What is the Difference Between Long-term and Short-term Interest Rates?
🆚 Go to Comparative Table 🆚The difference between long-term and short-term interest rates lies in their maturities, sensitivity to interest rate changes, and the factors that influence them. Here are the key differences:
- Maturities: Short-term interest rates are associated with loans that are payable within a period of less than or equal to one year, while long-term interest rates are associated with loans that have maturities of more than one year.
- Sensitivity to Interest Rate Changes: Long-term bonds are more sensitive to interest rate changes than short-term bonds due to their greater duration. Duration measures the sensitivity of a bond's price to changes in interest rates. For instance, a bond with a duration of 2.0 years will decrease by 2% for every 1% increase in rates.
- Factors that Influence: Short-term interest rates, such as the U.S. Bank Prime Rate, tend to move in lockstep with the Federal Reserve's Federal Funds Rate. On the other hand, long-term interest rates are more complex and market-driven, with the Federal Funds Rate being one of the drivers. However, long-term rates do not always move in response to changes by the Fed, especially in the secondary market for mortgage-backed securities (MBS).
In a normal yield curve, short-term interest rates are lower than long-term rates, reflecting higher yields for longer-term investments. However, when short-term interest rates exceed long-term rates, an inverted yield curve occurs, which has been viewed as an indicator of a pending economic recession.
Comparative Table: Long-term vs Short-term Interest Rates
Here is a table comparing the differences between long-term and short-term interest rates:
Feature | Short-term Interest Rates | Long-term Interest Rates |
---|---|---|
Definition | Interest rates on loans payable within one year or less. | Interest rates on loans payable in more than one year. |
Duration | Generally lower duration, less sensitive to interest rate changes. | Generally higher duration, more sensitive to interest rate changes. |
Risk | Lower probability of default compared to long-term interest rates. | Higher probability of default compared to short-term interest rates. |
Fluctuations | Subject to higher levels of fluctuation in the short term. | Less prone to fluctuations in the short term but could be more volatile in the long run. |
Economic Impact | Low rates promote growth by promoting borrowing and investing, and high rates deter growth by deterring borrowing and spending. | Low rates promote growth by promoting borrowing and investing, and high rates deter growth by deterring borrowing and spending. |
In general, short-term interest rates are associated with financial assets that have a maturity of less than one year, while long-term interest rates are associated with assets that have a maturity of more than a year. Long-term interest rates tend to be higher than short-term interest rates due to the higher possibility of default. Additionally, short-term interest rates are subject to higher levels of fluctuation in the short term, whereas long-term interest rates are less prone to fluctuations in the short term but could be more volatile in the long run.
- Long-term vs Short-term Financing
- Lending Rate vs Borrowing Rate
- Discount Rate vs Interest Rate
- Cash Rate vs Interest Rate
- Variable vs Fixed Interest Rate
- Exchange Rate vs Interest Rate
- Compound Interest vs Simple Interest
- Coupon Rate vs Interest Rate
- Current vs Long Term Liabilities
- APR (Annual Percentage Rate) vs Interest Rate
- Nominal vs Real Interest Rate
- Short Term vs Long Term Capital Gains
- Lending vs Borrowing
- Short Term Planning vs Long Term Planning
- Short Run vs Long Run
- Loan vs Borrow
- Cost of Capital vs Rate of Return
- Bank Rate vs Base Rate
- Rate vs APR