Assume policy makers implement fiscal expansion unexpectedly. Further assume that monetary policy is expected to keep interest rates constant in response to this unexpected fiscal policy. Given this information, we would expect that this will cause:
A) stock prices to rise.
B) stock prices to remain constant.
C) stock prices rise initially followed by decreases.
D) stock prices to fall.
E) an ambiguous effect on stock prices.

Question

Quizplus · Accepted Answer

Fiscal expansion would increase aggregate demand, leading to higher output and profits for firms. The expectation of constant interest rates from the central bank would also reduce borrowing costs for firms, leading to higher investment and further increasing profits. As a result, stock prices are likely to rise.

Assume Policy Makers Implement Fiscal Expansion Unexpectedly