How Low Can You Go?

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How Low Can You Go?

The interest rate is the proportion of the money that has been lent to the consumer by a financial institution. The Interest rate is at an all time low of 0.25%, following the Bank of England’s QE programme. The interest rates role in the economy is to encourage spending by consumers. Which is a main macro objective in these worrying times of low consumer confidence, the uncertainty drove multiple, unexpected, unsettling events.

Consumers in the economy will be able to take out loans from the bank and spend more confidently knowing they will not have to spend ridiculous amounts of money back (relative to the amount of money that they have taken out). In return, the money that is spent by the consumers will be introduced into the circular flow of money in the economy, which includes flowing into firms which in return means that firms will be able to invest their profits (following a potential increase in retained profits), which allow firms to invest in new technology to improve productivity (which also helps the UK’s international competitiveness) and also allow firms to increase their productive capacity which requires more workers. In hindsight, the unemployment rate will fall, this is due to the increased spending in the economy topped off with increased investments, which all stems from the fact that the interest rates are low (well at least this is the aim).

The Bank of England cut interest rates due to rumours of a recession following the Brexit vote but the question remains how low can you go? The small shift in interest rates alongside the lag time make monetary policy ineffective. Regardless by cutting the interest rates, it may still counter the increasing uncertainty in the UK economy by giving consumers confidence in their ability to spend which vast amounts of money in the circular flow of money.

Some people believe that the cutting of interest from 0.5% to 0.25% highlights that low-interest rates does not necessarily mean that there will be positive effects upon the economy, and it certainly cannot deal with economic shocks such as Brexit as they are unpredictable and the Bank of England did not have enough time to thoroughly plan out what to do after Britain had left the EU, in other words, the cutting of interest rates was an ‘impulse decision’. The interest rates were already too low, lowering it would put the Bank of England up against the ropes as the Bank of England will not be able to intervene effectively during a recession.

Since the 2009 recession, the reduction in interest rates has been effective. Only time can tell if the cutting of interest rates is really beneficial to an economy which is facing a battle of remaining one of the strongest economies in the world.

 

Comment by Obuasa Djabatey.

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