Choices by Poor Households When the Interest Rate for Deposits Differs From the Interest Rate for Loans

Publication Date: Apr 1998
Published by: Microfinance.com
Document Type: Journal Article

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To what extent do interest rates influence the household's decision to save or borrow?

Studies how poor households try to save and borrow in order to smooth consumption in the face of low and uncertain income streams

Suggests that they are constrained by credit limits and by the spread between the price paid for loans (borrowing) and the price earned for deposits (saving)

Simulates a model of financial choices by a poor household with favourable and unfavourable interest rates. The model accounts for the uncertainty of income, the intertemporality of financial contracts, the reality of credit limits, and different interest rates for loans and deposits

Results show that:

• the spread between the interest rates for deposits and loans means that it is sometimes optimal neither to save nor to borrow
• favourable interest rates may therefore help the household increase mean consumption and decrease its variability