Explore BrainMass

Borrowing and interest rates

In three or four sentences, explain whether each of the following statements is True, False or Uncertain. No points will be given for an undefended answer. Illustrate your answer with a properly labeled diagram where appropriate.


Solution Preview

1. Suppose that Harvey can borrow or save money at the same rate of interest and is exempt from
any income tax considerations. Based on current projections of interest rates, Harvey has
prepared a budget that shows his lifetime income and consumption plans over two periods?
Period 0, the remainder of his working life and Period 1, his retirement years. In this plan,
Harvey proposes to consume more than his income in Period 0. If a new forecast shows a
decrease in interest rates and if Harvey responds with a sensible adjustment to his plans, then,
ceteris paribus, Harvey might now plan to consume less than his income in Period 0.

An increase in interest rates would raise the cost of borrowing. In order to consume more than your income, you must borrow. If the cost of borrowing is less, Harvey would tend to borrow more, not less. Therefore, the ...