Question

Will a decrease in oil prices have an IMMEDIATE IMPACT on the U.S. real interest rate? Why or why not?

Answer 1

Generally reduced oil prices are associated with a lower real interest rate. This is because when oil prices are reduced the countries that export oil experience a reduction in their accumulated revenues from oil. The importing countries experience reduction in their cost of production because oil is considered to be a major raw material. With the decline in production cost aggregate supply of production is increased and there is a reduced general price level. With deflationary pressures and stabilized nominal interest rates the real interest rate rises. As far as the real interest rate in the United States it is concerned, it is expected to increase with a decrease in the oil prices but such transition may not occur immediately because there is a gestation period from buying oil increasing production and supplying the final goods in the market. Therefore there can be no immediate impact on the real interest rate.