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
Q. Simultaneous determination of Y in the IS-LM model? Simultaneous determination of Y and R in the IS-LM model   By combining IS curve and LM curve, we can graphically e

What are UN Millennium Development Goals? The UN Millennium Development Goals (MDGs): These are a set of objectives shared through the IMF, the OECD and the World Bank (WB)

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

What are the advantages of leaving resource allocation to price allocation? Ans) The 5 benefits are Neutral, Flexible, Freedom of choice, No administrative cost and lastly Dimin

Explain the difference among a floating and managed exchange rate. The key distinction here is that a floating exchange rate is set by market forces, i.e. supply and demand. A

Why law of demand does not hold in pakistan

2. Given the following information: Consumers are very optimistic about the future. The price of oil has just doubled. The money supply is growing at a 6% rate. The government has

Compared with the situation before 1981, the marginal tax rates imposed on individuals and families with high incomes are now lower. What was the top marginal personal income tax r

How credit is created or the creation of credit

Examine the pros and cons of commercial transactions in blood from the egoistic, the utilitarian, and the Kantian perspectives.