Question

1. There is widespread credible expectation that the general price level will fall in the near future;
   1. show and explain how this price expectation is likely to affect the prices of financial assets.
   2. Does the price signal have any implication for banking decisions? Why?

Answer 1

1.) Changes in the expectations of the price lead to changes in the financial assets. While volatility also reflects the nature of the asset prices and the one of the major factors behind it is the revisions in the expectations of the future returns.

So, as given if that there is expectation that general price level will fall which will increase the real income of the consumer which further will induce consumption expenditure which in turn again lead to increase in income it also increases money supply shifting its curve outward and keeping money demand at the same level interest rate decreases which leads to an increase in investment . This increase in investment i.e. increase in demand for financial assets will increase the price of financial aence, the expectation of fall in general price level in near future will increase the price of financial assets.

2) Yes, price signal do have the implications for banking decisions. As it has an impact on money supply and thus on interest rate. As in the given case there is decline in general price level indicating increase in money supply (M/P) so interest rate will decrease which will increase investment. Hence price signal affects the interest rate so it also has implications for banking decisions.