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
Kate uses a sewing machine to alter and repair clothes for one year in her own small business, Kate's Tailoring. She earns $20,000 during the year for various sewing projects. In t

The opportunity costs associated with the use of resources owned by a firm are: a. externalities b. implicit costs c. explicit costs d. sunk costs

According to liquidity preference theory, an increase in the price level causes the interest rate to: a.decrease, which decreases the quantity of goods and services demanded. b.inc

A government can finance its budget deficit by doing all of the following except: A. borrowing from its central bank. B. printing money. C. selling bonds. D. buying bonds.

Compare Classical economic theory to Keynesian economic theory. Which approach, if either is the US currently applying and what have been the effects of such policies?

Table below shows the descriptive statistics which have been condensed from the data sheet for the period 1987 Q4 to 2011 Q3.   GDP (%) Real Exchan

(a) Use this information to set up a diagram showing the firm''s total revenue and total cost schedules. In this diagram, show the points at which the firm is maximizing profits.

Explain modern theory of rent eith diagrams and defination

what is the company lidted in NASDAQ that is included in the dow jones industrial average

distinguish between state and dynamic multiplier and illusrate balanc budget theorm in hindi