ExpertMedium1 markMultiple Choice
AQA GCSE · Question 07 · How the economy works
Which of the following correctly indicates the overall effects an increase in interest rates is likely to have on economic growth and inflation?
Effect on economic growth Effect on inflation A Decrease Decrease B Decrease Increase C Increase Decrease D Increase Increase
Which of the following correctly indicates the overall effects an increase in interest rates is likely to have on economic growth and inflation?
| Effect on economic growth | Effect on inflation | |
|---|---|---|
| A | Decrease | Decrease |
| B | Decrease | Increase |
| C | Increase | Decrease |
| D | Increase | Increase |
Answer options:
A.
Decrease on economic growth, Decrease on inflation
B.
Decrease on economic growth, Increase on inflation
C.
Increase on economic growth, Decrease on inflation
D.
Increase on economic growth, Increase on inflation
How to approach this question
1. Consider the effect of an increase in interest rates on borrowing and saving for both consumers and businesses. 2. Determine how this change in behaviour affects overall spending (aggregate demand). 3. Relate the change in aggregate demand to economic growth and inflation.
Full Answer
A.Decrease on economic growth, Decrease on inflation✓ Correct
The correct answer is A. Higher interest rates discourage borrowing and spending, and encourage saving. This reduces aggregate demand, leading to lower economic growth and lower inflation.
An increase in interest rates is a tool of contractionary monetary policy. It increases the cost of borrowing and the reward for saving. As a result, consumers are less likely to take out loans for big purchases and more likely to save. Businesses are less likely to invest. This leads to a fall in aggregate demand. A fall in aggregate demand leads to a slowdown in economic growth (or a recession) and reduces the upward pressure on prices, thus decreasing inflation.
Common mistakes
Thinking that higher interest rates (a higher 'price' of money) directly cause prices of goods to rise. The effect is indirect, through aggregate demand.
Practice the full AQA GCSE Economics Paper 2
29 questions · hints · full answers · grading
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