Which of the following statements is correct?
A) The long-run real interest rate varies directly with changes in non-interest sensitive components of aggregate demand and inversely with potential output.
B) The long-run real interest rate varies inversely with changes in non-interest sensitive components of aggregate demand and inversely with potential output.
C) The long-run real interest rate varies directly with changes in non-interest sensitive components of aggregate demand and directly with potential output.
D) The long-run real interest rate varies directly with changes in non-interest sensitive components of aggregate demand and does not vary with potential output.

Question

Quizplus · Accepted Answer

The long-run real interest rate is determined by factors such as productivity and demographics, which affect potential output, and by changes in non-interest sensitive components of aggregate demand. It varies directly with changes in these non-interest sensitive components because as demand increases, interest rates rise to balance savings and investment. It varies inversely with potential output because as potential output increases, it can lead to lower interest rates due to increased supply of goods and services, making borrowing less necessary.

Which of the Following Statements Is Correct