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 individuals expect future taxes to decrease.Given this information,individuals will expect
A)an increase in the expected future interest rate and no change in expected future output.
B)an increase in the expected future interest rate and an increase in expected future output.
C)an increase in the expected future interest rate and a reduction in expected future output.
D)an increase in the expected future interest rate and an ambiguous effect on expected future output.

Question

Quizplus · Accepted Answer

If individuals expect future taxes to decrease, one would expect an increase in disposable income which would lead to increased consumption and investment in the short run. This would increase demand for goods and services, leading to an increase in the expected future interest rate. However, this increase in demand in the short run is unlikely to have a significant impact on potential output in the medium run, leading to no change in expected future output. Therefore, the correct answer is A.

Assume Individuals Consider Only the Medium Run Effects of Changes