Why is the UK making interest rates so low?

 

On 11 March 2020, the Bank of England cut the interest rates to 0.25% from 0.75%, and a week later it was reduced further to 0.1%. But why does reducing interest rates help limit the economic impact from coronavirus?

An interest rate cut is a monetary policy, which us used to increase aggregate demand (which is made up of consumption, investment, government spending and net exports. There are many reasons why a decrease in interest rates increases aggregate demand:

·       Reduces cost of borrowing: This can act as an incentive for consumers to take out mortgages and for firms to take out loans to finance greater spending and investment.

·       Deters individuals and firms from saving: A decrease in interest rates means you get a smaller return from saving. This encourages consumers and firms to spend money rather than saving it.

·       Exchange rate depreciation: Reduced interest rates mean that it is less attractive to save money in the UK as you would make more money from saving in other countries. This means there would be a decrease in demand for Pounds causing the exchange rate to fall. This leads to people in the UK buying less from abroad and exporting more because it is cheaper for other countries to buy our goods. This leads to net exports (Exports – Imports) decreasing.

Overall, a cut in interest rates leads to an increase in consumption, investment, and net exports, causing an increase in aggregate demand. Therefore, the UK cut interest rates to a low level to stimulate economic growth, after aggregate demand fell during lockdown.