Economics
Equilibrium Interest Rate
The equilibrium interest rate is the rate at which the demand for and supply of loanable funds in an economy are equal. At this rate, borrowers are willing to borrow the same amount that lenders are willing to lend. It represents the point of balance in the market for loanable funds, where there is neither excess demand nor excess supply.
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6 Key excerpts on "Equilibrium Interest Rate"
eBook - PDFFinancial Institutions
Markets and Money
- David S. Kidwell, David W. Blackwell, David A. Whidbee, Richard W. Sias(Authors)
- 2020(Publication Date)
- Wiley(Publisher)
1 Thus, when interest rates are higher, people spend less and save more, and business investment is choked off by the higher cost of funds. The equilibrium rate of interest (r*) is the point where the desired level of borrowing (B) by DSUs equals the desired level of lending (L) by SSUs. At this point, funds are allo- cated in the economy in a manner that fits people’s preference between current and future consumption and all capital projects whose return on investment exceed the firm’s cost of capital are funded. The equilibrium rate of interest is called the real rate of interest. The real rate of inter- est is the fundamental long‐run interest rate in the economy. The real rate is closely tied to the rate of return on capital investments and people’s time preference for consumption. It is called the real rate of interest because it is determined by real output factors in the economy. FLUCTUATION IN THE REAL RATE Using the supply and demand framework in Exhibit 4.1, you can see how economic factors that cause a shift in the desired lending or desired borrowing curves will change the equilib- rium rate of interest. EXHIBIT 4.1 Determinants of the Real Interest Rate The real rate of interest is the base interest rate for the economy. It is closely tied to the productivity of capital investments in the economy and people’s time preference for consumption. The equilibrium rate of interest is the point where the desired level of borrowing (B) equals the desired level of lending (L). The real rate of interest historically has been around 3 percent for the U.S. economy and has varied between 2 and 4 percent. Real interest rate (%) Desired lending: the amount SSUs want to lend Desired borrowing: the amount DSUs want to borrow Quantity of lending/borrowing in the economy ($) L = B r* 1 The terms surplus spending units (SSUs) and deficit spending units (DSUs) are defined in Chapter 1. 4.3 Loanable Funds Theory of Interest 111 Demand Factors.
eBook - ePub- W. Charles Sawyer, Richard L. Sprinkle(Authors)
- 2020(Publication Date)
- Routledge(Publisher)
Figure 15.4 . This equilibrium in the money market occurs as individuals and firms adjust their asset holdings. For example, at any interest rate higher than the equilibrium rate, the amount of money demanded by individuals and firms is less than the amount of money supplied. In this case, individuals and firms would buy financial assets that earn an explicit rate of return. By purchasing financial assets, the price of financial assets would rise, causing a fall in interest rates until the money market achieves equilibrium. Conversely, if the interest rate is below the equilibrium rate of interest, the amount of money demanded by individuals and firms is greater than the amount supplied. As a result, individuals and firm would sell financial assets, causing the price of such assets to fall and interest rates to rise.FIGURE 15.4The Equilibrium Interest RateNow that we know how the Equilibrium Interest Rate is determined, we can illustrate how the interest rate responds to changes in either the demand or supply of money. For example, assume that the money market is in equilibrium and the real income or the price level changes. A change in either one of these determinants shifts the demand for money and changes the Equilibrium Interest Rate. Two examples of these changes in money demand are shown in Figure 15.5 . First, assume that the money market is in equilibrium at point E, and the economy has an overall decline in real income. Such a decline in total real income is usually associated with a recession. As real income declines, the demand for money declines. This is represented by a shift in the demand for money from MD to MD1 . As a result, the new equilibrium in the money market is at F, and the equilibrium rate of interest declines to i1
eBook - ePub- F. A. Hayek, Lawrence H. White(Authors)
- 2019(Publication Date)
- Routledge(Publisher)
A. Hahn 10 and J. M. Keynes, of regarding the rate of interest as being solely dependent on the quantity of money and the varying desires of people to keep certain balances of money in hand. We are here not primarily concerned with the transitory or purely dynamic effects of monetary changes on the rate of interest. But if it is true—as we must assume in the light of all evidence—that changes in the quantity of money affect the rate of interest, there must exist, even in equilibrium conditions, some relationship between the quantity of money people want to hold and the rate of interest. It is this relationship which we must first try to elucidate. Extension of Concept of Equilibrium Used Now, as has been pointed out in an earlier chapter, 11 the desire of people to hold money cannot readily be fitted into the rigid definition of equilibrium we have used up to this point. At least, in an economy in which people were absolutely certain about the future, there would be no need to hold any money beyond the comparatively small quantities necessitated by the discontinuity of transactions and the inconvenience and cost of investing such small amounts for very short periods. But the assumption of certainty about the more distant future, although we have so far based our argument on it, is not really essential for our concept of equilibrium. The plans of the various individuals may be compatible with the extent to which they are definite, 12 and yet the individuals may at the same time be uncertain about what will happen after a certain date and may wish to keep some general reserve against whatever may happen in that more uncertain future
