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
Calculate the equilibrium price and quantity?

Given the following MV information, what is the optimal allocation of care according to the Preteens criteria, when the marginal cost of care is constant at $100. Person A Person B

ACCOUNTING SYSTEM-EXAMPLE I  Consider a very simple economy. It consists of a. A number of households. b. A single productive organization, a 'firm' - say the Jam Corpora

how can a country maintain equilibrium GDP with foreign trade?

The IS-curve in the AS-AD model The IS-curve is not affected by P in the AS-AD model We can define an IS-curve in the AS-AD model similarly to

Environmental engineers and scientists are becoming concerned about pharmaceuticals in the environment. An antibiotic is discharged into a small lake at an influent concentration o

Economists estimate the short run elasticity of demand for a Chipotle burrito is -2.25. i)    What degree of elasticity does Chipotle burritos exhibit? ii)    A 1% change in

What are the important tools to consider Monetary Policy? Important tools to consider Monetary Policy: a. What the money demand curve is b. Why the liquidity preference m

what is automatic stabilizer, example with diagram or graph please

How growth are improved living standards The two main benefits of growth are improved living standards and technological advancement. As an economy grows, the output of