Question

How is an autonomous tightening or easing of monetary policy different from a change in the real interest rate caused by a change in the current inflation rate?

Short answer

Inflation expectations have a considerable impact on people's present decisions on a variety of economic activities. It is crucial since these assumptions tend to diverge consumer spending, undermining economic stability.

Step-by-step solution

Concept of Inflation 

Inflation expectation refers to the expectation of future inflation among individuals in a country, such as businessmen, employees, and investors. Making suitable expectations about future inflation is important since the rate of effect of these expectations on future inflation is extremely high.

Explanation

Individuals' inflation expectations have a significant impact on their current decision-making on numerous economic activities. Because these assumptions tend to diverge consumers' spending, affecting economic stability, it is critical.

For example, if people expect inflation to rise in the future, they will tend to consume or buy a lot now because their actual income will fall in the future, according to their predictions. This rapid rise in spending will cause economic instability, disrupting supply, interest rates, and other macroeconomic variables.