Interest rate determination, Macroeconomics

Interest rate determination 

The real interest rate r will be equal to the equilibrium real interest rate

In the classical model we define equilibrium real interest rate r* as the real interest rate where savings is equal to investments, S(r*) = I(r*). As we know that S = I is a requirement for the financial market to be in equilibrium.  

In the classic model, real interest rate determines the flow of funds into and from the financial market. A higher real interest rates will result in larger flows of funds into the market (savings depends positively on r) and smaller flows out from the market (investment depends negatively on r). Real interest rate will be such that the flows into market are specifically equal to the flows out of the market. 

 

1861_Interest rate determination.png

Figure: Determination of the real rate

From this graph we can determine the size of investments and savings. In equilibrium when r = r*, S = I that is what we need for GDP identity to hold. Once we know savings, we can determine household savings from SH = S - SG - SR.  

In the classical model, expected inflation pe is an exogenous variable and because R = r + pe we can determine nominal interest rate from the real rate.

Posted Date: 8/14/2013 2:25:23 AM | Location : United States







Related Discussions:- Interest rate determination, Assignment Help, Ask Question on Interest rate determination, Get Answer, Expert's Help, Interest rate determination Discussions

Write discussion on Interest rate determination
Your posts are moderated
Related Questions
Some countries that supply oil to petrol manufacturers are located in or near the Middle East, others are not located in or near the Middle East. (i) Does the war benefit or har

Q. Define Nominal wages? The nominal wage is wage per unit of time in the currency used in the country- what we usually just call wage. When we mention wage in macroeconomics w

Give example of commercial banks how they create money For example, the borrower uses the money to buy an apartment, the funds are transferred to the seller of the apartment. T

Private sector in the circular flow The private sector total income is known as the national income. Because private sector receives the entire return from the factors of pr

Q. Explain Growth theory? The purpose of this topic is to try to explain growth in GDP. The models in this topic are very different from the rest of the models as they use only

Export Promotion Measures: While a number of  existing  export promotion schemes  such as  incentive related to Duty Free Replenishment Certificate (DFRC), Duty Entitlement Pa


If the marginal disutility of labor increases, the equilibrium real wage increases and the equilibrium quantity of labor goes up. True or false?

asiignment on ppc

The Price ceiling is the law that sets a maximum price below the equilibrium market price, but a price floor is the law that sets a maximum price above the market equilibrium price