Aggregate demand curve is downsloping because of the real balance effect. If prices are higher than averages, then the purchasing power of monetary assets decreases and individuals tend to feel poorer and buy less. If prices are lower than historical price averages, the purchasing power of monetary assets increases, individuals tend to feel wealthier and buy more.
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There is an inverse mathematical relationship between interest rates and financial assets. Securities markets, such as the New York Stock Exchange, are very sensitive to inflation which is the major cause for increasing interest rates. This sensitivity was observed in October 19, 1987 stock market crash. It was also observed in securities markets reactions to lowering of interest rates by the US federal reserve bank in 2001. |
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