There are two things to a buying decision – the rational, and the emotional inputs. Modern research suggests that emotional factors, such as status, fear of feeling left out, beauty, comfort are far more powerful than the purely objective factors such as cost and safety. Tarun also factors in the interest rate to understand the buyer’s rationale, in the weekly column, exclusively for Different Truths.
There was a big debate in our family recently. I was happy with our three-year-old car, while the kids wanted a new car. I saw nothing wrong with the present running of our car. But after a while, I gave up the struggle and agreed to buy a new car. However, my grey cells started to work on this interesting situation.
What determines the buying decision? If it needed alone, then we didn’t need a new car, as we’re getting transported quite well on the old one. If it was costing of the car, again that didn’t come into the picture, as there was no drop in car prices to stimulate our decision. It was simply the excitement to be gained out of the acquisition of something new. Since I was the earning member, my decision naturally took in the opportunity cost factor, while my kids or wife’s choice depended more on feeling better in a shiny new car.
Opportunity cost is the cost of the alternative thing that I could have spent my money on if I didn’t buy the car. Being a businessman, I have to always grapple with the question of investing in my business or increasing the consumption.
There are two things to a buying decision – the rational, and the emotional inputs. Modern research suggests that emotional factors, such as status, fear of feeling left out, beauty, comfort are far more powerful than the purely objective factors such as cost and safety.
If that is the case, then how far does interest rate make us decide what and when to buy? That is my current query.
The interest rate is a complex phenomenon, one which is still evolving due to the experiment of central banks with negative interest rates in the aftermath of 2008 crisis. Negative interest rates are the interest rates that banks charge, instead of offering, for money deposited with them.
The negative interest rates are a boon for the producers. They ramp up their production, because of the low cost of capital. A higher production would entail more innovative products and more competition. This drives down the prices of the products, thus stimulating demand because of cheaper and more innovative products. Since sales increase, the companies hire more people, thus increasing the purchasing power of the society as a whole. The producers and consumers are both increasing their respective roles. This creates a boom effect on the economy.
However, there is also a concept of time preference or/and time discounting that is talked about nowadays. This is especially important in the economic theory of Austrian School. The time preference means that a good or service obtained in present time is considered more valuable than the same good or service obtained in future. Thus, the interest rate generated boom feeds on itself, as people tend to begin purchasing goods, which they might otherwise have waited for since everyone around them is buying the same goods or services. Peer pressure becomes hard to resist.
As we have seen, negative interest rates have some solid good points backing them up. Summarising, they keep the inflation low, stimulate production, generate employment and feel good factor, thus meeting the twin objectives of growth and low inflation of a central bank.
But there has to be a flip side to it all, doesn’t it? Anything can’t be a panacea to all the problems. The first side effect, of course, is, that it dissuades savings in the economy. Since people are consuming more, they save less. Their savings do not fetch sufficient interest rates in any case. Thus, savings begin to suffer.
The second thing is, it promotes capital-intensive production. And any capital-intensive production is not labour-intensive. In many production centres worldwide, robots are beginning to take over production function. Since capital is coming at virtually little prices, manufacturers would cut down their costs by shifting to machines instead of humans.
The third problem, of course, is overproduction, and mal-production. Since machines have far more capacity to produce, the companies compete to increase their market share, and thus produce a lot more than the current demand, and then sell on credit, which is again available in plenty and in cheap. Another aspect is mal-production, which means that resources get used to things which are not most wanted by the society. This happens because of easy availability of capital. An example that comes to mind is the fidget that is so popular in the market nowadays!
That of course, is at the level of society. Coming back to my starting point of buying a car, the lower interest rates could prompt me to go into debt when otherwise I would have none of it. I could be tempted to buy a more expensive one, once I cross the Lakshman-Rekha of keeping myself debt free.
Negative interest rates are here to stay, make no mistake about that. It is part of the evolution of money on human civilisation timeline, and we are live witnesses as well as guinea pigs for the same experiment. Digitisation and the war on cash worldwide are facilitators to this experiment. This knowledge of negative interest rates and their consequences-helps us to be aware and be prepared for the same, to better safeguard our own interests.
In my next column, I shall talk about digitisation and interest rates, and other related things specifically in our own backyard, our beloved motherland, India.
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