1. Political short-term gain
Lowering interest rates can give the economy a short-run boost. Under normal conditions, most economists think a cut in interest rates will only give a short term gain in economic activity that will soon be offset by inflation. The quick boost can influence elections. Most economists advocate independent central banks to limit the influence of politics on interest rates.
2. Deferred consumption
When money is loaned the lender delays spending the money on consumption goods. Since according to time preference theory people prefer goods now to goods later, in a free market there will be a positive interest rate.
3. Inflationary expectations:
Most economies normally exhibit inflation, meaning a given amount of money buys fewer goods in the future than it will now. The borrower needs to compensate the lender for this.
4. Alternative investments
The lender has a choice between using his money in different investments. If one chooses one, one forgoes the returns from all the others. Different investments effectively compete for funds.
5. Risks of investment
There is always a risk that the borrower will go bankrupt, abscond, die, or otherwise default on the loan. This means that a lender generally charges a risk premium to ensure that, across his investments, one is compensated for those that fail.
6. Liquidity preference
General public prefer to have their resources available in a form that can immediately be exchanged, rather than a form that takes time to realize.
7. Taxes
Because some of the gains from interest may be subject to taxes, the lender may insist on a higher rate to make up for this loss.
Zainabdawa answered the question on July 27, 2018 at 14:18
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