What role does the interest rate play in the economy? Is the distinction between real and nominal interest rates an important one in discussing these roles?

What will be an ideal response?

The interest rate plays several roles in the economy. First, it affects the total output because of the inverse relationship between the interest rate and investment spending; governments often try to influence the interest rate to achieve policy goals. Second, it rations (or allocates) financial and real capital among competing firms and determines the composition of total output of capital goods. Third, it changes the level and composition of spending on research and development. These effects are based on changes in the real interest rate, which is the rate expressed in inflation-adjusted dollars, and not the nominal interest rate, which is the rate expressed in current dollars. It is the real interest rate, not the nominal interest rate, which affects investment decisions.