The
Keynes effect is a term used in
economicsEconomics is the social science that studies 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 rateAn interest rate is the price a borrower pays for the use of money they do not own, for instance a small company might borrow from a bank to kick start their business, and the return a lender receives for deferring the use of funds, by lending it to the borrower...
s affects expenditure more than it affects savings.
As
pricePrice in economics and business is the result of an exchange and from that trade we assign a numerical monetary value to a good, service or asset. If Alice trades Bob 4 apples for an orange, the price of an orange is 4 apples. Inversely, the price of an apple is 1/4 oranges.Price is only part of...
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 trapThe term liquidity trap is used in Keynesian economics to refer to a situation where the demand for money becomes infinitely elastic, i.e. where the demand curve is horizontal, so that further injections of money into the economy will not serve to further lower interest rates...
(when the LM curve is horizontal), or when expenditure is inelastic with respect to interest rates (when the IS curve is vertical).
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The
Keynes effect is a term used in
economicsEconomics is the social science that studies 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 rateAn interest rate is the price a borrower pays for the use of money they do not own, for instance a small company might borrow from a bank to kick start their business, and the return a lender receives for deferring the use of funds, by lending it to the borrower...
s affects expenditure more than it affects savings.
As
pricePrice in economics and business is the result of an exchange and from that trade we assign a numerical monetary value to a good, service or asset. If Alice trades Bob 4 apples for an orange, the price of an orange is 4 apples. Inversely, the price of an apple is 1/4 oranges.Price is only part of...
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 trapThe term liquidity trap is used in Keynesian economics to refer to a situation where the demand for money becomes infinitely elastic, i.e. where the demand curve is horizontal, so that further injections of money into the economy will not serve to further lower interest rates...
(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.