Economics – International trade and globalisation - Current account of the balance of payments | e-Consult

Answer:

Lowering interest rates is an expansionary monetary policy. It has several potential impacts:

• GDP: Lower interest rates make it cheaper for businesses and consumers to borrow money. This encourages investment by businesses and spending by consumers, leading to an increase in aggregate demand (AD) and therefore a rise in GDP.
• Employment: Increased investment and consumption will lead to higher levels of production and therefore increased demand for labour. This will result in a decrease in unemployment and an increase in employment.
• Inflation: Increased aggregate demand can lead to demand-pull inflation, particularly if the economy is operating close to full capacity. Lower interest rates can also lead to imported inflation if the value of the domestic currency falls (see below).
• Foreign Exchange Rate: Lower interest rates make the domestic currency less attractive to foreign investors. This reduces demand for the currency, leading to a depreciation of the foreign exchange rate. A weaker currency makes exports cheaper for foreign buyers, potentially boosting export demand. However, it also makes imports more expensive.

Conclusion: The policy is likely to lead to an increase in GDP and employment, but it carries the risk of inflation. It will also likely lead to a depreciation of the foreign exchange rate. The effectiveness of the policy depends on the responsiveness of investment and consumption to changes in interest rates.