Question

Suppose the U.S. government enacts an across-the-board increase in the income tax rates. Everything else held constant, this would cause the demand for U.S. Treasury bonds to_______ and the yields on municipal bonds to________.

Select one: decrease; decrease increase; increase decrease; increase increase; decrease

Answer 1

If income taxes are increased, disposable income of individuals will fall, which will reduce consumption expenditure in the economy. As a result, the IS curve will shift leftward. To maintain an equilbrium we move downward along the LM curve, i.e. money demand falls. At the new equilibrium, we have lower output and lower interest rates.

From the above reasoning, we can conclude,

Suppose the U.S. government enacts an across-the-board increase in the income tax rates. Everything else held constant, this would cause the demand for U.S. Treasury bonds to decrease (lower money demand) and the yields on municipal bonds to decrease (lower interest rates).