As Muslims, we generally avoid everything related to interest – but there is one case where interest rates affect us in a big way.
As an investor, understanding how the government uses interest as a tool for the economy will help you make better investments.
There are a lot of discussions right now around whether the Central bank is going to hold rates.
When you see articles like “Fed raises rates,” or “Bank of Canada Holds Rates,” in the news, here is what you need to know:
1. What is Inflation and How Does It Work?
Inflation is the rate that the level of prices for goods and services is increasing. It causes the purchasing power of cash to decrease (as many of us have noticed in recent years).
It is often expressed as an annual percentage, like 3% inflation.
Inflation can be caused by various factors, like increased demand, rising costs, or changes in government policies.
2. How Interest Rates in Control Inflation
The interest rate is the rate the Federal Reserve in the United States or the Bank of Canada use to influence the economy.
When the central bank raises interest rates, borrowing becomes more expensive. This leads to less consumer spending and investments.
Generally, this decrease in demand for goods and services slows down inflation.
When the central bank lowers interest rates, borrowing becomes cheaper, leading to increased spending and investments.
This boost in demand for goods and services accelerates inflation.
3. What to know as an Investor
Even as a Muslim, understanding the relationship between interest rates and inflation is important because it affects the value of assets.
Stocks: In general, rising interest rates will result in reduced consumer spending and investments, which lowers stock prices.
Lower interest rates can increase spending and investments, often increasing stock prices.
Real Estate: When interest rates rise, borrowing costs increase, making it more expensive to buy a home or invest in property.
Lower interest rates can make real estate more affordable, potentially increasing property values.
The better your understanding of how the environment affects your investments and the value of money, the easier it will become to make informed financial decisions.
Although we avoid interest as Muslims, it is so important for us to understand the implications of monetary policy on both the value of our investments, and the value of our money.
