Chapter 5
impact on large federal deficit on interest rates
Shift to the right for quantity of bonds.
M1 money growth in the United States was about 15% in 2011 and 2012, and 10% in 2013. Over the same time period, the yield on 3-month Treasury bills was close to 0%. Given these high rates of money growth, why did interest rates stay so low, rather than increase? What does this say about the income, price-level, and expected-inflation effects?
The income, price-level, and expected-inflation effects were small relative to the liquidity effect.
Will there be an effect on interest rates if brokerage commissions on stocks fall?
Yes, interest rates would rise because stocks become more liquid than before, which would reduce the demand for bonds
Would fiscal policy makers ever have reason to worry about potentially inflationary conditions?
Yes, higher inflation leads to a higher debt service burden and increases the costs of financing deficit spending.
What is the opportunity cost of holding $1,000 in cash if the relevant interest rate is 10 percent? If interest rates rise, this opportunity cost will ______, and individuals will hold ______ cash balances.
$100 increase smaller
Effect of a business cycle expansion on the bond market (results in higher equi interest rate)
A business cycle expansion will increase both the demand for and supply of bonds. For this to result in a higher equilibrium interest rate, the bond demand must increase by more than the increase in bond supply. both quantity and price of bonds shift to the right
How might a sudden increase in people's expectations of future real estate prices affect interest rates?
Interest rates would increase because real estate would have a relatively higher rate of return compared to bonds, which would cause the demand for bonds to decrease.
What will happen in the bond market if the government imposes a limit on the amount of daily transactions? Which characteristic of an asset would be affected?
Liquidity of bonds relative to other assets will decrease, increasing the interest rate and lowering bond's prices. If the government imposes a limit on the amount of daily transactions in the bond market, then bonds will become less liquid with respect to alternative assets. Such a regulation will mean that it will now be more difficult to find buyers and sellers in the bond market, thereby affecting the liquidity of bonds and the demand curve (which will shift to the left), increasing the interest rate and lowering bond's prices (for a given supply curve).
Effect on the rise of interest rates in the riskiness of bonds
Price of bonds to shift to the left. an increase in the demand for money, no change in the quantity of money, and a higher interest rate. From the graph, we see that a rise in the riskiness of bonds will cause the interest rate in the liquidity preference framework to increase and cause the interest rate in the bond market to increase .
Effect on interest rates when expected inflation falls
Quantity of bonds shifts to the right, and price of bonds shifts to the left
If the next governor of the Bank of Canada has a reputation for advocating an even slower rate of money growth than the current governor's reputation, what will happen to interest rates?
Slower money growth will lead to a liquidity effect, which will raise interest rates; however, the lower income, price level, and inflation will tend to lower interest rates.
Suppose that many big corporations decide not to issue bonds since it is now too costly to comply with new financial market regulations. Can you describe the expected effect on interest rates?
The impact will translate into a shift to the left in the supply curve, increasing bond's prices (lowering interest rates) and lowering the quantity of bonds bought and sold in the market. If many big corporations decide not to issue bonds because of new financial markets regulations, the supply curve of the bonds will be affected. The impact will translate into a shift to the left in the supply curve, increasing bond's prices (lowering interest rates) and lowering the quantity of bonds bought and sold in the market.
Recession
When income and wealth are falling, the demand for bonds falls, and the demand curve shifts to the left
Business cycle expansion
means growing income and wealth, which means demand for bonds rises and the demand curve for bonds shifts to the right, which means interest rates will increase When the economy expands, using the liquidity preference framework, the demand for money will increase, shifting the money demand curve to the right. Interest rates increase when there is a business cycle expansion. Therefore, interest rates are said to be procyclical.
