Encyclonomic WEB*pedia: INTEREST RATES, AGGREGATE EXPENDITURES DETERMINANT

INTEREST RATES, AGGREGATE EXPENDITURES DETERMINANT:
One of several specific aggregate expenditures determinants assumed constant when the aggregate expenditures line is constructed, and that shifts the aggregate expenditures line when it changes. A decrease in interest rates cause an increase (upward shift) of the aggregate expenditures line. An increase in interest rates cause a decrease (downward shift) of the aggregate expenditures line. Other notable aggregate expenditures determinants include consumer confidence, federal deficit, inflationary expectations, and exchange rates.
Interest rates are the annual charge for borrowing funds, usually specified as a percent of the amount borrowed. Changes in interest rates affect the overall expense of borrowing and thus expenditures undertaken with the borrowed funds. Higher interest rates tend to decrease expenditures and lower interest rates lead to an increase expenditures.
Most investment expenditures by the business sector and a fair amount of consumption expenditures by the household sector (especially for durable goods) are made with borrowed funds and are thus affected by changes in interest rates.
Businesses typically borrow the funds needed for capital goods, such as factories and equipment.

Households often borrow the funds used to buy durable goods, such as cars and furniture.
The expense of borrowing these funds depends on interest rates. Higher interest rates add to the overall cost of these expenditures. Lower interest rates reduce the overall cost of these expenditures. This means that changes in interest rates trigger changes in consumption expenditures and investment expenditures, and thus aggregate expenditures.
What It Does
Interest Rates

The exhibit to the right presents a standard Keynesian aggregate expenditures line. Like all aggregate expenditures lines, this one is constructed based on several ceteris paribus aggregate expenditures determinants, such as interest rates. They key question is: What happens to this aggregate expenditures line if interest rates change?
Lower Interest Rates
Suppose, for example, that the Federal Reserve System decides to implement expansionary monetary policy. Fearing an impending recession on the business-cycle horizon, they decide to expand the money supply with a corresponding decrease in interest rates.
A decline in interest rates can entice the business sector to boost investment expenditures. For example, a 1 percentage point interest rate decline (such as from 10 percent to 9 percent) can reduce the total interest cost on a $10 million construction loan by $300,000 over a five-year repayment period. This saving is bound to convince a few firms to undertake extra investment expenditures.
While the numbers might be smaller, a decline in interest rates is also likely to entice the household sector to boost consumption expenditures on durable goods. For example, a 1 percentage point interest rate decline can reduce the total interest cost on a $20,000 car loan by $6,000 over a five-year repayment period. This reduction in cost is also bound to convince a few households to make extra consumption expenditures.
To see how lower interest rates affect the aggregate expenditures line, click the [Lower Rates] button. The lower rates trigger an increase in aggregate expenditures, which is an upward shift of the aggregate expenditures line.
Higher Interest Rates
Alternatively, the Federal Reserve System might decide to implement contractionary monetary policy. Fearing the onset of higher inflation, the folks at the Fed might decide to reduce the money supply and subsequently increase interest rates. Higher interest rates have the opposite effect on both business investment and household consumption as lower rates. The interest cost of constructing a new factory is higher. So too is the interest expense of buying a new car.
To see how higher interest rates affect the aggregate expenditures line, click the [Higher Rates] button. The higher rates trigger a decrease in aggregate expenditures, which is a downward shift of the aggregate expenditures line.
What Does It Mean?
Changes in aggregate expenditures due to interest rates are important for a couple of reasons.
Business Cycle: Interest rates tend to rise and fall over the expansions and contractions of the business cycle. During an expansion, especially near the end of the expansion, interest rates tend to rise. Then once a contraction sets it, interest rates tend to fall. In fact, these interest rate changes are part of the "natural" business cycle mechanism. Higher interest rates during an expansion cause the decline in aggregate expenditures that result in a contraction. Lower interest rates during a contraction then cause the rise in aggregate expenditures that result in an expansion.

Monetary Policy: Interest rates are also affected by monetary policy that is designed to counter business-cycle instability. Expansionary monetary policy involves lower interest rates intended to increase aggregate expenditures and offset a contraction and address the problems of unemployment. Contractionary monetary policy involves higher interest rates intended to decrease aggregate expenditures and offset an expansion and address the problems of inflation.
Check Out These Related Terms...
     | aggregate expenditures determinants | consumer confidence, aggregate expenditures determinant | federal deficit, aggregate expenditures determinant | inflationary expectations, aggregate expenditures determinant | exchange rates, aggregate expenditures determinant | physical wealth, aggregate expenditures determinant | financial wealth, aggregate expenditures determinant | change in aggregate expenditures | change in aggregate demand | slope, aggregate expenditures line | intercept, aggregate expenditures line |
Or For A Little Background...
     | aggregate expenditures | aggregate expenditures line | determinants | gross domestic product | consumption expenditures | investment expenditures | government purchases | net exports | Keynesian economics | effective demand | psychological law |
And For Further Study...
     | aggregate market analysis | business cycles | circular flow | monetary economics | interest rates, aggregate demand determinant | buyers' preferences, demand determinant | Keynesian model | Keynesian equilibrium | injections-leakages model | aggregate demand | fiscal policy | multiplier | interest-rate effect |
Recommended Citation:
     INTEREST RATES, AGGREGATE EXPENDITURES DETERMINANT, AmosWEB Encyclonomic WEB*pedia, http://www.AmosWEB.com, AmosWEB LLC, 2000-2025. [Accessed: December 15, 2025].