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Assume that the current interest rate is Lees say that investors know that normally interest rates are 10%. How would this affect investors’ decisions with regard to how much money and bond holdings to keep? Investors will want to hold more cash instead of bonds. Because the investors know that normally interest rates are 10% which is more than the current interest 8%. That is to say investors expect the interest rates would increase in the future which will cause the decrease of value of bonds. 2.
By the middle of 2008 the Fed had driven the short-term interest ate close to zero, and it remained at essentially zero through the middle of 2010. How do you think this affected people’s decision of whether to hold on to money or hold bonds instead? There is no difference between holding money and holding bonds. Because the opportunity cost Of holding money is the interest rates that bonds earns. But when the interest rate is nearly zero, the CO of holding money is essentially zero. So there is no difference between holding money and holding bonds. 3.
Suppose that you own a $1 000 bond which earns 5% interest. Furthermore, assume that interest rates on newly issued bonds rise to 10%. Explain why no one would be willing to buy your bond for a $1000. In addition, calculate the price that you could reasonably expect to receive for your bond. A) Explain why no one would be willing to buy your bond for a $1000. Because they can buy the newly issued ones which earns a higher interest rate with $1000. B) Calculate the price tattoo could reasonably expect to receive for your bond. The coupon of our bond $50 and the bond must earn 10%.
So the proper price which will provide a same yield of 10%. . Suppose that you own a $1000 bond which earns 20% interest. Now assume that interest rates on newly issued bonds fall to 10%. How much could you reasonably expect to receive for your bond if you were to sell it? According to the question, the interest rate decreases so that the value of the bond will increase. Since the coupon of this bond is $200 per year that will not change, the price of my bond must be Then this bond price will earn the same yield. 2. Explain how the demand for money might change even if interest rates remain unchanged.
If the aggregate output increases, he demand for money will increase. More output means that the number of spending or transaction increase which will lead to an increasing of money demand. At the same time vice versa. 3. Explain how and why the demand for money might change even if the number of transactions in the economy does not. Fifth price of goods and services is rising, we need more money to satisfy the same consumption level. The same consumption level means that we consume the same number of goods and services or the number of transaction would not change. So the money of demand will increase.
At the same time vice versa. On the other hand, when the price level is rising , the nominal output(nominal output-??real output*price level) will increase. The higher the nominal output, the higher the demand of money and shifts the money demand curve to the right. Q 1. Label each of the following events as either leading to an increase or a decrease in the equilibrium interest rate? (a) A decrease in the price level. If the price level decreases, the nominal output will decrease and the demand of money will decrease. Since the money supply is fixed, the equilibrium interest rate will decrease. B) A decrease in the level of aggregate output If the level of aggregate output decreases, the demand of money will decrease. As the money supply is fixed, the equilibrium interest rate will decrease. (c) A sale of government securities by the Federal Reserve If Fed sells the government securities, the money supply will decrease as the graph showed below. The equilibrium of interest rate will increase. 2. Use a graph to illustrate the effect an expansionary fiscal policy (tax cuts and/or increases in government spending) will have on the money market. What happens to the interest rate?
What impact will this have on the effectiveness of fiscal policy? A) What happens to the interest rate? An expansionary fiscal policy will increase the demand for money and increase the interest rate. B) What impact will this have on the effectiveness of fiscal policy? An increase in the interest rate may lead investment to decrease, if investment is sensitive to the interest rate. An increase in the interest rate may cause consumption to decrease, if consumption is sensitive to the interest rate. The effect of fiscal policy will weaken if investment and institution are sensitive to the interest rate. . Illustrate each of the following situations using supply and demand curves for money. In each case explain what happens to the equilibrium interest rate. (a) Aggregate output increases. The interest rate increases. (b) The Fed sells government securities in the open market during a recession (GAP goes down) The change in the equilibrium interest rate is indeterminate. Because if the Fed sells government securities in the open market the supply of money will decrease. But if the GAP goes down the demand of money will decrease, too. We cannot determine that the effect of which side is stronger.
So here are three positions. First of all, the recession affects the money market more. The interest rate decreases. Secondly, the open market operation affects the money market more. The interest rate increases. Thirdly, the interest rate would not change. (c) During a period of rapid growth (GAP goes up), the Fed reduces the reserve requirement. The change in the equilibrium interest rate is indeterminate. If the Fed reduces the reserve requirement the supply of money will increase. But if the GAP goes up the demand of money will increase, too. We cannot determine that the effect of which side is stronger.
So here are three positions. First of all, the GAP affects the money market more. The interest rate increases. Secondly, reserve requirement affects the money market more. The interest rate decreases. 2. Answer the following three questions dealing with monetary policy. (a) Explain how the Federal Reserve might carry out a “tight” monetary policy: reduce the grog. N/the rate of the money supply. The Fed can carry out the “tight’ monetary policy by increasing the discount rate, increasing the required serve ratio or selling government bonds in the open market. B) Explain how the Federal Reserve might carry out an “easy” monetary policy: increase the growth rate of the money supply. The Federal Reserve can carry out an “easy” monetary policy by decreasing the required reserve ratio, decreasing the discount rate or buying government bonds in the open market. (c) How would each of the policies affect the equilibrium interest rate?