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ECO 4223 - CHAPTER 4 - CHAPTER SUMMARY QUESTIONS AND ANSWERS WITH SOLUTIONS 2024
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ECO 4223 - CHAPTER 4 - CHAPTERSUMMARY QUESTIONS AND ANSWERS
WITH SOLUTIONS 2024
4.0 - ANSWER This chapter surveys the determinants of interest rates and differences among rates on
different bonds & loans
4.1 The Loanable Funds Theory - ANSWER - In the loanable funds theory, the real interest rate is
determined by the supply & demand for loans
- The demand for loans equals investment. A higher interest rate reduces the quantity of loans
demanded.
- The supply of loans equals savings plus net capital inflows. A higher interest rate raises both parts of
this sum, so it increases the quantity of loans supplied.
-The equilibrium real interest rate, r*, is the rate at which the supply & demand for loans intersect
4.2 Deteminants of Interest Rates in the Loanable Funds Theory - ANSWER - Shifts in the supply &
demand for loans cause changes in the equilibrium real interest rate. Theses shift results from changes in
investment, savings arise from changes in private savings and public savings (the budget surplus or
deficit) Net capital inflows shift because of changes in confidence and changes in foreign interest rates.
- The nominal interest rate is the equilibrium real interest rate plus expected inflation. Countries with
high inflation have high nominal interest rates.
4.3 The Liquidity Preference Theory - ANSWER -In the liquidity preference theory, the nominal interest
rate isdeteremined by the supply and demand for money.
- The supply of money is the amount created by the central bank. The demand for money is the amount
people choose to hold. A rise in the nominal interest rate reduces the quantity of money demanded.
- The equilibrium nominal interest rate, i*, is the rate at which money supply and money demand
intersect. It changes when the central bank changes the money supply, or when money demand shifts.
Shifts in money demand arise from changes in aggregate spending or changes in transaction
technologies
4.4 The Term Structure of Interest Rates - ANSWER - The term structure is the relationship among
interest rates on bonds of different maturities (terms)
-According to the expectations theory of the term structure, the interest rate on an n-period bonds is the
average of the current one-period rate and the expected rates for the next n-1 periods.
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