Discuss the Extent to Which a Reduction in the Rate of Interest Can Be Effective in Increasing Consumer Expenditure and Investment

957 Words Mar 10th, 2015 4 Pages
The definition of consumer expenditure is the amount of money spent by households in an economy. The definition of investment is the spending by firms on capital good such as new machines etc. Finally the definition of interest rates is the proportion of a loan that is charged as interest to the borrower, normally expressed as an annual percentage. In the UK the interest rates are set by the Monetary Policy Committee and are usually used in order to influence levels of aggregate demand. Primarily, you must understand that lowering the rate of interest will make it cheaper for people to borrow as well as make it cheaper to pay back existing loans. As a result, firms may use this money that they have saved to spend on upgrading the …show more content…
Although this will lead of a rise in employment and economic growth, it does lead to higher rates of inflation and deterioration of balance of payments. A rise in inflation will have a negative adverse effect on consumer spending as well as investment levels because business confidence will be also lowered. Higher inflation rates will lead to a decrease in consumer expenditure because their savings will be worth far less than before and hence aren't willing to spend as much of their disposable income. Finally you must consider the fact that in terms of investment spending a rise in interest will obviously lead to a decrease in investment and especially the demand for shares.

In conclusion, on the one hand a reduction in the rate of interest can lead to a reduction in both consumer expenditure and investment because it makes borrowing cheaper encouraging people to take advantage of this leading to an increase in demand in the short term. However, there are factors that reduce the effectiveness of a reduction of interest rates such as increasing inflation and the effect is not sustainable because once the economy is at full capacity then no further expenditure and investment levels in the future can be achieved. As well as this there are also other alternatives that can be used in order to increase consumer expenditure and

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