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

Labour market, use a graph of the classical labour market to illustrate the...

use a graph of the classical labour market to illustrate the effects of a real wage existing in the market that is lower thhan the equilibrium real wage

Same Basket of Goods, assume the cost of a market basket in 2008 is 1717.0....

assume the cost of a market basket in 2008 is 1717.0. Calculate the cost of the same basket of goods and services in 2007. Price index in 2008 was 100 and price index in 2007 was

Proportion of students entering a university, Historically, the proportion ...

Historically, the proportion of students entering a university who finished in 4 years or less was 64%. To test whether this proportion has decreased, 122 students were examined an

Objective of empirically analyses, The aim of this paper is to observe and ...

The aim of this paper is to observe and interpret the correlations between oil price changes, and changes to key macroeconomic indicators. From this we will be able to observe if t

Discuss about asymmetric information, A) With asymmetric information, free ...

A) With asymmetric information, free markets may not lead to efficient outcomes because the market for a service or product may break down due to adverse selection. Explain what ad

Inflation, What are the effects of neutral inflation

What are the effects of neutral inflation

Determine modified accelerated cost recovery system, Suppose new instrument...

Suppose new instruments for a firm cost $18,000 along with an additional installation fee of $2,000, both of that are depreciable. Complete the depreciation schedule display below

Describe the economic justification for free trade policies, Some manufactu...

Some manufacturing and agricultural products produced in the Midwest are exported to overseas markets.  US consumers and businesses also purchase many products produced outside the

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