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Chapter 5: Q.9 (page 164)

How might a sudden increase in people鈥檚 expectations of future real estate prices affect interest rates?

Short Answer

Expert verified

This will lead the bond demand curve to shift to the left, resulting in a decrease in the equilibrium bond price as well as a rise in the interest rate.

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 future real estate values are expected to rise sharply, the demand for real estate will rise in compared to bond demand, and bond demand would fall as a result.

This will lead the bond demand curve to shift to the left, resulting in a decrease in the equilibrium bond price as well as a rise in the interest rate.

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Most popular questions from this chapter

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

In the aftermath of the global economic crisis that started to take hold in 2008, U.S. government budget deficits increased dramatically, yet interest rates on U.S. Treasury debt fell sharply and stayed low for quite some time. Does this make sense? Why or why not?

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.

If the next chair of the Federal Reserve Board has a reputation for advocating an even slower rate of money growth than the current chair, what will happen to interest rates? Discuss the possible resulting situations.

Increasing prices erode the purchasing power of the dollar. It is interesting to compute what goods would have cost at some point in the past after adjusting for inflation. Go to http://minneapolisfed.org/index.cfm. What would a car that costs $22,000today have cost the year you were born?
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