Interest Rate
The quantity theory shows that the rate of money growth determine
the rate of inflation. and the fisher equation tells us to add the real
interest rate and inflation together will determine the nominal
interest rate.
An increase in the rate of money growth of 1 per cent cause a 1 per
cent increase in the inflation rate.and a 1 per cent increase in the
rate of inflation cause a 1 per cent increase in the nominal interest
rate.
Inflation and Nominal Interest Rate
Real and Nominal Interest Rates
Real and Nominal Interest Rates
ex ante real interest rate and ex
post real interest rate
• Ex ante real interest rate: the real interest rate
the borrower and lender expect when the loan is
made
• Ex post real interest rate: the real interest rate
actually relized.
• Ex ante real interest rate: i = r + πe
• Ex post real interest rate: i = r + π
The Nominal Interest Rate and
Demand for Money
• The nominal interest rate is the opportunity cost of holding
money
• comparing the real returns on alternative asset such as
bond
• Demand for money depends on the price of holding money
• Hence, demand for real money depends on both the level
of income and the nominal interest rate.
• General money demand function:
The Nominal Interest Rate and
Demand for Money
• Money demand fuction: