ECONOMICS (CBSE/UGC NET)

Detailed explanation-1: -Lower interest rates encourage consumption and discourage saving because there is less point in saving money. When interest rates decrease, it becomes cheaper for individuals to borrow money, which can encourage them to consume more.

Detailed explanation-2: -Generally a decrease in real interest rates stimulates personal consumption, which is what Professor Krugman has pointed out. When the real interest rate goes down, in other words, the magnitude of the substitution effect, which stimulates consumption, outweighs that of the income effect, which reduces interest income.

Detailed explanation-3: -An increase in interest rate will shift the consumption function downwards as consumer spending will reduce. When interest rates go up, the cost of borrowing goes up, making people consume less using debt. Also, if people save their money, they will get a higher rate of return when interest rates are high.

Detailed explanation-4: -When interest rates decline, savings account rates also drop. When interest rates rise, savings account rates are bid up. Generally speaking, central banks and governments support low-interest rate environments. This artificially pushes down the rates earned everywhere else in the economy.

Detailed explanation-5: -The substitution effect decreases the agent’s consumption since higher interest rates raise the price of consumption. Thus, a necessary condition for a decrease in consumption in response to an increase in interest rates is that the substitution effect dominate the income effect.