Question

Why do interest rates on loans tend to be lower in a weak economy than in a strong one?
a.
A weak economy tends to have low inflation, so interest rates drop to match.
b.
Borrowers in a weak economy are less likely to default on their loans, so interest rates are correspondingly low.
c.
In a weak economy there is less demand for credit, so the price drops.
d.
The strength or weakness of an economy is determined by interest rates; low interest rates actually cause a weak economy.


Please select the best answer from the choices provided

A
B
C
D

Answer 1

C

In a weak economy businesses and consumers borrow less, so demand for credit falls and the “price” of loans (interest rates) tends to fall. (Low inflation also helps push nominal rates down, but the demand effect is the primary explanation among the choices.)