From 2007 to 2009,the long-term real interest rate paid by the safest corporatio

Question

From 2007 to 2009,the long-term real interest rate paid by the safest corporations increased from 2.3 percent to 3.8 percent.During that same period,the overnight loans rate fell from 4.5 percent to 0,25 percent a year.

A rise in the long-term real interest rate plays a role in the monetary policy transmission process because it does all of the following except_______.

A. it lowers the Canadian interest rate differential

B. it decreases consumption expenditure

C. it increases saving

D. it decreases investment

Explanation / Answer

Rise in long-term real interest rates tends to decrease consumption expenditure and increase savings. Secondly, rise in long-term real interest rates increase the cost of borrowing for firms and this increase in cost of borrowing reduces the profit margin of firm and prompts them to decrease their investment spending.

However, increase in long-term real interest rates tends to increase the interest rate differential.

In the given case, in 2007, long-term real interest rate was 2.3 percent and short-term interest rate was 4.5 percent. So, there was a interest rate differential of 2.2 percent.

In 2009, long-term real interest rate was 3.8 percent and short-term interest rate was 0.25 percent. So, there was a interest rate differential of 3.55 percent.

Thus, Canadian interest rate differential has increased.

Hence, the correct answer is option (A).

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