6. Expectations

Question 1

How can inflation expectations be measured?

Answer 1

Surveys

Comparing the yields on nominal bonds with that on real gov bonds of the same maturity

Question 2

What are the 2 ways in which bonds differ?

Answer 2

Default risk and maturity

Question 3

What does an upward sloping yield curve indicate?

Answer 3

The long term interest rates are higher than the short term interest rates. Financial markets expect the short term rates to increase

Question 4

When adding expectations to the AD-AS model, what assumptions change?

Answer 4

Consumption now depends on wealth

Investment now depends on expected and current income and interest rates

Question 5

What is total wealth made up of?

Answer 5

Human and non human wealth

Question 6

What is non human wealth?

Answer 6

The sum of financial wealth and housing wealth

Question 7

What is human wealth?

Answer 7

The expected present value of after tax current and future labour income

Question 8

What are the implications of the dependence of consumption on expectations for the relation between consumption and income?

Answer 8

• a permanent decrease in income causes a one to one decrease in consumption
• a temporary decrease in income causes a less than one to one decrease in consumption
• consumption may change even if income doesn’t change due to consumer confidence

Question 9

How does the IS curve accounting for expectations compare to the old one?

Answer 9

The new one is steeper since a change in interest rates leads to a small increase in output

Question 10

Back loading

Answer 10

Where small cuts in gov spending and large expected cuts in the future will cause output to increase in the current period

Question 11

How are expectations formed on a given government programme

Answer 11

• credibility of programme
• timing of programme
• composition of programme
• state of gov finances in the first place