Question

Suppose that changes in nominal interest rate have a negligible effect on velocity of money. Then, if risk premium of a country increases, what happens to consumption, investment and net exports in short run? How does price level change from short run to new long run? Explain.

Answer 1

Changes in nominal interest rate have a negligible effect on the velocity of money after this the risk premium of a country increases then the effect on consumption investment and net exports in the short run are as follows.
Changes in the nominal interest rate is both positive or negative positive effect means the rise in in the nominal interest rate but under the control of the investment policies so that it is easy for the Businessman to invest in different project according to the requirement so a nominal increase is a good policy to control excess investment or the productivity or of the business activities.
It does not affect the velocity of the money in a broader sense the availability of money in Access will create a problem of inflationary situation in the economy but the economy must consider that investment is much more important than the savings so that’s the only reason time to time bank will follow the policy of rise in nominal interest rate and to control the inflation Central Bank will follow the different monetary and fiscal policies in the economy
Defect on consumption and the investment is positive or may be negative with the nominal rise in interest rate will little bit reduce the investment and if the investment will decrease then the production will decrease and ultimately the supply in the market is also decreases and this ultimately affected the demand of the economy so that the consumption will goes down.
The effect on net export is also positive or negative but in a broader sense the rise in nominal interest rate will also little bit decreases the net export of the country because of the decrease in the production
The price level changes from short run to long run in the following sense. Sometimes it will increases the prices of a commodity is both in the short run and in the long run.