/or tax advisors before making any financial decisions.
Want to join the conversation?
- Is it possible that there is high unemployment and high inflation. If so, what does the Feds do?(8 votes)
- What is inflation?(2 votes)
- Inflation is when the overall price of things goes up over time. This can happen for a few reasons:
- Sometimes when the government prints too much money, the value of each dollar goes down, so you need more dollars to buy the same thing.
- Other times, inflation happens because there's a lot of demand for something, and people are willing to pay more for it. For example, if everyone wants to buy a certain type of toy, the toy company might raise the price.
- Inflation can also happen when the cost of making things goes up. For example, if the price of steel goes up, car companies might raise the price of their cars because it's more expensive for them to make them.(9 votes)
- Is there any limits on how much the Feds can control the economy? And what about private companies that give loans? The government cannot control their interest rates, can't they?
Please help me on this one!(4 votes) - Why does inflation happen(3 votes)
- The world's economy creates resources faster than the world consumes them, so the amount of stuff to buy just keeps on rising. Sometimes, though, the amount of stuff created is less than is needed, so people are willing to pay more to get it.
Economics is a voodoo science. You can find every sort of answer if you poke around in it for a while.(1 vote)
- Not doing a very good job at that. 0:30(3 votes)
Video transcript
You may have noticed that interest
rates on loans and savings accounts can change from time to time. For instance, one year you might pay a certain interest rate on a car loan, but the next time you shop for a car, that rate might be several
percentage points higher or lower. So what makes interest
rates rise and fall? Now, the actual process
is much more complicated, but essentially,
interest rates fluctuate mostly as a result of things the Federal Reserve does
to keep our economy stable. The Federal Reserve (or “the Fed”) is the central bank
of the United States and it has two main goals: to keep prices stable – that is, to make sure
inflation doesn’t get out of control, and to encourage job creation
when employment is low. When a lot of people are out of work, the Fed might try
to encourage job creation by pushing interest rates down. When interest rates go down, it becomes cheaper to borrow money, which means people
and companies will be more likely to take out loans. And as a result,
they’ll spend more money. That increased spending will fuel the economy and, hopefully,
lead to the creation of more jobs. Think about it this way, when you buy a home, you might
also hire movers and painters, maybe buy some new furniture
and plant some flowers from the garden center. And the person who sold you
the home needs a new place to live, so they might do the same. The net effect of all this spending helps create new jobs. On the other hand, if inflation is high
and prices are rising too fast, the Fed might try
to slow down the economy and steady those prices
by pushing interest rates up. When interest rates go up, it becomes more expensive
to take out a loan. In turn people will be less likely to borrow money
and they’ll buy fewer things. Meaning there’ll be less demand
for goods and services, which will cause sellers
to drop their prices. And, as a result, those prices will stabilize. By encouraging interest rates to rise and fall at certain times, the Fed is trying
to stabilize prices, create jobs,
and keep the economy secure.