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Chapter 5: Q.19 (page 164)

M1 money growth in the U.S. was about 15%in localid="1647014587488" 2011and2012, and 10%in 2013. Over the same time period, the yield on 3-month Treasury bills was close to 0%. Given these high rates of money growth, why did interest rates stay so low, rather than increase? What does this say about the income, price-level, and expected-inflation effects

Short Answer

Expert verified

The interest rate was low since the liquidity effect outweighed all other benefits.

Step by step solution

01

Introduction

Inflation is defined as a condition in which the price of all goods and services begins to rise, reducing people's real purchasing power.

02

Explanation

Money supply expansion is typically associated with high predicted inflation, strong economic growth, and a rise in interest rates over time. However, between 2011 and 2013, unemployment was high, economic growth was slow, and economists were more concerned about deflation. All other effects were smaller at the time in comparison to the liquidity effect. As a result, the interest rate remained low for a long time.

As a result, the interest rate was low since the liquidity effect outweighed all other benefits.

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Most popular questions from this chapter

1. Explain why you would be more or less willing to buy a share of Microsoft stock in the following situations:

a. Your wealth falls.

b. You expect the stock to appreciate in value.

c. The bond market becomes more liquid.

d. You expect gold to appreciate in value.

e. Prices in the bond market become more volatile.

Explain why you would be more or less willing to buy long-term Delta Air Lines bonds under the following circumstances:

a. The company just released its financial statements, indicating that income decreased and liabilities increased.

b. You expect a bull market in stocks (stock prices are expected to increase).

c. You have analyzed your country鈥檚 monetary policy and expect interest rates to decrease.

d. Brokerage commissions on bonds fall.

e. Your income and wealth increased over the last two years.

Go to the St. Louis Federal Reserve FRED database, and find data on net worth of households and nonprofits (HNONWRQ027S) and the 10-year U.S. Treasury bond (GS10). For the net worth indicator, adjust the units setting to 鈥淧ercent Change from Year Ago,鈥� and for the 10-year bond, adjust the frequency setting to 鈥淨uarterly.鈥�

a. What is the percent change in net worth over the most recent year of data available? All else being equal, what do you expect should happen to the price and yield on the 10-year Treasury bond? Why?

b. What is the change in yield on the 10-year Treasury bond over the last year of data available? Is this result consistent with your answer to part (a)? Briefly explain.

An important way in which the Federal Reserve decreases the money supply is by selling bonds to the public. Using a supply and demand analysis for bonds, show what effect this action has on interest rates. Is your answer consistent with what you would expect to find with the liquidity preference framework?

Explain why you would be more or less willing to buy gold under the following circumstances: a. Gold again becomes acceptable as a medium of exchange.

b. Prices in the gold market become more volatile.

c. You expect inflation to rise, and gold prices tend to move with the aggregate price level.

d. You expect interest rates to rise
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