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In: Economics

The bond price and interest rate fall during an economic (business cycle) recession. Do you agree?...

The bond price and interest rate fall during an economic (business cycle) recession. Do you agree? Use the supply and demand for bonds to explain your answer in your own words.

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Expert Solution

During recession, the whole economy faces a contraction in the economic activities. Market interest rate is the main link between the investors and savers of the economy. Market interest rate is determined by the supply and demand interaction of loanable fund market. During recession , Businesses and firms demand for more credit to finance the investment on the other hand common people demands for more credit to purchase goods and services. Thus , during recession demand for liquidity increases,at the same time there is a decrease in the supply of credit by the bank. Thus, similar to the other market, as demand for loanable fund increases and supply for loanable fund decreases this will lead to have a sharp rise in the market interest rate.

On the other hand, bond price and interest rate have inverse relation. Though, recession doesn't effect bond directly as the return of bond is fixed but as market interest rate rises during recession it will effect the bond price and the bond price will fall during recession.

so I agree that during recession bond price will fall but the market interest rate will go up.

Rahul Sunny answered 2 years ago
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