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2. (50 points) Consider the following table of interest rates on zero-coupon government securities of various maturities: Table 1: Interest rates maturity (years) interest rate 1 0% 2 0.25% 3 0.5% 4 1% 5 2% Use these values to answer the following questions: (a) Under the expectations theory, what are expected future interest rates on one- year bonds in one, two, three, and four years' time? 2 (b) Suppose that, because interest rates are constrained at their zero lower bound, the central bank announces a forward guidance policy to say that it will not increase interest rates before year four. If the policy is believed by market participants, what will be the effect on the expectations of future interest rates you found in part (a)? What will happen to the interest rates in Table 1 under the expectations theory? Is the policy effective at lowering long-run interest rates? 2. (50 points) Consider the following table of interest rates on zero-coupon government securities of various maturities: Table 1: Interest rates maturity (years) interest rate 1 0% 2 0.25% 3 0.5% 4 1% 5 2% Use these values to answer the following questions: (a) Under the expectations theory, what are expected future interest rates on one- year bonds in one, two, three, and four years' time? 2 (b) Suppose that, because interest rates are constrained at their zero lower bound, the central bank announces a forward guidance policy to say that it will not increase interest rates before year four. If the policy is believed by market participants, what will be the effect on the expectations of future interest rates you found in part (a)? What will happen to the interest rates in Table 1 under the expectations theory? Is the policy effective at lowering long-run interest rates