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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 is likely to have a significant positive impact on UK investment. Firstly, lower interest rates reduce the cost of borrowing for firms. For example, in 2020, the interest rates fell dramatically from 0.75% to 0.1%.
Firms are more inclined to borrow money as the expenses associated with loans decrease, leading to greater confidence in making investments. Consequently, businesses may initiate new projects or expand existing operations, knowing that the cost of financing is reduced. Additionally, lower interest rates often stimulate consumer spending, which can further motivate companies to invest to meet rising demand.
Ultimately, this can lead to increased production, creation of jobs, and a boost to economic growth overall.
Step 2
Which one of the following would be most likely to result from lower base interest rates?
Answer
The correct option is B: the external value of the pound. Lower interest rates typically lead to reduced investment returns for foreign investors, which can decrease demand for the national currency, thereby lowering its exchange rate. The other options do not accurately reflect the likely outcomes of lower interest rates.