According to the Lucas critique,if past increases in the short-term interest rate have always been temporary,then
A)the term-structure relationship using past data will then show only a weak effect of changes in the short-term interest rate on the long-term rate.
B)the term-structure relationship using past data will show no effect of changes in the short-term interest rate on the long-term rate.
C)one cannot predict the term-structure relationship as it depends on expectations.
D)the term-structure relationship using past data will nevertheless show a strong effect of changes in the short-term interest rate on the long-term rate because of a change in the way expectations are formed.

Question

Quizplus · Accepted Answer

The Lucas critique suggests that relationships observed in historical data (like the term-structure relationship between short-term and long-term interest rates) may not hold if policy or the economic environment changes, particularly because expectations adjust. However, if past increases in short-term rates were always temporary, historical data might show only a weak effect on long-term rates, as market participants might expect these increases to be reversed and not significantly alter their long-term interest rate expectations.

According to the Lucas Critique,if Past Increases in the Short-Term