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

compute the higer level-four-firm concentration ratios, (a) The four-firm ...

(a) The four-firm concentration ratios for the following industries have been found from the Economic Census for Manufacturing (NAICS 31-33) as follows. The four-firm concentration

The income tax rate is reduced, If income falls below its potential and the...

If income falls below its potential and the income tax rate is reduced, this will: A. raise the passive deficit but reduce the structural deficit. B. raise both the passive and str

When patulin molds can occur, Occurrence: It is found in a range of foods b...

Occurrence: It is found in a range of foods based on fruits. Presence of patulin in fruit juice is a indication that the juice was extracted from poor quality fruit which is undesi

Checkijaskfd, kajfasklfasklfj laksflaskfads

kajfasklfasklfj laksflaskfads

The functions of price mechanism in a free market economy, Price Mechanism ...

Price Mechanism Price mechanism is the point, which equilibrates supply and demand within a market. It is a mechanism of pricing. The price mechanism is one, which permits the p

Policy position by utilizing the examples, While referring to the "EYE on Y...

While referring to the "EYE on YOUR LIFE" section on page 183 of the textbook, apply this concept to your life. Develop your own policy position on price floors and price ceilings.

Foreign trade, how can a country maintain equilibrium GDP with foreign trad...

how can a country maintain equilibrium GDP with foreign trade?

Federal income tax be changed to a flat tax, Take a position on the followi...

Take a position on the following economic issue in the "yes" or "no" selection, support your position with economic theory and critical thinking skills. ISSUE: Should the Feder

How much money can banks create, How much money can banks create? Does...

How much money can banks create? Does this mean that banks can create an unlimited amount of money? The answer is no - that would require them to lend an unlimited amount of m

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