ALL PLEASE In this problem, we will consider a central bank that sets the short-

Question

ALL PLEASE

In this problem, we will consider a central bank that sets the short-run interest rate and households and businesses whose decisions depend on the long-run interest rate. Let the short-run real interest rate at time t be the interest rate on one-year borrowing, denoted The central bank will set this interest rate. Let the (annualized) real interest rate on an n-year loan that a household or firm can obtain in period t be denoted R (since households can borrow for different periods of time, there will be different real interest rates [n R for different maturities n -so for instance, at time t, there wil be an interest rate on a five-year loan R1 and a potentially different interest rate on a ten-year loan R' ). [10] Question 2.1 [2 point Assume that the central bank sets the current real short-run interest rate to Rt1J-2% and the private sector believes that this short-run real interest rate will prevail in the future as well. According to the expectations hypothesis, what should be the real interest rate in period t on a two-year loan? What should be the interest rate on a five-year loan? Question 2.2 /3 points/ Assume that the central bank lowers the short-run real interest rate to zero in period t but the private sector expects that in period t+1, the short-run real interest rate will return to 2% and stay at 2% thereafter. According to the expectations hypothesis, what should be the real interest rate in period t on a two-year and a five-year loan? Question 2.3 /3 points Assume that the central bank lowers the short-run real interest rate to zero in period t and the private sector expects that the short-run real interest rate will remain at zero also in periods t + 1 and t + 2, after which it will return to 2% and stay at 2% thereafter. According to the expectations hypothesis, what should be the real interest rate in period t on a two-year and a five-year loan?

Explanation / Answer

The expectation of two year will be

as

100

200

300

450

so two year period is the answer.

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