Suppose individuals expect a cut in future taxes. Explain what ...

[evelyn o bentley]

Suppose individuals expect a cut in future taxes. Explain what effect this expected reduction in future taxes will have on the yield curve and on stock prices in the current period.
 
  What will be an ideal response?

Question 2

Assume that investment does not depend on the interest rate. A reduction in government spending will cause which of the following for this economy?
 
  A) no change in the interest rate
  B) no change in output
  C) no change in investment
  D) an increase in investment
  E) none of the above

[otokexnaru]

Answer to Question 1

The reduction in future taxes will cause the future one-year rate to rise. This increase in the expected one-year rate will cause the two-year rate to rise by approximately half the change in the future expected rate. The current one-year rate does not change. So, the yield curve gets steeper (as the long-term rate rises). The effects on stock prices again depend on whether it is anticipated or not. If anticipated, stock prices do not change. If partially unexpected, the effect on stock prices is ambiguous: the rise in future i will decrease stock prices while the increase in future Y will increase stock prices.

Answer to Question 2

E

[evelyn o bentley]

Excellent

[amcvicar]

Thanks for the timely response, appreciate it