Answer to Question #169799 in Macroeconomics for Z

Question

Explain how the interest rate works in the classical system to stabilize aggregate demand in the face of autonomous changes in components of aggregate demand such as investment or government spending.

Answer 1

An increase or decrease of the interest rate in the classical system tends to lower or higher economic activity, and as a result decrease or increase in aggregate demand.

When interest rates rise, it becomes more costly to borrow money.Therefore aggregate demand decreases. When interest rates fall, the opposite happens.