Federal Reserve is assuming that this will increase the likelihood of people to revert to consumption. Since fears of loss of wealth through lowered stock prices and real estate prices on the back of recession taking its toll also depressed the consumption pattern of people. The lowered interest rates will allow cheaper credit to people and reopen the avenue to invest in real estate and stock market to realize gains. Furthermore, in theory it is expected to increase the demand for mortgages loans and recover the home loans industry too. Consumer loans ranging from mortgages, car loans, student loans and credit card loans are expected to increase through these measures.
Likewise, the decrease in interest rates would lead to an increase in demand for investment loans by small and medium enterprises as well as big industrial entities. This cheaper credit would allow them to expand their manufacturing capacities or pursue project expansions and developments. As a result of this jobs will be created in the economy and the US economy will hopefully be able to recover from its recession. This instilling of consumption and investment in will hopefully breathe a new life into the US economy. Since the US economy is highly dependent on the consumption factor of GDP (the gross domestic product). The statistical abstract of the US 2002 stated that the average propensity to consume (amount of consumption divided by amount of income) in the United States was greater than 0.95, which was highest amongst Canada, United Kingdom, Netherlands, Germany, Italy, Japan and France.( cited in McConnell &Brue, 2005). Therefore, these measures by Federal Reserves are undertaken to increase the aggregate demand (the amount of real output buyers collectively desire at each possible price level) in the economy. Investment and consumption affect the overall aggregate demand. Graph 4 shows this concept, wherein, it is assumed that at AD1 the consumption and Investment in economy is zero. An increase of $5 in the investment while keeping consumption constant at $0 shifts the aggregate demand curve to the right to a higher demand curve AD2.
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