Importance Of Interest Rates In The Economy

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Interest rates are the amount charged and expressed as a percentage by a lender to a borrower for the use of assets. Interest rates are typically determined on a annual basis, known as the annual percentage rate. Examples of assets borrowed could include, cash, consumer goods, large assets, such as a vehicle or building. Interest rates are determined by the bank of England this is because retail banks are usually the first financial institutions to expose money to the economy, they are the primary instruments used by the central bank (bank of England) to manipulate the money supply. There are many ways in which Interest rates effect the UK economy examples of this are price of borrowing, mortgage interest payments, the value of the pound …show more content…
Correspondingly to this they act as a mechanism whereby the supply of funds is matched to the demand for funds. In this process they provide five important services. These are bought together in the money market, the money market is the market for short term debt instruments for example government bills in which financial institutions are active participants. Central banks are important in this market because it is through money markets that central markets exercise the control on interest rates. For example, this is the price of borrowing money. This takes me onto the open market operations which is the sales or purchase by the authorities of government securities in the open market in order to reduce the (or increase) money supply and thereby affect interest rates. With open market buying the sales and purchases of the governments securities which typically the central banks will buy the government bonds in exchange for deposits. This essentially means that an increase in base money means and an increase in bank reserves furthermore which also increases liquid assets and money supply; overall a decrease in interest …show more content…
Bank of England control official interest rates and can change the money supply and they do this by using monetary policy and in this case expansionary monetary policy. One way in which this mechanism can affect economic activity is if the financial company on receipt of money from the central bank decides to adjust its portfolio asset. Therefore if it decides it has exceeded its money balance, it could decide to purchase other assets. Consequently this will mean it will drive prices up, reduce the yields on these assets which should then reduce interest rates and the cost of borrowing is cheaper for households and firms and in turn boost aggregate demand. In contrast there is also great danger to this because if the policy is conducted for too long, the growth in money supply could be excessive and then result in inflation rising above target levels. Therefore it is important for central banks to acknowledge this and turn the monetary 'tap ' off in

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