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
Consider the following: An economy is found to have output, y = 20000 Also assume that the government runs a deficit where tax revenue T= 4000 and government expenditures G=5000

A new industry develops, and our government wants to protect it from foreign competition. Which one of the following arguments would appropriately describe this type of protection?


A financial manager wants to design an investment portfolio for a client. The client has $50,000 available to invest, and the planner has identified four investment options for the

How central bank increases the target rate Let's say that the central bank increases the target rate. When the target rate increases, the central bank needs to raise the overni

he questions posed are broad and open ended so be careful to allow yourself enough research and planning time. If you are completely on top of the material delivered in class, then

Why might a perfectly competitive market firm be willing to run at a loss in the short run? The assumptions of a PCM firm should be outlined in order to end that the PCM firm i

A firm's current profits are $1,300,000. These profits are expected to grow indefinitely at a constant annual rate of 3 percent. If the firm's opportunity cost of funds is 6 percen

Monetary Policy Vs. Fiscal Policy According to monetarists, money is very important in determining the level of aggregate demand and that monetary policy is very potent. In con

The final and most important part of the methodology is the impulse response functions which will provide the most information with regards to the aim of the project. In order to a