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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 typically leads to lower borrowing costs for firms and consumers. As seen in the chart, interest rates fell significantly from 0.75% to 0.1% in 2020, which indicates a substantial decrease.
This decrease encourages firms to borrow more due to the lower cost of loans. When firms are more incentivized to borrow, they often feel more confident in investing in new projects or expanding existing operations. This increase in investment is vital for economic growth.
Furthermore, lower interest rates make investments financed through borrowing more profitable and less risky, as the cost of repayment decreases. Consequently, firms can enhance their production levels.
Also, when firms invest more, there is a potential increase in consumer consumption, as firms may hire more workers or increase wages to accommodate their new projects. This stimulates the economy further. By reducing the cost of savings through lower returns, consumers are also more likely to spend, contributing to greater consumption and investment.
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 are likely to lead to a depreciation of the currency, as lower interest rates make investments in that currency less attractive compared to others. This can decrease demand for the pound, leading to its lower external value.
- A: This option is incorrect because lower interest rates typically lead to an increase in the average price of houses due to higher demand from buyers who can borrow more.
- C: This is incorrect, as lower base rates are often associated with increased employment as companies invest more.
- D: This option is also incorrect because lower base interest rates are likely to foster economic growth rather than reducing it.