Interest rate problem

In general, there internal and external determinants that affect the interest rate level.

Internal determinants include:

Domestic comsumption level
Domestic saving level
Domestic investment level

Lower interest rate can stimulate comsumption and investment in short term, but it will also result in lower saving level. Therefore, monetary policy makers would adjust the interest rate level in order to maintan the desire level of the factors mention above.

External determinants include:

1 Exchange rate
2 Net export

A decrease in interest rate would reduce the saving level, because the saving account is now providing less return. People would withdraw their funds from saving and put them in other sectors. Foreigners will withdraw their funds too, and that cause capital outflow and depreciates the value of a currency. However, the lower the currency value is, the better the net export would result. Therefore, the local monetary authority would choose a desire interest rate level to balance exchange rate and the export level.


For Hong Kong, exchange rate is a major factor because our currency is peg with the US dollar. We should also condiser housing and property market as another important factor under the consumption category. As far as I know, mortgages make up a large sum of loands in the banking system. Lower interest rate can stimulate the property market. In contrast, higher interest rate will result in higher level of mortgage loan default, and that harms the banking system as well as the local economy (As you may have known it from the experience in 2003 recession) Therefore, local monetary authority would determine the interset rate level according to the health of property market, which also secure a low bad-debt level to protect the banking system.

For the United States, their interest decision is based on exchange rate, net export, the property market, and investment level. As USA has sustainted huge trade deficit (a negative net export) for a long period of time, in order to resolve the problem, the US dollar exchange rate must be lowered against their major trade partner. USA treasury secretary Henry Paulson is demanding China, US largest trade partner, to increase its currency value against USD; therefore, US demand a lower exchange rate, which enforces a downward pressure on the interest rate. On the other hand, the sub-prime mortgage industry in US is experiencing a hugh numbers of default in loan. Similar to the case of Hong Kong, in order to save the property market and decrese the default rate of loans, a decrease in interest rate is needed. Finally, as you might have heard recently, DowJones has been falling due to the bad-debt problem incurred by the properity market bubble. A decrease in interest rate would induce people to save less and put their money in higher return instruments such as stocks.

Hope this helps.

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