Interest rate determination, Macroeconomics

Assignment Help:

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.


Related Discussions:- Interest rate determination

Sales tax on restaurant food, If you were a restaurant owner and you knew t...

If you were a restaurant owner and you knew that the demand for your restaurant was elastic, how would you feel about a sales tax on restaurant food? Explain.

Finding relate to economist''s traditional focus, Recently, a bank was tryi...

Recently, a bank was trying to decide what fee to charge for "expedited payments" - payments that the bank would transmit extra-speedily to enable customers to avoid late fees on c

State major fiscal objective of chancellor george osborne, Major fiscal obj...

Major fiscal objective of Chancellor George Osborne The major fiscal objective of Chancellor George Osborne when coming to office in May 2010 was to remove the UK's structural

What do you mean by yield curve, Q. What do you mean by yield curve? Yi...

Q. What do you mean by yield curve? Yield curve is a graph of interest rates of different maturity (recalculated to yearly rates) at a specific point in time. It's common for t

Change of production possibilities curve affects, Analyze the relationship ...

Analyze the relationship between the production possibilities curve and the circular flow diagram. Discuss how the change of production possibilities curve affects the circular flo

Subsidizing the price of milk, "Subsidizing the price of milk or other agri...

"Subsidizing the price of milk or other agricultural products is not very expensive considering how many consumers there are in the United States. Therefore, there is little harmfu

Unemployment, Suppose that between January 2011 and January 2012 the total ...

Suppose that between January 2011 and January 2012 the total number of people employed and the unemployment rate both fell. Briefly explain how this is possible. [2 marks]

Price discrimination is forbidden, Suppose the ABC chemical company discove...

Suppose the ABC chemical company discovers a drug that cures the common cold. ABC has plants in Europe and in the United States and can produce the drug in either continent at a ma

Determine the net terminal year cash flow, A company is assessing a propose...

A company is assessing a proposed 4-year project.  The depreciable cost will involve the following: $300,000 for the equipment, $20,000 for shipping, and $30,000 for installation.

Write Your Message!

Captcha
Free Assignment Quote

Assured A++ Grade

Get guaranteed satisfaction & time on delivery in every assignment order you paid with us! We ensure premium quality solution document along with free turntin report!

All rights reserved! Copyrights ©2019-2020 ExpertsMind IT Educational Pvt Ltd