What Determines the Level of the Interest Rate in the UK?

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What Determines the Level of the Interest Rate in the UK?

Show How Changes in the Interest Rate can affect Economic Growth.

Through the essay, I will explain how the money market determines the level of interest rate set in the UK and show how economic growth is affected by changes in the interest rate, referring to inflation and the monetary transmission mechanism.

Interest rates is the price people pay for money and because economic activity takes place according to how much money goes through the economy, the rate that the interest is set at influences how much money is spent.  It is money that is exchanged for goods and services, it is how much goods and services are measured by and it is the value that can be held to pay for goods and services at a later date – the most important item in economy.  In layman’s terms, a change in interest rates encourages or discourages borrowing, and therefore economic growth increases or decreases accordingly.

The definition of interest rate is simply the opportunity cost of holding wealth in either the form of money or an asset bearing interest (Parkin et al, 2005).  If people do not have enough money, which is a necessity as it is a means of payment for nearly all good and services, they would have access to money from a lender, who would put a price on the loan they borrow; an example of the interest rate.

As the interest rate is used as an economic tool by the Central Bank to achieve monetary objectives, the interest rate set affects our economy in a number of ways and it is important to see what determines the level of interest rate in the UK.  The rate is established by the money market that consists of individuals demanding money and the financial institutions supplying the money.  

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The bank is a supplier of money, and they are able to offer loans with funds that they have and offer an interest rate on this, affecting the amount people plan to hold using that bank.  The interest rate that banks charge is determined by how much the Central Bank charges those for their deposits, and then the banks set the rate higher than this.  The rate the Central Bank charge is called the repo-rate.  If the repo-rate was increased, commercial banks would have to increase there rate; an increased interest rate would decrease the quantity of money demanded ...

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