How do changes in interest rates affect investment?

Lower interest rates tend to encourage borrowing for investment because they reduce the cost of financing. When interest rates decrease, the cost of taking out loans becomes cheaper for businesses and individuals, making it more attractive to invest in new projects, equipment, or expansion. This increased availability of affordable credit can lead to higher levels of investment spending, which is a crucial component of overall economic growth. Consequently, lower interest rates stimulate economic activity by enabling more borrowing and spending on investment.

In contrast, higher interest rates typically discourage borrowing since the cost of loans increases, leading to a reduction in investment activity. Additionally, the idea that interest rates do not affect investment decisions entirely overlooks the critical role that financing costs play in business decision-making. Finally, lower interest rates increasing the cost of borrowing is inaccurate, as lower rates actually reduce borrowing costs. This dynamic is fundamental to understanding the relationship between interest rates and investment in macroeconomic theory.