Explain how interest rates influence the incentive to invest. Why does an increase in the market interest rate reduce the incentive to invest?


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Carefully consider the following problems and answer the accompanying questions after reading the report and referring to the relevant chapter of your textbook (also see Grading Rubric on the last page).
In January, 2012, the McKinsey Global Institute published
“Debt and deleveraging: Uneven progress on the path to growth.” In the executive summary, the following observations were made about the state of investment spending in the United States (and the U.K.):
“Today, annual private investment in the United States and the United Kingdom is equal to roughly 12 percent of GDP, approximately 5 percentage points below pre-crisis peaks. Both business investment and residential real estate investment declined sharply during the credit crisis and the ensuing recession.”
The authors identify six ‘markers’ of successful recovery from a financial crisis. One of those markers is a credible plan for balancing the government’s budget in the long-run. In their words, we need “long-term fiscal sustainability.” Long-term fiscal sustainability is important for today’s economic growth.
1. Define economic growth and identify what is the single biggest factor responsible for long-run economic growth. In your answer you need to define that single biggest factor responsible for long-run economic growth.
2. Explain how interest rates influence the incentive to invest. Why does an increase in the market interest rate reduce the incentive to invest? This paragraph should comprise the bulk of your paper.
3. Explain how large government budget deficits year after year will have an impact on the equilibrium interest rate
??
using the Loanable Funds model.
4. Summarize in a concluding paragraph – why did the McKinsey Global Institute conclude that long-term fiscal sustainability is important for economic growth?



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