What effect would a fall in the interest rate have on GDP?

GDP (output) is affected by consumption, investment, government spending and net exports. A fall in the interest rate have a varying effect upon each of these. Consumption is likely to increase as saving becomes less worthwhile and therefore spending become relatively cheaper, increasing GDP. Investment will also increase as in order to invest in capital equipment, firms must take out loans as it is usually very expensive and they do not have the necessary liquidity. A fall in the interest rate will mean a fall in the repayments on these loans, making the capital equipment cheaper. As consumer expenditure increases, firms are also more likely to further increase investment as confidence and expectations rise, therefore a rise in GDP will occur. The effect on net exports is likely to depend on the real interest rate. Whilst a fall in the interest rate will weaken the pound, increasing exports and reducing imports, if this happens in other countries that compete with the domestic country the effects may be cancelled out. The diminishing rate of marginal returns must also be considered. If the interest rate has already fallen dramatically, a small further change is unlikely to have any significant effect. Finally tthe multiplier effect should be considered. Whilst a large multiplier will emphasize the effect on GDP of a change in one of its components, a small one (less than 0) will minimise them.

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