Interest rate sensitivity

Assumptions about interest rate sensitivity affects the type of policies that are preferred in a country, fiscal policy and monetary policy.

If investments have low interest rate sensitivity and money demand has a high interest rate sensitivity, fiscal policy is preferable. By this is meant that fiscal policy will provide a significantly enhanced growth in the economy, but a low interest rate increase does not affect investment significantly and interest rate cuts will not have any further impact on investment in the community.

If investments has a high interest rate sensitivity and money demand a low interest rate sensitivity, monetary policy is preferable. By this is meant that monetary policy produces a significantly higher growth in the economy, as investment increases sharply as they have a high interest rate sensitivity and fiscal policy to increase the demand in the country will result in significantly higher interest rate that beats out the investments.