Explain how higher interest rates can impact the aggregate demand level in an economy and help close an inflationary gap?

Interest Rates changes can impact an economy in different ways. With higher interest rates, consumers are more prone to save (because they get more money in interests) and therefore they consume less. Furthermore, they are less prone to borrow money from banks (it is more expensive to do so) and therefore the investment level falls (as less people are borrowing money to set up businesses). Both Consumption and Investment are components of the Aggregate Demand curve and therefore, when a reduction in these components occurs, the aggregate demand curve will shift to the left, closing the inflationary gap.

CD
Answered by Carlo D. Economics tutor

1844 Views

See similar Economics IB tutors

Related Economics IB answers

All answers ▸

The supply function for the production of good A is P=50+45Q. The demand function is P= 100-5Q. Find the equilibrium price and quantity.


How would you explain, in your own words, the concept of "Decreasing Returns to Scale"?


Evaluate the effectiveness of Fiscal Policy in promoting economic activity during a recession.


Explain why a perfectly competitive firm will make normal profit in the long run.


We're here to help

contact us iconContact ustelephone icon+44 (0) 203 773 6020
Facebook logoInstagram logoLinkedIn logo

MyTutor is part of the IXL family of brands:

© 2025 by IXL Learning