Affect of a decrease in interest rates on macroeconomy

Question 1

Impact on firms,consumers and AD

KAA1

Answer 1

Knowledge:
Interest rates=cost of borrowing and reward for savings
Analysis
Lower interest rates-higher MPC-lower MPS-increase consumption-lower savings-higher AD
Lower cost of borrowing for firms-increased incentive to invest-increase in investment

Higher AD-reduced cyclical unemployment and negative output gap-increase in actual economic growth

Investment is an injection into the circular flow of income-positive multiplier effect-AD increases further

Application:
Bank of England dropped interest rates to 0.1% during COVID to stimulate AD
Consumption is 60-65% of UK AD

Diagram:
AD/LRAS diagram

Question 2

Classic AD evaluation, why might people not want to deposit in banks

Eval 1

Answer 2

Demand-pull inflation-domestic goods are less price competitive in international markets-reduction in net exports

Short run phillips curve- decrease in unemployment-increase in inflation

Loss of trust in banking system-deters people from saving in banks

Application:
Post global recession, interest rates dropped, but many consumers my not have wanted to deposit money in banks

Question 3

Effect on exchange rates and importers

KAA2

Answer 3

Knowledge/analysis:
Increased in interest rates-increase in hot money inflows-increase in demand for British Pounds from foreigners-appreciation in the currency

SPICED

Imports are cheaper for UK consumers-increased purchasing power-increased variety

Reduction in input costs for importers-reduction in the costs of production-increased in the quantity and quality of resources-increase in potential economic growth

Application:
Precious metal
Crude Oil
Car Manufacturing

Possible diagrams:
Outwards shift in SRAS/LRAS

Question 4

Impact of depreciation,marshall lerner

Eval 2

Answer 4

Appreciation in the UK currency-exports are now more expensive- less competitive in international markets-less injections into the circular flow of income

Reverse marshall lerner condition
If the PED of imports and exports is grerater than one, an appreciation in the currency will lead to a worsening in the current account deficit

Reverse J curve:
Appreciation causes the current account deficit to worsen in the long run

Application:
2025 Current account deficit = around £18-£20 billion
One of the UK governments Macroeconomic objectives is balance of payment stability