In the late 1990s, the U.S. government ran a surplus for the first time in decades....

In the late 1990s, the U.S. government ran a surplus for the first time in decades. It instituted a buyback program, whereby the Treasury bought outstanding government bonds. How would this program affect the bond market price, yield, and quantity of bonds? How might it affect the liquidity of government bonds?

Expert Solution

The primary question here is, why do the government buyback bonds and securities? It is done to reduce the long term borrowing rate/ interest rate. By doing so it will increase Investment (I) and Domestic Consumption(C), since loans are available at lower rates, and borrowing costs are lowered.

The bond prices in turn will increase, as bond prices are inversely related to interest rates. Due to a higher bond price, people will sell their bonds and this will increase liquidity in the market. Bond Yield is the return a person earns on the bonds invested in. As the interest rate lowers, and bond prices increase, the return earned, or bond yields will reduce.

Also since banks provide a lesser interest rate on savings people prefer not to keep a huge sum in the banks, encouraging them to spend this money on goods and services, stimulating demand and creating jobs.

The buyback move is often initiated to increase liquidity in the market- it has the same effect as increasing the money supply in the market.

Rahul Sunny answered 2 years ago

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In the late 1990s, the U.S. government ran a surplus for the first time in decades....

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