To conclude, the modern theory of interest maintains that the determinants of the rate of interest along with the level of income are – (a) saving function, (b) investment function, (c) liquidity preference function, and (d) the quantity of money. According to Modern Theory of Interest, there are four determinants of the rate of interest. These are the savings, investment, liquidity preference, and money supply. To get a satisfactory explanation to the rate of interest, the modern theory involved two curves, namely, IS curve and LM curve. The IS curve shows the equilibrium in the real sector while the LM curve represents the equilibrium in the monetary sector. The point of intersection of the two curves, namely, IS and LM gives us the Criticisms of the Modern Theory of Interest : 1. Static Theory. It is a static theory that explains the short-run behaviour of the economy. Thus it fails to explain how the economy behaves in 2. Interest Rate not Flexible. The theory is based on the assumption that the interest rate is flexible In expounding the modern theory of interest, Professor Hansen, in his Monetary Theory and Fiscal Policy, points out that there are four determinants of the rate of interest: 1. The investment demand schedule; 2. The consumption function; Further, this theory was elaborated by Ohlin, Roberson, Pigou and other new-classical economists. This theory is an attempt to improve upon the classical theory of Interest. According to this theory, the rate of Interest is the price of credit which is determined by the demand and supply for loanable funds. In the words of Prof. Lerner: The classical theory of the rate of interest seems to suppose that, if the demand curve for capital shifts or if the curve relating the rate of interest to the amounts saved out of a given income shifts or if both these curves shift, the new rate of interest will be given by the point of intersection of the new positions of the two curves.
20 Aug 2019 But government borrowing has an effect of increasing the cost of borrowing or the interest rate paid by individuals and businesses. MMT takes the interest rate (with the interest rate being the opportunity cost of holding money). But G-S point out that in a modern economy, most money is interest bearing (e.g.
The classical theory of the rate of interest seems to suppose that, if the demand curve for capital shifts or if the curve relating the rate of interest to the amounts saved out of a given income shifts or if both these curves shift, the new rate of interest will be given by the point of intersection of the new positions of the two curves. The Classical Theory Of Interest Rate As the classical thesis, rate of interest is ascertained by the supply of and demand for capital. The supply of capital is administered by the time preference and output of capital is based on savings, waiting or thrift.