Effect of Decreased Interest Rate on the Macro Economy

Running head: MACROECONOMICS
Macroeconomics
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1MACROECONOMICS
Table of Contents
Answer 7....................................................................................................................................2
Effect of decreased interest rate on the macro economy........................................................2
Answer 9....................................................................................................................................3
Zero lower bound interest......................................................................................................3
Answer 10..................................................................................................................................4
Effect of Brexit on UK macro economy................................................................................4
References..................................................................................................................................6

2MACROECONOMICS
Answer 7
Effect of decreased interest rate on the macro economy
Interest rate is one of the important macroeconomic variables reflecting the borrowing
cost of money in the form of cash, credit, stocks, bonds, mortgage and government
borrowing. As change in interest affects different macroeconomic variables, it is used as an
important instrument to influence economic growth of a nation (Goodwin et al. 2015).
Change in interest rate affects macro-economic variable such as spending, investment,
exchange rate, inflation rate, housing and asset market.
Spending of household depends on level of income. Households do not spend their
entire income for making purchase of different things in the economy. Part of the income is
saved. The tendency to save depends on the prevailing interest rate. As household earns
interest on saving, they tend to save more when interest rate is high. When there is a decrease
in interest rate, the opportunity cost of holding money reduces. This in in turn encourages
people to save less and spend more. A decline in interest rate thus increases household
spending, which in turn has a positive impact on aggregate demand and economic growth.
Interest rate also influence the level of investment. As interest rate is the cost of
borrowing, decrease in interest rate means a cheaper cost of borrowing. This encourages
firms and investors to borrow more in order to make purchase of large equipment (Agenor
and Montiel 2015). With increase in the level of investment, production expands contributing
to economic growth of the nation.
Another important macro variable gets affected from a decrease in interest rate is
exchange rate. A lower interest rate makes it less attractive to save money in the concerned
currency denomination. This reduce demand domestic currency causing a decline in relative