The Bank of Canada expects inflation to exceed its target level in the next year. To combat this it initiates contractionary fiscal policy. Following this, investor's attitude towards risk lessens and they become more cautious about what they invest in. What would the SML look like in the next year:

Question

Quizplus · Accepted Answer

Contractionary fiscal policy can lead to higher interest rates, increasing the risk-free rate and causing the SML to shift up. However, increased risk aversion among investors would steepen the SML as they demand higher returns for additional risk.

The Bank of Canada Expects Inflation to Exceed Its Target