V_output_policy_expectation_ho

V_output_policy_expectation_ho - ECON110B V. Expectations,...

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76 ECON110B V. Expectations, output and policy Major implications: expectations of both future output and future interest rates affect current spending and therefore current output Monetary policy - How the effects of monetary policy depend crucially on how expectations respond to policy - Δ Monetary policy Δ Short-term interest rate What happens to spending and output depends on how changes in the short-term interest rate lead people and firms to change their expectations of future interest rates and future income Fiscal policy - The role of expectations: different story 1. Expectations and decisions: Taking stock 1) Expectations, consumption, and investment decisions a. The channels through which expectations affect consumption and investment spending 77 i) An increase in current and expected future after-tax real labor income, or a decrease in current and expected future real interest rates, increases human wealth and leads to an increase in consumption ii) An increase in current and expected future real dividends, or a decrease in current and expected future real interest rates, increases stock prices which leads to an increase in nonhuman wealth and an increase in consumption iii) A decrease in current and expected future nominal interest rates leads to an increase in bond prices, which leads to an increase in nonhuman wealth and an increase in consumption iv) An increase in current and expected future real after- tax profits, or a decrease in current and expected future real interest rates, increases the present value of real after-tax profits, which leads to an increase in investment b. Expectations affect consumption and investment decisions, both directly and through asset prices
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78 Expectations and spending: the channels 2) Expectations and the IS relation a. Major simplification - Only two periods: the present and the future (all future years lumped together) b. Aggregate private spending (private spending) - The sum of consumption and investment - ) , ( ) ( ) , , ( r Y I T Y C r T Y A + - IS relation: G r T Y A Y + = + ) , , ( c. Extension: to take into account the role of expectations - To allow spending to depend not only on current variables but also on their expected values in the future period 79 - G r T Y r T Y A Y e e e + = + + ) ' , ' , ' , , , ( - Primes denote future values, and e’ s expected values - Y or Y ’e increase A - T or T ’e increase A - r or r ’e increase A d. New IS curve Graph V – 1: The New IS curve
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80 - The IS curve is drawn for given values of current and future expected taxes, T , and T ’e , for given values of expected future output, Y ’e and fore given values of the expected future real interest rate, r ’e . e. Steeper
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This note was uploaded on 09/18/2008 for the course ECON 100B taught by Professor Rauch during the Winter '07 term at UCSD.

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V_output_policy_expectation_ho - ECON110B V. Expectations,...

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