Suppose policy makers implement a fiscal expansion that is not fully anticipated by financial market participants.We know that this will
A)always cause stock prices to fall.
B)always cause stock prices to rise.
C)tend to cause stock prices to rise if the LM curve is very flat.
D)tend to cause stock prices to rise if the LM curve is vertical.

Question

Quizplus · Accepted Answer

Fiscal expansion that is not fully anticipated by financial market participants may lead to an increase in income and output, causing an increase in the demand for money. If the LM curve is very flat, this increase in demand for money may lead to a small increase in interest rates, causing an increase in stock prices. However, if the LM curve is vertical, an increase in the demand for money will cause a large increase in interest rates, leading to a decrease in stock prices. Therefore, the correct answer is C - tend to cause stock prices to rise if the LM curve is very flat.

Suppose Policy Makers Implement a Fiscal Expansion That Is Not