What is the spread?
Have you ever wondered what the spread is? Let’s try to explain it to you in an easy way.
Imagine that countries are like people who borrow money. When a country needs money, it can ask for a loan from those who have money available (investors), promising to return it with a small extra, called interest. The more a country is considered reliable (meaning the lower the probability that it will decide not to return the money), the lower the interest it will have to pay to borrow money. The spread is the difference between the interest rate paid by a country considered very safe (reliable) and the one paid by another country, considered less trustworthy.
Why does the spread go up or down?
If a country proves to be credible by always repaying its debt, investors will lend it money without asking for a high-interest rate. But if one day that country starts experiencing economic difficulties and forgets to pay back the loans received, investors might start trusting it less and demand a much higher amount upon maturity, meaning the interest rate would increase. So, the spread increases when a country is considered less reliable by investors, perhaps because it has a lot of debt or because its governments are unstable. On the other hand, if the economy is solid and the rules are clear, the spread decreases because investors trust it more and, consequently, demand less interest.
Why is the spread important for everyone?
You might think: “Okay, I understand what the spread is, but why should I care?” In reality, if you don’t care about the spread, the spread will care about you. If the spread increases, it means the state has to pay more interest on its debts. And where do the resources to pay these interests come from? Directly from the citizens! Furthermore, if the government spends more to repay debts, it has fewer resources available to invest in essential services such as schools, healthcare, and transportation. If the spread is high, families and businesses also pay higher interest on mortgages and loans, which means they might struggle to pay their installments.
How can the spread be kept under control?
A country can reduce the spread by adopting good habits such as:
- Managing public money well
- Having a stable government
- Keeping the economy strong
Now you know what the spread is! It may seem like a co4mplicated concept, but in reality, it’s all about trust and reputation. Discover more economic concepts explained simply—visit the blog of the Museum of Saving and read our in-depth articles.