Higher interest rates affect consumer spending decisions, especially for big ticket items such as automobiles. When interest rates are high, it indicates an overall high level of consumer demand for goods and services. In the auto industry, it denotes that consumer demand for cars is relatively high. When the supply of vehicles produced does not meet consumer demand, it drives car prices higher. The problem is that increased demand and high interest rates indicates the economy is growing too quickly. This can lead to quick and dramatic economic downturns.
Decreasing Demand
To prevent an economic downturn, the Federal Open Market Committee (FOMC), a branch of the U.S. Federal Reserve, adjusts interest rates higher to discourage borrowing. Higher interest rates mean that it costs more for consumers to borrow money for auto loans. The goal of adjusting interest rates higher is to decrease demand to achieve price stabilization for vehicles. As interest rates increase, demand for cars decreases. This decrease in demand then relieves some of the upward price pressure on cars.
Purchasing Power
High interest rates depreciate the value of a dollar, giving consumers less purchasing power. This means consumers have to pay more for a car when interest rates are higher than they would have to pay for the same car when interest rates are low. This decrease in purchasing power often leads to a decrease in consumer demand in the auto industry. This decrease in demand can lead to auto manufacturer's cutting production to reduce the supply of cars in the economy.
Market Equilibrium
The FOMC will often continue to raise interest rates until the committee believes the economy has reached a point of market equilibrium. In the auto industry, market equilibrium means the interest rate adjustments the FOMC makes achieves the goals of price stabilization and a balance between supply and demand for cars. When the FOMC feels as though it is moving toward reaching these goals, it will stop raising interest rates higher. If consumer demand for cars decreases too much, the FOMC may consider lowering interest rates to increase demand.
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