GDP of an economy is measured on basis of a countrys output regardless of price fluctuations since it is measured against a price index and any change in prices will affect output level and price index equally. Similarly, change in interest rate, like prices, does not affect GDP. However, the impact of interest rate levels and prices affects other factors related to GDP, like Gross Domestic Income, by moving output levels and thus, employment level. There is a direct relationship between GDP and GDY (Gross Domestic Income) where GDY involves income to household (HY), income to businesses (BY), income to government (GY) and income to foreigners (FY). Given the equality of GDP and GDY, the increasing production level or prices will always increase income by same amount and therefore, there will always be enough income to consume all output generated. However, income alone does not promise supply of money in market since that funding to purchase is provided by financial institutions.
Aggregate Planned Expenditure (APE) is the sum of demand of output from household, business sector, government and exports excluding imports since increase in imports normally decrease the demand for local output. Like GDY, APE also has a positive and direct relationship with GDP with quick response time for aggregate demand with any change in GDP. In stable economies with less interest rate fluctuations, the relationship between interest rate and household consumption or demand is less obvious. However, even if interest rate fluctuates largely, the saving pattern, project planning and other considerable factors of an economy lower the consumption by insignificant percentage and therefore, the overall impact of interest rate level is negligible for APE.
The supply of funding in U.S. is in the form of tangible paper money or coins while checking accounts are considered as intangible components of money supply. When this money is used again and again to purchase output in a country, it generates velocity. This velocity is enhanced by increase in lending of non-banking institutes that enhance product purchasing. The total output of a nation cannot surpass the product of money supply and its velocity since ASF is key determinant of how much money can actually be spent on products. Within the constraint of money supply any increase in price level with decrease the aggregate money supply funding since the amount of output that can be borrowed will reduce.
The supply of funding is generated by banks who take deposits from customers and place reserves with Federal Reserve Bank as an insurance against their earnings from deposits. Apart from these required reserves, working reserves are often set aside by banks to avoid insufficient reserve position which may cost interest payments to the banks. This working reserve has an indirect relationship with interest rate which implies that when interest rates are high, the cost of working reserve will increase and therefore, banks will offload their reserves by lending more money in market, thereby, increasing money supply. This suggests a positive relationship between money supply and interest rates level.
Given the sufficient level of APE and its equality with GDP, supply of funding is generated to match the level of APE and GDP. However, before the access of ASF there is a need for its demand i.e. Aggregate Demand for Funding (ADF) which is often included in ASF since normally the Aggregate Planned Expenditure is equal to GDP which means adequate funding is available in market to consume output. However, ADF comes in when demand is made by the producers of output who need funding to support their production. This situation occurs when Aggregate Planned Expenditure is less than the output level leaving producers with decreased sales and more overhead and labor expenses and therefore, increased demand for funding which is equal to the output level.