Nominal interest rate is the rate of interest applicable before adjustment for inflation. If the compounding frequency of an interest rate, say monthly or yearly, is not the same as the time unit, this interest rate is referred to as nominal. Therefore, the real interest rate applicable during trade activity is obtained by subtracting inflationary pressure.
In instances where traders plan to exploit the interest-rate differential between two countries based on their nominal interest rates, they should first account for the influences these respective countries currency exchange rates could have on their business activity. The “interest rate differential is essentially what such prospecting traders obtain as profit” during such trading activity but it relies heavily on the currency exchange rates remaining constant (Fabozzi 2008). Given the unpredictability of currency exchange rates, this carry trades could result in huge losses.
Different countries may have slightly different interest rates since the rates quoted are based on nominal and not effective interest rates. Doing this understates the interest rates and when compared to the equivalent effective interest rates, it exposes prospecting traders to losses and liability arising from the differences. The two traders would not only be exposing themselves to the risks associated with exchange rate unpredictability, but also differences in their target markets effective interest rates as stated and as is.
Aggregate demand is “the summation of all the demands within a country at any given instance” (Tucker 2010). It has a direct impact on the economy and can be manipulated as a tool to alter economic position of a country. As a sum of the products that will be bought at all price levels, it is demand of the GDP of a country.
During the Great Depression as reported by Spulber (1989), “President Roosevelt tried many tactics to introduce remedial action into his country’s economic system” (pg 104). One of the many he tried was to manipulate public spending using the aggregate demand. By extending Thanksgiving by a week, he increased the rate of consumer spending moving the AD curve to the right – an increase. This exogenous increase lead to an increase in real output and slowly introduced inflationary pressure to counter the effects of the depression.
Aggregate supply on the other hand is the sum total of all the supply in a country at any given instance. Arnold (2010) shows that “the interplay of aggregate demand and aggregate supply forms an important indicator of the country’s economic state and offers an opportunity to correct any anomalies” (pg 352). When the aggregate demand is increased, the aggregate supply increases too resulting in increased real output, employment and GDP of the country. Such manipulations afforded the United States under President Roosevelt the chance to recover from the Great Depression.
Arnold, R. A. (2010). Expectations theory and the Economy. In Economics (p. 352). Australia: South-Western Cengage Learning.
Fabozzi, F. J. (2008). Foreign Exchange. In Handbook of Finance: Financial Markets and Instruments (p. 695). Hoboken: John Wiley & Sons.
Spulber, N. (1989). Antistagflation Policies. In Managing the American economy, from Roosevelt to Reagan (p. 104). Bloomington: Indiana University Press.
Tucker, I. B. (2010). Aggregate Demand and Aggregate Supply. In Microeconomics for today (p. 258). United Kingdom: South Western Educational Pub.