Suppose there are two types of bonds (one-year bonds and two-year bonds)and that the yield curve is initially upward sloping in period t.Note: For this question assume that: (1)expected inflation is zero; and (2)the relevant interest rate on the vertical axis of the IS-LM model is the one-year interest rate.Based on our understanding of the IS-LM model,of the yield curve and of financial markets,we know with certainty that an announcement in period t of a partially unexpected future increase in taxes (to be implemented in period t + 1)will have which of the following effects?
A)stock prices will increase in period t
B)stock prices will fall in period t
C)the yield curve will become steeper in period t
D)none of the above

Question

Quizplus · Accepted Answer

An unexpected future increase in taxes will reduce the expected future income of firms, which will lead to a decrease in stock prices.

Suppose There Are Two Types of Bonds (One-Year Bonds and Two-Year