Low-interest Rates On British Economy Essay

Question:

Discuss the impact of low-interest rates on british economy by using microeconomic and macroeconomic theory.

Answer:

Introduction

The interest rates in the British economy are determined by the Central Bank of England. The Central bank of England is a national regulatory body that holds controls on both fiscal and monetary policies in the Britain. The economic system of a country is composed of both microeconomic and macroeconomic subsystems. The microeconomic theory is related to the economic conditions of an individual industry/household/customer. While, the macroeconomic theory is concerned with the state of the economy as a whole in the country. The macroeconomic theory covers major economic issues, such as currency value, inflation rates, GDP, economic development, infrastructure development, unemployment, income level, outputs, and occupation in the nation (Dransfield, 2013). This report discusses and analyses the impact of the interest rates on the British Economy by using the microeconomic and macroeconomic theories.

As a result of low-interest rates by the Central Bank of England, the local and foreign investors are making a huge investment in the science, research, education, technology, training, and employment. The low-interest rates lead to fall in the commercial rates in the form of the relatively lower value of the British Pound, low borrowing costs, and low mortgage interest rates. The low-interest rates will create benefits to both customers and investors in the form of more consumption and high investments. The low-interest rates will result in a sharp rise in the purchasing power of the customers (Beer, 2013).

Impact of Low-interest rates on British Economy by Using Microeconomic and Macroeconomic Theory

Interest rates are the rates of interests paid by the borrowers or debtors for using the money borrowed from the lenders or commercial banks. It is a percentage of the principal amount paid on the payment of loans or credits for a certain period of time. The interest rates have affected the British economy to the great extent. It has contributed to the national economic development and growth that has allowed the foreign investors to invest hugely by running their business operations in the country (Golin and Delhaise, 2013).

The Central Bank of England has continued with its economic policy with the low-interest rates over the last seven years to promote the investment, consumption, employment, and economic development. There are several reasons for keeping the low-interest rates by the Central Bank of England. Firstly, It will lead to better infrastructure development, high economies of scale, high purchasing power, more employment, and high demands. It will create a lot of employment opportunities for both fresh and experienced employees. Secondly, as a result of low interests by the Central Bank of England, the costs of borrowings have decreased that encourages the people to make more investments and savings because of low principal payment on credits and loans. The low-interest rates create more value to the national currency (Pound) that assists in the national economic development and high GDP because of lower funds paid by the local industries for the import of the raw material, goods, and services from other countries (Giudice, Kuenzel, and Springbett, 2012). It also attracts the foreign investors to make huge investments in the business because of the favorable economic policies.

The low-interest rates have decreased the prices of the government debt interest payments that will lead to fall in the tax rates in the future which will keep all investors or industrial sectors satisfied. The low-interest rates have reduced the prices of the goods and services that exceeds the demands than supply. The low-interest rates have also encouraged the increased industrial activity and growing demand for the goods and services. It has also promoted the import and export of the goods and services with other countries. As a result of the low-interest rates, the local companies will have to pay the lower costs for purchasing the raw materials, goods, and services from other countries. Similarly, it will also assist in the export of the goods and services to the foreign customers at low costs. The low-interest rates will create more earnings to the industrial sectors by promoting the industrial activity. The low-interest rates will increase the industrial productivity by reducing the cost of production because the low-interest rates and inflation will keep the prices of oil lower that will lead to low transportation cost (Piana, 2002). The lower interest rates will also provide the industries a framework to recruit the highly talented and experienced workforce at lower rates.

The microeconomic theory studies the economic behavior of an individual firm, household, industry or consumer. It covers several issues, such as demand, supply, cost, production, production efficiency, market structures, pricing, distribution, profit maximization and resource strength of an individual firm. According to a microeconomic theory which is known as‘Time Preference theory of Interest’, the rate of time preference determines the rate of interests and the interest rates determine the consumer behaviors. This theory explains the concept of interest rates through the demand for accelerated satisfaction (Simon, 2015).

