Financial investment and interest rates have a positive relationship. Financial investment represents investment in bonds or shares or money saving in the bank. If the interest rate increases, the return of investment will be better. You will get more return on shares (or bonds) and earn more money on savings. In conclusion, the higher the interest rate, the higher the financial investment. The South African economy continues to grow. The Gross Domestic Product has been on a steady increase on an annual basis, since 1998 (SARB, 2007: S-148). In 1998, the rate of growth was 0,5 % (the lowest in the last decade). In 2006, it was 5,0%. The private sector capital formation (investment) has increased gradually since 1998 (at 4,8%), except for the year 1999 when we observe a negative growth: -7,6%. In 2006, the growth exceeded 12% (SARB, 2007: S-148, S-114-120). The private sector employment declined until 2001. However, since this year, we can observe a change in the trend with a growth of employment rates to reach exceptional figures last year (SARB, 2007: S-132, S-152).
[...] The possible causes for the increase in the interest rate could be: To decrease the supply of money Make the cost of credit more expensive To lower inflation More consumer spending Less consumer savings Greater demand for cash Lower demand for investment Interest rate below money market equilibrium Reserve bank have difficulty in selling of government stock Increase in bank rate means increase in interest rate The Keynesian transmission mechanism Reserve bank lowers repo rate = banks borrow more from RB = money supply increases = portfolios have excess cash = investors buy money market securities = price of securities increases = interest rates decrease = investment increases = aggregate demand increases = inventories decrease = production increases i i Ms Md Money I E C+I1+G+X-M C+I0+G+X-M I1 IO Y The impact of government borrowing on interest rates Government borrowing (to finance budget deficits or increase expenditure) creates the “crowding effect on private investment, because in effect it pushes up the demand for money and that in turn pushes up interests rates (Fourie 2001:56). [...]
[...] If Y increases, (economy is in an upswing and economic activity increases) more goods are produced and exchanged, and more money is required to conclude transactions, which results in an increased demand for money. Effect of Increase in Income For a decrease in MD will decrease, and curve will move to the left. A decrease in the average price will require less money to conduct transactions, which will lead to a decrease in money demand. Effect of decrease in Price The credit multiplier Total reserve R = 3,5 + 3,5 = = 0.07 Credit multiplier = 1/R = 0.07 = 14.285714 = 14.3 The prime rate The lowest rate at which a clearing bank will lend money to its clients on overdraft is called the prime rate. [...]
[...] You will get more return on shares (or bonds) and earn more money on savings. To conclude, it is obvious that the higher the interest rate, the higher the financial investment will be. A reduction in the government expenditure G decreases ( E decreases ( stocks increase ( discourages production ( GDP and Y decrease. Graphically: Expenditure C + I0 + G0 C + I0 + G1 G0 G1 I0 Y1 Y0 Income A reduction in the exports X decreases ( decreases ( Total expenditure decreases ( discourages production ( GDP and Y decrease. [...]
[...] GDP and Capital Formation The money demand MD = f [interest rate Income Price - + + The amount of money people require for transactions, determines the total demand for money. There are 3 types of demand, or reasons for holding money namely: Transactions demand: - where money is in active form for transactions - amount of transactions are determined by Y and P. more transactions more money required>> MD curve moves to the right. Positive relationship between Y and MD. [...]
[...] The repo rate decreased from 2002 until 2005 from to which resulted in the prime rate deceasing from 17% in 2002 to in 2005.The decrease in the bank rate resulted in an increase in money supply and downward pressure on the interest rate. This indicates an inverse or negative relationship between money supply and the interest rates. However in 2006 the repo rate again started to increase from to which in turn the prime rate increased in accordance with the repo rate from to 12.5 %.The increase in repo rate happened due to various risks (oil price, consumer spending etc.) which was identified by the Monetary Policy Committee which could have resulted in a further deterioration in the inflation rate, if not increased. [...]
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