UK interest rates and economic growth

Why have constant low interest rates not had the desired effect of increasing GDP like economic theory would dictate?

Interest rates have been at a record low of 0.5% for more than three years now an outcome the monetary policy committee had in mind was an increase in GDP. This increase in GDP would stem from the theory that comparatively low interest rates should increase consumer spending and also investment. These increases contribute to an overall increase in demand in the economy, which in an ideal world would lead to no/minimum inflation while decreasing unemployment as supply tries to keep up with demand.


The increase in consumer spending and investment comes from the idea that such a low interest rate gives people and firms’ very little incentive to save, so therefore spend more. The interest rate means that consumers get very little interest on their savings in banks and it also means for firms that it is 'cheaper' to borrow money from banks to finance ventures such as buying new machinery as they pay less interest on their loans.


This seems like justifiable plan, but the theory is under the constraints of ceteris paribus, meaning that it will work with all other things staying equal, so no other interferences on the economy. This highlights a limitation that can be seen in many economic theories and is the reason why economists cannot predict the future of an economy, which does not live up to the expectation of many people.

The interference that is stopping this seemingly painless answer to our problems are the fiscal policies also being undertaken. The restrictive fiscal policies are a way of reducing the national deficit (not national debt as the media often publicises). The government are rightly trying to reduce this deficit to a reasonable level, which allows the national debt to become manageable.

Austerity reduces government spending in the economy, which directly reduces the demand in an economy. It also leads to a potential reduction in consumer spending as benefits or public sector wages are reduced. This reduction in demand and other factors such as low confidence counteract the increase in demand that should be seen due to the low interest rates. In addition since interest rates are low but have not really increased demand in the economy to a sufficient level, they will have to stay at this record low for the foreseeable future, while different monetary devices are used such as quantitative easing.

Urbanisation- always a good thing for the economy?

Economic growth often implies the conversion of rural land to urban uses as regional economies transition from a rural-based economy to an urban economy based on industry and services. We all generally agree growth is a good thing, but it is not as clear to me as to whether urbanisation is a result of growth or facilitates the growth.

Urbanisation occurs naturally as firms and the public try to reduce the amount of time and money spent on commuting and transporting goods or services. This then counteracts the cause of labour and factors of production immobility, so decreasing the level of ‘forced’ unemployment. It also has the effect of potentially improving prospect for jobs, education and housing. Living in cities permits people and their families to benefit from the increase in the number of opportunities due to proximity, variety, and competition. This all contributes to the demand in an economy, which is needed to drive economies forward and fund an increase in GDP.

However as with most if not all economy changing activities, there are unintended consequences of urbanisation. The main consequence being the social impact of the influx of people, it is often associated with increases in: crime, inequality and congestion. In addition there is a lot of opposition to urbanisation from environmental groups for obvious reasons as it will increase the demand for resources that contribute to global warming.

It is clear that urbanisation has positive implications on economic growth; I initially would have argued that it cannot have this effect if there is not already a certain level of growth occurring already for the cities to be able to handle the rural flight. A city needs to be able to have the capability to supply the increase in population or it would just not work and also there would be no attraction for the new population in the first place. My view has changed since looking into the subject more closely and realising that what is helping the developing countries while they experience big increases in GDP is the increased urbanisation of their most successful areas. India is a great example as it is going through huge urbanisation and is showing that it is an integral part of the economy initially growing.

On the other hand there are examples, as ever, to show that this is not true for all countries. Parts of Africa are going through structural changes and urbanisation is a big part of those changes. I would suggest that even though these changes are occurring, they are not bringing about anywhere near the same level of growth as in India. The reason for this is Africa’s urbanisation is driven by the ‘push’ factors, which are environmental overload and degradation, resource scarcity and conflict in rural areas. Whereas India’s urbanisation is due to the ‘pull’ factors, that result from economic opportunities in the cities. Africa has experienced little industrial growth to go alongside this fast growth of cities, and some African cities are imploding due to infrastructure dilemmas. African urbanisation therefore runs oppositely to general urbanisation that provides greater access to jobs, basic services, and social safety nets.

I ultimately think that urbanisation provides more positives for an economy than negatives, providing the country going through it can handle the increased demands that it brings with it. I feel urbanisation is more welcome and has a greater chance of making a real impact when it is done due to the 'pull' factors I highlighted earlier. However as Africa gets to grips with its levels of urbanisation I see the potential for it to progress using the resources that it has, which could even see it eventually becoming a big force if it exploits its huge energy providing potential.