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

question 54

Multiple Choice

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

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