Interest rate

Reasons for changes in interest rate (determinants of interest rate)

- consumption. When people are taking borrowings (loans), they usually spend this money immediately (they buy cars, houses, trips, etc.). So people prefer goods now, not in the future, that why demand for loans is increasing and , therefore, in a free market system there will be a positive interest rate (growing interest rate).

- inflationary expectations (expectations about inflation rate in the nearest future). The lender ( a person who gives a loan) has to secure from expecting losses because of increasing rate of inflation. 

- risks of investment. There is always a risk that the borrower will go bankrupt  or otherwise default on the loan. This means that a lender generally charges a risk premium to ensure(guarantee) that, across his investments, he is compensated for those that fail.

- taxes. Some of the gains from loans ( profit from loans) may be subject to taxes, the lender has to insist on higher rate to compensate losses. 

Interest rate and Balance of Payments.

Higher interest rate will lead to:

- decrease in consumption of import goods. Consumers would, probably, consume less because of high expenses on borrowing.

- decrease in production goods ( goods for export) because it would be more expensive to produce goods (more money is needed to pay interest rate), therefore goods for export will be more expensive and less competitive. 

Lower interest rate will lead to:

-increase in the amount of import goods. Consumption is rising since people have more money to spend (easier to borrow money).

-increase in production in the country, the amount of goods for export is rising.

 

Is the Bank of England's decision correct?

From my point of view the Bank of England made a right decision. I’m going to look at this closely.

There are advantages and disadvantages in this decision.

One of the main disadvantages is that with low interest rate banks would decrease their rate for deposits. For people, who have their own money, there wont be a reason to keep their money in the bank on a deposit account, because they will receive a very low interest. On the other hand low rate of deposit will encourage “money keepers” to invest ( put their money into investment funds), because they can make more profit from dividends. Low interest rate will boost economy. Households will purchase more and, on the other hand, firms and companies will produce more (they will receive chipper funds to expand their production). Low interest rate would also reduce inflation, large number of firms and companies (suppliers) will keep inflation at low rate.   

Of course all this changes in interest rates would lead to a positive effects on the economy if the government would not change other factors in the economy in a positive way (changes in fiscal policy, supply side policy, tariffs of trade, in others).