Question

1. In March 2010, Greece announced that it might have trouble in the future paying off the bonds it had sold to finance its huge government deficits. The Wall Street Journal reported, “Prevailing uncertainty over Greece's ability to fund itself ... kept Greek government bonds under increasing pressure Thursday, pushing 10-year Greek yields above 7%.” (Source: Emese Bartha, "Pressure Intensifies on Greek Debt,”Wall Street Journal, April 8, 201 a. Use a demand and supply graph for the Greek bond market to illustrate why the interest rate on Greek government bonds was increasing. Be sure that your graph indicates any shifts in the Demand curve and /or supply curve for Greek bonds.

Answer 1

Question 1

It has been stated that Greek government has expressed that there will be trouble for it in paying off bonds in future due to financial trouble.

This will make the Greek bonds very risky and thus demand for Greek bonds will decrease.

This decrease in demand for Greek bonds will shift the demand curve for Greek bonds to the left.

Following is the required figure -

Price of Bond E1 Е P1 D D1 Q1 Quantity of Bonds

The above figure shows that leftward shift of the demand curve has resulted in a fall in the price of the Greek bonds.

The price of bond and interest rate has inverse relationship. When price of bond decreases, interest rate of bond increases and vice versa.

So,

The decrease in price of Greek bonds due to decrease in demand has resulted in an increase in the interest rate on Greek bonds.