Long Run Interest Rate

6 Key excerpts on "Long Run Interest Rate"

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  eBook - PDF

  Financial Institutions

  Markets and Money

  • David S. Kidwell, David W. Blackwell, David A. Whidbee, Richard W. Sias(Authors)
  • 2020(Publication Date)
  • Wiley

    (Publisher)

  This chapter explains the role of interest rates in the economy and provides a basic explanation of the fundamental determi- nants of interest rates. The chapter serves as a foundation for Chapters 5 and 6, which also deal with interest rates. ■ vectorfusionart/Shutterstock Even though we understand the factors that cause interest rates to change, only people who have a crystal ball can predict interest movements well enough to make consistent profits. The gutters of Wall Street are littered with failed interest rate prediction models. 4.1 WHAT ARE INTEREST RATES? For thousands of years, people have been lending goods to other people, and on occasion, they have asked for some compensation for this service. This compensation is called rent— the price of borrowing another person’s property. Similarly, money is often loaned, or rented, for its purchasing power. The rental price of money is called the interest rate and is usually expressed as an annual percentage of the amount of money borrowed. Thus, an interest rate is the price of borrowing money for the use of its purchasing power. To a person borrowing money, interest is the penalty paid for consuming income before it is earned. To a lender, interest is the reward for postponing current consumption until the maturity of the loan. During the life of a loan contract, borrowers typically make periodic interest payments to the lender. On maturity of the loan, the borrower repays the same amount of money borrowed (the principal) to the lender. Like other prices, interest rates serve an allocative function in our economy. They allocate funds between surplus spending units (SSUs) and deficit spending units (DSUs) and among financial markets. For SSUs, the higher the rate of interest, the greater the reward for postponing current consumption and the greater the amount of saving in the economy.

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  eBook - ePub

  The Pure Theory of Capital

  • F. A. Hayek, Lawrence H. White(Authors)
  • 2019(Publication Date)
  • Routledge

    (Publisher)

  Part IV The Rate of Interest in a Money Economy Passage contains an image Twenty-Six Factors Affecting the Rate of Interest in the Short Run

  The ‘Rate of Interest’ in Equilibrium Analysis and the Money Rate of Interest

  The task of the first three Parts of this book has been to show, by the same general method as is used by equilibrium analysis to explain the prices of different commodities at a given moment, why there will be certain differences between the prices of the factors of production and the expected prices of the products, and why these differences will stand in a certain uniform relationship to the time intervals which separate the dates when these prices are paid. In conformity with an old-established practice, we have described these price differ-ences, which can be expressed in terms of a time rate, as the rate of interest. But, as we have warned the reader early in this book, this ‘rate of interest’ is not identical with the price for money loans to which this term is applied in a money economy. It is not a price paid for any particular thing, but a rate of differences between prices which pervades the whole price structure. Insofar as the money rate of interest is concerned, our rate of interest is merely one of the factors which helps to determine it, and is the phenomenon most nearly corresponding to it which we can find in our imaginary moneyless economy. But if it were not for the well-established usage, it would probably have been better to refer to this ‘real’ phenomenon either, as the English classical economists did, as the rate of profit, or by some such term as the German Urzins.1

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  eBook - ePub

  Macroeconomics For Dummies

  • Dan Richards, Manzur Rashid, Peter Antonioni(Authors)
  • 2016(Publication Date)
  • For Dummies

    (Publisher)

  Part 3

  The Long-Run Macro Economy

  IN THIS PART … Understand the importance of economic growth and the determination of the economy’s long-run growth path. Discover that in the long run, inflation is determined by money growth. Discover that in the long run, real interest rates primarily reflect households’ willingness to save. Passage contains an image Chapter 8

  GDP Growth in the Long Run

  IN THIS CHAPTER Compounding growth: The rule of 70 Marginalizing firm decisions Growing GDP over time Steadying the state

  We’ve said it before and we’ll say it again: Economists love models. Building an economic model and considering its implications forces you to think hard about which assumptions lead to which results and whether those assumptions make sense. And it’s only after you have a model that you can begin to test it with evidence.

  Some of the time, or maybe most of the time, economists disagree at one or more of these stages. They argue over assumptions. They argue over the empirical evidence. They argue over arguing. But in macroeconomics, one area where economists don’t argue too much is about the nature of the long run. There is a lot of agreement about the economy’s long-run behavior and which macroeconomic policies will promote a healthy long-run growth path.

  That long-run path is an anchor — a full equilibrium. It is in fact the potential output described in Chapter 3 , because it reflects full employment of the economy’s capital and labor resources. Whatever happens in the short run, there are forces (sometimes weak but always present) that pull the economy back toward that potential. Put somewhat differently, recessions can cause the economy to drift away from its long-run equilibrium for some time and by a significant amount. But ultimately the economy always returns to that long run, full-employment path.

  In this chapter, you’ll hear about the long-run growth model that most macroeconomists think works for modern economies like the U.S. You’ll also get an idea of the critical but complicated role that society’s willingness to save plays in that model — and what the long-run equilibrium says about interest rates and the price of credit as well.

