Assume individuals consider only the short- run effects of changes in future macro variables when forming expectations of future output and future interest rates. Suppose current government spending increases and that individuals expect future government spending to increase. Given this information, we know with certainty that:
A) the current output effects are ambiguous.
B) the current interest rate will decrease.
C) current output and the current interest rate will both increase.
D) the current interest rate will increase.
E) current output will increase.

Question

Quizplus · Accepted Answer

While individuals expect future government spending to increase, the effect on current output is ambiguous. There may be an increase in demand and production in the short-run, but this may be offset by future expectations of higher taxes or inflation. The current interest rate cannot be determined from this information alone.

Assume Individuals Consider Only the Short- Run Effects of Changes