What Is a Good Interest Rate?

What a "good" interest rate is depends on circumstances. Interest rates function, among other things, as a regulatory force in the economy. They serve to control inflation, slow fast growth and send signals to investors as to what they market will bear at any given time.

Low Rates

All borrowers, whether personal or institutional, want to borrow money at low rates. This is called "cheap" or "easy" money. When the money supply is plentiful, rates will fall, and the banking system is sending a signal that it is a good time to invest. Banks will see a good interest return since the economy is getting better, while both individuals and businesses will pay less for their loans and investments. This, however, cannot last forever.

High Rates

An economy, no matter how prosperous, can handle only so much investment and spending. Eventually, people begin wondering how long a good run can last. People spend themselves into debt and soon roll back on discretionary buying. Money begins to run out in the banks. The result is that rates go up. This both signals that times are getting "tighter," as well as the money available is getting scarcer. This is the purpose of rates: it regulates spending and sends signals to both investors and consumers.

So What is "Good?"

It might be easier to show what is a "bad" interest rate. If rates remain low even as consumer demand begins to trail off, then the rate is bad. It is bad because it sends the wrong signal. Investors will continue to borrow and invest even when consumer demand is not there. This will mean lots of "idle dollars." This is the very definition of inflation and an economic downturn is not too far away. If rates remain high for a long period of time, this is also bad, since it holds back the ability of an economy to produce, consume and create employment.

A Good Interest Rate

Given all this, a good interest rate is one that does its job: sending the proper signals to the economy in that it reflects economic reality faithfully at a given time. A good interest rate tells people to hold off when they begin to go into consumer debt, and to begin buying when money is plentiful. A good interest rate follows supply and demand in the pursuit of low inflation and moderate debt. A good interest rate does not create the economy, it reflects the economy. It follows the needs and demands of both capital and consumer dollars.