ECB Cuts Rates for Eighth Time, Fed keeps them on hold

Answer the following questions to check your understanding of the story.

1) Why is the Eurozone lowering its policy interest rate but the United States is not?

a) The ECB expects an appreciation of their currency and the Fed doesn’t.

b) The Eurozone inflation rate is lower than the U.S. inflation rate.

c) The Fed expects rising inflation and the ECB doesn’t.

d) The Eurozone government wants a rate cut and the U.S. government doesn’t.

Wrong! - Does the ECB make its policy decisions by the appreciation of its currency or by comparing its inflation rate with the U.S. inflation rate? Aren’t the ECB and the Fed independent?

Well Done! - By not lowering the interest rate, the Fed can keep inflation in check by slowing increases in investment and consumption expenditure. The ECB can cut its rate because the Eurozone has little expected inflation.

2) How will the Eurozone economy respond to the policy interest rate cut?

The policy interest rate cut eventually ____________.

a) increases the real GDP growth rate and decreases inflation

b) decreases the real GDP growth rate and inflation

c) increases the real GDP growth rate and inflation

d) decreases the real GDP growth rate and increases inflation

Wrong! - Does the policy interest rate cut increase or decrease aggregate demand? How do the real GDP growth rate and inflation change?

Good Job! - The policy interest rate cut eventually increases aggregate demand. Within one to two years, the real GDP growth rate increases and the inflation rate rises.

3) Why did the euro rise following Christine Lagarde’s statement that the central bank is nearing the end of its rate-cutting cycle?

Christine Lagarde’s statement _______________.

a) decreased the expected future euro exchange rate

b) decreased the euro interest rate relative to foreign interest rates

c) decreased the world demand for Eurozone exports

d) increased the expected future euro exchange rate

Wrong! - How does a decrease in the euro interest rate relative to foreign interest rates, a decrease in the world demand for Eurozone exports, and a decrease in the expected future euro exchange rate change the value of the euro in the foreign exchange market?

Correct! - Christine Lagarde’s statement increased the expected future euro exchange rate, which increased the demand for euros and decreased the supply of euros.

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