What are the possible effects of a decrease in the interest rate set by the central bank?

A decrease in the real interest rate will reduce the cost of borrowing for firms, so these firms will tend to borrow more to finance investment. There may also be a consumption effect if consumers decide to spend more and save less in response to lower interest rates. Investment and consumption will both be higher.  As AD = C + I + G + (X-M), then an increase in consumption and investment will lead to higher aggregate demand. In an AD/AS diagram, this would be shown by an outwards shift in the AD curve leading to higher output and a higher general price level. 

[then draw diagram on whiteboard]

VN

Related Economics A Level answers

All answers ▸

How to define the term "external costs"


Despite a plunge in the value of Sterling during 2016, the UK managed to post the highest current account deficit on record. Why did the plunge in sterling not translate into a reduction in the CA deficit?


Explain the factors which might determine the natural rate of unemployment (15 marks)


Explain two reasons for an outward shift in the supply curve