Suppose the nominal rate of interest in an economy is 10% and rate of inflation is 6% per annum respectively,
a)Determine the real rate of interest.
b)Discuss two factors that lead to a change in the general level of interest rate.
Suppose the nominal rate of interest in an economy is 10% and rate of inflation is 6% per annum respectively, a) Real rate of interest = Nominal rate of interest - Inflation rate = 10% - 6% = 4% b) There are different factors that influence interest rates, including inflation, taxes, and liquidity. Other factors that play a role include the state of the economy and political gains. Lowering rates before elections can influence the election outcomes. Deferred consumption, international forces, supply and demand, and other factors influence rates. Changes in the state of the economic and financial system play an important role. Two important factors are interventions by the national authorities and monetary policy. Monetary policy is one way to control economic growth and the inflows and outflows of money. Fewer consumers take out loans and mortgages when the charges are high. This limits the cash outflows and affects spending because people choose to save and have less money to spend. Then the government may choose to stimulate economic growth by reducing the rate. Consumers borrow and spend more, and the growth rate increases at a rapid pace. To avoid overheating, the government will increase the rate once again. Finally, the demand and supply of money also play an important role. Supply refers to the quantity of financial products and services available. Governments use different instruments to manipulate supply and demand, including buying significant volumes of securities, market operations, selling securities, and others.