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

Question

Quizplus · Accepted Answer

The expected reduction in government spending will lead to a decrease in aggregate demand, which will in turn lead to a decrease in the expected future interest rate. However, since the reduction in government spending is expected to be temporary, it will not have a significant impact on expected future output.

Assume Individuals Consider Only the Medium- Run Effects of Changes