CFA Practice Question

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CFA Practice Question

Which statement is FALSE regarding the neutral interest rate?
A. It is not affected by short-term imbalances in the economy.
B. It is a fixed number for a particular country but it varies across different countries.
C. Different economists may come up with different neutral rates of interest for any given economy at any time.
Explanation: A is true. The neutral interest rate is affected by changes in the structure of the economy such as changes in the rate of population growth, the rate of technological change.

B is false. The neutral interest rate is not a constant and tends to vary as the economy is subject to shocks.

C is true. They may have different views of the growth rate, expected inflation etc. That's why the neutral interest rate is not directly observable. The rate has to be estimated, usually with a lot of uncertainty.

User Contributed Comments 2

User Comment
rosslinton Looking at the explanation for why A is incorrect, it states that it is affected. However, the actual selection says it is not affect. Making the statement false. Please let me know if this needs updated or I am just reading this wrong. Thanks!
AdeyemiK the changes mentioned arent short term changes, theyre changes to the long run potential of the economy, hence though they affect ST imbalances as theyre LT factors they also affect the long term growth rate hence the trend rate. ST imbalances alone dont affect the rate (think SRAS vs LRAS factors)
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