Finance and Econ dudes, HW answer check please

[axelfox]

Just wanna do an answer check and help on some HW of mine. Tell me if I got the right answers, or correct me. Thanks.

1. What effect will a sudden increase in the volitility of gold prices have on interest rates?

- Since money is backed by gold, the sudden increase in volitility affect the dollar value in which loans/bonds are being paid back. This is partly known as inflation risk

2. Explain what effect a large federal deficit might have on interest rates.

- A large federal deficit means that the gov't has to borrow money by issuing T-Bonds/Bills. To create the demand, they increase the interest rates. As a result, the bond prices drop.

3. The president of the United States announces in a press conference that he will fight the higer inflation rate rate program with a new anti-inflation program. Predict what will happen to interest rates if the public believes him.


-Been racking my brain on this one, but don't know.

Thanks again.

 

[pamchenko]

<< 3. The Prez. of USA announces that he will fight the higher inflation rate with a new anti-inflation program. Predict what will happen to interest rates if the public believes him. >>



does the anti inflation program work? if that is not an issue, and if the key condition is that the public believes him, wait...the public doesn't control interest rates, greenspan does? i guess he will look at indicators.

 

[ManiacMonkey]

I migh thave to try this hw check in the forum...

 

[judgejudy]

3. It really depends on what this &quot;program&quot; entails. If it means increasing interest rates later, than obviously interest rate will go up. And the public will be persuaded to put their money into bonds. Since, the president can't actually increase the interest rate himself however, this method doesn't seem feasible unless this plan incorporates the fed. The president can tax people on certain things to help stem inflation but this wouldn't really have an impact on the interest rate.

 

[judgejudy]

Your number 1 is wrong. Money isn't backed by gold. I think the answer is, since volatility increases, the risk increases by investing in gold, and people will put there money into bonds since bonds are one substitute for gold. Since there will be a higher demand for bonds, the government will lower interest rates.

 

[Javelin]

Question 3 is not especially clear in what it is asking but...

It depends greatly on what measures are being taken in the anti-inflationary campaign and what theoretical framework you use to analyze it. If fiscal policy is tightened to combat inflation, under the IS-LM model, this would lead to lower interest rates.

Under the rational expectations framework, if the public believes inflation will be kept under control then it will be so. Perception would become reality. Therefore there is no need for any change in interest rates. Of course, a monetarist would argue that inflation is purely a monetary phenomenon so any action by the president would be irrelevant.

 

[trmiv]

judgejudy is correct, the U.S. dropped the gold standard in 1971.

 

[axelfox]

The exact words for question 3 are:

The president of the United States announces in a press conference that he will fight the higer inflation rate rate program with a new anti-inflation program. Predict what will happen to interest rates if the public believes him.

Dang, you guys are really getting into it. We are just study interest rates and bonds (supply and demand).

 

[Javelin]

Ok, the answer to question 3 is that interest rates will go down. Assuming that the real interest rate in unchanged, a decrease in expected inflation will cause nominal rates to fall.

Real interest rate = nominal rate - inflation

 

[denali]

for #3 Most anti-inflation plans should cause the short term interest rates to rise. Because with higher interest rates people/business will have less money to spend thus less demand for good/services and thus prices should fall leading to less inflation. The long term interest rate should fall because people will want to lock in a higher interest rate today than they could get in the future. What you would end up with is an inverted yield curve in which short term interest rates are higher then long term interest rates. This is what the US had in 1998 and 1999.

 

[fdiskboy]

I'm going to agree with Javelin, interest rates will drop.

 

[DonaldDuck82]

<< 1. What effect will a sudden increase in the volitility of gold prices have on interest rates? >>




<< - Since money is backed by gold, the sudden increase in volitility affect the dollar value in which loans/bonds are being paid back. This is partly known as inflation risk >>



US currency, which i am assuming you are talking about, hasn't been on the gold standard for about 25 years.

 

[axelfox]

Thanks for the gold standard update. Although I haven't been alive for 25 years, I read somewhere awhile back that cash was backed by gold.

 

[DonaldDuck82]

sorry i was wrong, it has been thirty years since the US was off the gold standard, thanks for the sarcasm though and i thought that maybe you should throw away that book you were reading

 

[DonaldDuck82]

<< A monetary system that backs its currency with a reserve of gold, and allows currency holders to convert their currency into gold. The U.S. went off the gold >>



link

just on case you were wandering about what i said