effects of a rise in interest rates (3)

Question 1

macroeconomic impact of a rise in interest rates

Answer 1

1. currency appreciation + worsened BOP -> high interest rates = higher COB + RFS -> incr hot money inflow -> foreign investors attracted to high rate of returns -> incr demand for pound -> appreciation -> imports cheap, exports expensive -> less price comp. -> less export revenue -> worsened current account deficit
2. less eco. growth + incr unemployment -> COB + RFS incr -> less investment (withdrawal) + consumption -> less AD -> less real GDP -> limited growth -> -ve multiplier -> less demand = less DFL = incr cyclical unemployment -> less consumption -> AD falls more -> wider -ve output gap

Question 2

evaluate macro impact of rising interest rates

Answer 2

• MLC -> current account will not worsen if exports = price inelastic; reverse J-curve; BOP will improve initially
• lower inflationary pressure (Phillips Curve)
• imports cheaper for UK residents -> good for importing industries

Question 3

micro impact of a rise in interest rates

Answer 3

1. reduced consumer spending -> incr mortgage costs for households -> lower spending on non-essential goods -> less demand for businesses -> reduced revenue -> reduced profits -> less funds to reinvest in capital and R&D -> less dynamic efficiency -> firm may shut down if AR<AC -> affects luxury sectors e.g. cars, housing

Question 4

evaluate micro impact of a rise in interest rates

Answer 4

• necessities less affected due to negative PED -> firms in these sectors don’t face a significant change in revenue
• wealth effect for savers -> higher interest rates = incr reward for savings -> can lead to incr consumer spending
• luxury sectors are quite dominant e.g. Apple -> make SNP in short and long-run