Question

True / False:

Answer 1

Answer:

1. True
2. false
3. True
4. True

Explanation:

1) when the federal deficit of a nation grows larger the federal government the increase the rate of bonds and other financial securities being issued to the public in a bid to raise funds to offset the Federal deficit and this in turn will lead to higher interest rates been set by the federal reserve as well

2) when there is an excess amount of money in circulation following the injection of a huge amount of money in the market the demand of goods and services will rise higher( increase in purchasing power ) than the supply of goods hence inflation will increase

3) long term interest rates are less sensitive to economic booms and recessions because most economic booms do not last long enough to affect the long term interest rates.

4) decreasing the short-term interest rates during bad economy is a a very effective tool used by the Fed to help ease economic burdens on citizens taking or holding short term loans

Answer 2

Answer:

1. The larger the federal deficit, other things held constant, the higher are interest rates. TRUE

Explanation:

The government raises money to cover the deficit by issuing bonds, hence the supply of bonds is increased and therefore the price of bonds decreases. The price of bonds is negatively correlated with the interest rates and hence it leads to an increase in interest rates.

2. If the Fed injects a huge amount of money into the markets, inflation is expected to decline, and long-term interest rates are expected to rise.  FALSE

Explanation:

When the Fed injects a huge amount of money into the markets, the supply of money would increase and this would shift the money supply curve to the right. In the short-run, the interest rates would decrease. This is also known as the 'Liquidity Effect'. However, the liquidity effect is followed by the following offsetting effects,

-Income effect

-Price level effect

-Expected inflation effect

The net effect on interest rates depends on the magnitude of the above mentioned effects. Additionally, an increase in the money supply may lead people to expect a higher price level in the future, thus inflation may increase.

3. Long-term interest rates are not as sensitive to booms and recessions as are short-term interest rates.  TRUE

Explanation:

During a recession or a boom, the monetary authorities, use fiscal policy to intervene the market. They, change the short-term interest rates to moderate the economy during a boom or a recession.

4. When the economy is weakening, the Fed is likely to decrease short-term interest rates. TRUE

Explanation:

When the economy is weakening, that is, it is in a recession, short-term interest rates are decreased, which would stimulate the economy. Firms would be able to get loans at a cheaper price and households would have to pay less credit on mortgages etc. This would increase the output of the economy.