Question

Do not write more than 5 sentences for any short answer question. Be sure to use terminology from class to explain your answer. Explain what happens to interest rates and the quantity of money if there is a business cycle recession. (Tip: try to graph this on a sheet of a paper before writing your response.)

Answer 1

Dear Student,

The positive correlation of nominal money and real economic activity over the course of many business cycles is a key empirical fact about the U.S. economy.

The interest rate cycle is closely related to the economic or Business cycle. In theory, movements in interest rates should mirror the economic cycle. If the economy is growing strongly and inflationary pressures increasing – Central Banks will increase interest rates to slow down the economy and prevent inflation.

An increase in interest rates can affect a business in two ways: Customers with debts have less income to spend because they are paying more interest to lenders. Sales fall as a result. Firms with overdrafts will have higher costs because they must now pay more interest.

Worry about decreased consumer spending, increasing delinquency and recession Increase interest rates to slow down the economy and restrict credit Decrease interest rates to easy delinquency pressure, encourage borrowing and allow people to make big purchases on credit Worry about inflation, too much borrowing, and rising housing prices