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Low Interest Rates - PDF

Added on - 30 Nov 2020

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Assignment 1 – Economics (Pablo Martinez)a) Please indicate the main pros and cons of low interest ratesInterest rates are used by central banks as a tool to control and manage the macro-economy. It is a reality that average interest rates in developed markets havedecreased for the past 30 years. There are several advantages and disadvantages ofhaving low interest rates.One of the main advantages that most people think of, in relation to low interest ratesis its stimulative effect on economic activity. By reducing interest rates, central bankscan increase the amount of long-term investments which further helps the economieslong-term performance. For example, the number of mortgages tend to be higherwhenever interest rates are lower. Therefore, low interest rates mean the cost oflending is lower, increasing aggregate demand in the economy. If aggregate demandincreases then the price of assets will also increase, and people will be more wealthyand there will be lower cost of financing capital purchase for businesses. Furthermore,farmers and businessmen tend gain from lower interest rates as they are encouragedto invest in large equipment and machinery whenever interest rates are low.However, there are also some constraints in relation to low interest rates. One ofthem, is that low interest rates tend to increase aggregate demand, resulting in anincrease in inflation. Furthermore, those in the economy who rely in interest incomewill suffer if interest rates prevail in the long-run. An extreme argument against lowinterest rates is the idea of St. Louis Fed President James Bullard that central bankspromise to maintain low interest rates in time, may lead to the deflation established inJapan.b) Is it possible to see higher interest rates in the Eurozone in the mid-term? (replyapprox. 100 words)The impact of the coronavirus on the economy has further depressed nominal interestrates and inflation. There has been a general decrease in consumption and investment,and central banks have used their tools to reduce the cost of money and offer as muchliquidity as necessary to control the decrease in prices. One of the options is that in themedium term the central banks decide to raise interest rates to control inflation thatmay occur whenever the coronavirus crises is over. However, as a result of thecoronavirus, private saving could probably increase, and central banks may decide tolower interest rates in order to stimulate the economy.
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