Question

What is the extent to which the asset approach can explain the impact of an increase in interest rates.

How would I critically evaluate it?

Answer 1

There is inverse relationship between assets price and interest rate. Interest rate which is offered by the various financial institutions is considered as risk free, and Investors judge that opportunity of cost of parting with money rises. Thus, they do not invest in assets and prices of these assets tend to fall.

furthermore, rise in interest rate pushes up cost of capital, thus business firms look it as rise in cost of output. Thus, firms reduce investment.

But assets prices are not solely affected by the change in interest rate. Other factors such as profits and other government policies have strong bearings on assets prices.

High profits in assets may lead to huge investments even if interest rate rises, Thus assets prices are partially explained by the interest rate.