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How are interest rates decided? (Liquidity Preference Theory)

  • 13-01-2019 8:54pm
    #1
    HeathenSkeptic
    Registered Users Posts: 7 ✭


    Hello so I'm a LC Economics student and I'm having trouble understanding how the supply of money and demand for liquid funds affect interest rates.

    From my notes if demand for cash etc. remains the same while the supply of money increases then the interest rate falls, it encourages investment and discourages savings.

    But why would interest rates fall? Is it because there's more money therefore interest rates are somehow valued differently? Nothing goes into more detail than that because I'm assuming I just need to know how does the change in equilibrium affect saving and investment.

    But why would interest rates fall and vice versa depending on the money supply???
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  • #2
    Geuze
    Registered Users, Registered Users 2 Posts: 13,717 ✭✭✭✭Geuze


    HeathenSkeptic wrote: »
    Hello so I'm a LC Economics student and I'm having trouble understanding how the supply of money and demand for liquid funds affect interest rates.

    From my notes if demand for cash etc. remains the same while the supply of money increases then the interest rate falls, it encourages investment and discourages savings.

    But why would interest rates fall? Is it because there's more money therefore interest rates are somehow valued differently? Nothing goes into more detail than that because I'm assuming I just need to know how does the change in equilibrium affect saving and investment.

    But why would interest rates fall and vice versa depending on the money supply???

    Short answer:

    if there is more supply of something, its price falls

    In the KT of LP, the int rate is the price of money.


  • #3
    HeathenSkeptic
    Registered Users Posts: 7 ✭HeathenSkeptic


    Geuze wrote: »
    Short answer:

    if there is more supply of something, its price falls

    In the KT of LP, the int rate is the price of money.

    OH that makes more sense if I think of it as the price of money, thank you!


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