Name : NOOR-ANNA H.

SALIAN Date: MAY 06, 2025

Topic: DETERMINATION OF INTEREST RATES

SUMMARY SHEET

1. What is the topic about?

The topic is about the determination of interest rates. Interest rates
are the cost of borrowing money or the return on lending money. They
represent the percentage charged by a lender to a borrower for the use of
assets. These assets can range from money lent to individuals or
businesses to large-scale investments made by governments or
corporations. Interest rates are a fundamental element of financial markets,
influencing borrowing, saving, and investment decisions across the
economy.

2. What new information did you learn from the topic? Include new terms
and their meanings.

After reading the lesson given, there is a lot of new information that I
learned from the topic. It includes the following terms:

● Real Interest Rate: This is the interest rate adjusted for the
effects of inflation. It reflects the true purchasing power return on an
investment, revealing the actual increase in your ability to buy goods and
services. The formula is often approximated as: Real Interest Rate ≈
Nominal Interest Rate - Inflation Rate.

● Nominal Interest Rate: This is the stated or quoted interest rate,

the number you actually see on a loan agreement or investment prospectus.
It does not account for inflation, potentially misleading if inflation is high.

● Demand for Loanable Funds: This represents the total demand for
borrowing at different interest rates. Businesses borrow to fund investments,
and consumers borrow for purchases like homes and cars. As interest rates
fall, the quantity demanded increases.

● Supply of Loanable Funds: This refers to the total amount of

savings available for lending at different interest rates. Households save for
retirement, and businesses save excess cash. As interest rates rise, the
quantity supplied increases (incentivizing saving).
3. Which of the new information is most significant to you? Why?
The most significant new information remains the distinction between
real and nominal interest rates. The nominal interest rate is the stated rate,
the number prominently displayed on loan agreements and investment
brochures. However, this figure can be deceptive, especially during periods
of high inflation. Inflation erodes the purchasing power of money; therefore,
the real interest rate provides a more accurate picture of the investment's
true return. This is calculated by removing the impact of inflation from the
nominal interest rate, and its value reflects the actual increase in your ability
to buy goods and services. Understanding this crucial difference between
nominal and real interest rates allows for making more accurate financial
projections and sound investment strategies. Ignoring this distinction can
lead to poor financial decisions, as one might believe they are earning a
higher return than they actually are.

○POINT COUNTER-POINT

The counter-point, arguing that large fiscal deficits lead to higher

interest rates, is generally more accurate than the point suggesting no
relationship. While 2008 presented an anomaly with low interest rates
despite a large deficit (due to extraordinary circumstances like the global
financial crisis and central bank actions), the counter-point's logic holds true
under normal economic conditions.

When the government borrows heavily, it increases demand for

loanable funds. This increased demand, in a market with a relatively fixed
supply of funds, pushes interest rates upward. Essentially, the
government's borrowing "crowds out" private sector borrowing, forcing
businesses and individuals to compete for the remaining funds at higher
prices (interest rates).
 The 2008 example is a specific case driven by exceptional
circumstances. Central banks globally slashed interest rates to stimulate
the economy during the crisis, overriding the usual upward pressure from a
large deficit. This exception doesn't negate the general principle that
increased government borrowing, in most cases, contributes to higher
interest rates. The counter-point accurately reflects this fundamental
economic relationship.

1. Interest Rate Movements: Interest rates are influenced by various

factors, including inflation, economic growth, and monetary policy. To
explain the changes over the past year, we need to consider the specific
economic climate. Let's assume the past year saw moderate economic
growth and a slight increase in inflation. Central banks, to combat inflation,
might have raised interest rates to curb borrowing and spending. This would
explain an upward trend in interest rates. Conversely, if economic growth
slowed or inflation decreased, interest rates might have been lowered to
stimulate the economy.

2. Interest Elasticity: Interest elasticity measures the responsiveness of

demand to changes in interest rates. A high interest elasticity means
demand is very sensitive to interest rate changes; a low elasticity means it's
less sensitive. The federal government's demand for loanable funds is likely
less interest-elastic than household demand. This is because the
government's borrowing is often driven by essential spending (defense,
social security), making it less sensitive to interest rate fluctuations
compared to household borrowing for discretionary items (cars, homes),
which can be easily postponed if interest rates rise.
3. Impact of Government Spending: Expanding the space program would
increase government spending, leading to a higher demand for loanable
funds. This increased demand, assuming a relatively stable supply of funds,
would put upward pressure on interest rates, making borrowing more
expensive for both the government and the private sector.

4. Impact of a Recession: During recessions, economic activity slows,

reducing demand for loanable funds. Businesses invest less, and consumers
borrow less. This decreased demand, coupled with potentially expansionary
monetary policy by central banks (lowering interest rates to stimulate the
economy), leads to lower interest rates. Historically, interest rates have
generally fallen during recessions.

5. Impact of the Economy: The expected interest rate in one year

depends on anticipated economic growth and inflation. Higher expected
economic growth usually leads to higher expected interest rates (increased
demand for funds). Higher expected inflation also leads to higher expected
interest rates, as lenders demand higher returns to compensate for the
erosion of purchasing power caused by inflation.

6. Impact of the Money Supply: Increasing money supply growth

generally puts downward pressure on interest rates. An increased money
supply increases the overall amount of funds available for lending,
increasing the supply of loanable funds. With a higher supply and relatively
stable demand, the price of borrowing (interest rates) tends to fall.
PROCESSING OF UNDERSTANDING

SUPPLY AND DEMAND INFLATION’S ROLE

Nominal interest rates, unadjusted
Interest rates balance the supply for inflation, reflect the stated loan
and demand for loanable funds. or investment rate. Inflation
Higher rates incentivize saving reduces purchasing power, so
(increasing supply), while lower lenders demand higher nominal
rates stimulate borrowing rates to offset this loss, creating a
(increasing demand). Equilibrium positive correlation between
occurs where supply equals expected inflation and nominal
demand. Above equilibrium, a rates. The real interest rate,
surplus lowers rates; below, a adjusted for inflation, represents
shortage raises them. This the actual return or cost. If
dynamic interplay of saving and inflation exceeds expectations, real
borrowing determines the rates fall, benefiting borrowers; if
market's equilibrium interest inflation is lower than expected,
real rates rise, favouring lenders.

MONETARY POLICY’S INFLUENCE ECONOMIC GROWTH IMPACT

Central banks manipulate interest Economic growth and interest rates
rates and the money supply via generally share a positive, yet
open market operations complex, relationship. Strong
(buying/selling government growth boosts demand for loans,
bonds), reserve requirements increasing interest rates as
(adjusting the percentage banks borrowers compete for limited
must hold), and the discount rate funds. Conversely, slower growth
(the rate at which banks borrow reduces borrowing demand,
from the central bank). Lowering causing rates to fall. However, this
rates stimulates borrowing and relationship is affected by inflation
economic growth, potentially (central banks may raise rates to
increasing inflation, while raising combat it), the supply of savings,
rates curtails inflation but may and global economic factors.
slow growth and increase Therefore, while growth typically
unemployment. The effectiveness pushes rates up, other forces can
of these tools depends on various influence the outcome.