How would a cut in government expenditures leading to a decrease in budget deficit (keeping all...

How would a cut in government expenditures leading to a decrease in budget deficit (keeping all the other factors constant) affect bond prices? Explain and show with the help of a well-labeled demand and supply diagram for bonds. Please also state the impact of this change in bond prices on interest rates.Immersive Reader

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Expert Solution

When there will be a cut in the government expenditure it will be automatically reflected by decrease into fiscal deficit of the country because there would be lack of expenditure on the part of the Government whereas there is no change in the overall collection of income in the form of taxes.

It would be leading to overall increase in the government fiscal surplus because there will be a cut on the part of the government expenditure.

There is an inverse relationship between fiscal deficit and Bond prices because there is a direct relationship between bond yield and fiscal deficit so decrease in fiscal deficit would be leading to decrease in the bond yield and it would be leading to increase in the bond prices because Bond yields and Bond prices are inversely related to each other.

Impact of this change on the bond price of the interest rate would be that the interest rate is inversely related to the bond prices and the bond prices will be going up the interest rate will be coming down

So it can be summarised that decreasing the fiscal deficit would be having a multiplier effect in to the economy in form of affecting the bond prices and interest rates.

jeff jeffy answered 1 year ago

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