Available until 4 Dec |Learn more- Jagdish Handa(Author)
- 2002(Publication Date)
- Routledge(Publisher)
part sevenTHE RATES OF INTEREST IN THE ECONOMY
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chaptertwentyTHE MACROECONOMIC THEORY OF THE RATE OF INTERESTThe rate of interest is one of the endogenous variables in the Keynesian and classical models, so that its analysis is properly conducted as part of a complete version of those models. These were presented in Chapters 13 and 14.This chapter singles out the competing views on the determination of the rate of interest and focuses on their differences and validity. It also highlights the very important difference between the comparative static and the dynamic determination of the rate of interest.key concepts introduced in this chapter
• The Fisher equation of the nominal rate of interest• Stocks versus flows of funds• The loanable funds theory• The liquidity preference theory• The excess demand function for bonds• The dynamics of interest rate determination• The neutrality of money and inflation for the real rate of interestMacroeconomics avoids the bewildering array of interest rates on the numerous assets in the market by focusing on one single rate of interest, without completely specifying which rate of interest it is, as for example in the IS-LM model of Chapters 13 and 14
- Björn A. Hansson(Author)
- 2017(Publication Date)
- Routledge(Publisher)
22 It is then evident that the loan rate influences the demand for invested services and thereby their prices. Hence, the real rate as here defined has now “a tendency to adjust itself to the actual loan rate of interest in every period” (ibid., p.249). To say that the loan rate is the same as the real rate of interest and therefore ‘normal’ has then no meaning, since it is a part of the determination of the real rate.Thus Lindahl interprets the real rate as a particular level of the loan rate :“as the rate of interest on loans which emerges as a result of the pricing process, when equilibrium between the different factors, above all between the demand for and the supply of saving, has been attained” (ibid.).In fact, this shows that a complete equation system which includes the money rate (assuming that such a system can be constructed) cannot be in equilibrium unless the loan rate and the real rate, i.e. the expected rate of profit, are the same. Consequently in 1939 Lindahl makes the following assessment of the independence of the investment schedule:“[it] will indeed have been influenced in various ways by the loan rate in preceding periods, but it can nevertheless be regarded as independent of the loan rate during the current period …. However, the conclusion remains that it is impossible on the basis of this investment schedule alone to single out any definite real rate as having a decisive influence on the loan rate” (ibid., p.262).Henceforth, the equilibrium rate is the rate which equalizes supply (savings ex ante) and demand (investment ex ante) in the capital market. This is exactly the argument which Hammarskjöld voiced against Myrdal’s version of the real rate as an independent entity in the determination of the money rate (cp. sect. VI:3:3). The new definition of the real rate has affinities with Wicksell’s second characteristic of the normal rate.
eBook - PDFMathematical Interest Theory
Third Edition
- Leslie Jane Federer Vaaler, Shinko Kojima Harper, James W. Daniel(Authors)
- 2019(Publication Date)
- American Mathematical Society(Publisher)
Spending now may provide instant gratification, but offered enough compensation, one may be 503 504 Chapter 10 Determinants of interest rates persuaded to lend (invest) the money instead. When the loan is repaid, the lender should have more to spend than what he started with. Interest is the compensation for deferring consumption. On the other hand, a person who wishes to buy a particular good or service now but does not have the required fund on hand can either borrow the money for it or wait until he has the money. If he chooses to borrow the money, then he would expect to pay a charge to compensate the lender. The interest rate of a loan indicates the price the borrower pays to use the lender’s money. A high interest rate corresponds to a high price while a low interest rate corresponds to a low price. Suppose there are one thousand people, each willing to lend $10,000 for one year. Many of these potential lenders would agree to lend for a large amount of interest, but the number would be smaller for a low amount of interest. That is, more lenders would be willing to sell the use of their money for a high price while fewer lenders would be willing to sell for a low price. A visual representation of this can be made with a graph where the vertical axis represents the price (amount of interest in dollars) of the loan, and the horizontal axis represents the number (quantity) of people that are willing to lend. The resulting graph (Figure (10.2.1)) is known as a supply curve since the number of willing lenders represents the supply of loans. Quantity of loans Price of loan FIGURE (10.2.1) Supply curve for loans Now suppose there are one thousand people, each wishing to borrow $10,000 for one year. Only a small proportion of them would borrow if the amount of interest required is large, but a higher proportion would borrow if the amount of interest required is small.
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