People want money because of its purchasing power in terms of the goods it will buy.The quantity of real balances demanded falls as the interest rate rises. On the other hand, when interest-bearing assets are risky, people prefer to hold some of the safe asset, money. When there is no immediate need to make transactions, this leads to a demand for holding interest-bearing time deposits rather than non-interest-bearing sight deposits. The demand for time deposits will be larger with an increase in the total wealth to be invested.
Interest rates are a tool to regulate the market for bonds. Being sold and purchased by the Central Bank, bonds depend on the latter for their supply and price.
Interest rates affect household wealth and consumption. Consumption is believed to depend both on interest rates and taxes. Higher interest rates reduce consumer demand. Temporary tax changes are likely to have less effect on consumer demand than tax changes that are expected to be permanent.
There also exists a close relationship between interest rates and incomes. With a given money supply, higher income must be accompanied by higher interest rates to keep money demand unchanged.
A given income level can be maintained by an easy monetary policy and a tight fiscal policy or by the converse.
