A little bit about interest rate movement

This blog is to support another article. Although, I hope it is will be interesting to read independently.

There are several factors drive the decision making of a government (central bank in this case) in raising or lowering their existing interest rate, intuitively every event in market will affect the decision, but there is some major events will be dominant factors in taking decision, some if its:

Inflation: Higher inflation tend to make currency is not attractive anymore, since the effective interest rate is calculated as the difference of interest rate and the inflation.
Example, Rupiah 8% interest rate with 6% inflation have 2% effective interest rate, if inflation rise into 6.3% then the effective interest rate become 1.7%, it makes the investor more likely to convert the Rupiah into some other currencies with higher effective interest rate.
For lower inflation attractiveness of related local currency work in the opposite way.
In short, higher inflation makes government likely to increase the interest rate and vice versa.

Country's risk: the riskier a country, the more effective interest rate should be applied. An equal 2% of effective interest rate between Indonesia and Singapore will make investor choose Singapore than Indonesia from this point of view. That's why safest country used as benchmark by other country in make their decision. So far, most country in world make decision regarding their central bank after decision from US central Bank.For example, Bank Indonesia(Indonesia's central Bank) keep the spread of interest rate and inflation wider than US spread.
However, there are already some changes in using US as benchmark by another country regarding latest situation.


Credit traffic: high interest rate make people unwilling to borrow money or make credit, and economic traffic will be significantly affected by this. The reason if this is more active money transferred, which is mean money circulation happen faster, more people could use the money, more active economy,in the end is higher economic growth. Also this is one reason why stable country, such as developed country have much lower interest rate compare with developing one. Japan, in fact has less than 1% interest rate and at some times hits deflation condition (interest rate less than 0), however there are also other factors explain this anomaly. One of it is Cultural behavior.


Note that, all list above based on my own conclusion so far from newspapers and some sources, and my intuition tell me its work that way, CMIIW. I mean it is not theoretical explanation, thats why clarification of issue above are highly appreciated.

Also note that in some circumstances there are some exceptions of contrary thing actually happen, for example, china government recently announced that it will help dollar not to fall further, from early thought low dollar value could make more power for china to spend, but since china income highly driven by its export, especially to US, lower dollar means lower income. also most of china reserve is in Dollar, 1 basis point(which is 0.01%) movement in dollar value will affect reserve of big country like china value of millions of dollar .