Essay on Interest Rate as Determinate of the Level of Consumption in UK Economy

An interest rate is an amount that lenders charge in the form of percentage of the principal to a borrower for asset usage. They usually are noted annually. According to Barro, an interest rate is expressed as a yearly price that is charged by a lender to a borrower in an attempt at obtaining a loan (1987). An interest rate is a price that relates to present claims on resources that connect to future demands of the funds. It dictates the nature of expenditure of the consumer and the ultimate determinant of the overall effect of interest rate changes primarily by consensus attitude of the consumers on whether to spend or save. The economy of UK is majorly defined by its interest rate, particularly on the cost of credit. Interest rates have a significant impact on the economy of the UK. In general, high-interest rates increase the cost of borrowing, increase mortgage interest payment, increases the incentives to save rather than spend, increases the value of the currency, affects consumers and firms, expands the government interest rate payment and reduces confidence in investing. Eventually, the currency will appreciate making the exports less competitive, and inflation will tend to be lower. It could also slow down the rate of economic growth and increase the rate of unemployment. The borrowing cost will also increase.

The impact of interest rate on the economy of UK can be narrowed down to how it affects the level of consumption in the country. Historically, lower interest rates have led to increased levels of consumption. Very low-interest rates have lowered the motivation of the banks in the past to participate in lending activities, thus reducing consumption levels. The changes in interest rates have profound effects on in consumption behaviours of households, portfolio allocation of both local and international traders and decisions of capital accumulation by firms in the financial and exchange rate market. The changes affect the aggregate demand and supply positions in the economy that may immediately occur or take a lag of up to two years. They also influence the plans and expectations of agents of the economy about their future. It is imperative to note that the impact of interest rate on consumers is sometimes hard to predict. If the level of confidence of consumers is high, then they would not be discouraged from spending, and they would be willing to pay more interest. However, with high-interest rates profoundly affects the rate of consumption when consumers have a low confidence level. Many consumers in the UK are mainly concerned about the booming housing market, in which they believe that the boom will eventually come to burst. The rise in interest rates would catalyze the stoppage of rising house prices. The reduction in house prices lowers the expenditure of the consumers.

Low-interest rates reduce the cost of doing business, investing and living. This results in stimulation of the economy since car and home loans become affordable. Such a scenario also ignites the tendency of borrowing more to spend more. Inflation levels are also affected by interest rates. When the government of the UK changes the rate at which banks lend money, the entire economy is subjected to ripple effects.

Reference

Barro, R. J. (1987). Government spending, interest rates, prices, and budget deficits in the United Kingdom, 17011918. Journal of monetary economics, 20(2), 221-247.