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

What will be an ideal response?

The current one-year rate will fall with no change in the expected future rate. The two-year rate, given that it is an average of the two one-year rates, will fall. The change in the two-year rate will approximately equal half the change in the one-year rate. The yield curve will shift down and get steeper. What happens to stock prices depends on whether this was fully or partially expected? If fully anticipated, stock prices do not change. If at least partially unexpected, stock prices will rise because of the interest rate effect and the higher output (changes in which were unexpected).