Effect of Interest Rates on Savings, Mortgages and Economy

Higher interest rates would have the following effects

• Increased incentive to save and less consumption. However, people with savings will get more income from the higher returns, therefore their spending may increase.
  
• Borrowing more expensive, therefore, lower consumption and investment
• Increased mortgage payments leaving homeowners on variable mortgages with less disposable income leading to lower consumer spending. This will not affect people on fixed rate mortgages until the end of their period
  
• Appreciation in the exchange Rate because hot money flows cause increased demand for sterling. The appreciation will help reduce inflation and could worsen the current account deficit.

The overall effect is to slowdown economic growth, lower inflation but could cause a rise in unemployment

However,

• Higher rates may not reduce investment and consumption because they are optimistic and willing to pay higher rates.
• If interest rates increased around the world at the same time then there wouldn't be more hot money flows for the pound and the pound wouldn't appreciate.
• Depends on the situation of the economy. If the economy is at full capacity then lower AD may reduce inflation without causing lower economic growth.
• In the UK, people are sensitive to interest rates changes because many have variable mortgages which take a high % of their disposable income. Even a small change in interest rates can have a big impact on disposable income and spending which is 66% of Aggregate Demand.
• Higher interest rates may help improve the current account because higher interest rates will reduce consumer spending and therefore, reduce consumer spending on imports.
• However, higher interest rates will cause an appreciation in the exchange rate. An appreciation makes exports more expensive and therefore reduces exports