question archive Assume that bond market participants suddenly expect the Fed to substantially increase the money supply
Assume that bond market participants suddenly expect the Fed to substantially increase the money supply
Subject:EconomicsPrice:2.88 Bought3
Assume that bond market participants suddenly expect the Fed to substantially increase the money supply.
a. Assuming no threat of inflation, how would bond prices be affected by this expectation?
b. Assuming that inflation may result, how would bond prices be affected?
c. Given your answers to (a) and (b), explain why expectations of the Fed s increase in the money supply may sometimes cause bond market participants to disagree about how bond prices will be affected.
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a. Assuming no threat of inflation, the Fed adding money supply is done by purchasing bonds. This increases demand and causes a bond market rally, so prices rise and yields fall.
b. If inflation is assumed to result, market participants will require an inflation premium on the yields they require. As interest rates rise, prices will fall.
c. Bond market participants can disagree about how bond prices will be affected by Federal Reserve Open Market Operations based on their varying perspectives on how inflationary increasing the money supply will be.
