Expectation Theory in the Second Time Around Online Exams and Class Help Service

Explain what Expectation Theory of interest rate really means. Eight years ago, when I took up a post in the Department of Economics at University of Illinois at Champaign.

Eight years later, “definition: – The (applied) mathematical average of the (applied) geometric or past long term rates over the entire period of long term loan and present short-term rates during the same period.” And last but not least, “implication: – As an analytical tool, Expectation Theory is a tool for evaluating the relative value of various market rates and their implications for the future. It can be used to evaluate the expected future effects of the changes in market interest rates and in market prices of certain goods and services.

It also is a tool for identifying the probable equilibrium that will result from the absence of any change in market prices. Free Flow of Money Theory or FFF is a general theory, which suggests that monetary conditions are driven by the expectations and wishes of the public regarding the money supply. The currency market is a very complex place indeed. And, if we are to get out of it all, we would need to make a lot of decisions and use a lot of tools, if we are to survive, which seems to be the essence of human existence.

So, the second time around, it was a little different with “definition: – The (applied) mathematical averages of both geometric or past long term rates over the whole period of long term loans and present short-term rates over the period of short term loans. Implication: – FFF is a tool to evaluate the expected future effects of changes in market interest rates and in market prices of certain goods and services.” Now, what does this mean?

Well, there are no new tools to be used, only old ones made more precise. One has to be careful about using an old model with a new view of economics, because it might lead to conclusions that are no longer applicable today. That might mean the end of a particular view or concept, which was very useful in its time. However, it would mean that people have more options and can apply a wider variety of tools.

Let me give you a very quick overview of what the theory means in the world economic and in personal economics. The assumption is that people have the same expectations as the government, and economic analysts, as to how the economy should run; they expect the same policies and economic conditions to occur.

If everyone believes that the government will always be supportive, the assumption is that people have the same expectations, then the economic policy makers also believe in the same, so their actions will follow. The assumption is that people expect the government to always provide them with the right amount of public funds; and if there is less than that, there is bad news.

In simple terms, the theory is based on the assumption that financial institutions have expectations that the government will always lend to them, and that the government will always return that borrowed money to them, at interest. When the private banks, corporate firms or individuals do not lend to the government or not return the borrowed funds to them, there will be bad news, because the institutions will think that the economy is in crisis.

But, that is not the case. The expectation theory says that all that matters is whether the institutions make more loans in the future. The fact is that the government will always support the banks or private institutions by providing the needed funds in the future.

I think there are many economic models that are similar to this one, but I think they are not as comprehensive as this one. For one thing, they are not as good because they have only one part of the story to tell.

Economic growth cannot happen if there is not an investment, and if there is no investment, then there is no growth. So, my second time around I started using the expectations theory to study the whole picture, and I found that the assumptions that I had made in the first theory were still valid for me, but they were not as good as they should be.

Posted on October 21, 2020 in Take My Examination

Share the Story

Back to Top
Share This