9.4.8—Interest rate determination

An interest rate is the price of borrowing or the return to saving. In a money-market model it is determined where money demand meets the available money supply; in a loanable-funds model it balances saving and borrowing demand.

State the model before explaining a shift. A larger money supply can lower the equilibrium rate in a simple liquidity model, while higher investment demand or lower saving can raise the rate in a loanable-funds model.

If the central bank supplies more liquid balances and money demand is unchanged, the market rate may fall, encouraging borrowing; if confidence simultaneously raises investment demand, the net movement is less clear.

“The interest rate” is not one universal number, and the policy rate, market yields and loan rates can differ.