Exam 5: Understanding Interest Rates, Savings, and the Wealth Effect

In the loanable funds theory of interest consumer demand for credit is assumed to be relatively elastic with respect to changes in the rate of interest.

The speculative demand for money states that investors speculate when interest rates are high.

What, then is the rational expectations theory of interest rates? How does it differ from earlier interest-rate determination theories, such as The Classical, Liquidity Preference and Loanable Funds ideas?

Possible explanations for the "convergence" of market interest rates in Western Europe at the inception of the European Monetary Union (EMU) include:

The theory which argues that the risk-free interest rate is determined by the interaction of the supply of savings (coming mainly from households) and the demand for investment capital (principally from business) is known as the:

According to the Rational Expectations Theory:

Ms. Jones purchased a 20-year Treasury bond bearing a 12% coupon rate. She purchased the bond at par ($1,000). If rates fall to 9%, what will be the new price of the bond?

What are the principal limitations of the Loanable Funds Theory of Interest?

In the rational expectations theory concerning interest rates business and household decision-makers are assumed to be:

Households are savers in the economy, while businesses are not.

At low rates of interest less money is normally demanded in the economy because most investors feel bond prices must eventually rise.

Foreign demand for loanable funds is relatively insensitive to interest-rate differentials between the U.S. and the rest of the world.

The Classical theory of interest assumes that interest rates are the principal determinant of the quantity of savings and that the demand for borrowed funds comes primarily from consumers and government.

According to your text, the principal determinant of the volume of saving by households (i.e., individuals and families) is:

Interest rates on securities issued by borrowers in the economy other than the government must reflect the different types and degrees of risk that investors in those securities must assume.

Using each of the sentences or phrases listed below, indicate which key term or concept presented in this chapter goes with them: a. A theory of interest rates based upon changing views on the future behavior of interest rates and the value of financial assets. b. People may save less as interest rates rise due to expected higher rates of return. c. A saver's asset and debt position affects his or her response to changing market interest rates.

The cautionary motive for holding money arises because we live in an uncertain world and cannot predict exactly what our expenditures or even our income will be in the future.

The investment demand schedule in the classical theory of interest rates slopes downward and to the right, reflecting the declining net marginal productivity of capital as the volume of investment grows.

The demand for money is one of the most important concepts in the Liquidity Preference Theory of Interest. What are the three main components of the demand for money in this idea about how interest rates are determined?

The wealth effect