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-term and long-term interest rates in Europe?
A) Long-term interest rates will tend to be higher than short-term interest rates.
B) Long-term interest rates will be about the same as short-term interest rates.
C) Both long- and short-term interest rates would be expected to fall sharply.
D) No relative change in short and long term interest rates could be predicted.

Question

Quizplus · Accepted Answer

When a central bank raises interest rates, short-term interest rates tend to rise faster than long-term interest rates. This is known as a yield curve flattening. Therefore, it is likely that long-term interest rates will be higher than short-term interest rates in Europe if the ECB raises interest rates in the future.

In an Effort to Maintain Price Stability, It Is Expected