ECON1102 Lecture Notes - Lecture 3: Gross Fixed Capital Formation, Nominal Interest Rate, Real Interest Rate
18 May 2018
School
Department
Course
Professor
3 – Interest Rates, Investment and Saving
Interest Rates
Nominal interest rate – measures return on loan in terms of money
Real interest rate – measures return on loan in terms of goods and services
• i.e. adjusting for inflation (CPI)
Approximation: real rate ≈ oial rate – inflation rate
• r ≈ i – π
Expected real rate (and inflation rate) is what matters for economic decisions
• Ex-post: r ≈ i – π
• Expected: r ≈ i – πe
Fisher Effect:
• Assume the real interest rate is a constant
• Fisher effect implies that nominal interest rate will move one-for-one with changes
in expected inflation
Negative nominal interest rates:
• Nominal interest rates were thought to be subject to zero lower bound (ZLB)
• i.e. r = – πe
• Recent evidence indicates the possibility of negative nominal interest rates
Investment
Investment: Purchase of new capital goods (used in the production of future goods and
services)
• Private gross fixed capital formation
Private business investment
Dwelling construction
• Inventory investment
• Public investment
Investment and capital stock
• Investment is a flow variable
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2
• Accumulation over time gives capital stock
Economics influences on investment
• Compare:
Value of marginal product of capital (VMPK) – benefit
User cost of capital (UC) – cost
• VMPK = MPK x p
Other things equal, the marginal product of capital (MPK) is the increase in
output due to the use of an additional unit of capital
Where p = sales prie of usiness’ output
• Two important influences on user cost of capital:
1. Price of capital goods
2. Real interest rate
Other things equal, a rise in real interest rate will make investment less attractive
Other things equal, a rise in the price of capital goods will make investment less
attractive
• Cost v Benefits
Benefit of new capital is the value of additional output it provides
Cost is given by user cost of capital: VMPK ≥ UC is favourable
Investment and the real interest rate
• Other things equal, an increase in the real interest rate will cause an increase in user
cost and this will make less capital investments worthwhile
• Implies a negative relationship between investment and the real interest rate
• Can generally write: I = I r; ∂, MPK
• Investment demand schedule:
Shift to right = more optimistic, increase in MPK
find more resources at oneclass.com
find more resources at oneclass.com
Document Summary
Interest rates r i i. e. adjusting for inflation (cpi) Nominal interest rate measures return on loan in terms of money. Real interest rate measures return on loan in terms of goods and services. Approximation: real rate (cid:374)o(cid:373)i(cid:374)al rate inflation rate. Expected real rate (and inflation rate) is what matters for economic decisions: ex-post: r i , expected: r i e. Fisher effect: assume the real interest rate is a constant, fisher effect implies that nominal interest rate will move one-for-one with changes in expected inflation. Negative nominal interest rates: nominal interest rates were thought to be subject to zero lower bound (zlb, recent evidence indicates the possibility of negative nominal interest rates i. e. r = e. Investment: purchase of new capital goods (used in the production of future goods and services: private gross fixed capital formation. Investment is a flow variable: accumulation over time gives capital stock. Value of marginal product of capital (vmpk) benefit.
