Interest Rates - 2021 Revision Update

In this revision video we evaluate the extent to which a period of very low monetary policy interest rates has benefitted the UK economy.

Advantages of a period of low interest rates

1. Reduced incentive to save – increases the propensity to consume out of disposable income – leads to a higher level of AD – stimulates growth
2. Reduced mortgage interest rates increases effective disposable income of home-owners and might make it more affordable for first-time buyers to buy
3. Low interest rates reduce the cost of external finance for businesses needing to borrow to fund capital investment – this can then help to increase LRAS
4. Low interest rates help keep a country’s exchange rate low which then improves the price competitiveness of exports which can contribute to a higher level of AD
5. Low interest rates helps to lower the risk of price deflation especially after a severe negative economic shock such as the Global Financial Crisis and the 2020-21 covid-19 pandemic
6. Government can borrow cheaply when financing their own investment spending

Risks from a lengthy period of low interest rates

1. Savers suffer a loss of income if real interest rates become negative
2. Cheap mortgages drive property prices higher which worsens affordability and makes renting more expensive
3. Banks don’t necessary pass on lower interest rates to their borrowers especially if the credit risk is high
4. Commercial banks find it harder to attract savings deposits and lower interest rates on loans might make them less profitable
5. Lower interest rates can lead to excessive amounts of consumer debt which can be damaging when an economy hit recession
6. The economy might become too dependent on easy money / low rates