Question

Suppose the central bank implements a monetary expansion in the current period and is not expected to continue this policy in the future. Explain what effect this policy will have on the shape of the yield curve and on stock prices. (about 50-100 words)

Answer 1

Central bank implements a monetary expansion in the current period, meaning the central bank increases money supply and thus reduces the interest rates in the current period.

This policy of increase in money supply is not expected to continue in the future where the interest rates might rise.

As the money supply will increase in the current period the interest rates decline.

The shape of the yield curve is upward sloping as the investors and financial markets expect future interest rates to increase as the expansion policy is not expected to be continued in the future.

The stock prices increase because people want to invest where the returns are greater.

Companies also buyback shares and issue dividends which increase investments in shares.

As the bank interest rates decline, the investors flood to the stock markets in search of higher returns, increasing the stock prices extensively.

answered by: anonymous