Lower Interest Rates Increase Asset Prices - Key Concept

Lower interest rates tend to cause the prices of assets such as stocks, houses, and other investment properties to rise. Why does this happen? When the Fed increases the money supply, people find themselves with more money balances than they want to hold. To reduce these excess balances, people increase their purchases of goods and services, and their purchases of assets like houses and corporate equities. Increased demand for these assets raises their prices.As the prices of real financial assets rise, household wealth increases. Because people are wealthier, they increase their consumption spending more. As the prices of houses and other physical assets rise, these assets become more profitable to produce. Entrepreneurs invest to expand production and their new investment contributes to increased aggregate demand. In summary, reduced interest rates increase aggregate demand in the economy.