Economics: Interest Rate Determination

PreferableOcarina avatar
PreferableOcarina
·

Start Quiz

Study Flashcards

30 Questions

What is the relationship between the quantity demanded of an asset and the risk of its returns relative to alternative assets?

Negatively related

Which of the following is NOT a characteristic that affects the quantity demanded of an asset?

Supply

What determines the interest rate in an economic system?

Interaction of supply and demand of funds

Which of the following is NOT a type of interest rate in Malaysia?

GDP Rate

Why do we assume a single interest rate in the entire economy?

Because interest rates on different securities tend to move together

What is the role of local, state, and federal governments in the credit market?

They are a significant part of the demand side of the credit market

What happens to the demand for bonds when household savings increase?

The demand curve shifts to the right

What is the effect of higher expected interest rates in the future on the demand for long-term bonds?

The demand curve shifts to the left

How does an increase in the expected return on other assets, such as stocks, affect the demand for bonds?

The demand curve for bonds shifts to the left

What happens to the demand for bonds during a recession?

The demand curve shifts to the left

What is the effect of an increase in expected inflation on the demand for bonds?

The demand curve shifts to the left

What is the relationship between wealth and the demand for bonds?

An increase in wealth leads to an increase in the demand for bonds

What happens to the expected return on bonds when there is an expected inflation?

It decreases because of lower real interest rate

What is the effect of an increase in the riskiness of bonds on the demand curve?

The demand curve shifts to the left

What is the result of increased information costs of bonds on the demand curve?

The demand curve shifts to the left

What is the effect of an increase in liquidity on the demand curve for bonds?

The demand curve shifts to the right

What is the primary assumption in Keynes' theory about individuals' financial asset preferences?

They inherently prefer money among all financial assets.

What determines the equilibrium level of income according to Keynes?

The relationship between savings and investment

What happens to the price of bonds when there is a decrease in expected interest rate?

The price of bonds increases

What causes a shift in the supply of bonds?

Changes in the wealth and liquidity of bonds

Why do people hold bonds instead of money, according to Keynes?

Because bonds offer higher returns

What is the transactionary motive for holding money?

To finance transactions and daily expenses

How does the interest rate affect the precautionary motive for holding money?

It has no effect

What is the speculative motive for holding money?

To take advantage of changes in bond prices

What is the impact of an increase in income on the demand for money?

It shifts the demand curve to the right.

What happens to the demand for money when the price level rises?

It increases because people want to hold more money to maintain their real purchasing power.

What is the relationship between the price of bonds and the interest rate?

When the price of bonds falls, the interest rate rises.

What are the two factors that cause the demand curve for money to shift?

Income and price level.

Why do people want to hold more money as income rises?

Because they want to carry out more transactions and hold more money as a store of value.

What is the effect of a rise in the price level on the demand for money?

It increases the demand for money.

Study Notes

Determinants of Bond Demand

  • Wealth: an increase in wealth leads to a rise in the demand for bonds and a shift to the right of the demand curve
  • Expected return:
    • Higher expected interest rates in the future lower the expected return for long-term bonds, decreasing demand and shifting the demand curve to the left
    • Changes in expected return on other assets (e.g., stocks, real assets) can also shift the demand curve for bonds
    • An increase in expected inflation lowers the expected return for bonds, causing demand to decline and the demand curve to shift to the left
  • Saving: an increase in household saving leads to an increase in wealth, raising the demand for bonds and shifting the demand curve to the right

Interest Rate Determination in an Economic System

  • The interest rate is determined through the interaction of the supply of funds (savings or loanable funds) and the demand for surplus funds (demand for loanable funds) in the credit market
  • The quantity demanded of an asset is negatively related to the risk of its returns relative to alternative assets
  • The quantity demanded of an asset is positively related to its liquidity relative to alternative assets

Changes in Equilibrium Interest Rates

  • Shifts in the demand for money:
    • Income effect: an increase in income causes the demand for money to increase and the demand curve to shift to the right
    • Price-level effect: a rise in the price level causes the demand for money to increase and the demand curve to shift to the right
  • Keynes's liquidity preference analysis:
    • Individuals inherently prefer money among all financial assets
    • Interest is paid to persuade people to exchange their money for less liquid assets
    • There are three motives behind the general preference for holding highly liquid money: transaction, precaution, and speculation

Keynes's Motives

  • Transaction motive:
    • Demand for money is positively determined by income
    • Interest rate does not have any influence on the demand for money
  • Precautionary motive:
    • Demand for money is positively determined by income
    • Interest rate does not have any influence on the demand for money
  • Speculative motive:
    • Demand for money is negatively influenced by interest rate
    • People may hold money balances in excess of their transactions and precautionary needs to take advantage of changes in bond prices

Risks, Liquidity, and Information Costs of Bonds

  • Risks: an increase in the riskiness of bonds causes the demand for bonds to fall and the demand curve to shift to the left
  • Liquidity: increased liquidity of bonds results in an increased demand for bonds, and the demand curve shifts to the right
  • Information costs: increased information on bonds results in an increased demand for bonds, and the demand curve shifts to the right

Learn about the factors that influence the demand and supply of assets, including risk and liquidity. Understand how the interest rate is determined through the interaction of supply and demand in the credit market.

Make Your Own Quizzes and Flashcards

Convert your notes into interactive study material.

Get started for free

More Quizzes Like This

Mastering the Bond Market
5 questions

Mastering the Bond Market

BlissfulMoldavite9442 avatar
BlissfulMoldavite9442
Fixed Income Securities Quiz
5 questions
Financial Markets: The Bond Market
10 questions
Use Quizgecko on...
Browser
Browser