Interest rates typically follow a _ pattern relative to economic activity and the default premium typically follows a _ pattern relative to economic activity

Business Dec 23, 2020

Interest rates typically follow a _____ pattern relative to economic activity and the default premium typically follows a _____ pattern relative to economic activity.

a) procyclical; procyclical,

b) procyclical; countercyclical,

c) countercyclical; procyclical,

d) countercyclical; countercyclical.

Expert Solution

Answer: C

Interest rates are inversely correlated with economic growth because of monetary policy implemented by the central bank. The central bank lowers rates during a recession and raises them during a recovery. This means interest rates are counter-cyclical. Default premiums increase with the likelihood of default which increases during a recession and falls in a recovery. Thus default premiums is pro-cyclical and the answer is C.

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