The global economy is under significant stress to include U.S. state and local governments given expectation...

The global economy is under significant stress to include U.S. state and local governments given expectation of lower income taxes and lesser fees and tolls.

a) How should expectations of financial stress impact the yield of municipal debt given actions by investors to include individuals and mutual funds?

b) whether the supply or demand curve within a loanable funds framework (% and $) should change and in what direction. Should state/local governments expect to pay more or less to borrow?

Expert Solution

Since the recession kind of economy due to Coronavirus has been unprecedented the Us Fed will sharply reduce interest rates and thus the yield to maturity of municipal debt instruments will fall causing its prices to increase. Hence for mutual funds amd retail investors it would be costlier to buy them as the net assets value also increases.

Lowered interest rates means an expansionary monetary policy and thus supply lf loanable funds rises causing higher liquidity in market an dhence the aggregate demand curve shifts rightwards in AS AD framework or LM curve shifts rightwards in IS LM framework. Also since government announces fiscal stimulus packages it will naturally borrow more from banks pushing up interest rates higher again on overnight basis amd thus net amount paid back will be more.

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Rahul Sunny answered 6 months ago

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