"Higher interest rates lower equilibrium real GDP and thus slow the rate of economic growth." Critique...

"Higher interest rates lower equilibrium real GDP and thus slow the rate of economic growth." Critique (and explain the underlying basis for) this quote noting whether it is true all of the time or only some of the time.

Expert Solution

The underlined link of the above quotation is as follows:

Higher interest rates leads to a decrease in the investment spending in the economy. This is because as the interest rates become higher the cost of borrowing to invest increases. This discourages investment spending in the economy.

Decrease in investment spending due to higher interest rates leads to a decrease in the aggregate demand as well. Decrease in aggregate demand leads to a decrease in level of output in the economy and Thus a Decrease in the equilibrium real GDP. The rate of economic growth decelerates.

Hence, it is true that higher interest rates lower equilibrium real GDP and thus, slow the rate of economic growth.

However it should be noted that it is not true all the time. One situation which defies this argument is when the investment spending is completely insensitive to the changes in the rate of interest. In this situation higher interest rate would not lead to a decrease in the investment spending as the investment spending is insensitive to the changes in interest rates.

Hence, the above given quotation is not true for all the time.

Rahul Sunny answered 2 years ago

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