The relationship between the long-run real interest rate and potential output:
A)Is direct
B)Is inverse
C)Is constant since the long-run real interest rate is primarily determined by risk
D)Depends on the actions of central bankers

Question

Quizplus · Accepted Answer

The relationship between the long-run real interest rate and potential output is inverse. As potential output increases, the demand for credit increases, which pushes interest rates up. However, over the long run, increases in potential output also tend to increase the supply of savings, which puts downward pressure on interest rates. The net effect is an inverse relationship between the long-run real interest rate and potential output.

The Relationship Between the Long-Run Real Interest Rate and Potential