What determines interest rate? Flashcards
1
Q
what is Loanable funds theory ?
A
- real interest rates are determined by the supply and demand for loans
- The theory assumes only one type of loan and one interest rate; it ignores the diversity of rates illustrated
- The theory also assumes that savers lend directly to investors, which ignores the role of bank
2
Q
what is Capital inflows?
A
- funds provided to a country’s investors by foreigners
3
Q
what is Capital outflows ?
A
- Funds provided to foreign investors by a country’s savers
4
Q
Net capital inflows :
A
capital inflows minus capital outflows
5
Q
Private saving :
A
- saving by individuals and firms
6
Q
Public saving :
A
- saving by the government (tax revenue minus government spending)
7
Q
Budget surplus :
A
- a positive level of public saving
8
Q
Budget deficit :
A
- a negative level of public saving
9
Q
what affects have a higher real interest rate in the demand for loans ?
A
- A higher real interest rate makes investment more costly, so fewer projects are undertaken. Lower investment means that investors want fewer loans.
10
Q
Effects on the supply of loans, if the interest rate increase:
A
- higher returns to saver
- higher interest rate encourages people to save more
- decreases capital outflows.
11
Q
the equilibrium real interest rate, r*:
A
- it is the interest rate at which the supply and demand curves intersect.
12
Q
what happens when there is an excess of supply of loans?
A
- it means that the interest rate is higher than the equilibrium
- Not all lenders can find borrowers
- In this situation, lenders should offer lower interest rates to attract borrowers, pushing rates down
13
Q
what happens when there is an excess of demand for loans?
A
- it means that the interest rate is lower than the equilibrium
- not all borrowers can find lenders
- borrowers offer higher rates to attract lenders, pushing rates up
14
Q
Meaning of Budget surplus:
A
- a positive level of public saving
15
Q
Meaning of Budget deficit:
A
- a negative level of public saving
16
Q
what is Capital Flight ?
A
- sudden decrease in net capital inflows that occurs when foreign savers lose confidence in an economy
17
Q
Two categories of saving :
A
- Private Saving
- Public Saving
18
Q
Why might capital flows shift?
A
- Changes in Confidence
- Foreign Interest Rates
19
Q
How Foreign Interest Rates affected local interest rate ?
A
- interest rates in different countries are connected
- they tend to move in the same direction An event that raises the interest rate in one country, such as a higher budget deficit, reduces net capital inflows to other countries. The supply of loans falls in the other countries, so their interest rates rise too.
20
Q
Fisher equation : (formula)
A
- the nominal interest rate equals the real rate plus expected inflation:
I= r + pie
- “r” is the real interest rate
- “i” is the nominal rate
- “pie” is expected inflation
21
Q
Theory of Adaptive expectations: definition and formula
A
- theory that people’s expectations of a variable are based on past levels of the variable; also, backward looking expectations.
pie = pi-1
- “pie“ mean expected inflation
- “pi-1“ mean inflation of the last year
22
Q
Liquidity preference theory:
A
- the nominal interest rate is determined by the supply and demand for money
23
Q
the key simplifying assumption that only two kinds of assets exist: (liquidity preference theory)
A
- Money
the medium of exchange
People use money to purchase goods and services
they can’t use bonds.
- Bonds
It pay interest but money does not
24
Q
what is money supply ?
A
The money supply is the total amount of money in the economy.
25
what is money demand ?
Money demand is the amount of wealth that people choose to hold in the form of money.
26
The equilibrium interest rate :
-Money demand and Money supply
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27
Liquidity Preference Theory: Factors That Can Change the Nominal Interest Rate
* -Shifts in Money Supply
- Decisions by the central bank
* -Shifts in Money Demand
- Changes in aggregate spending
- Changes in transaction technologies
28
Nominal GDP formula: (total spending)
* An economy’s total spending:
**nominal GDP = real GDP x aggregate price level**
29
Increase in nominal GDP (aggregate spending)
* Rise in real GDP (economic growth)
* Rise in the price level (inflation).
* In either case, higher spending shifts money demand to the right, raising the equilibrium interest rate
30
transaction technologies effects in Nominal GDP
* the methods that people use to obtain money and spend it.
* Transaction technologies evolve over time, changing the amount of money that people wish to hold.
31
Factors That Explain Differences Among Interest Rates
- Maturity (term)
- Default risk
- Liquidity
- Taxation
32
what is "Term structure of interest rates"?
* Relationships among interest rates on bonds with different maturities
33
Expectations theory of the term structure
* the "n" period interest rate is the average of the current one-period rate and expected rates over the next n - 1 periods
34
Expectations Theory of the term structure (formula)
**![]()in(t) = 1/n . [i1 (t) + Ei1 . (t + 1) + ... + Ei1 . (t + n - 1)]**
* **E** means **“expected.”**
* **"in(t)"** be the **interest rate** on an n-period bond in period t
* **"n"** stand for **maturity**
* **"t"** stand for **term** (period of loan - the year)
35
what is Term premium (t) ?
* It is a extra return on a long-term bond that compensates for its riskiness;
* **tn** denotes the term premium on an "n" period bond
36
The Expectation Theory with a Term Premium (formula)
![]()
**in(t) = 1/n . [i1 (t) + Ei1 (t + 1) +. . .+ Ei1 (t + n - 1)] + *_r_***
* **"E"** means**“expected.”**
* **"in(t)"**be theinterest rateon an n-period bond in period t
* **"n"** stand for **maturity**
* **"t"** stand for **term** (period of loan - the year)
* **"r"** stand for **Premiun**
37
what is the meaing of "Yield curve" ?
* it is a progressive line in a graph that compare interest rates on bonds of various maturities at a given point in time
38
Equation Yields: formula
**![]()in (t) = i1 (t) + rn**
* **"in(t)"** be the **interest rate on an "n" period bond in period t**
* **"n"** stand for **maturity in _year_**
* **"t"** stand for **term** (period of loan - the year)
* **"r"** stand for **Premiun**
39
Inverted yield curve:
* downward-sloping yield curve signifying that short- term interest rates exceed long-term rates
40
How is posible to forecast Interest Rates ?
- The expected path of interest rates determines the shape of the yield curve
- the yield curve tells us about the expected path of rates
- so the _inverse of the yield help to forecast the interest rate._
41
Sovereign debt:
* bonds issued by national governments
42
what are the Bond-rating agencies?
* firms that estimate default risk on bonds
- Rating agencies summarize their judgments with a grade for each coun- try’s debt.
For example, Standard & Poor’s gives ratings from AAA (triple A, the highest) to D (the lowest).
- Sometimes a plus or minus is added to the letter grade
43
Sovereign Debt Ratings: (example 2010)
44
what is consider junk bond ?
* corporate bond with an S&P rating _below BBB_
45
what is "High-yield spread:"?
* difference between interest rates on BBB and AAA corporate bonds with 10-year maturities
46
Municipal bonds:
bonds issued by state and local governments
