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

Economic-social-cultural and political-legal factors, For each of the host ...

For each of the host countries you have selected for examination (PEST-C analysis), conduct a preliminary assessment of the geographic, economic, social-cultural, and political-leg

Determine about the interest rates, Determine about the interest rates ...

Determine about the interest rates The interest rate may be fixed or floating. If it is fixed, you will pay the same percentage for the entire duration of the loan. With a floa

Quality of health care, Explain how changes in the quality of health care w...

Explain how changes in the quality of health care will influence the demand for care.

European commission bail, Will the Euro survives? 1. Why are Greece, Ire...

Will the Euro survives? 1. Why are Greece, Ireland, Italy, Portugal, and Spain sometimes referred to as the euros zones "peripheral countries"? 2. Why did the European commis

Estimate the value of wacc method, You can work on this assignment individu...

You can work on this assignment individually or in a group of up to 4 people.  If you choose to work as a group, your group should hand in one assignment and you will all receive t

Anti-trust legislation, Explain why anti-trust legislation supports a perfe...

Explain why anti-trust legislation supports a perfectly competitive market. Give at least one specific example of legislation to justify your explanation.

Main causes of inflation in an economy, Question 1: Differentiate betwe...

Question 1: Differentiate between income, price and cross elasticities of demand. How will the concept of price elasticity be useful to the owner of a supermarket who wan

HOMEWORK, How do you figure out the answer to this question: You are a stud...

How do you figure out the answer to this question: You are a student at a university. You pay $8,000 per year in tuition, $5,000 per year in living expenses, and $1,000 per year fo

Explain about penicillic acid, Q. Explain about Penicillic Acid? This m...

Q. Explain about Penicillic Acid? This mycotoxin has biological properties similar to patulin. It is produced by a large number of fungi, including many Penicillia as well as m

Solow model, Q1. The poorest countries in the world have a per capita incom...

Q1. The poorest countries in the world have a per capita income of about $600 today. We can reasonably assume that it is nearly impossible to live on an income below half this leve

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