Question

(a)discuss the general equilibrium approach to interest rate determination. (b) what effect does an increase in saving has on equilibrium interest rate and income (c) what is financial intermediation

Answer 1

A. Equilibrium approach to interest rate determination is an approach which focuses on determining the interest rate which focuses on establishing the equilibrium between the supply and demand of money. In an economy, multiple relationships exists between the main economic variables like, when the supply of money rises and the demand decreases, the equilibrium interest rates falls. The vice versa also holds true.

B. Increase in savings implies a decrease in demand of money, which as per the theory mentioned above implies a fall in interest rates (which will further decrease the interet earnings on savings which makes it less attractive and on a longer term lead to people saving lesser and thus leading to spending more, thus increasing demand for money and thus increasing interest rates). Increase in savings also implies people are spending less, leading to producers decreasing the prices to attract more buyers. Thus prices will decrease thus decreasing interest rates further.

C. Financial intermediation is any institution or individual who acts as a intermediary or a middleman to enable or facilitate any financial transaction between any 2 or more parties. Financial intermediaries are expected to be a more trust worthy party making it possible for the other parties who may or may not have sufficient trust in each other to do any financial transaction. Financial intermediaries maybe commercial banks, investment bank's, insurance companies or such established entities.