Monetary policy of a country is maintained by a regulatory committee which regulates money supply and interest rates. Money plays an important role in the economic activities of a country. Recession causes unemployment as was seen during the 2008 when unemployment percentage rose to 10 percent. The Federal open market committee adopted policies like buying mortgage backed securities and reducing interest rates for a long period .The cost and benefits of very low interest rates have been analyzed to understand the changes in the economic activities. By reducing interest rates economic activity is stimulated by more spending on capital goods and increased household expenditure. Another benefit is that the financial position of the banks improved. Reduced rates help to increase the net interest margin and capital. Benefit of low interest rates is that the prices of assets can be raised. When the money supply increases there is more money with the public which is used for purchases of goods thereby increasing the demand, making the price also go up. The demand and supply of bonds also depends on the interest rates. Bond prices are related to interest rates and are also determined by the bond market equilibrium. A change in the price of Bonds will change the demand for it. If the returns for the bonds are higher the demand is more .When the price of a bond is high and the interest is low the demand will be less showing a downward sloping demand curve. When bonds are supplied, higher interest makes it expensive to borrow so supply is less and when interest rate is low quantity supplied is high so the supply curve slopes upwards.
Maintaining low interest for long periods has adverse effects of inflation and rise in debts of households. It encourages spending rather than saving. This is a disadvantage for the savers who depend on interest income. The real return on investments also falls, so for those who want higher rates will look for high yielding investments. Low costs create greater risks for banks as more speculative activities and mortgage backed securities are financed by the available resource thereby creating risks of a financial crisis. Other costs due to low short term interest is that long term overinvestments are done .Any unexpected rise in interest rates will create a loss. According to the Liquidity Preference frame work the money market also determines interest rates as the bond market. The bond market helps to understand the effects of expected inflation while the money market gives the effects of income changes, money supply and level of prices. When the money supply is increased it is further increased due to the effects of income, expected inflation and level of price. Low interest rates for longer period may lead to a deflation in the economy. This would result in the cost for servicing debts. All monetary activities are related and decision making on such issues definitely involves risks and predictions.
