A New Interpretation of the Mechanism for the Determination of Interest Rate and Its Policy Implications

19 Pages Posted: 23 Aug 2015

See all articles by Wenge Huang

Wenge Huang

Independent

Jinsong Zhang

Southwestern University of Finance and Economics (SWUFE)

Date Written: June 30, 2015

Abstract

This paper first indicates that saving equals to the liquidity preference plus the supply of loanable funds and the liquidity preference is just opposite to the supply of loanable funds. Meanwhile, the paper proposes a new model in which interest rate is determined by the investment demand curve and the symmetrical curve of the liquidity preference curve about Y axis. On such basis, the paper notes that the existence of liquidity preference makes effective demand always deficient. Thus market failure becomes the norm and the government is obliged to take aim at the interest rate which is determined by the desired investment and desired saving. So far the paper has thoroughly clarified how interest rate is determined and constructed a new and compact macroeconomic analytical framework. Further, the paper attempts to discuss the new model’s inspiration to Taylor rule and other deductions brought by the new model.

Keywords: liquidity preference, supply of loanable funds, saving, determination of interest rate, insufficient effective demand

JEL Classification: E12, E43, E52

Suggested Citation

Huang, Wenge and Zhang, Jinsong, A New Interpretation of the Mechanism for the Determination of Interest Rate and Its Policy Implications (June 30, 2015). Available at SSRN: https://ssrn.com/abstract=2647825 or http://dx.doi.org/10.2139/ssrn.2647825

Wenge Huang (Contact Author)

Independent ( email )

No Address Available

Jinsong Zhang

Southwestern University of Finance and Economics (SWUFE) ( email )

55 Guanghuacun St,
Chengdu, Sichuan 610074
China

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