evaluate the view that maintaining low interest rates for a sustained period of time may be damaging to the UK’s macroeconomic stability. 25 marks Jun 2018

Question 1

Intro

Answer 1

• Interest rates determine the cost of borrowing and rewards for saving<br></br>- Monetary policy involves changes to the money supply and cost of borrowing<br></br>- The BoE’s Monetary Policy Committee aims to keep inflation at 2%<br></br>- Macroeconomic stability involves stable growth and low inflation rates<br></br>- Low interest rates were introduced after the 2008 financial crisis to stimulate demand

Question 2

P1 - Impact on AD

Answer 2

• Low interest rates reduce incentives to save and increase consumption<br></br>- Cheaper mortgages and borrowing costs encourage investment<br></br>- Lower interest rates increase the marginal efficiency of capital<br></br>- Decrease in hot money inflows leads to currency depreciation<br></br>- Currency depreciation makes exports cheaper and imports more expensive<br></br>- Increase in AD and investment can increase long-term growth<br></br>- Draw a diagram to illustrate these points

Question 3

P2 - Inflationary pressure and debt

Answer 3

• Increase in aggregate supply leads to inflationary pressure<br></br>- Higher demand leads to higher demand for labour and possible reduction in unemployment<br></br>- Buildup of debt can lead to long-term financial burden and defaulting on loans<br></br>- Low interest rates may lead to speculative bubbles<br></br>- Low interest rates may reduce their effectiveness over time

Question 4

P3 - Alternative options

Answer 4

• Keynesian economists suggest fiscal policy can boost consumption and investment<br></br>- QE is an alternative to low interest rates, but may put inflationary pressure on the economy<br></br>- Over £895bn has been pumped into the economy through QE<br></br>- Inflation is currently at 7% and over £400bn of QE has been used since the pandemic began

Question 5

Conclusion

Answer 5

• Low interest rates have short-term benefits for stimulating demand<br></br>- Long-term benefits include potential for increased investment and growth<br></br>- However, persistent low interest rates can have negative impacts on macroeconomic stability and reduce effectiveness<br></br>- Alternative policies like fiscal policy and QE are available to stimulate the economy