People are said to have rational expectations if they Group of answer choices assume that this year’s inflation rate will be equal to the average inflation rate over the past 10 years use all available information in forming their expectations about inflation assume that this year’s inflation rate will be the same as last year’s inflation rate merely guess at the inflation rate
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During a time when the inflation rate is increasing each year for a number of years, are adaptive expectations or rational expectations likely to give the more accurate forecasts? Briefly explain.
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$\begin{array}{l}{\text { Inflation Inflation is generally described as the increase over }} \\ {\text { time of the cost of a particular product or service. The rate of }} \\ {\text { inflation depends on many factors and does not remain con- }} \\ {\text { stant. Inflation causes the value of a dollar to decrease over }} \\ {\text { time. Over the past ten years, the average rate of inflation was }}\end{array}$$ 2.4 \% .$Source: Bureau of Labor Statistics. (a) Suppose a house costs $\$ 165,000$ today. If the average rate of inflation continues at this same rate, estimate the cost of a similar house in 10 years. (b) Find the cost of a $\$ 50$ pair of jeans in 5 years. (c) Explain why these estimates may or may not be accurate.
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Because of a recession, the inflation rate expected for the coming year is only $3 \%$. However, the inflation rate in Year 2 and thereafter is expected to be constant at some level above $3 \%$. Assume that the real risk-free rate is $r^*=2 \%$ for all maturities and that there are no maturity risk premiums. If 3 -year Treasury notes yield 2 percentage points more than 1-year notes, what inflation rate is expected after Year 1?
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