Question

1) Draw the Bond market for AMERICAN TREASURIES. Be sure to label everything. Show what happens before and after the government increases the deficit to send out stimulus checks in response to the COVID-19 virus. 2) Does borrowing increase or decrease? 3) Do interest rates increase or decrease? 4) Does lending increase or decrease?

Answer 1

1.

In following graph, US treasury bond price (P) and quantity (Q) are measured along vertical and horizontal axes. D0 and S0 are initial treasury bond demand and supply curves intersecting at point A with initial price P0 and quantity of treasury bonds Q0.

After government increases deficit by increasing spending for COVID package, government finances this deficit by issuing more bonds. The bond supply curve shifts rightward to S1, intersecting D0 at point B.

2.

Government borrowing increases from Q0 to Q1.

3.

Bond price decreases from P0 to P1. Since bond price and interest rate are negatively related, lower price increases interest rate.

4.

At lower bond price, equilibrium lending also increases (from Q0 to Q1).