What factors would lead to a rise in the cost of credit in an economy, Essay

What factors would lead to a rise in the cost of credit in an economy, and in what circumstances - Essay Example The formula, when applied, can show the annual rate of interest to be paid towards exhausting borrowed money. Acceptance of credit is often termed as a source of finance to a business due to the fact that it escalates with business expansion. (Siegel, et al, 1997) A nation’s central bank can determine the cost of credit in an economy by either raising or lowering it. For instance; in 1989 the bank of Japan raised the rates of discount by 0.5% to 4.25%. Once the new rate took effect immediately, it would help in stabilising the economy’s prices by curbing the pressures due to inflation and enhance economic growth. The discount rate is applied by the central bank while charging interests in the bank loans extended to other banks. Therefore, the raising of discount rates would amount to a rise in the cost of credit to the whole economy in entirety. An example to illustrate this instance of Japan is the immediate announcement by big banks in Japan, where they said that they would escalate the prime lending rates for long-term funds to 6.8% from the previous 6.5%. (Reuters, 1989) The apt measurement of the credit cost is the prevailing real interest rates in the economy. Market interest rates have been influenced by the inflationary levels and thus cannot present the true meaning of interest rates in the economy. Thus, it is the rise in the real interest rates in a nation that lead to a rise in the cost of credit in the market. Also according to the center for popular economics, the cost of credit in a country may rise due to an increase in taxes. If the real interest rates in an economy and which are reflected in the GDP deflator rose and the taxation levels did the same, they would have an upward effect on the credit costs. (Center for popular economics, 1896) A country’s economy depends so much upon the amounts of credit held by persons in it. Attitudes of people towards the credit can also change the course of things in the