IAI Actuarial Core Principles · Business Economics · Role of money and interest rates in the economy
A central bank cuts its policy rate. Which sequence best describes the interest-rate channel of the transmission mechanism that follows?
The correct sequence is lower market and lending rates, cheaper borrowing, more consumption and investment, and therefore higher aggregate demand. A rate cut reduces the cost of credit and the reward for saving, so interest-sensitive spending expands. The alternatives describe tightening effects or fiscal channels unrelated to the rate cut.
- ALower money market and bank lending rates, cheaper borrowing for firms and households, higher consumption and investment, higher aggregate demandCorrect
- BHigher bank deposit rates, greater saving, lower consumption, lower aggregate demand
- CLower government spending, smaller budget deficit, lower aggregate demand
- DAppreciating currency, cheaper imports, lower net exports, lower aggregate demand
- Higher reserve requirements, reduced lending, lower investment, lower aggregate demand
Explanation
A policy rate cut lowers short-term market rates and then bank lending rates. Cheaper credit raises interest-sensitive spending such as business investment, housing and durable goods, increasing aggregate demand. The other options describe contractionary effects or are unrelated to a rate cut.
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