Increase in Interest Rates - Essay Example

Interest rates refer to the rate at which interest is paid by debtors for the use of funds borrowed from lenders. Interests are usually charged by lenders as compensation for the loss the lenders incur when another party is using their assets. Assets borrowed may be consumer goods, cash, and large assets such as buildings or vehicles (International Monetary Fund Staff 2011). Interest is a leasing or rental charge imposed on the borrower for the use of the asset. In cases of large assets, such as buildings or vehicles; interest rates are normally referred to as lease rates. In cases where money is lent, the lender could have invested the funds in some income-generating projects instead of lending them. Additionally, instead of lending massive assets; the lenders can use the assets themselves to generate income. Low-risk borrowers are normally charged low-interest rates compared to high-risk borrowers (Development, O. F. E. C.O. A. 2013).
High-interest rates raise the pound's value. This comes about as a result of hot money flows following investors’ interest to save in British banks as a result of the UK’s strong rates compared to other countries (Development, O. F. E. C.O. A. 2013). Having a strong pound has the effect of making the United Kingdom’s exports to be less competitive. On the other hand, the imports will increase, resulting in a reduction in the Aggregate demand in the economy (International Monetary Fund Staff 2011).
An increase in interest rate will also increase the borrowing cost. Interest paid on loans and credit cards is extremely expensive and with an upsurge, consumers will be discouraged from saving and borrowing. On the other hand, people who have loans already will have a smaller amount of disposable income since they will be spending more on interest payments. The eventual outcome of this will be a reduction in consumption. Consequently, this will lead to a decline in the value of assets held by each household, thus; dampening consumer spending in the form of the wealth effect.
Interest rate increments may also result in an upsurge in the cost of government debt interest payments (International Monetary Fund Staff 2011). The United Kingdom government currently pays over twenty-three billion pounds annually on its national debt. Therefore, an increase in government expenditure on interest payments would lead to high taxes in the future. This will have an adverse in the economy since the heat will be felt by the consumers (International Monetary Fund Staff 2011). Read More