Question

A recession is expected in the market next year with falling output accompanied by a slow in inflation. Draw one graph showing what this will do to the bond market, one graph to show what this will do to the money market (explain whats going to happen to the market interest rate). explain how both of the markets are associated.

Answer 1

1-In a recession, you would usually expect a fall in the inflation rate due to lower demand and lower economic activity. The inflation rate fell in major recessions like 1929- 32, 1981,1991 and 2020.

2-However, it is not guaranteed inflation will fall in recession. For example , we could have a period of stagflation. - rising inflation and falling output (e.g. after a rise in the price of oil - 1974 and 2008) .Also, of countries respond to a fall in output by printing money, then this could lead to hyperinflation ( e.g. Zimbabwe in 2008).

3-Just like in the market for goods and services,the Equilibrium in the bonds market is determined by the interaction of the demand curve for bonds and the supply curve for bonds..The demand curve for bonds explains the quantity of bonds that the investors would demand at different interest rates or bond prices while everything else is held constant. The supply curve for bonds that are supplied by the businesses .

4-A curve that shows the relationship between the amount of money supplied and the interest rate; because the central bank controls the stock of money, it does not vary based on the interest rate, and the money supply curve is vertical.

5-When interest rares are raising, both businesses and consumers will cut back on spending.

6-This will cause earnings to fall and stock prices to drop.As interest rates move up ,the cost of borrowing becomes more expensive. This means that demand for lower- yield bonds will drop, causing their price to drop.

7-Industries generally need long- term loans, which are provided in thr capital market.

8-The short- time interest rates of the money market influence the long- term interest rates of the capital market. Thus, money market indirectly helps the industries through its link with and influence on long- term capital market