Page 73 - Microsoft Word - 00 BA3 IW Prelims STUDENT.docx

Macroeconomics 1 – The domestic economy

Interest rate management

7.1 The impact of increasing interest rates on the economy

Internal factors

 Consumer spending (C) falls higher interest rates raise the cost of credit

 Investment (I) falls Higher cost of capital reduces value of
investment

 Asset values fall e.g. value of bonds, will drop, due to inverse
relationship between prices v rate of interest.

 Savings (S) may rise To protect against fall in asset values

 AD falls Net effect of the above

External factors

 Foreign funds are attracted higher interest rates attract foreign depositors
into the country

 The exchange rate rises, at Demand for currency increases
least in the short term

Net effect

 Reduces the inflationary In most cases its intended effect
pressures in the economy

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