Redistribution Effects of Interest Rate Changes

Topics: Interest rate, Money, Consumer theory Pages: 2 (351 words) Published: April 10, 2011
Redistribution effects of interest rate changes - Further work - Money markets - Markets - Economics bank - Virtual Bank of Biz/ed

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Markets - Money markets

Further work - Redistribution effects of interest rate changes

Higher interest rates, other things being equal, lead to a reduction in consumer spending and lower interest rates tend to encourage it. However, this is not true for all individuals. For example, a person living off income from savings deposits would receive a larger money income if interest rates were higher than if they were lower. This higher income may encourage a higher level of spending than would otherwise have been possible. So interest rate rises (falls) have redistribution effects - net borrowers are made worse (better) off and net savers are made better (worse) off. To complicate matters further, the spending of these different groups may respond differently to their respective changes in disposable income. T

However, the way monetary policy in the UK is managed means only one interest rate for the economy as a whole, and can only take account of the impact of official rate changes on the aggregate of individuals in the economy. From this perspective, the overall impact of the effects mentioned above on consumers appears to be that higher interest rates tend to reduce total current consumption spending, and lower interest rates tend to increase it. This is particularly relevant for the UK because such a high proportion of adults have a mortgage. A mortgage is the amount of money borrowed for the purchase of a property - usually a domestic property. The UK has a very high proportion of homeowners - far more so than otther European countries. When interest rates change so do mortgage rates. A rise in the interest rate of 1% adds an extra £56 per month to an average £100,000 mortgage repaid over 25 years. With having to pay extra on their mortgage, consumers' disposable...
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