In an effort to maintain price stability, it is expected that the European Central Bank will raise interest rates in the future. Which of the following is the most likely effect of such an action on short- and long-term interest rates in Europe?
A)Long-term interest rates will tend to be higher than short-term interest rates.
B)Both long- and short-term interest rates would be expected to fall sharply.
C)Long-term interest rates will be about the same as short-term interest rates.
D)No relative change in short- and long-term interest rates could be predicted.

Question

Quizplus · Accepted Answer

When the European Central Bank raises interest rates, short-term interest rates are likely to rise more quickly than long-term interest rates. This is because short-term interest rates are more sensitive to changes in the policy interest rate than long-term interest rates. As a result, the difference between short- and long-term interest rates, known as the yield curve, is likely to flatten, but not necessarily invert. Therefore, option A, which states that long-term interest rates will tend to be higher than short-term interest rates, is the most likely effect of such an action.

In an Effort to Maintain Price Stability, It Is Expected