Question

I'm having trouble distinguishing which of the interest rates, either nominal or real, central banks are able to control directly. Expanding on that, is there a difference between monetary policy's impact on short and long-run interest rates? I understand that monetary policy can control short-run nominal interest rates, but is the same true for long-run nominal interest rates? Do central banks have any control over real interest rates or only nominal? I am so confused.

Essentially, what are the differences between these four types of interest rates:

1. Short-Run Nominal Interest Rates

2. Long-Run Nominal Interest Rates

3. Short-Run Real Interest Rates

4. Long-Run Real Interest Rates

And which are controlled by monetary policy?

If this seems all over the place and incomprehensible, then I would appreciate a general explanation of monetary policy with respect to nominal and real interest rates if possible!

Answer 1

Central banks can control nominal interest rate indirectly by by their impact on inflation.Central banks cannot directly set interest rate for loans.such as personal loan, mortgages etc.

A short term interest rate is the interest rate charged on short term loans and the long term interest rate is the interest rate charged on long term loans.So the difference between the two is the length of time it takes to pay back the loan.Monetary policy directly affects short term interest rate and influences the availabilty and cost of credit n the economy. Monetary policy affects the long run price level hrough money creation .It also affects interest rate on reserves.Low and stable inflation is the most important contribution made by monetary policy in the long run.

Central banks try to control the money supply in the economy and money supply affects interest rate and inflation . Increase in money supply lead to lower interest rate .This can be done only in the short run.Thus central banks can control short term nominal interest rate.

1)A nominal interest rate is the interest rate before taking inflation into account. Short term nominal interst rates are set by the central bank.Interest rates are kept low by central banks to increase economic activity.

2)Long term nominal interest rates are averages of daily rates measured as percentage.

3)Real interest rate  is an interest rate that has been adjusted to remove the effects of inflation in order to reflect to the borrower the real cost of funds and tthe real return to the investor. This is short term real interest rate

4).Long term interest rates refer to bonds maturing in ten years.

Short term nominal interest artes are controlled by central bank.

Policy makers view short term nominal interest rate as the mian instrument of monetary policy.