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  eBook - PDF

  CFIN

  • Scott Besley, Eugene Brigham, Scott Besley(Authors)
  • 2021(Publication Date)
  • Cengage Learning EMEA

    (Publisher)

  115 CHAPTER 5: The Cost of Money (Interest Rates) Copyright 2022 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s). Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it. 3. When the U.S. economy shows signs of expanding too quickly, the Fed normally takes actions to increase interest rates to discourage too much expansion and to control future growth so that it does not result in high inflation. 4. During recessions, short-term rates decline more sharply than do long-term rates. This situation occurs for two reasons. First, the Fed operates mainly in the short-term sector, so its intervention has the strongest effect here. Second, long-term rates reflect the average expected inflation rate over the next 20 to 30 years. This expecta- tion generally does not change much, even when the current rate of inflation is low because of a recession. 5-5 INTEREST RATE LEVELS AND STOCK PRICES Interest rates have two effects on corporate profits. First, because interest is a cost, the higher the rate of inter- est, the lower a firm’s profits, other things held constant. Second, interest rates affect the level of economic activity, and economic activity affects corporate profits. Interest rates obviously affect stock prices because of their effects on profits. Perhaps even more important, they influence stock prices because of competition in the marketplace between stocks and bonds. If interest rates rise sharply, investors can obtain higher returns in the bond market, which induces them to sell stocks and transfer funds from the stock market to the bond market.

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  eBook - ePub

  Studies in the Theory of Money and Capital

  • Erik Lindahl(Author)
  • 2016(Publication Date)
  • Taylor & Francis

    (Publisher)

  In the real world we must naturally be content with a more summary procedure than that suggested above. The desideratum is in each case to keep the short term rate at such a level as to allow for the expected increase in consumption goods for the period. Hence the long term rate should be held at a (lower) level corresponding to the anticipated future level of short term rates.

  If physical productivity has for one cause or another declined in the capital goods industries, and this lower scale of production is expected to continue, a reduction of the rate of interest is necessary to prevent a price fall. This reduction should be regulated in a manner exactly analogous to that required for raising the rate in the opposite case.

  (b) If the changed productivity in the capital goods industries is temporary , the above reasoning must be modified in certain respects.

  In so far as these changes are due only to altered expectations and valuations of risk on the part of entrepreneurs, and consequently have no material basis, they will not influence the supply of consumers’ goods. The result will be merely a rise or fall in nominal incomes during the period of time occupied by the change. With a passive monetary policy, the larger or smaller total income of the community, if not neutralized by an opposite change in saving, would disturb the equilibrium between the demand and supply of consumers’ goods, and thereby cause variations in the price level. This should be counteracted in the first place by raising or lowering the short term interest rate during the period in question. The long term rate determined principally by the future (unchanged) level of interest rates, should follow only in so far as this is necessary as a result of the shift in the short term rate. Excessive changes in rates, with their disturbing effect on productive activity, can in certain cases be avoided by supplementing discount policy by other monetary measures. For example, if incomes were higher as a result of a more optimistic attitude towards production on the part of a certain group of entrepreneurs, this would be neutralized with a minimum of disturbances if the interest rates for these particular entrepreneurs were raised (especially for new investment), but were maintained unchanged for others. Such a differentiation of interest rates or credit rationing naturally presupposes that the Central Bank is in a position to judge the situation accurately.

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  Macroeconomics as a Second Language

  • Martha L. Olney(Author)
  • 2011(Publication Date)
  • Wiley

    (Publisher)

  PART II The Long Run 69 Chapter 5 Long-Run Economic Growth Why are some nations rich and others poor? Why do standards of living sometimes rise quickly and other times slowly . . . or not at all? Economists answer these questions with models of economic growth. Economies can produce more output—become richer—when there are more inputs or when the inputs’ productivity rises. KEY TERMS AND CONCEPTS • Growth • Growth rate of the economy • Rule of 70 • Aggregate production function • Capital-labor ratio • Constant returns to scale • Scale of production • Economies of scale • Increasing returns to scale • Diseconomies of scale • Decreasing returns to scale • Growth accounting • Residual growth • Total factor productivity (TFP) • Labor productivity • Capital productivity • Capital stock • Investment • Depreciation rate • Human capital • Property rights • Intellectual property rights • Productivity growth slowdown • Productivity growth resurgence 71 72 Chapter 5 Long-Run Economic Growth KEY EQUATIONS • Real GDP per capita • Rate of change • Aggregate production function KEY GRAPH • Aggregate production function WHAT IS GROWTH? Economists use the word “growth” in two different contexts: short-run and long- run contexts. For macroeconomists, the short run is a period of a few months to a few years. Macroeconomists who focus on the short run use the term growth to refer to changes in real GDP from quarter to quarter, or year to year. Some use the phrase “growing the economy” to refer to policies or events that make real GDP increase over the short run. The long run is a period of a decade or a generation. Long-run growth refers to changes from decade to decade, or generation to generation. Changes in what? Unfortunately for students, there are two answers. Some economists and text- books use one definition of long-run growth; others use the other.

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