Question

When the Government runs a budget deficit, it must sell Treasury bonds to finance that deficit....

When the Government runs a budget deficit, it must sell Treasury bonds to finance that deficit. To analyze the impact of increased government spending, assume the Treasury will be selling new 1-year Treasury bills. Use a supply and demand for bonds model to determine what is likely to happen to interest rates on 1-year bills. (Explain your graph)

Homework Answers

Answer #1

Here, the demand and supply of the bonds were at an equilibrium at point A. the price of the bond is $95 and interest rate is 5%. As the supply of the bond increase the new supply curve will shift at S1. here the price of the bonds will drop at 90 and the interest rate which is inversely related to the price will increase to 10%. The new equilibrium will be at B. At a higher quantity and lower price.

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