What Happens When Interest Rates Rise? Understanding How Money Works Through Japanese News

* Approx. 1,200 characters, 4-minute read

Recently, you may have heard in the news that the Bank of Japan has raised interest rates.
But what exactly is an interest rate?
And why does a rise in interest rates affect our daily lives?
In this article, we will briefly explain how interest rates work and their impact on our lives.

① What is an interest rate, anyway?

Simply put, an interest rate is the rental fee percentage for borrowing money.

For example, suppose you borrow 1 million yen from a bank for one year.
* At a 1% interest rate, the interest is 10,000 yen
* At a 4% interest rate, the interest is 40,000 yen
Even if you borrow the same 1 million yen, the higher the interest rate, the more money you have to pay back.

Conversely, for those who have money deposited in a bank, a rise in interest rates may increase the interest they receive.

② Why does the Bank of Japan raise interest rates?

For example, suppose a loaf of bread that cost 100 yen at the supermarket now costs 120 yen.
The rise in prices of various goods, not just bread but also food and daily necessities, is called “inflation.”
If prices continue to rise rapidly, the amount of things you can buy with the same amount of money decreases.

Therefore, the Bank of Japan sometimes tries to curb excessive price increases by raising interest rates.
When interest rates rise, the burden of borrowing money increases.
As a result, companies may refrain from building new factories, and households may put off expensive purchases.
Consequently, the number of people wanting to buy goods decreases, making it harder for prices to rise.
However, the Bank of Japan decides interest rates by considering not only prices but also the economy and wage trends.

Revised Version: How Raising Interest Rates Stabilizes Prices
① Prices rise too much (inflation) → ② Bank of Japan raises interest rates → ③ It becomes harder for companies and individuals to borrow money → ④ Corporate investment and individual spending decrease → ⑤ Demand for goods and services weakens → ⑥ The speed of price increases slows down

③ How does a rise in interest rates affect our lives?

Here are three familiar examples.
🏠 Housing Loans
When borrowing money from a bank to buy a house, a rise in interest rates may increase your repayment amount.
🏦 Bank Deposits
The interest earned on money deposited in a bank may increase.
🏢 Corporate Activities
Since the burden on companies to borrow money also increases, they may refrain from investing in new stores or factories.

In other words, when interest rates rise, the burden on borrowers tends to increase, while those who deposit money may see benefits.

④ Can interest rates rise even if price increases settle down?

Yes. The Bank of Japan may raise interest rates even if price increases have settled down.

First, “prices falling” and “the speed of price increases slowing down” are different things.
For example, suppose the price of bread changed as follows:
* Last year: 100 yen → 110 yen (+10 yen)
* This year: 110 yen → 113 yen (+3 yen)
The price of bread itself is rising, but the speed of the price increase is slowing down.

So, if the price increases continue to settle down, is there no need to raise interest rates?
Actually, what is important here is the forecast of “what will happen to prices in the future.”
For example, even if the rise in gasoline and food prices has settled down for now, if corporate performance is strong, wages are rising, and more people are shopping, then the number of people wanting to buy goods and services may increase in the future, and the rise in prices may accelerate again.
The Bank of Japan sometimes anticipates such future price increases and raises interest rates in advance.

Also, if interest rates have been kept extremely low to support the economy, and there is a prospect that prices will rise stably, they may gradually raise interest rates so as not to overstimulate the economy.
On the other hand, if it is expected that price increases will weaken further and the economy will worsen, they may postpone additional rate hikes or consider rate cuts.

In other words, the Bank of Japan is not just looking at current prices, but is deciding interest rates while forecasting future prices and the economy.

Summary: What we can learn from this news

Interest rates are not just numbers at a bank.
They are related to various situations, such as when we buy a house, when companies open stores, and when we save money in a bank.

When interest rates rise, it becomes harder to borrow money, and the amount of money used in society tends to decrease.

This is the basic mechanism for using interest rates to adjust prices and the economy.
Next time you see news that “the Bank of Japan has raised interest rates,” please try to think, “What kind of impact will this have on housing loans, deposits, and prices?”

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* Interest rate figures are examples for explanation. Actual housing loan and deposit interest rates vary depending on the financial institution and contract details.