Q: 4 If the public expects the Fed to... [FREE SOLUTION]

Chapter 25: Q: 4 (page 675)

If the public expects the Fed to pursue a policy that is likely to raise short-term interest rates permanently to 5%, but the Fed does not go through with this policy change, what will happen to long-term interest rates? Explain your answer.

Short Answer

Expert verified

They'll most likely lower their expectations as a result of this downward move, and we'll see long-term interest rates fall as a result.

Step by step solution

Step:1 Introduction

Monetary policy refers to the macroeconomic policies set by each country's central bank. It is the policy adopted by the central bank to control the interest rate, exchange rate, and inflation rate in an economy by manipulating the money supply.

Step:2 Explanation

Because the public expects short-term rates to rise, long-term rates are likely to rise as well. However, if the Federal Reserve does not follow through on this proposed increase in short-term rates, they will not rise, implying that the public's perception of the situation must be altered. As a result, expectations are being revised. Let's name it based on what the public believes will happen in terms of interest rates in the short and long run. So they're revising their expectations since they recognized they were mistaken to assume these higher short-term rates in the first place. They'll most likely shift their expectations downward as a result of the downward shift.