Suppose the interest rate has been at 3% forever. The central bank decides that

Question

Suppose the interest rate has been at 3% forever. The central bank decides that it wants the inflation rate to be 2% to try to boost investment. (Assume no other shocks are hitting the economy)

1.Suppose the central bank comes back after a moderate amount of time (a year, maybe). Will the interest rate still be at 2%? What will it find?

2.Suppose the central bank again lowers the rate to 2%. How quickly will the interest rate return to 3% this time?

3.Now the central bank gets mad, and decides to lower the rate to 2% and leave it there permanently. How will the central bank have to do this?

4.What will the inflation rate (and interest rate) be after a long time? What happened when the central bank tried to keep the interest rate low?

Explanation / Answer

1. no, the interest rate is 2%, people will show interest to buy products and services instead of saving the funds for future purposes.

2. when the interest rates are much lower, the inflation rates will goes up. there is an iverse relationship existed between these two.

3. as i said earlier, if they minimize interest rates low, the proportionate of savings will comes down and it may leads to increase in inflation.

4. in these conditions, the rate of inflation definitely goes up, but we can not determine how much exactly it increases.

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