The level of investment in the economy is sensitive to changes in the prevailing interest rate. In general, if interest rates are high, investment decreases. Conversely, if interest rates are low, investment increases. This inverse correlation is key in understanding the relationship between the interest rate and investment.
Demand for Money
Individuals, businesses and governments are said to demand money, or rather, need money. The demand for money is used to finance deficits, cars or education.
Low Interest Rates
Investment in education, infrastructure or business expansion takes money to accomplish. If interest rates are low, students, governments and business can borrow the money they need more cheaply.
High Interest Rates
When interest rates are high, investment becomes more expensive. As money becomes more expensive to borrow, businesses, governments and individuals start slowing their investment plans.
The Federal Reserve
The Federal Reserve (the Fed) also affects interest rates with its monetary policy. The purpose of monetary policy is to control the economic conditions in the U.S. by influencing interests rates.
Economic conditions may influence investor expectations. In a strong economy, borrowers expect good conditions to continue so they may be comfortable borrowing more, potentially driving up interest rates. However, during weak economic conditions, the opposite is true.