Canadian Securities Course (CSC) Level 1 Practice Exam

What are three ways that higher interest rates affect the economy?

1. They promote higher inflation rates, encourage borrowing, and reduce unemployment

2. They stimulate consumer spending, lead to government budget surpluses, and boost exports

3. They reduce business investment, encourage savings, and reduce consumption

4. They lower taxes, increase disposable income, and improve overall welfare

The correct answer is: They reduce business investment, encourage savings, and reduce consumption

Higher interest rates influence the economy in several critical ways, particularly in relation to investment, savings, and consumption. When interest rates rise, borrowing becomes more expensive, which tends to reduce business investment. Companies are less likely to take loans for expansion or new projects because the cost of financing has increased, leading to a slowdown in business growth and possibly job creation in the long term. Additionally, higher interest rates encourage individuals to save more rather than spend. When consumers see that they can receive better returns on savings accounts or fixed-income investments due to higher rates, they may choose to defer spending in favor of accumulating wealth through savings. Lastly, the cost of credit impacts consumer behavior. As borrowing costs rise, individuals may reduce their consumption of goods and services that require financing, such as homes or cars. This can lead to a general slowdown in economic activity since consumer spending is a significant component of overall economic health. These dynamics illustrate how higher interest rates can suppress both investment and consumption while promoting a culture of saving.