Econ HW 4 - Homework #4 1. Interest rate is pro-cyclical,...

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Homework #4 1. Interest rate is pro-cyclical, and it moves the same direction as the aggregate level of economy. According to the textbook, there are several reasons why interest rates are pro- cyclical. First, inflation affects the interest rates. From Fisher Hypothesis, nominal interest rate is equal to the sum of the real interest rate and the expected inflation rate. Inflation is pro-cyclical, and therefore interest rate should be pro-cyclical, too. Second, when economy is booming, demand for loans by firms and households are high, the interest rate would be driven up. Third, Federal Reverse raises the interest rates to cool down the economy during the expansion, and lowers the interest rates to stimulate the economic activities. From the graph, the recessions during 1960, 1970, 1982, 1991 and 2001 demonstrated the above relationship between interest rates and RGDP. T-bill rate fell during those periods. 2. The interest rate is a lagging variable. Inflation is a lagging variable to the aggregate
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Econ HW 4 - Homework #4 1. Interest rate is pro-cyclical,...

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