Hi, It states that the return on alternate assets will impact the short term interest rate. Is this because a higher return on alternate assets will reduce demand for money market instruments, and could lead to a reduction in interest rates (to encourage borrowing/lending)? Thanks
Hi AKS01 Short-term interest rates are basically the return on money market investments. These are short-term low-risk investments. Alternative (ie similar) investments to these will be short-term government bonds for example. If returns increase on these government bonds, then demand for these government bonds is likely to rise and demand for money market instruments is likely to fall, all else being equal, as investors move towards the higher returns. Assuming the issuers of money market investments want to continue borrowing at the same level, they'll then need to make these instruments more attractive relative to government bonds. To do this, the central bank may increase short-term interest rates (ie the return on the money market investments). In this way, the return on alternative asset classes (government bonds here) could impact on the level of short-term interest rates. I hope this helps.
