Final answer:
A reduction in interest rates can effectively boost both consumer expenditure and business investment by making borrowing more affordable. The effectiveness can vary based on economic expectations and existing debt levels, and may be limited when rates approach the zero bound.
Step-by-step explanation:
The extent to which a reduction in the rate of interest can be effective in increasing consumer expenditure and investment is significant, as lower interest rates often lead to more affordable credit. This makes it easier for consumers to borrow for large purchases, such as homes and cars, thus boosting consumer expenditure. Furthermore, businesses are more likely to take out loans for investment purposes when interest rates are low, since the cost of borrowing is reduced, potentially resulting in the expansion of business activities and economic growth.
However, the effectiveness of interest rate reductions can be dampened if consumers and businesses expect economic conditions to worsen, or if they already have high levels of debt. In such cases, despite low interest rates, the appetite for additional borrowing may be limited. Additionally, if interest rates are already at very low levels (approaching zero), central banks may find it difficult to stimulate further lending and spending, as seen in scenarios where nations face the zero percent interest rate lower bound problem.