Chapter 16 Expectations, Output and Policy

Chapter 16 Expectations, Output and Policy. Section Instructor Nadine A. Dessouky.

Sheet 7.

I. Multiple Choice Questions: Changes in future expected interest rates can affect current consumption. Suppose individuals expect future interest rates to decrease. Consumption will change as a result of this lower expected future interest rate because of its effects on which of the following? A) human wealth B) the value of stocks C) the value of bonds D) all of the above E) none of the above.

2 . Suppose individuals now believe that there will be a future tax cut. This reduction in expected future taxes will cause which of the following to occur in the current period? A) the LM curve to shift down B) the LM curve to shift up C) the IS curve to shift rightward D) the IS curve to shift leftward E) none of the above.

3. Suppose individuals now believe that there will be an increase in the future expected interest rate. This increase in the expected future interest rate will cause which of the following to occur in the current period ? A) an upward shift of the LM curve B) a leftward shift of the IS curve C) the IS curve to become flatter D) the LM curve to become steeper E) none of the above.

4. Which of the following will cause the LM curve to shift up? A) an increase in the expected future interest rate B) an increase in current income C) an increase in expected future taxes D) all of the above E) none of the above.

5. Assume that the current demand for goods DOES depend on expectations in the IS-LM model. A monetary expansion in the current period will cause a rightward shift in the IS curve if A) current and expected future real interest rates are positively related. B) current and expected future real interest rates are negatively related. C) current and expected future real interest rates are unrelated. D) the central bank is expected to reverse any current movements in monetary policy in the future. E) monetary policy cannot affect, directly or indirectly, the position of the IS curve in the current period..

6. Suppose the central bank reduces the money supply. This monetary contraction will always cause a greater reduction in output when it is accompanied by A) an increase in expected future taxes. B) an increase in expected future interest rates. C) a reduction in expected future output. D) all of the above E) none of the above.

7. Suppose policy makers pass a budget that reduces the budget deficit. A deficit reduction package such as this has a greater chance of increasing current output when A) the policy is front-loaded. B) financial markets believe that taxes will not increase in the future. C) financial markets believe CBE will lower interest rates in the future. D) all of the above E) none of the above.

8. Suppose there is a simultaneous reduction in expected future output and reduction in the future expected interest rate. This will cause which of the following to occur? A) the IS curve to shift left in the current period B) the IS curve to shift right in the current period C) the LM curve to shift up in the current period D) the LM curve to shift down in the current period E) an ambiguous effect on the position of the IS curve in the current period.

9. When answering this question, assume individuals consider only the short-run effects of changes in future variables when forming expectations of future output and future interest rates. Suppose policy makers announce a reduction in government spending. Which of the following will occur as a result of this reduction in government spending? A) a reduction in the expected future interest rate and no change in expected future output B) a reduction in the expected future interest rate and an increase in expected future output C) a reduction in the expected future interest rate and an ambiguous effect on expected future output D) none of the above.

10. When answering this question, assume individuals consider only the medium-run effects of changes in future variables when forming expectations of future output and future interest rates Suppose policy makers announce a reduction in government spending. Which of the following will occur as a result of this reduction in government spending? A) a reduction in the expected future interest rate and no change in expected future output B) a reduction in the expected future interest rate and an increase in expected future output C) a reduction in the expected future interest rate and a reduction in expected future output D) a reduction in the expected future interest rate and an ambiguous effect on expected future output.

11. Assume individuals consider only the long run effects of changes in future macro variables when forming expectations of future output and future interest rates. Suppose policy makers announce a reduction in government spending. Which of the following will occur as a result of this reduction in government spending? A) a reduction in the expected future interest rate and no change in expected future output. B) a reduction in the expected future interest rate and an increase in expected future output. C) a reduction in the expected future interest rate and a reduction in expected future output. D) a reduction in the expected future interest rate and an ambiguous effect on expected future output..

II. Analytical Questions. Explain why the new IS curve that takes into account expectations is likely steeper than the original IS curve that ignored expectations. Small effects of changes in policy rate on aggregate spending Multiplier effect is small.

2. Explain what effect an increase in future expected output will have on the IS curve and LM curve in the current period..

3. Explain what effect a reduction in the future expected interest rate will have on the IS curve and LM curve in the current period..

4. Compare the following three ways to model expectations: animal spirits, adaptive expectations, and rational expectations ..

5. Suppose the central bank implements a monetary expansion in the current period and is expected to continue this monetary expansion in the future. Use the IS-LM model to illustrate graphically and explain the effects of this policy on current output and the current interest rate..

6. Suppose the central bank announces that it will pursue a monetary expansion in the current period and a monetary expansion in the future. Explain how the credibility of the central bank might influence the effectiveness of this monetary policy action and announcement of a future monetary policy action..

7. Suppose fiscal policy makers pass a budget that increases taxes in the current period and are expected to raise taxes in the future. Use the IS-LM model to illustrate graphically and explain the effects of this policy on current output and the current interest rate..

8. Explain whether a fiscal policy that causes an increase in current and future government spending can cause a reduction in current output..

9. Using the information in this​ chapter, evaluate whether each of the following statements is​ true, false, or uncertain..

ii. The introduction of expectations in the goods market model makes the IS curve flatter, although it is still downward sloping.

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iv. The rational expectations assumption implies that consumers take into account the effects of future fiscal policy on output..

v. Expected future fiscal policy affects expected future economic activity but not current economic activity. (remember number 8 in the analytical questions).

vi.Depending on its effect on​ expectations, a fiscal contraction may actually lead to an economic expansion..

10. For each of the changes in expectations of the following factors, determine whether there is a shift in the IS curve, the LM curve, both curves..

b) An increase in the current real policy interest rate LM curve will shift up.

c) An increase in expected future taxes. . .

d) A decrease in expected future income IS will shift to the left.