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 individuals expect the central bank to pursue monetary contraction in the future. Given this information, we know with certainty that:
A) current output will increase.
B) the current interest rate will increase.
C) current output and the current interest rate will both decrease.
D) the current output effects are ambiguous.
E) the current interest rate effects are ambiguous.

Question

Quizplus · Accepted Answer

Individuals expect monetary contraction in the future, which will lead to lower future output and higher future interest rates. To offset these expected future changes, individuals will reduce their current consumption and increase their current saving, leading to a decrease in current output and an increase in the current interest rate.

Assume Individuals Consider Only the Short- Run Effects of Changes