Question

Predict what will happen to interest rates under different scenario in the following

the public suddenly expects a large increase in stock prices.

a large federal deficit is expected in the coming year

the fed guarantees that it will pay creditors if the corporation goes bankrupt in the future. What will happen to the interest rates on Treasury securities?

Inflation is expected to increase in 2018

Answer 1

1) Interest rates will rise. When public expects the price of stock price increases then they increase the demand of stock because this will increase their expected return. Due to this demand curve of stock shifts rightwards and increases interest rate.

2) When people expect that federal deficit will become large in coming year then demand of bond falls in the market because risk of buying bonds increases.This shifts the demand curve leftwards and decreases equilibrium bond price and increases interest rate.

3) When government gives guarantee then risk of default decreases and increases the demand of Treasury securities in the market. The increased demand for Treasury securities increases the interest rate on these securities.