Expected 1-Year Interest Rates 2020 5.00% 2021 6.00% 2022 7.00% 2023 8.00% The aim of this question is to show you how the government (more precisely, the Fed) can change long-term interest rates by changing people's expectations about future short-term interest rates. Such a policy is called forward guidance. The above table shows the expectations of bond market investors about future 1-year interest rates. For example, the interest rate on the 1-year bond in 2020 is 5.00% (this one is known with certainty in 2020). The market expects the interest rate on the 1-year bond in 2021 to be 6.00 percent, and so on. So currently: Interest rate on the 2-year bond in 2020 = percent Interest rate on the 3-year bond in 2020 = percent Interest rate on the 4-year bond in 2020 = percent The Fed announces that beginning in 2022 it will keep the 1-year interest rate at 6.00% for every subsequent year. Assume that people believe that the Fed will be successful in achieving this goal. As a result: Interest rate on the 2-year bond in 2020 = percent Interest rate on the 3-year bond in 2020 = percent Interest rate on the 4-year bond in 2020 - percent

Expected 1-Year Interest Rates 2020 5.00% 2021 6.00% 2022 7.00% 2023 8.00% The aim of this question is to show you how the government (more precisely, the Fed) can change long-term interest rates by changing people's expectations about future short-term interest rates. Such a policy is called forward guidance. The above table shows the expectations of bond market investors about future 1-year interest rates. For example, the interest rate on the 1-year bond in 2020 is 5.00% (this one is known with certainty in 2020). The market expects the interest rate on the 1-year bond in 2021 to be 6.00 percent, and so on. So currently: Interest rate on the 2-year bond in 2020 = percent Interest rate on the 3-year bond in 2020 = percent Interest rate on the 4-year bond in 2020 = percent The Fed announces that beginning in 2022 it will keep the 1-year interest rate at 6.00% for every subsequent year. Assume that people believe that the Fed will be successful in achieving this goal. As a result: Interest rate on the 2-year bond in 2020 = percent Interest rate on the 3-year bond in 2020 = percent Interest rate on the 4-year bond in 2020 - percent

ENGR.ECONOMIC ANALYSIS

14th Edition

ISBN:9780190931919

Author:NEWNAN

Publisher:NEWNAN

Chapter1: Making Economics Decisions

Section: Chapter Questions

Problem 1QTC

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