Question

2.What is expected to happen to bond prices and therefore on interest rates when the expected inflation increases? Why? Explain and show with the help of a well-labeled demand and supply diagram for bonds

Answer 1

When there would be an expected increase in the inflation, it can be reflected onto the bond prices and the interest rates as follows-

A. There is always an inverse relationship between interest rates and the inflation in the country as when there would be higher amount of inflation in the country, it would mean that the the interest rate will be lower which will help the economy in growing.

Whereas when there is increase in the interest rates, it would mean that there would be lack of inflation in the economy because it is done in order to curb the money flow into the economy.

B.Inflation will also be having a inverse relationship with Bond prices because due to increase in the inflation, the disposable amount of the bond holder would be losing the value due to increase in the inflation and it would be less worthy so it is inversely related to the price of the bonds.

This can be properly reflected through various economic scenario when there is increase in the inflation in the economy there would be decrease in the bond prices and decrease in the interest rates as well.