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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 has significant implications for UK investment. When interest rates are lowered, the cost of borrowing decreases, making it more affordable for firms to take out loans for expansion and new projects. According to the chart, the base rate fell from 0.75% in 2016 to as low as 0.1% in 2020. This drastic reduction encourages increased investment since firms face lower costs when financing projects.
Moreover, lower interest rates increase consumer spending, as individuals are likely to borrow more for major purchases like homes or consumer goods. As firms see higher demand for their products, they are motivated to invest further in production capacity to meet this demand.
In summary, lower base interest rates stimulate UK investment by reducing borrowing costs, promoting consumer confidence, and encouraging firms to invest in growth opportunities.
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 generally lead to a decrease in the value of the currency, making exports cheaper and imports more expensive. This can result in a deterioration of the external value of the pound as lower rates might deter foreign investment while domestic investors seek better returns abroad.