Answer to Question #169203 in Macroeconomics for Z

Question

Explain how the interest rate works in the classical system to stabilize aggregate demand in the face of autonomous changes in components of aggregate demand such as investment or government spending.  

Answer 1

Solution:

In the classical system, when interest rates rise, it becomes more expensive to borrow money. As a result, there is a decrease in economic activity such as consumer expenditures and capital investment. Therefore, the aggregate demand will decrease.

On the other hand, when interest rates fall, it becomes cheaper to borrow money, which can be used in consumer purchases and capital investment resulting in an increase in economic activity. Therefore, aggregate demand will rise.