Expectations is a critical topic on macroeconomics and defines the pivotal elements of every market economy and controlling all the economic transactions and decisions. The activities within an economy are usually defined by the expectations of the people.
In normal situations, when the supply of goods like oil falls, its price rises pushing for higher production by producers while consumers conserve on its use to get substitutes and get prepared for more. The price controls are significant in controlling the expectations and eliminating the poorly executed economic plans or activities.
The government intervenes in the economic expectations or plans to ensure price controls so as to eliminate the inflationary expectations, which may be extremely challenging to reverse. The central banks are significant in controlling the inflationary expectations in an economy.
The central banks use the inflation targeting strategy to deal with the inflationary activities, which may come forth. One of the merits of inflation targeting is that it may prevent the economy from getting into the inflationary spiral.
The 2007-09 financial crisis proved the inflation targeting programs ineffective pushing the countries for financial stability as a top priority in the definition of the prowess of the economy.
Upon economic tests, the inflation targeting proved to be a bit futile compared to the value for financial stability. The inflation target is subject to a number of negative elements in the economy such as supply of basic commodities required in production such as oil.
Expectations affect real output as Say’s law dictates supply creates its own demand.
As production generates equal income as the full value of the sold product, total income must be enough to purchase all the produced output.
When individuals anticipate bad times in the future, they may hold back their expenditure in the inclusion of consumption and investment thus creating a gap between the potential GDP and the real GDP.
The archetypal downward spiral is the outcome since the anxious consumers may decide to have higher savings with little expenditure. The firms may lay off employees as well as reduce the new investments to ensure there has not been production of goods and services, which cannot be sold.
Increase in levels of unemployment lowers income, which in return reduces demand and advances in intensifying the downward spiral.
The expansionary monetary policy is one of the strategies in countering unemployment declines. A lower rate of interest may encourage one in consumption by ensuring saving appear less interesting.
A lower interest rate may encourage investment by making new plant as well as equipment cheaper to finance. In terms of net present value, a lower discount rate will raise the NPV for any kind of earnings thus attracting the business managers to ensure exclusive investment proposals have been considered even at higher interest rate.
Controlling inflation may be observed as the responsibility of central banks but it may not always work that way as other policies outside the central bank may be equally useful in the process.
If the high inflation in an economy is influenced by the inflationary expectations, the wage and price controls may be the most outstanding solution.
The approach has demerits in the form of:
It may not work unless the government is extremely credible in its commitment to maintain the controls to the best and punish the violators.
Rigid wage and price control may create a high level of inflation in the economy.
Fiscal policy is the other macroeconomic tool that the government uses to control government spending, taxation and manage the budget deficits.
Reference
Moss, D. (2014). A Concise Guide to Macroeconomics, Second Edition: What Managers, Executives, and Students Need to Know (5th ed.). New York: Harvard Business Review Press.
