1. Suppose the yield curve is upward sloping. How should one interpret this part
ID: 1219709 • Letter: 1
Question
1. Suppose the yield curve is upward sloping. How should one interpret this particular yield curve?
2. Suppose there is a reduction in government spending. Such a fiscal policy action will cause
Select one:
a. the natural real interest rate to rise.
b. the natural real interest rate to fall.
c. no effect on the natural real interest rate.
3. As the LM curve becomes steeper, an unexpected decrease in consumer confidence
Select one:
a. will cause a relatively large increase in output and relatively large increase in the interest rate.
b. will cause a relatively small increase in output and relatively small increase in the interest rate.
c. is more likely to cause stock prices to rise.
d. is more likely to cause stock prices to fall.
4. Suppose an increase in government spending occurs that is at least partially unexpected. Explain what effect this will have on stock prices.
5. To reduce the nominal interest rate in the medium run, what type of policy should the central bank pursue? Explain.
Explanation / Answer
The yield curve is a simple graph which answers the question of what type of rates a person is getting for lending money to the government in different periods of time on a risk free basis? In general this yield curve is upwardly sloping because for higher periods the rates are high. This is because for a longer period(say 10 years) the risk is also high than a shorter period(say 1 month). Within this 10 years there are various risks like the person might need the cash, there might be inflation or the dollar might devalue. Thus with longer period of lending, the interest will also increase. b-with reduction in government spending, the IS curve will shift to the left and hence the interest rate will fall. d-will cause more likely stock prices to fall because of lack of consumers confidence. With the increase in government spending, the economy will expand and consumerism will increase. This will cause the stock prices to increase. To reduce the nominal interest rate,the central bank should start printing money slowly.It can also follow contractionary fiscal policy(though this is not done by the central bank). In totality the central bank should increase the money circulation.
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