Chapter 10, Problem 39PS

Summary Introduction

To determine:

As per the liquidity preference theory, if the inflation is expected to be falling over the next few years, does the long-term interest rates will be higher than short-term rates or not.

Introduction:

The liquidity preference theory is a theory which says that investors demand a risk premium on long-term maturity bonds as they involve high risk. The liquidity premium can be measured as a spread between the expected short rate and the forward rate of interest.