HOW RATE OF INTEREST IS DETERMINED
Among the theories which seek to explain the determination of the rate of interest we might mention:
(i) Classical or Real Theory. (ii) Loadable Funds or co-Classical Theory, and (iii) Keynesian or Liquidity Preference Theory.
All these theories of interest seek to explain the determination of the rate of interest though the equilibrium between the forces of demand and supply. In other words, all these three theories of interest are ‘demand and supply theories’ with rate of interest as the mechanism which brings about equilibrium between demand and supply. The difference among the theories of interest lies in the answer to the question: demand for what and supply of what? According to the Classical Theory of interest, rate of interest is determined by demand for saving tell invest and supply (If lugsail. Loadable Funds theory seeks to explain the determination of the rate of interest through the equilibrium between demand for loadable funds and supply or loadable funds. Apart from current savings, loadable funds include other things also. Keynesian Theory of interest asserts that the rate or interest is determined by the demand for money to hold (i.e., liquidity preference) and the supply of money, We will now discuss these theories one by one.