Which factor is most impacted by an increase in interest rates?

An increase in interest rates has a significant impact on both investment and consumption. Higher interest rates make borrowing more expensive, which discourages businesses from taking loans to invest in expansion, new projects, or capital goods. This leads to a reduction in overall investment within the economy. At the same time, consumers face higher costs when financing purchases, such as homes or cars, leading to a decline in consumer spending. Since both investment and consumption are vital components of aggregate demand, an increase in interest rates tends to negatively affect these areas, ultimately dampening economic growth.

The other factors such as consumer confidence, aggregate supply levels, and government spending do experience some influence from interest rate changes, but they are not as directly and immediately affected as investment and consumption. For example, while consumer confidence may decrease in response to higher rates, it does not directly respond to them like investment decisions and consumer purchases do. Aggregate supply levels are influenced by other factors, such as production costs and supply chain conditions, and government spending is primarily determined by fiscal policy rather than interest rates. Thus, investment and consumption are the factors most impacted by changes in interest rates.