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Bank of England base interest rate, 2016–2020 (a) With reference to the chart above, explain the likely impact of a reduction in the base interest rate on UK investment - Edexcel - A-Level Economics A - Question 3 - 2022 - Paper 2
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Bank of England base interest rate, 2016–2020 (a) With reference to the chart above, explain the likely impact of a reduction in the base interest rate on UK invest... show full transcript
Worked Solution & Example Answer:Bank of England base interest rate, 2016–2020 (a) With reference to the chart above, explain the likely impact of a reduction in the base interest rate on UK investment - Edexcel - A-Level Economics A - Question 3 - 2022 - Paper 2
Step 1
With reference to the chart above, explain the likely impact of a reduction in the base interest rate on UK investment.
Answer
A reduction in the base interest rate tends to have several effects on UK investment:
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Increased Investment: Lower interest rates reduce the cost of borrowing, making it more affordable for firms to obtain loans. This incentivizes them to invest in new projects and capital.
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Specific Data Reference: As evident from the chart, interest rates dropped significantly from 0.75% in early 2016 to 0.1% in 2020. Such a drastic reduction indicates a more favorable environment for borrowing and investment.
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Confidence Boost: Lower interest rates boost business confidence. Firms may feel more secure about the economic outlook and, as a result, more likely to commit to investment decisions.
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Profitability of Borrowing: With the cost of borrowing reduced, investments financed by loans become more profitable and less risky, encouraging firms to act on growth opportunities.
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Increased Consumption: As savings yields decrease, consumers might be incentivized to spend more. This increase in consumption can further stimulate investment as businesses respond to higher demand.
Step 2
Which one of the following would be most likely to result from lower base interest rates?
Answer
The correct answer is B the external value of the pound. Lower base interest rates can lead to a depreciation of the currency as returns on investments might decrease, making it less attractive to foreign investors.
- A is incorrect because a decline in interest rates is likely to stimulate housing demand, causing house prices to rise.
- C is incorrect; typically, lower interest rates may lead to increased employment as businesses expand.
- D is not correct since lower interest rates generally support economic growth by making borrowing cheaper.