Explain how an increase in interest rates can affect total spending in the UK.

Interest rates have an impact on the component of aggregate demand (AD) in an economy. AD is made up of consumption + investment + government spending + net trade. A rise in interest rates would mean consumption decreases, higher returns on savings would mean that consumers will choose to save more and spend less. The cost of investment has increased so it is now more expensive for businesses to borrow money, meaning cost of borrowing is high so firms are unlikely to be taking out large loans to pay for new capital equipment. Government spending is also likely to decrease, just in the same way as with investment, it will cost the government more to borrow money to spend on public services such as the NHS. Net trade is linked to exchange rate and an increased in interest rates will see an appreciation in the value of the pound. Meaning that there would be a rise in the amount of importing as strong pound make imports cheaper and exports dearer.