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 future government spending.Which of the following will occur as a result of this expected 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

Question

Quizplus · Accepted Answer

The expected reduction in government spending is likely to reduce the demand for loanable funds, which will reduce the expected future interest rate. However, in the medium-run, the effect on expected future output is ambiguous, as it depends on several factors such as the nature of the government spending cuts, the response of private investment, and the overall state of the economy. Therefore, option A is the best choice.

When Answering This Question,assume Individuals Consider Only the Medium-Run Effects