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Question 2 (10 marks) After prolonged recession, the financial market participants anticipated deflation would occur in the future. a) How would the anticipated deflation affect

Question 2 (10 marks)

After prolonged recession, the financial market participants anticipated deflation would occur in the future.

  1. a) How would the anticipated deflation affect the interest rate? Illustrate this problem using a diagram of the loanable funds approach.

  2. b) What effect would you expect this forecast to have on the slope of an inverse yield curve? Explain with the graph of yield curve.

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