Keynes effect
Encyclopedia
The Keynes effect is a term used in economics
to describe a situation where a change in interest rate
s affects expenditure more than it affects savings.
As price
s fall, a given nominal amount of money will become a larger real amount. As a result the interest rate will fall and investment demanded rise.
This means that insufficient demand in the product market cannot exist forever.
There are two cases in which the Keynes effect does not occur: in the liquidity trap
(when the LM curve is horizontal), or when expenditure is inelastic with respect to interest rates (when the IS curve is vertical). The Patinkin-Pigou real balance effect
shows that due to wealth effects of changes in price level, insufficient demand cannot persist even in the two cases above.
Economics
Economics is the social science that analyzes the production, distribution, and consumption of goods and services. The term economics comes from the Ancient Greek from + , hence "rules of the house"...
to describe a situation where a change in interest rate
Interest rate
An interest rate is the rate at which interest is paid by a borrower for the use of money that they borrow from a lender. For example, a small company borrows capital from a bank to buy new assets for their business, and in return the lender receives interest at a predetermined interest rate for...
s affects expenditure more than it affects savings.
As price
Price
-Definition:In ordinary usage, price is the quantity of payment or compensation given by one party to another in return for goods or services.In modern economies, prices are generally expressed in units of some form of currency...
s fall, a given nominal amount of money will become a larger real amount. As a result the interest rate will fall and investment demanded rise.
This means that insufficient demand in the product market cannot exist forever.
There are two cases in which the Keynes effect does not occur: in the liquidity trap
Liquidity trap
A liquidity trap is a situation described in Keynesian economics in which injections of cash into an economy by a central bank fail to lower interest rates and hence to stimulate economic growth. A liquidity trap is caused when people hoard cash because they expect an adverse event such as...
(when the LM curve is horizontal), or when expenditure is inelastic with respect to interest rates (when the IS curve is vertical). The Patinkin-Pigou real balance effect
Pigou effect
The Pigou effect is an economics term that refers to the stimulation of output and employment caused by increasing consumption due to a rise in real balances of wealth, particularly during deflation....
shows that due to wealth effects of changes in price level, insufficient demand cannot persist even in the two cases above.