11. Bond prices and interest rates Suppose the following diagram represents the money market in the United States. Assume the money market is currently in equilibrium, as indicated by the grey star. INTEREST RATE (PERCENT) 6.0 5.5 5.0 4.5 4.0 -- 3.5 3.0 2.5 2.0 0.6 0.7 Money Supply 0.8 0.9 1.0 1.1 1.2 QUANTITY OF MONEY (Trillions of dollars) A Current Interest Rate (Yield) = 1.3 Annual Interest Payment Bond Price A New Curve Money Demand Suppose a decrease in nominal incomes causes the demand for money to decrease by $0.2 trillion at every interest rate. Use the green line (triangle symbols) on the previous graph to illustrate the effects of this change. Before the interest rate adjusts, there will be an initial surplus of money in the financial system, causing the demand for bonds to increase. This means that people who want to sell existing bonds can raise the price of their bonds. ? To understand how a change in bond prices affects the interest rate, consider the following formula: To reach the new equilibrating . At the initial interest rate of 4%, a bond with a yearly interest payment of $180 would have sold for interest rate of %, the change in demand just described must cause the price of existing bonds to yield on existing bonds and the interest rate offered on new bonds would equilibrate the supply and demand for money. , at which point the
11. Bond prices and interest rates Suppose the following diagram represents the money market in the United States. Assume the money market is currently in equilibrium, as indicated by the grey star. INTEREST RATE (PERCENT) 6.0 5.5 5.0 4.5 4.0 -- 3.5 3.0 2.5 2.0 0.6 0.7 Money Supply 0.8 0.9 1.0 1.1 1.2 QUANTITY OF MONEY (Trillions of dollars) A Current Interest Rate (Yield) = 1.3 Annual Interest Payment Bond Price A New Curve Money Demand Suppose a decrease in nominal incomes causes the demand for money to decrease by $0.2 trillion at every interest rate. Use the green line (triangle symbols) on the previous graph to illustrate the effects of this change. Before the interest rate adjusts, there will be an initial surplus of money in the financial system, causing the demand for bonds to increase. This means that people who want to sell existing bonds can raise the price of their bonds. ? To understand how a change in bond prices affects the interest rate, consider the following formula: To reach the new equilibrating . At the initial interest rate of 4%, a bond with a yearly interest payment of $180 would have sold for interest rate of %, the change in demand just described must cause the price of existing bonds to yield on existing bonds and the interest rate offered on new bonds would equilibrate the supply and demand for money. , at which point the
Chapter1: Making Economics Decisions
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Transcribed Image Text:11. Bond prices and interest rates
Suppose the following diagram represents the money market in the United States. Assume the money market is currently in equilibrium, as indicated
by the grey star.
INTEREST RATE (PERCENT)
6.0
5.5
5.0
4.5
4.0 A
3.5
3.0
2.5
2.0
0.6
bonds
0.7
Money Supply
0.8
0.9
1.0
1.1
1.2
QUANTITY OF MONEY (Trillions of dollars)
A
Current Interest Rate (Yield) =
1.3
Annual Interest Payment
Bond Price
New Curve
Suppose a decrease in nominal incomes causes the demand for money to decrease by $0.2 trillion at every interest rate. Use the green line
(triangle symbols) on the previous graph to illustrate the effects of this change. Before the interest rate adjusts, there will be an initial
surplus
. This means that people who want to sell existing
of money in the financial system, causing the demand for bonds to increase
can raise
the price of their bonds.
Money Demand
?
To understand how a change in bond prices affects the interest rate, consider the following formula:
To reach the new equilibrating
At the initial interest rate of 4%, a bond with a yearly interest payment of $180 would have sold for
interest rate
%, the change in demand just described must cause the price of existing bonds to
yield on existing bonds and the interest rate offered on new bonds would equilibrate the supply and demand for money.
, at which point the
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