With the interest rates having been cut four times since December 2009, by 350 basis points, the South African Reserve Bank (SARB) declared that the domestic economy is slowing. Two consecutive quarters of negative growth is evidence that an economy is in recession. The contraction in growth is believed to have been caused by a slump in export demand, forcing both manufacturers and miners to cut production. The SARB’s monetary policy committee is in meeting to discuss further rate cuts, an appropriate tool to restrict further deterioration of the economy. Whether I agree or disagree with SARB’s view is going to be determined.
Aggregate demand (AD):
AD shows the relationship between the amounts of real output (real Gross Domestic Product - GDP) that buyers collectively desire to purchase at each possible price level. When the price level rises, the quantity of real GDP demanded decreases. When price level falls, the quantity of real GDP demanded increases. Short run aggregate supply (ASsr):
ASsr shows the level of real domestic output that firms will produce at each price level. When the price level rises, the quantity of real GDP supplied increases. When the price level falls, the quantity of real GDP supplied decreases. Long run aggregate supply (ASlr):
ASlr is vertical at the economy’s potential output.
Interest sensitive expenditure (IS):
IS shows the rate of interest and level of output for a market in equilibrium. The increase in interest rate will shift the Aggregate Expenditure (AE) curve downwards. A decrease in the interest rate will shift the AE curve upwards.
Determinants of the AD curve
Change in Investment spending:
Cetaris paribus, an increase in the real interest rates lowers investment spending, shifting the AE curve downwards and AD curve to the left. A decrease in the real interest rates increases investment spending, shifting the AE curve upwards and AD curve to the right. Change in...