Deflation causes the demand for bonds to ________, the supply of bonds to ________, andbond prices to ________, everything else held constant.A) increase; increase; increaseB) increase; decrease; increaseC) decrease; increase; increaseD) decrease; decrease; increase
Question
Deflation causes the demand for bonds to ________, the supply of bonds to ________, andbond prices to ________, everything else held constant.A) increase; increase; increaseB) increase; decrease; increaseC) decrease; increase; increaseD) decrease; decrease; increase
Solution
Deflation is a decrease in the general price level of goods and services. When deflation occurs, the purchasing power of money increases – alternatively, the real value of money – enabling one to buy more goods with the same amount of money.
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Demand for Bonds: During deflation, the real interest rate (nominal interest rate - inflation) increases because the inflation rate is negative. Bonds pay a fixed interest rate, so when real interest rates increase, bonds become more attractive, leading to an increase in demand for bonds.
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Supply of Bonds: Deflation discourages businesses from investing in new projects due to the decrease in price levels, which leads to lower profitability. Therefore, businesses issue fewer bonds, leading to a decrease in the supply of bonds.
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Bond Prices: The price of bonds is inversely related to the yield (interest rate). When the demand for bonds increases and the supply decreases, the price of bonds increases.
So, the correct answer is B) increase; decrease; increase.
Similar Questions
Along the supply curve for bonds, an increase in the price of bondsa.decreases the interest rate and increases the quantity of bonds supplied.b.decreases the interest rate and decreases the quantity of bonds supplied.c.increases the interest rate and increases the quantity of bonds supplied.d.increases the interest rate and decreases the quantity of bonds supplied.
When interest rate in the economy decreases , the price of existing bonds ____.2 pointsa) Increasesb) Fluctuatec) Decreasesd. Any of the above
Which of the following is not a reason why governments and central banks worry about deflation? The real value of debt increases. There may be cuts to real wages when unemployment is high. Consumers delay spending. The real value of debt decreases. The real interest will be higher than the nominal interest rate.
Analyse what can cause deflation.
In the figure above, a factor that could cause the supply of bonds to shift to the right isA) a decrease in government budget deficits.B) a decrease in expected inflation.C) a recession.D) a business cycle expansion.
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