Interest Rate Determination

Connections

The money market model connects with the foreign exchange (Forex) market because the interest rate in the economy, which is determined in the money market, determines the rate of return on domestic assets. In the Forex market, interest rates are given exogenously, which means they are determined through some process not specified in the model. However, that process of interest rate determination is described in the money market. Economists will sometimes say that once the money market model and Forex model are combined, interest rates have been "endogenized". In other words, interest rates are now conceived as being determined by more fundamental factors (gross domestic product [GDP] and money supply) that are not given as exogenous.

The money market model also connects with the goods market model in that GDP, which is determined in the goods market, influences money demand and hence the interest rate in the money market model.