Overnight rate question

If a country’s economy is growing at an unsustainably rapid rate and the central bank decreases its target overnight interest rate, the country’s:


inflation rate is likely to increase.


long-term rate of economic growth will increase.


expected rate of inflation is likely to decline.

I choose the wrong answer, but couldn’t explain the right one? Somebody pl help me in this question?

i would think its A. my reasoning being:

reducing the overnight interest rate allows funds to be borrowed cheaper…and is considered a stimulant…in an already growing economy further policy to promote growth and borrowing will ultimately lead to inflation

let me know if im right

From the Federal Reserve website: A higher discount rate can indicate a more restrictive policy, while a lower rate may be used to signal a more expansive policy.

I thought you increase rates when the economy is over heating? But assuming the question really means decreasing rates, most likely the answer is A here.

I agree with ohai. The question is counter-intuitive because the central bank would really want to raise target interest rates. Maybe the question is trying to explain that would be the case.

As the money supply expands (due to reduction in the target interest rate), inflation should increase (not decrease) -> C is incorrect, A is correct.

I guess it’s possible that a reduction of target interest rates would increase long-term growth expectations. That is the reason why Central banks try to lower interest rates during recessions to stimulate recovery. I’m not sure whether that impact is long-term though but rather short-term to medium-term. When the economy is growing at unsustainable rates, it’s highly unlikely there would be any positive impact on long-term growth expectations. Therefore, B is a bad option.

A is the only remaining answer that is correct.

yeah this is drilled in by schweser/andy holmes during the lectures and showing the graphs…the idea of overheating and continuing to overheat regardless of the current situation…holmes uses the example of some politicians promoting doing this leading up to elections when it is unnecessary because they want to continue unsustainable growth, which eventually just leads to an inflationary environment…its not so much of a bad question/counter intuitiveness as much as just trying to make sure u get that u cant just keep pushing growth without any consequences

The right answer is A. tks for your support.