Question 3. Suppose an economy in which goods and financial markets are influenced by both the current and future expectations of economic variables. But this time the change occurs in fiscal policy; government reduces budget deficit.

1. Using the framework of IS and LM curves, explain that if there is no future expectation, output (Y) falls in the short run (explain what shifts and why).
2. What could happen to income (Y) and interest rate (i) in the short run when there is expectation for the future?