How Do Interest Rates Affect the Customer Demand?

Interest rates have a real and profound affect on consumer and retail demand. Interest rates relative to the consumer are about the cost of borrowing money, including credit card rates. At the same time, less directly, businesses see lower rates as a signal to expand, to borrow money and seek short-term profits by offering lower prices to the public. In the most general terms, low rates mean economic recovery and consumer spending.

Low Rates

The Federal Reserve controls general interest rates. This is important because the Fed also is in charge of monetary policy more generally, which seeks to control inflation. The "real" interest rate is the Fed rate plus the rate of inflation. If rates are lowered by the Fed, given the structure of the American economy based on consumption, people will buy more. Businesses will borrow more. Low rates are a signal that it is now OK to borrow, invest and spend.

High Rates

Both low and high rates are closely connected to demand. Elastic markets such as luxury goods and entertainment are in high demand as rates lower. Stocks usually go up as money is transferred from the bond market. All of this gives corporate America and its retail sector the green light to expand, offer more products and engage in heavy advertising for short-term profits. Since most believe, as rates go down, they cannot stay down, the stress is on the short term. Eventually, once consumer demand has leveled off and debt rises, rates will go up.

Elastic Demand

Demand is the public's desire for goods. It is reflected in prices. Elastic demand refers to those goods that a household can live without. Inelastic demand refers to those staple items that must be bought regardless of the interest rates or any other macroeconomic measure. The demand for inelastic sectors does not change. If anything, it forces households to go into debt to afford basic food, hygiene and transportation items that are not discretionary. Therefore, rates are connected most clearly with elastic demand items. Inelastic items can change in that in expansionary times, consumers might buy name brands and place more purchases on credit cards. In recessions, consumers might go to generic brands or switch to cash to avoid high interest charges. It is also possible that consumers will save less in recessions and spend the same amount of discretionary cash, driving rates even higher as liquidity becomes more scarce.

Stocks and Bonds

High rates are very good for the bond market, especially short-term bonds that are more volatile. They attract investment during times of high interest rates because the return on these monies loaned will be high. As rates fall, money is sent to the stock markets. As firms financing with debt demand more cash, interest rates will have to increase to attract bond money. Therefore, an equilibrium is reached as rates change. Long-term bonds do not change as much as rates tend to even out the longer the term. Short-term bonds are for quick profits if rates are to go up.