Monetary Policy - How Rising Interest Rates affect Aggregate Demand
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- AQA, Edexcel, OCR, IB, Eduqas, WJEC
Last updated 11 Feb 2023
In this study video we look at how a period of rising interest rates can affect one or more of the components of aggregate demand.
Economic Effects of Higher Interest Rates in the UK
- Consumer Spending: Higher interest rates make it more expensive for households to service their debts, reducing effective disposable income.
- Household Saving: The return on saving usually rises – leading to an increase in the propensity to save and a fall in consumer demand
- Investment: Higher interest rates make borrowing more expensive for firms, which can reduce their investment in new capital
- Exchange Rates: A rise in interest rates can lead to an appreciation of the domestic currency, making exports more expensive and imports cheaper. This can lead to a decrease in aggregate demand as firms and consumers reduce spending on foreign goods
- Asset Prices: Higher interest rates can also reduce the value of assets such as stocks, bonds, and housing, leading to a decrease in aggregate demand as households reduce spending in response to lower wealth.