Question

The Fed raised interest rates three times last year. According to Gensler (2017), " the Federal Reserve Open Market Committee raised the interest rate by 25 basis points to a range of 1% to 1.25%". Most of the committee supported this decision and stocks remained unchanged. This increase signals a confidence in the US economy. Unemployment is down. Credit scores are at an all time high. The Fed is deciding on interest rates this year. Some say it is too soon to start cutting them. Class, Interest rate is a macroeconomic variable but what effect could this interest rate increase have on consumer spending and the microeconomic environment? How does interest rate changes affect consumer and producer surplus?

Answer 1

An increase in interest rates leaves consumers with lower disposable income, as they will now have less money in hand after paying their interest obligation. This will thus lead to a fall in consumer spending.

The microeconomic environment because of the increased interest rates would be slower, as consumer spending will fall, which will lead to a slower down economy and GDP because of the multiplier effect.

Interest rates affect producers and consumers. Increased interest rates reduce consumer spending and thus being down prices, thereby lowering down consumer and producer surplus.

Similarly, reduced interest rates increase producer and consumer surplus.