Assume all policy rates, current and expected into the future had been 2%. Suppose the Fed decides to tighten monetary policy and increase the short-term policy rate r1t from 2% to 3%. What is the impact on stock prices and its magnitude?
1. The increase is expected to be permanent; future dividends are unchanged.
2. The increase is expected to be permanent; future dividends and output are expected to diminish.
3. The increase is expected to be temporary; future dividends are unchanged.
Answer options: Small increase, Small decrease, medium increase, medium decrease, large increase, large decrease.