However, Households will predict the higher price levels and consequently
, wage costs rise and the AS shifts to AS1 and the economy moves back to Y, but
with a higher price level of P2.
Policymakers can use monetary and fiscal policies in order to
rise the employment lever and the output and that would result in a rapidly
increased price level. When policymakers decide a specific point on the
Phillips Curve, they can use any monetary and fiscal policy to get to that
This view is supported by the
example that between 2011 and 2016 in UK the unemployment rate and the
inflation have fallen. This may all have occurred due to the post-brexit
period, rather than the demand and pull pressures.
This does not mean that the
Phillips Curve relationship is not available anymore. Between 2007 and 2009 the
unemployment rose and the inflation fell, and now, the post-brexit period is
showing the same characteristics.
Lower interest rates make it
cheaper to borrow. This tends to encourage spending and investment. This leads
to higher aggregate demand (AD) and economic growth. This increase in AD may
also cause inflationary pressures.
In theory, lower interest
rates will reduce the incentive to save (it will encourage consumers to spend
rather than hold), will make the cost of borrowing cheaper, will reduce the
monthly cost of mortgage repayments , will make it more attractive to buy
assets such as housing. Also it can create a depreciation in the exchange rate
the UK reduce interest rates, it makes it relatively less attractive to
save money in the UK (you would get a better rate of return in another
country). Therefore there will be less demand for the Pound Sterling causing a
fall in its value. A fall in the exchange rate makes UK exports more
competitive and imports more expensive. This also helps to increase aggregate
Overall, lower interest rates
should cause a rise in Aggregate Demand (AD) = C + I + G + X – M Lower interest
rates help increase (C), (I) and (X-M)
AD/AS diagram showing effect of a cut in interest