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Effectiveness of the Interest Rate Adjustment - Coursework Example

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This paper discusses the effects of a change in the level of interest rate of investment and on consumption. Interest rates can be defined as the cost of borrowed funds or as the opportunity cost of borrowed resources. Interest rates are used by governments to implement certain monetary policies …
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Effectiveness of the Interest Rate Adjustment
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Effectiveness of the Interest Rate Adjustment

Download file to see previous pages... nt levels in the economy, when there is an increase in the interest rates then the lower will be the rate of investment while a reduction in the interest rates then there will be an increase in investment.

When investment increases it will result to demand push inflation which originates from the real sector, when investment increases then the aggregate demand will increase and this will result into inflation. However when the investment levels increase then we expect the level of employment and income in the economy to increase, this will be beneficial to the economy where the rate of employment will increase and the output level of the economy will also increase in terms of GDP.

According to Keynes theory on the demand for money he highlighted that individuals will demand money for speculative purposes, precautionary purposes and liquidity preferences. Speculative demand for money occurs where the individuals will prefer to hold money as an asset when other assets do look attractive, The level of speculative demand for money will depend on the interest rates and the income levels, when interest rates are high then the speculative demand for money is lower and when the interest rates are lower then the individuals will hold more speculative money demand, for this reason therefore individuals will hold more money and will not invest when the interest rates are high but when the interest rates are low the individuals will hold less speculative money and they will invest in other assets.




Consumption behaviour and interest rates:

According to Keynes consumption constitutes the largest proportion of expenditure in an economy, however in his theory he defined consumption as a function of income, consumption therefore was equal to the autonomous consumption level...
This paper offers a comprehensive review of the relationships between interest rates, investment behaviour and level of consumption with the help of the postulates of Keynesian theory. It is shown, that when interest rates are adjusted they will affect the level of borrowed funds. Interest rates will therefore affect the consumption behaviour and at the same case affect the investment behaviour in the economy. Interest rates can also determine the amount of money supply in an economy, and because the higher the money supply then the higher the inflationary pressure interest rates are used as a way to fight inflation in an economy
Investment can be defined as accumulation over time by firms of real capital goods and these goods yield the future flow and acquisition of other goods, investment levels in an economy will be determined by the interest rates which are the opportunity costs of borrowed funds.
Consumption constitutes the largest proportion of expenditure in an economy, however in his theory he defined consumption as a function of income, consumption therefore was equal to the autonomous consumption level plus the marginal propensity to consume which is multiplied by the income minus tax.

Consumption is affected by changes in the level of interest rates, when interest rates are high then the demand for borrowed fund will decline and therefore the less the ability by consumers to spend, when interest rates are low then the demand for borrowed funds increase and for this reason the higher the ability by consumers to spend. ...Download file to see next pagesRead More
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