Monetary Economics Essay Example | Topics and Well Written Essays - 750 words

Monetary Economics - Essay Example When the Fed lowers rates then we expect an increase in borrowing, when rates are reduced there is an expectation that inflation will rise, therefore inflation will increase when the rates are reduced. When the Fed lowers rates then we expect an increase in borrowing, an increase in borrowing means that there will be an increase in spending which will lead to an increase in output. An increase in output means that the economy will grow. When the Fed lowers interest rates this may result into an increase in money supply, n increase in money supply in the economy means that there will be a rise in expected inflation rate and therefore inflation rates are expected to increase. Calculation of future spot rate is complicated in that we assume that the 3rd year rate is equal to the five year rate, in the last calculation we consider two years which is the second and third year rate and also assume that the third year rate is equal to 2.04, the values provided are an estimate of what is expected by investors and this is because of uncertainties in future. The yield curve is a curve that depicts the yield or the cost of borrowing over time, the yield curve is an upward sloping curve and this means that if an investor invests his funds for a duration of t years then the yield will be a function of time, this means that the more the investor invests in terms of years then the higher is the yield. Prevailing interest rates which is the cost of borrowing will determine the position of the yield curve, in our case the chart shows that the yield curve has shifted downwards compared to the