Question

Use a S/D analysis for bonds and explain the impact of each of the following on the equilibrium quantity of bonds outstanding, and the equilibrium bond prices and yields.

a. inflationary expectations in the economy fall evoking a much stronger response from issuers of bonds than investors in bonds.

b. all leading indicators point to stronger economic growth in the near future, and the response of bond purchasers dominates that of bond issuers.

Answer 1

a. The supply demand analysis of bonds when inflationary expectation in the market fall, for any nominal rate of interest the real interest rate falls. This makes the supply curve to shift left and and the demand curve to shift right. But since the issuers have stronger reaction the supply will have greater impact on the equilibrium quantity ie., Equilibrium quantity falls . The equilibrium price rises and yield (interest rates)falls.

b. When the economy growth is stronger in the future and is dominated by response of bind purchases it is the demand which will be the deciding factor.ultimately , the price of bonds fall and the interest rate increases ie., Yield increases.