Assume that the one- year interest rate is on the vertical axis of the IS- LM model and that the yield curve is initially upward sloping. If financial market participants now expect the central bank will pursue a monetary expansion in the future, we would expect which of the following to occur?
A) The yield curve will become vertical.
B) The yield curve will become steeper.
C) The yield curve will become horizontal.
D) The yield curve will become downward sloping.
E) The yield curve will become flatter.

Question

Quizplus · Accepted Answer

If market participants expect future monetary expansion, they anticipate lower future interest rates, which would flatten the yield curve as long-term rates decrease relative to short-term rates.

Assume That the One- Year Interest Rate Is on the Vertical