The Relationship between the Real Interest Rate and Spending on Durable

Goods When the real interest rate increases, spending on durable goods decreases. From Spending on Durable Goods to Real GDP Look again at Figure 10.2 “The Monetary Transmission Mechanism”. We have so far explored the links from the Fed’s decision on a target to spending on durable goods and net exports. Now we examine how changes in spending affect total output in the economy. The aggregate expenditure model allows us to see how changes in aggregate spending translate into changes in GDP, at a given price level. The idea underlying the aggregate expenditure model is that, by the rules of national income accounting, real GDP must equal both production and spending. If spending increases, then it must be the case that production increases as well. The key diagram of the aggregate expenditure model is shown in Figure 10.8 “Aggregate Spending Depends Positively on Income”. Variations in the real interest rate influence the level of aggregate spending through the level of autonomous spending (the intercept term). To see why, recall that total spending is the sum of consumption, investment, government purchases, and net exports. The intercept term of the expenditure relationship includes all the influences on spendingother than output. Thus any changes in consumption, investment, or net exports that arenot induced by changes in output show up as changes in the intercept term. In particular, if an increase in interest rates causes firms to cut back on their investment spending, then the planned spending line shifts downward.

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