Question & Answer

Explain how in 2022, the rising inflation and higher prices in the United States affected the demand for loanable funds, the supply of loanable funds, and interest rates in the United States (LO1)

During the Covid-19 pandemic, U.S. interest rates were extremely low. Explain how the low interest rates affected businesses’ and households’ behavior to borrow. (LO2)

Use the loanable funds framework to explain how European economic conditions might affect U.S. interest rates. (LO1, LO2)

Consider a period in which stock prices are very high, such that investors begin to think that stocks are overvalued and their valuations are very uncertain. If investors decide to move their money into much safer investments, how do you think this would affect general interest rate levels? In your answer, use the loanable funds framework to explain how the supply or demand for loanable funds would be affected by the investor actions, and how this would affect general interest rate. (LO1)

Offer an argument for why a political regime that favors a large government will cause interest rates to be higher. Offer at least one example of why a political regime that favors a large government will cause interest rates to be lower. (Hint: Recognize that the government intervention in the economy can influence other factors that affect interest rates.) (LO2) 

During the credit crisis of 2008 and 2009, U.S. interest rates were extremely low, which enabled businesses to borrow at a low cost. Holding other factors constant, this should have resulted in a higher number of feasible projects, which should have encouraged businesses to borrow more money and expand. Yet, many businesses that had access to loanable funds were unwilling to borrow during the credit crisis. What other factor changed during this period that more than offset the potentially favorable effect of the low interest rates on project feasibility, therefore discouraging businesses from expanding? (LO2)

When economic crises in countries are due to a weak economy, local interest rates tend to be very low. However, if the crisis is caused by an unusually high rate of inflation, the interest rate tends to be very high. Explain why. (LO2)

Consider the prevailing conditions for inflation (including oil prices), the economy, the budget deficit, and the Fed’s monetary policy that could affect interest rates. Based on these conditions, do you think interest rates will likely increase or decrease during this semester? Offer some logic to support your answer. Which factor do you think will have the greatest impact on interest rates? (LO2)

The interest rate on a one-year loan can be decomposed into a one-year risk-free (free from default risk) component and a risk premium that reflects the potential for default on the loan in that year. A change in economic conditions can affect the risk-free rate and the risk premium. The risk-free rate is usually affected by changing economic conditions to a greater degree than the risk premium. Explain how a weaker economy will likely affect the risk-free component, the risk premium, and the overall cost of a one-year loan obtained by (1) the Treasury, and (2) a corporation. Will the change in the cost of borrowing be more pronounced for the Treasury or for the corporation? Why? (LO2)

Jayhawk Forecasting Services analyzed several factors that could affect interest rates in the future. Most factors were expected to place downward pressure on interest rates. Jayhawk also expected that although the annual budget deficit was to be cut by 40 percent from the previous year, the deficit would still be very large. Because Jayhawk believed that the deficit’s impact would more than offset the effects of other factors, it forecast interest rates to increase by 2 percent. Comment on Jayhawk’s logic. (LO2)

Offer an argument for why the terrorist attack on the United States on September 11, 2001, could have placed downward pressure on U.S. interest rates. Offer an argument for why those attacks could have placed upward pressure on U.S. interest rates. (LO1, LO2)

War tends to cause significant reactions in financial markets. Why might a war in the Middle East place upward pressure on U.S. interest rates? Why might some investors expect a war like this to place downward pressure on U.S. interest rates? (LO2)

Why might you expect the interest rate movements of various industrialized countries to be more highly correlated in recent years than they were in earlier years? (LO2)

How might expectations of higher prices in the United States affect the demand for loanable funds, the supply of loanable funds, and interest rates in the United States? Offer a logical explanation of why such an impact on interest rates in the United States might spread to other countries. (LO1, LO2)

During periods when investors suddenly become fearful that stocks are overvalued, they dump their stocks, and the stock market experiences a major decline. During these periods, interest rates also tend to decline. Use the loanable funds framework discussed in this chapter to explain how a massive selloff of stocks leads to lower interest rates. (LO1)

Why do forecasts of interest rates made by experts differ? (LO3)

Estimate the real interest rate over the last year. If financial market participants overestimate inflation in a particular period, will real interest rates be relatively high or low? Explain. (LO2)

What is the difference between the nominal interest rate and real interest rate? What is the logic behind the implied positive relationship between expected inflation and nominal interest rates? (LO2)

Assume that if the U.S. dollar strengthens, it can place downward pressure on U.S. inflation. Based on this information, how might expectations of a strong dollar affect the demand for loanable funds in the United States and U.S. interest rates? Is there any reason to think that expectations of a strong dollar could also affect the supply of loanable funds? Explain. (LO1, LO2)

Would increasing the money supply growth place upward or downward pressure on interest rates? (LO1, LO2)

Explain how the expected interest rate in 1 year depends on your expectation of economic growth and inflation. (LO2)

Explain why interest rates tend to decrease during recessionary periods. Review historical interest rates to determine how they react to recessionary periods. Explain this reaction. (LO1, LO2)

If the federal government planned to expand the space program, how might this change affect interest rates? (LO1)

Explain what is meant by interest elasticity. Would you expect federal government demand for loanable funds to be more or less interest-elastic than household demand for loanable funds? Why? (LO1)

Explain why interest rates changed as they did over the past year. (LO2)