5. Where the Interest Rate Is Decided

In micro, an interest rate was the price of a single deal, like the interest on one cafe's loan; in macro, it becomes the one price that steers saving, investment, and demand across the whole economy. But the schools split over which market sets it — the classicals watch the market for saved funds, Keynes watches the market for money.

• The Market for Saved Funds — In micro, the question was whether one person saves. In macro, the stage is a market where the whole country pools its saving. The interest rate is the price of borrowed money. A higher rate coaxes out more saving. It also scares off borrowers who wanted to invest. Where the two meet, as the formulas below show, sits the equilibrium rate. A government deficit eats into the pool, pushes the rate up, and crowds private investment out. For example, imagine all your classmates pool their 🐷 piggy-bank 💰 money in one box. If many friends want to borrow and money is scarce, the charge goes up. If the teacher borrows big first, less is left for everyone else.
• The Market for Money — In micro, money barely showed up at all. In Keynes's macro, the money market sets the interest rate. People like holding money because it is handy. The more nervous they feel, the more they hold. The central bank fixes how much money exists. The rate settles where the two meet, as the formulas below show. Print more money, and the rate falls. For example, the whole class together carries a fixed pile of 💰 cash. On field-trip day everyone wants to carry more, so cash gets scarce. Scarce cash means borrowing it costs more — a higher interest rate.