Question

Assume prices are fully flexible and the economy is described by the parameters below. Suppose that news organizations, like the Wall St. Journal, pick up on the problems associated with rising inequality start reporting that the prospects for long-term economic growth look grim. If this causes consumer confidence to fall by 5%, by how much will the equilibrium real interest rate change? Use a negative sing if it falls, and no sign if it increases. Round your answer to one decimal point. (For example, X.X)

C0 = 2,000 CY = 0.8 Y* = 16,000 t = 25% I0 = 5,000 Ir = 2,500 G = 1,000 MY = 0.2 Xf = 0.1 Yf = 2,000 Xε = 400 ε0 = 5 εr = 10 rf = 5%

Answer 1

The impact of a decrease in consumer confidence on the equilibrium real interest rate is not precisely quantifiable without additional data. In general, a fall in consumer confidence is likely to lead to a reduction in interest rates as part of a monetary response to stimulate economic activity.

Step-by-step explanation:

When assessing the impact of a decrease in consumer confidence on the equilibrium real interest rate, it is important to consider the broader economic implications. In the scenario where the Wall St. Journal reports on the potential long-term economic harm caused by rising inequality, this can lead to a fall in consumer confidence. This fall in confidence can decrease consumption and investment demand, thereby impacting the aggregate demand for goods and services in the economy.

Traditionally, decreased demand in an economy would lead to a decrease in the real interest rate as a response by the monetary authorities to stimulate the economy. However, to quantify this change in interest rates, more information on how shifts in consumer confidence directly affect consumption, investment, and central bank policy would be required, which is not provided in the current scenario. Furthermore, other factors, such as regulation, fiscal policy, global economic conditions, and market sentiment, could also have an influence on interest rates.

The description provided refers to the relationship between government borrowing and interest rates. The information indicates that an increase in government borrowing can lead to higher interest rates, as the demand for financial capital shifts. According to the consensus estimate mentioned, a 1% increase in budget deficits could lead to a 0.5-1.0% rise in the long-term interest rate. This piece of information, while related to government borrowing and not directly tied to consumer confidence, provides insight into one mechanism through which economic factors affect interest rates.