Question

Choose the best option for each of the 4 underlined parts in the sentence below: The Congressional Budget Office (CBO) projects a federal budget deficit of $3.3 trillion in 2020, more than triple the shortfall recorded in 2019. Other things equal, the drastic increase in the government’s borrowing needs would result in (an increase/a decrease) in the (supply of/demand for) bonds, (a decrease/an increase) in bond prices, and (an increase/a decrease) in bond yields or interest rates.

Answer 1

The Congressional Budget Office (CBO) projects a federal budget deficit of $3.3 trillion in 2020, more than triple the shortfall recorded in 2019. Other things equal, the drastic increase in the government’s borrowing needs would result in an increase in the supply of for bonds, a decrease in bond prices, and an increase in bond yields or interest rates.

Explanation

Because of a huge projected budget deficit, the goverment would need to raise money. It would therefore issue bonds in order to raise it. This would cause an increase in the supply of bonds in the bond market. When the supply of bonds increases relative to the demand, its price comes down. The bond prices are inversely related to the yield or interest rates. Therefore, when the price of bonds comes down, the yiled/interest rates go up.