An enquiry into the nature of relationship between private investment and interest rate in India

Abstract

The debate over what is the optimal level of interest rate for the Indian Economy is one which has not been talked about much but has come to capture the imagination of policymakers, academicians and the corporates in recent times. The sharp focus on the appropriate level of interest rates in India is well justified given its ultimate implications on growth and inflation especially in the current economic scenario. According to the conventional neoclassical theory, interest rate affects two critical components of aggregate demand – consumption and investment, the relationship of the latter with interest rate more talked about than the former. A rise in interest rate raises the opportunity cost of investment and lowers investment demand ultimately leading to lower output.