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How have interest rates changed over the last thirty years? What affects have these had on the economy and why?

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1. 2. How have interest rates changed over the last thirty years? What affects have these had on the economy and why? Contents 1. INTRODUCTION 2 2. BACKGROUND 3 WHAT IS THE INTEREST RATE 3 WHAT IS THE AIM OF THE INTEREST RATE 3 Monetary policy 3 This is the transmission mechanism - or the economic route map between changing interest rates and inflation 4 3. THE ECONOMICS OF INTEREST RATES 5 WHY DOES A CHANGE IN THE INTEREST RATES AFFECT THE ECONOMY? 5 HOW INTEREST RATES AFFECT AGGREGATE DEMAND? 5 A FEW OF THE AFFECTS THAT INTEREST RATES HAS ON THE ECONOMY 7 Housing Rates 7 Credit Card and Loan Rates 8 Spending and saving 8 Marginal efficiency of capital 9 Exchange rates 9 Balance of Payments 9 HOW INTEREST RATES AFFECT ECONOMIC INDICATORS 11 GDP 11 INFLATION 12 ECONOMIC GROWTH AND JOBS 14 UNEMPLOYMENT 15 PHILLIPS CURVE 17 Graphs to show the idea of the Phillips curve 17 4. SUMMARY AND CONCLUSION 19 5. HOW THE CENTRAL BANK CAN CHANGE INTEREST RATES 21 IS CURVE 21 LM CURVE 22 6. BIBLIOGRAPHY 23 3. Introduction In this investigation I will set out to answer these two questions. How have interest rates changed over the last ten years? What affects have these changes had on the economy? I will answer these questions by comparing changes in interest rates to changes in economic variables like inflation, unemployment and exchange rates. I will then compare what the relationship should have been in theory to what really happened in real life. I will also show how economic growth has changed as the interest rates have changed, whether it has changed as economic theory dictates and if not why. To show how it affects the economy I will look at inflation, economic growth or GDP, unemployment and use graphs to back up the economic theories. 4. Background What is the interest rate The interest rate is a figure set by the central bank to try and stimulate or slow down the growth of the economy. ...read more.


This will strengthen the exchange rate. When the pound increases against other currencies, our exports become more expensive abroad, so exporters get less money. Also foreign goods become cheaper in Britain so British products are less desirable. Imports and Exports are factors of demand so when imports go up and exports go down demand within the British economy goes down. This causes a slow down in the economy, and unemployment. Balance of Payments The balance of payments is concerned with two different accounts. These are the current account and the capital account. The current account is a record of the visible and invisible exports and imports in Britain. If British companies import more products than they export then the current account is in deficit. In the same way if we buy more of our own goods than foreign imports we will have a surplus. The capital account shows us the investment in and out of the country, It also shows us the speculation i.e. the oversees purchasing of �'s, stocks, shares etc. If we have more investment and speculation coming into the country then we will have a surplus. If we have less coming in to the country we have a deficit. The balance of payments is affected by interest rates: Firstly the interest rates can stimulate investment in the country. This is because if the rates of interest are raised then investors will get more of their money back when they invest in our banks and other companies. The change in interest rates can also change the exchange rate in the same way. More foreigners will invest and this will make the exchange rate appreciate. If the exchange rate appreciates it becomes more difficult for Britain to sell their goods abroad and in this country. This means that there will occur a deficit in the current account. So the interest rates will be lowered to stimulate the economy and the exchange rates will fall. ...read more.


The IS curve stands for investment and saving and the LM stands for liquidity and money. IS curve The IS curve shows us, for any given interest rate the level of income/output that brings the goods market into equilibrium. Taking the investment function and the Keynesian Cross and combining them constructs the IS curve. The investment function is that investment is inversely related to the interest rate. This is because if you lower interest rates then it will become cheaper to get loans and then pay them back so it's easier to then invest money into a business and make a profit on that investment. Thus an increase in the interest rate reduces the investment. On the Keynesian cross the reduction of investment shifts the planned expenditure downwards, reducing income when in equilibrium with actual expenditure. So, an increase in the interest rate lowers income and the other way round. So if you lower interest rates then you increase income/output. When you increase output you are increasing economic growth, which is measured in GDP. LM curve The LM curve is controlled by how much money there is in circulation, which is controlled by the central bank issuing and selling, bonds. When they change the amount of bonds they issue the money goes in or out of the system. If you decrease the amount of money in the system then you cause a contraction of the LM curve. When you put this into the IS-LM model you can see how this changes the interest rate. If you increase the money in circulation then you get an expansion, this can also be shown on the IS-LM curve. Expansion - increase of money This model shows that as you increase the money supply LM, the interest rates fall and the income and output increase. Contraction - decrease in money supply This model shows the opposite of the last one because as you decrease the money supply, LM through buying bonds the interest rate goes up the income goes down and you slow down the economy. 8. ...read more.

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