Explain the importance of low interest rates in bringing about a recovery from recession in an economy like the UK. (10)

Interest rates are tools of monetary policy set by the Bank of England. They are currently at 0.5% in the UK. A recession is defined as two consecutive quarters of negative economic growth. Low interest rates mean that consumers and businesses would earn a smaller return on their funds that are sitting in a bank account, thus decreasing their savings ratio and increase the ammount of money they borrow as it is cheaper. This means consumers spending more and businesses should borrow more to invest. Because both consumption and investment are components of AD, this will increase overall AD as they both rise, shown on my diagram by a rightward shift in the AD curve to AD2, and an increase in the long run capacity of the economy (through business investment) to LRAS2. Low interest rates also increase hot money flows out of the UK, as investors look for other currencies where their funds can achieve a greater return. As a result of increased supply of sterling (from investor selling) there is a depreciation in the pound. This means that the price of imports increases, causing them to fall, and the price of UK exports decreases, causing them to rise. Because X and M are components of AD, increases in X and decreases in M would increase aggregate demand, and so boosting economic growth, shown on my diagram by an increase in output from Y1 to Y2