Q:

How do Treasury interest rates affect the economy?

A:

Quick Answer

When the interest rates on Treasury bonds are low, the U.S. government has access to low-cost borrowing, according to the Wall Street Journal. This can encourage deficit spending to improve infrastructure, such as highways and schools, which in turn fuels longer-term economic growth.

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Full Answer

Treasury yields also impact the economy at a consumer level because they influence the interest rate on other loans such as mortgages. Because these loans carry a greater risk of default, their interest rates are generally set higher than those of government bonds to attract investors. As a result, increases in Treasury rates are generally followed by increases in mortgage rates, making homeownership less affordable and decreasing demand for new housing, according to Zacks. This slows economic activity in the construction industry. Additionally, adjustable rate mortgage payments increase, which causes consumers to feel poorer and spend less on non-essential items, thereby dampening economic growth.

Higher Treasury rates can also create international demand for U.S. bonds and create an influx of currency purchases that drives up the value of the U.S. dollar, according to About.com. A higher exchange rate results in fewer exports, which can weaken export-reliant businesses and reduce a country's GDP, as Investopedia explains. In an import-heavy economy, a rising dollar value can also dramatically drive down the price of many consumer goods and decrease inflation. Although the Federal Reserve aims to maintain a low level of inflation, falling consumer prices can harm the economy by encouraging individuals not to spend while awaiting lower prices.

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