Economics-interest rate

  1. Why an increase in the volume of output cause interest rate to rise? Any one can explain thoroughly?
    Last edited by a moderator: Mar 24, 2014
  2. jcsd
  3. May you rephrase your question?

    Anyway, if get your question right: an increase in output usually means fuller application of means of production (like: low unemployment). If there is too much demand it causes, instead of bigger production, just inflation. To combat such excessive demand, central banks raise interests rates. (higher interest rates means lower spending on credit).
  4. I like Czcibor's explanation. I'll use the U.S. in my example.

    On the yield curve, short-term interest rates are controlled by the Federal Reserve. Long-term interest rates are only influenced by the Fed. Long-term rates are determined by bond market participants. Long-term rates are speculation about future short-term rates. In other words, long terms rates are bets about where the Fed will move short-term rates in the future.

    To answer your question, the Fed could keep short-term rates low even though GDP is rising. Inflation would rise, but so would long-term rates. The yield curve would get steeper. The Fed controls the short-term rates through open market operations: the New York Fed intervenes in the bond market by buying or selling Treasury bonds to control the effective Fed Funds rate.

    The rise in long term rates would signal that investors believe that the Fed will be raising short-term rates in the future to control inflation.
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