Suppose there are two types of bonds (one-year bonds and two-year bonds) and that the yield curve is initially upward sloping in period t. Note: For this question assume that: (1 ) expected inflation is zero; and (2 ) the relevant interest rate on the vertical axis of the IS-LM model is the one-year interest rate. Based on our understanding of the IS-LM model, of the yield curve and of financial

markets, we know with certainty that an announcement in period t of a partially unexpected future increase in taxes (to be implemented in period t + 1 ) will have which of the following effects?

A) stock prices will increase in period t
B) stock prices will fall in period t
C) the yield curve will become steeper in period t
D) none of the above

D