This theory attempts to explain the interest rates with the equation of comparing the perceived value of expected future returns with the interest rates on the savings by the customers. This theory explains, if the interest rates increase, the demand pattern for the goods and services from the customers decreases because of the additional amount to compensate the consumers for foregoing current consumption. In contrary to this, if interest rates reduce, the consumerism or customers’ demand increase. The time preference amount of money is expressed as a proportion of consumers’ current income that will compensate them for the forgoing consumption. The interest rates decide the consumers’ buying behaviors and consumption (Cable, 2010). According to this theory, if the future income is expected to be higher than current income of the customers, then there will be high time rate of preferences that will induce the customers more savings than spending.

On the other hand, the macroeconomic theory studies the economic behaviors at a whole including all industries, customers, and households. It covers unemployment, demand and supply, production, cost, profits, labors, pricing, and distribution of all industries and customers in the aggregate. The Keynesian theory explains the macroeconomic system. According to Keynesian theory, the interest rates are determined by the demand and supply pattern. According to this theory, the high-interest rates will lead to lower the profitability of investment. There is an inverse relationship between the investment and the rate of interest. The low-interest rates will encourage the firms to borrow and invest hugely. The planned investment spending increases with a fall in the rates of interest. Savings also depend on the interest rates as savings are directly related to the interest rates. The people make more savings with a rise in the interest rates (Hall and Atkinson, 2016). The interest rates also have an inverse relationship with the income of the people. The higher interest rates, lower the income of the people. So, Keynesian Model determines the impact of interest rates on the income, saving, investment and demand and supply pattern.

It is expected from the Central Bank of England to keep the interest rates static or lower in the future in order to promote the entrepreneurship and industrial activity. The low-interest rates through the cash-flow channel will encourage the higher spendings in aggregate. The reduction in the interest rates will make savings less attractive and borrowings more attractive. If the Central bank of England continues its monetary policy with the lower interest rates, the growing demand pattern for the gross domestic products will be increased. The central Bank of England is expected to keep the interest rates lower to encourage the economic growth, full employment, and price stability (Hodder Education, 2015). It will reduce the unemployment rates by creating a lot of employment opportunities for the local and outside employees. As a result of the low-interest rates, the international trade will be promoted and enhanced because of exchange of the goods and services in the great quantities between the countries. It will also enhance the customer spending on the goods and services.

It is expected that the Central Bank of England will not increase the interest rates untill 2018 that will be a good news for both investors and customers. The low-interest rates will raise the supply of the money and demand for the goods. It is expected from the Central bank of England to keep the interest rates lower or static for the next 4-5 years to boost the international trade and push the global demands higher. The low-interest rates will boost the prices of the assets as well as high shares prices and housing. The high share prices will maximize the wealth as well as living standards of the people.

Conclusion

In the conclusive statement, it is identified that both microeconomic and macroeconomic theories provided a detailed analysis of the impact of the low-interest rates on the British Economy. The Central Bank of England will be expected to continue its monetary policy with the low-interest rates for the national economic development. The low-interest rates will create a lot of new business opportunities for the local and foreign investors. The low-interest rates will also create more value to the national currency of the Britain. The Low rates of interest will attract the investors to invest hugely in the research, development, technology, training, and education so that new employment opportunities could be created. The low-interest rates will also promote the consumerism by increasing the purchasing power of the customers. So, the low-interest rates will continue to be the national economy stronger in the future and will add value to the national currency in comparison to other currencies.

References

Beer, M. (2013) Early British Economics from the XIIIth to the middle of the XVIIIth century. UK: Routledge.

Cable, V. (2010) The Storm: The World Economic Crisis and What It Means. Britain: Atlantic Books Ltd.

Dransfield, R. (2013) Business Economics. UK: Routledge.

Giudice, G., Kuenzel, R., and Springbett, T. (2012) The UK Economy: The Crisis in Perspective. Great Britain: Routledge.

Golin, J., and Delhaise, P. (2013) The Bank Credit Analysis Handbook: A Guide for Analysts, Bankers and Investors. USA: John Wiley& Sons.

Hall, S. and Atkinson, F. (2016) Oil and the British Economy. UK: Routledge.

Hodder Education (2015) Edexcel Economics A Student Guide: Theme 2 The UK economy - performance and policies. UK: Hachette Publication.

Piana, V. (2002) Interest Rates: A Key Concept in Economics [Online]. Available at: economicswebinstitute.org/glossary/interest.htm. (Accessed: 26 March 2016).

Simon, J. (2015) Low Interest Rates and Environmental Risks [Online]. Available at: How to cite this essay: