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Unformatted text preview: Each of the variables in the output equation is tied to the interest rate. Consumption tends to fall as the interest rate rises because the incentive for saving increases. Investment tends to fall as the interest rate rises because the cost of borrowing money increases. Government spending is not really affected by the interest rate. Net exports tend to rise as interest rates rise because domestic investment is relatively more attractive to both domestic and foreign investors. When monetary policy and fiscal policy are used the interest rate is affected. Expansionary monetary policy directly lowers the interest rate by making money easier and cheaper to obtain. Contractionary monetary policy directly raises the interest rate by making money harder and more expensive to obtain. Expansionary fiscal policy increases the interest rate by decreasing the savings rate through lower taxes and...
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- Fall '10