Models of Determination of Interest Rates Essay

Models of Determination of Interest Rates Essay

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The Interest Rate (IR) is considered as one of the most important economic factors affecting every household, firm and government all over the world. It is, as described by Parkin et al (2005), the opportunity cost of holding money, that is, the price of borrower are willing to pay for the use of the loan. On the other hand, it is also the compensation to the risk that lenders take in lending the money. (, n.a. 2003) By lenders and borrowers, it refers to individuals, businesses, financial instruments and governments. IR can be also categorised into nominal IR that is the stated one on financial market and real IR that implies the return of investment in terms of value. IR is said to be an indicator of economy situation and reflection of government policy as well. Therefore fluctuations of IR would have great impact on different areas in the economy and it is crucial to understand what determines it and how it would affect the world.

This paper presents a general analysis of models of determinations s of interest rate, which are relevant to the UK economy. Thereafter, the effects of changes in IR to the economy growth will be examined. Then a conclusion will be drawn to generate the key points the paper has mentioned.

Out of all, state of economy is the fundamental parameters of IR. (Toews, 2006) when an economy experiences a growth period, IR is decreased to stimulate the amount of money circulating in the market. Conversely, IR is relatively high when a stagnation or recession occurs.

Figure 1 illustrates the relationship between real GDP which represents the economic grow and IR over 40 years in the UK. In the late 1980s the UK experiencing a huge stagnation period and from the figure the IR was hig...

... middle of paper ... are beyond the scope of the essay to discuss.


Heakal R, (November 12, 2003). , Investopedia Inc. Retrieved April 8, 2006, from

< How do interest rates affect inflation? >, (n.d.). Bank of England. Retrieved 4 April, 2006, from

, (n.d.). Revision Retrieved 5 April, 2006, from

, (n.d.). WebFinance Inc. Retrieved 4 April, 2006, from

Parkin, M., Powell M., Matthews K, (2005). Addison-Wesley, pp 604 606

Toews, B. (n.d.). < Chapter 2 Assignment, Determination of Interest Rates>, retrieved 6 April, 2006, from

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