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Chapter 5: Q.14 (page 164)

Suppose that people in France decide to permanently increase their savings rate. Predict what will happen to the French bond market in the future. Can France expect higher or lower domestic interest rates?

Short Answer

Expert verified

Bond demand will rise, and the interest rate will fall.

Step by step solution

01

Introduction

The amount demanded of an asset is directly related to wealth, expected return on asset, and liquidity of the asset, and negatively proportional to expected return on alternative asset, liquidity of the alternative asset, according to the theory of portfolio choice.

02

Explanation

If people suddenly start saving more, demand for bonds will rise, and the bond's demand curve would shift to the right. Because the interest rate and the bond price are inversely related, the bond price will rise and the interest rate will decline.

As a result, bond demand will rise, and the interest rate will fall.

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Most popular questions from this chapter

Would fiscal policymakers ever have reason to worry about potentially inflationary conditions? Why or why not?

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