1) Interest rates affect consumption, investment, and net exports which determines aggregate demand. Higher rates decrease borrowing and demand while lower rates increase borrowing and demand. 2) Interest rates can be used to target inflation levels. Higher rates lead to lower inflation while lower rates lead to higher inflation. 3) Changing interest rates also impacts unemployment levels. Raising rates decreases output and employment while lowering rates increases output and employment.

1. INTEREST RATES
The Price of Liquidity

2. How does Interest Rates Affect AD?
• Consumption
– Many consumer goods are bought on credit,
so an increase in interest rates discourages
this as the price of borrowing has now gone
up. So AD decreases.
– Equally AD will increase if interest rates fall
as saving is discouraged and borrowing is now
more attractive

3. How does Interest Rates Affect AD?
• Investment
– Much of the investment is financed through
borrowing so the same principle as
consumption applies here.
– LOW INTEREST RATE = HIGHER INVESTMENT

4. How does Interest Rates Affect AD?
• Net Exports
– Interest Rates can influence the value of a
currency
– This is due to the flow of Hot Money, the
higher the interest rate the greater the flow
the stronger the local currency gets.
– A strong pound will lead to imports being
cheaper, so consumers suck in imports, this
leads to a trade deficit and a low net exports
– Exports as a result of a strong pound are now
more expensive

5. •Strong
•Pound
•Imports
•Cheaper
•Exports
•Dearer

6. Interest Rates & Inflation
• Interest Rates can be used to help a
central bank reach an inflation target
• A higher interest rate will mean inflation
is lower
• A lower interest rate will mean inflation
is higher
• This can be observed on a AD/AS Curve

7. LOW INTEREST RATES
HIGH INTEREST RATES
PL3
PL1
PL2
AD2 AD1 AD3
Y2 Y1 Y3

8. Interest Rates & Unemployment
• A tightening of monetary policy (raising
interest rates) will lead to unemployment
due a fall in output
• A loosening of monetary policy (lowering
interest rates) would increase
employment due a rise in output

9. Interest Rates & Current Account
• If Interest Rates are high then it lowers
AD which discourages the purchase of
Imports which means the trade balance
would look favourable
• Lower interest rates would lead to a rise
in AD so consumers suck in imports, which
makes the trade balance worse