Question

From the end of 2009 to the end of 2019, the size of the United States National Debt held by the public grew from $6.8 trillion to $17.2 trillion. During the same period, the 10 year US Treasury Bond yield to maturity fell from 3.59% in December 2009 to 1.86% in December of 2019. Explain how such an increase in the supply of government bonds can lead to a fall in the interest rate. Second, consider that the 10 year bond rate has fallen further in 2020 to 0.68 percent on October 1, despite a further increase in the national debt ($20.5 trillion as of June 30, 2020) due to the decline in the economy and increase in federal government spending. Why has this continued in 2020 during an economic crisis?

Answer 1

Bonds yeilds are significantly affected by monetary policy. This policies may come from the actions of central bank, such as the Federal Reserve, a currency board or other types of regulatory comimittes. Monetary policy at its core is about determining interest rates. In turn, interest rates define the risk-free rate of return. The risk free rate of retrun has a large impact on the demand for all types of financial securties, including bonds. A bond's yeild is based on the bond's coupon payments divided by its market price, as bond price icrease, bonds yeilds fall. Falling interest rates makes bond price rise & bond yields fall & vice-versa. When interest rates are low, bond price increases because investor are seeking better return. Demand for the bond would decline, and the yeild would rise until supply & demand reached a new equilibrium.

Interest rates ara a key part of a nation's monetary policy. Monetary policy is shaped and set by a government administration and executed through its central bank. Central banks are aware of their ability to influence asset prices through monetary policy. They often use this power to moderate swings in the economy. During recessions, they look to hold off deflationary forces by lowering interest rates, leading to increases in asset prices. Increase asset prices have a mildly stimulating effect on the economy. When bond yeild fall, it result in lower borring costs for corporations & the government, leading to increased spendings.