• Join over 1.2 million students every month
  • Accelerate your learning by 29%
  • Unlimited access from just £6.99 per month

Discuss the extent to which a reduction in the rate of interest can be effective in increasing consumer expenditure and investment.

Extracts from this document...

Introduction

Interest rates are rates charged by the banks and financial institutions on borrowers and savers and depend hugely on the base rate set by the central bank. A cut in interest rates is mainly used in monetarist policies, and in this case a cut in interest rates will belong in a loose monetary policy. Interest rates are normally used to influence levels of aggregate demand. Lower interest rates would mean that saving becomes unattractive as the rate of return on savings is much less, it would mean that mortgage payments will also be lower as it is based on interest rates and also credit is easier to obtain. Consumers will therefore increase their spending on goods and services within the economy as their discretionary income would have increased dramatically. ...read more.

Middle

However the reduction of interest rates may not after all affect levels of consumer expenditure and investment. The reasons for increases of consumer expenditure and investment levels as mentioned above are all valid if ceteris paribus is assumed. However in reality both factors of aggregate demand can be affected by many other external factors. Consumer expenditure can be affected by the marginal propensity to consume; therefore if a country has a low level of marginal propensity to consume then a reduction in interest rates actually makes very a tiny difference to consumption levels. Consumer expenditure can also be affected by income elasticity of demand; both reasons can reduce the effectiveness of a reduction of interest rates on consumer expenditure. A cut in interest rates as shown on the diagram will increase aggregate demand; however increases in aggregate demand will have tradeoffs, although ...read more.

Conclusion

In conclusion, a cut in interest rates is a very simple solution to increase consumer expenditure and investment levels in the short term. However there are factors that reduce the effectiveness of a reduction of interest rates such as the fact that interest rates will lead to increasing inflation and the effects is not sustainable as once the economy is at full capacity then no further expenditure and investment levels in the future can be achieved. There are also other alternatives to increases consumer expenditure and investment levels such as the introduction of supply side policies, for example increases in provision of education. \ ?? ?? ?? ?? Discuss the extent to which a reduction in the rate of interest can be effective in increasing consumer expenditure and investment. 1 | Page ...read more.

The above preview is unformatted text

This student written piece of work is one of many that can be found in our AS and A Level Macroeconomics section.

Found what you're looking for?

  • Start learning 29% faster today
  • 150,000+ documents available
  • Just £6.99 a month

Here's what a star student thought of this essay

4 star(s)

Response to the question

This essay engages well with the task, looking at how interest rates increase consumption and investment, and then looking at factors which limit the effectiveness of this policy. If this essay wanted to get the top marks, it needed to ...

Read full review

Response to the question

This essay engages well with the task, looking at how interest rates increase consumption and investment, and then looking at factors which limit the effectiveness of this policy. If this essay wanted to get the top marks, it needed to be explicit when discussing "the extent to which it is effective". In my opinion, the foundations for this are already there in the conclusion, it just needs a few sentences such as "The effectiveness depends upon the marginal propensity to consume" etc.

Level of analysis

The analysis is strong here, as mechanisms are well explained. For example, the first paragraph explores each step from the interest rate decreasing to the final increase in aggregate demand. Being able to explain how each step follows from the last is a good skill, and this essay does it fluently. I particularly liked the discussion of the accelerator model, and the diagrammatical analysis as this shows a strong understanding of what interest rates contribute to. There is a limitation in the diagram, though, and I would always advise using a Keynesian long run aggregate supply (LRAS) curve. I say this as it allows evaluation of the effectiveness depending upon what the previous macroeconomic equilibrium was, and where this was on the curve. It was nice to see an awareness of the ceteris paribus argument, as consumption and investment are heavily influenced by external factors. It would've been good if this argument was elaborated upon by saying that the Monetary Policy Committee therefore have to make a difficult value judgement of how much to reduce interest rates by. To address the question of "to what extent" the essay needed to discuss the size of the decrease in interest rate, following onto a discussion of what happens if the interest rates are already low (and therefore ineffective).

Quality of writing

The essay has a strong structure, with a clear introduction and conclusion. The introduction defines the key terms, and summarises the points of the essay. I liked the progression throughout the essay. It begins with knowledge, then explains how interest rates affect consumption and investment through analysis. Then there is a perceptive debate about the effectiveness. Being able to show this progression will make it easy for examiners to allocate marks, and it shows a strong and convincing writing style. Technical terms are used fluently. It just needed to address the "extent"!


Did you find this review helpful? Join our team of reviewers and help other students learn

Reviewed by groat 12/03/2012

Read less
Not the one? Search for your essay title...
  • Join over 1.2 million students every month
  • Accelerate your learning by 29%
  • Unlimited access from just £6.99 per month

See related essaysSee related essays

Related AS and A Level Macroeconomics essays

  1. Peer reviewed

    To what extent is inflation a serious economic problem.

    5 star(s)

    If inflation is increasing at a 'strato-inflationary' rate then investment can be planned, although the inflation rates are increasing dramatically, if correctly planned inflation will not affect the cost of output. So the rate of which inflation is climbing may also affect the extent of the problems.

  2. Peer reviewed

    How can inflation be reduced?

    5 star(s)

    To create this atmosphere the state should cut inheritance tax so small businesses that are "in the family" don't suffer when a family member dies and the business and assets are bestowed upon another family member. Modifying the inheritance tax could result in either a smaller tax (in percentage I.e.

  1. Governments set economic objectives - Discuss the relative importance of each of these objectives ...

    taxpayers will have to pay more to cover increased government expenditure and also to make up the taxes the unemployed would have paid if they were in work are only two costs the taxpayers will have to bear. In the UK Budget 2002, �115 billion was spent on social security

  2. Using the data and your economic knowledge, evaluate the contribution that the growth of ...

    do aim a proportion of their spending at improving consumer confidence, amongst other things. However, in doing this, they 'to some extent, they decide what is produced and consumed, rather than the individual'. For example they may decide to spend a large amount of money on promoting certain food and therefore more of this specific food will be produced.

  1. Expansionary monetary policy is not the main explanation of either the turning point or ...

    Defence spending had represented 3.01% of GDP in 1935, but grew rapidly to 3.71% in 1936, 4.82% in 1937, 8.72% in 1938, and finally, its pre-War peak was at 15.19% in 1939. Rearmament is therefore very important in explaining the extent of the recovery, and hence so is fiscal policy.

  2. Comparing the effects of immigration on GDP in Malaysia, Japan and South Africa.

    It is because there are more people working in the services industry as the services industry has contributed a lot to the GDP which means there are a lot of job vacancies in the industry. From here, we can see that Japan was maintaining their economy growth well and successfully

  1. Greece financial crisis: The main causes of this crisis are? What are ...

    that are undesirable from the lender's point of view: that is, activities that make it less likely that the loan will be paid back. ? Lenders do often impose restrictions on borrowers so that borrowers do not engage in behavior that makes it less likely that they can pay back the loan.

  2. ECONOMICS PAST PAPER QUESTIONS WITH ANSWERS - price elasticity and inflation.

    If the rates of taxes are very high, this may reduce the elasticity of supply. Q4) Explain the difficulties of measuring inflation accurately. (8) Ans 4:- Inflation is a sustained rise in the general price level and is measured by a price index.

  • Over 160,000 pieces
    of student written work
  • Annotated by
    experienced teachers
  • Ideas and feedback to
    improve your own work