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

Trade-off proposals, While referring to the "EYE on YOUR LIFE" section on p...

While referring to the "EYE on YOUR LIFE" section on page 235 of the textbook, and the economic concepts you have accumulated during our course, consider the trade policies that se

Money and credit, MONEY AND CREDIT  In any modern economy, the quantity...

MONEY AND CREDIT  In any modern economy, the quantity of money, aggregate volume of credit and its sectoral composition are important variables which exert significant influenc

Explaining balance of payments, Explaining balance of payments: First,...

Explaining balance of payments: First, with the second oil shock of  1979-80 and  doubling of  India's  import bill along with  dismal  export performance as result of severe

Market index for small cap stocks, The Russell 2000 is a market index for s...

The Russell 2000 is a market index for small cap stocks - What do these changes in P/E ratios over last year tell you about current valuation in small caps and the different market

Consumption function in the IS-LM model, Q. Consumption function in the IS-...

Q. Consumption function in the IS-LM model? The consumption function will be the same as in cross model, consumption will depend positively on Y. In the classical model, consum

Relate overnight interest rates with interest rates, Relate overnight inte...

Relate overnight interest rates with interest rates By controlling overnight interest rates, the central bank will affect the interest rates with longer maturity. The reason f

Determine nominal & real demand for money., Suppose that the quantity theor...

Suppose that the quantity theory of money holds & the velocity of money are constant at 5. Output is fixed at its full employment value of 10,000 & the price level is 2. a) Ver

Accounting system-example iii, ACCOUNTING SYSTEM-EXAMPLE III  Now suppo...

ACCOUNTING SYSTEM-EXAMPLE III  Now suppose the Jam Co. manufactures some herbal chemicals and flavors which it sells partly to Extracts Co., partly to Bottling Co., some are co

Illustrate the problem for economic performance, Illustrate the problem for...

Illustrate the problem for UK economic performance This is a foremost problem for UK economic performance and helps elucidate the persistent deficit on the current account of

Give detail explanation about the inflation, Give detail explanation about ...

Give detail explanation about the Inflation Price index is computed at a particular point in time, inflation over a time period, mainly one year Inflation may just as

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