Question

Determine the likely effects of the following hypothetical news items on output, the real interest rate, inflation, stock prices, and bond prices (up/down/unchanged/ambiguous). Explain briefly.

a. Congress and the President agree on a major tax cut. The Fed keeps the real interest rate stable.

b. Housing starts are unexpectedly low, indicating a decrease in housing investment. The Fed is worried about a recession and will do whatever it can to prevent a reduction in output.

c. New data show that the government has overestimated recent productivity gains. The data show that the economy is operating above potential output and that the Fed will have to do something to prevent a rise in inflation.

d. A survey of telecom equipment producers indicates that capital investment is likely to grow by 10%. Prior to the survey, analysts had expected that capital investment would grow by 20%. Assume the Fed’s objective is to keep the real interest rate stable.

Answer 1

Determine the likely effects of the following hypothetical news items on output, the real interest rate, inflation, stock prices, and bond prices (up/down/unchanged/ambiguous). Explain briefly.

a. Congress and the President agree on a major tax cut. The Fed keeps the real interest rate stable.

Answer - The tax cut by the govt. or the fed increases the hpousehold demad due to the increase in the number of worker take home pay .The business ca be boosted by tax cut as it increase the firm after tax cash flow and this is sued for the payment of dividend and expand the activity by more investment and hiring or workers.The likely effect of tax cut majorily effect the lower rela interest rate as the govt. have to invest more to lend out in the business for the economic boom. The inflation rate will also be lower due to enough supply of money and tend to make the demand of the product lower .The tax cut will reault in fall of stock price as the company will be sharing more unit this will increase the stockk up .The bound price will remained unchanged due to fluctuating market .There will UP in output

b. Housing starts are unexpectedly low, indicating a decrease in housing investment. The Fed is worried about a recession and will do whatever it can to prevent a reduction in output.

Answer - To prevent the reduction in output of housing , the tax cut will lower the real interest for more housing investment , so it will go down , the inflation will go down , the stock price will go down and the bound price will also go down .This will be the effect of tax cut in order to prevent the recession in housing sector .

c. New data show that the government has overestimated recent productivity gains. The data show that the economy is operating above potential output and that the Fed will have to do something to prevent a rise in inflation.

Answer- In this case if overestmination is done in the recent productivity gain .It will likely effect in real interest rate to be lower , inflation rate to be up ,stock price down and the bound price as ambigious.The output will go down due to overestimation  .

d. A survey of telecom equipment producers indicates that capital investment is likely to grow by 10%. Prior to the survey, analysts had expected that capital investment would grow by 20%. Assume the Fed’s objective is to keep the real interest rate stable.

Answer -The likely effect considering the real interest rate to be stable , the output will go up , effecting the inflation to be DOWN ,stock price UP and the bound price to be Down

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