2009 exam problem 5

CFA Level III
#1

Part B. ii. describe negative effect of lowering rates- answer is too vague for me. Can anybody clarify?

#2
  1. Inflation 2) Money will flow out from the country to those countries where rates are higer 3) Less savings
#3

pupdawg82 Wrote: ------------------------------------------------------- > 1) Inflation > 2) Money will flow out from the country to those > countries where rates are higer > 3) Less savings Lowering rates will increase inflation?

#4

derswap07, Yes, lowering rates will increase inflation as you can see in real world. Conversely, if inflation is too high, central bank uasully increase rates to depress inflation.

#5

derswap07 Wrote: ------------------------------------------------------- > pupdawg82 Wrote: > -------------------------------------------------- > ----- > > 1) Inflation > > 2) Money will flow out from the country to > those > > countries where rates are higer > > 3) Less savings > > Lowering rates will increase inflation? Lowering rates will: a) make borrowing less expensive driving individuals and corporations to spend more putting upward pressure in prices increasing inflation. This is enforce by the fact that lower interest rates do not attract investments from savings as the trade-off of consumption today versus tomorrow become less attractive. b) make the currency depreciate against others as long as the interest differential increases. Depreciation makes imports more expensive driving up the price levels, hence inflation. Cheers

#6

The question is a bit tricky, it is referring to an active monetary policy by increasing money supply (increase agg demand in the economy). Hence the reduction of int rate will increase borrowing (or reduce savings since lower opportunity costs of int income forgone) and increase spending which ultimately increase inflation. But in the real world high inflation in a country will drive the interest rate higher relative to another country with lower inflation rate. This is what happened to Vietnam in 2008 when inflation was peak at about 25% that year.

#7

Kindly post the link to this 2009 past exam. thanks