Readers Question. Explain how interest rates could be used to boost the economy. Why, then do the govenment frequently hesitate to take such steps.
Interesting Question.
Generally, lower interest rates help increase consumer spending, investment and economic growth. Lower interest rates help increase Aggregate Demand for various reasons.
- Lower interest rates make borrowing cheaper encouraging investment and spending
- Lower interest rates make mortgage payments cheaper, increasing disposable income of consumers.
- Less incentive to save. Therefore increased incentive to spend
- Lower exchange rate, making exports cheaper and boosting AD.
Most people in the economy like to see interest rates cut, especially homeowners and businessmen. Why then do Governments or Central Banks hesitate to cut rates?
- Lower interest rates can cause inflation. If Aggregate Demand increases faster than aggregate Supply, the economy will experience inflation. Inflation is said to create instability and uncertainty in the economy.