Explain how higher interest rates can impact the aggregate demand level in an economy and help close an inflationary gap?

Interest Rates changes can impact an economy in different ways. With higher interest rates, consumers are more prone to save (because they get more money in interests) and therefore they consume less. Furthermore, they are less prone to borrow money from banks (it is more expensive to do so) and therefore the investment level falls (as less people are borrowing money to set up businesses). Both Consumption and Investment are components of the Aggregate Demand curve and therefore, when a reduction in these components occurs, the aggregate demand curve will shift to the left, closing the inflationary gap.

CD
Answered by Carlo D. Economics tutor

1922 Views

See similar Economics IB tutors

Related Economics IB answers

All answers ▸

What are the distinctive characteristics of a perfectly competitive market?


Describe the effects of the introduction of an indirect tax on different stakeholders within an economy.


Explain how a reduction in income tax could affect both aggregate demand and aggregate supply in an economy


State the key assumptions and characteristics of a competitive market and outline the difference between the short-run and the long-run.


We're here to help

contact us iconContact ustelephone icon+44 (0) 203 773 6020
Facebook logoInstagram logoLinkedIn logo

MyTutor is part of the IXL family of brands:

© 2026 by IXL Learning