Monitoring money supply

PUBLISHED : Wednesday, 21 March, 2007, 12:00am
UPDATED : Wednesday, 21 March, 2007, 12:00am

A senior business reporter at the South China Morning Post looks at interest rates

China's central bank raised interest rates by 0.27 per cent over the weekend in an attempt to slow its booming economy.

Several other key central banks around the world are also meeting this week, but they are all trying to control very different economies.

Interest rates measure the cost of money. They indicate how much it costs to borrow money, and how much the bank will pay you to hold your savings.

Official interest rates are set by a central bank, which is an arm of the government.


The People's Bank of China raised the lending rate to 6.39 per cent and the deposit rate to 2.79 per cent.

Higher interest rates make it more expensive to borrow money, and more attractive to keep money in the bank. This means there will be less money supply, or available cash, in the economy.

This is why higher interest rates are often referred to as a 'tightening' action.

If it's more expensive to borrow money to buy a new car, you'll probably look for a slightly cheaper vehicle, or you won't buy one at all.

When a whole country does this, it helps cool down the economy.

Higher interest rates help to slow down spending habits and keep more money out of the system and in banks, collecting interest.

China's economy is growing so fast that the government is concerned about inflation, which occurs when prices rise because people have a lot of cash to spend.


The Bank of Japan has a very different problem. They met earlier this week to discuss Japanese interest rates, which have been near zero per cent for the past 10 years because the country's economy is in the doldrums. So the government wants people to spend more money to revive the economy. Japan's key lending rate is only 0.5 per cent.


In the United States, the body that decides interest rates is called the Federal Reserve's Federal Open Market Committee.

They have also been meeting this week, and their main interest rate, which markets around the world watch, is the rate at which banks lend money to each other.

This interest rate, called the federal funds rate, was 5.25 per cent before today's meeting.


In general, economies around the world are flush with cash at the moment, since interest rates have been relatively low in recent years.

This means many central banks are now looking to raise rates to tighten the money supply in order to avoid inflation.

Interest rates are closely watched by stock market investors because if it is more expensive to borrow money, it is harder for businesses to expand and have more profits.

As the shareholder of a company, you want it to expand and grow to generate more profits.

Therefore, tighter interest rates generally are seen as a bad thing for stock markets, at least in the short term.


Basis point : A basis point - 1/100th of 1 per cent - is used to measure the change in a financial instrument. It is commonly used for calculating changes in interest rates.

Interest rates : Interest is the fee paid to borrow money. The lender gets paid for allowing someone else to use his money. If you are receiving interest on your savings account, the bank is the borrower and you are the lender. If you are paying interest on a loan, you are the borrower. The rate at which interest is paid is called the interest rate.

Central bank : A central bank, reserve bank or monetary authority is responsible for controlling the supply of money in the country. Its responsibility is to maintain the stability of the national currency and money supply. People's Bank of China, the US Federal Reserve, the Bank of Japan and the European Central Bank all serve generally the same purpose for their country's economies.

Inflation : This is a general rise in prices. Slow, steady inflation is normal, but rapid inflation means there is too much money supply. Hong Kong's inflation rate is around 1 per cent.