Understanding Expectations to Design Better Policies, ERC grant

Luigi Iovino

Expectations about economic variables are a key driver of how households and firms react to changes in the economic environment, including policy interventions. When a central bank cuts interest rates, for instance, the economy will expand only if businesses and households expect the rates to remain low for some time. Only in this case, in fact, will they borrow, spend, and invest more, thus contributing to economic growth. If, on the other hand, they expect interest rates to rise again soon, they will not react to the cut and the expansion will not materialize.