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Chapter 5: Q.16 (page 164)

Would fiscal policymakers ever have reason to worry about potentially inflationary conditions? Why or why not?

Short Answer

Expert verified

Fiscal policymakers must be concerned about inflation.

Step by step solution

01

Introduction

Inflation is defined as a condition in which the price of all goods and services begins to rise, reducing people's real purchasing power.

02

Explanation

Yes, fiscal planners must be concerned about inflation since rising inflation will raise people's expectations for treasury securities returns. They will not invest in them otherwise.

To raise funds, the government requires more people to invest in their securities. During the inflationary period, the government must provide greater returns to attract capital, raising the project's cost.

As a result, fiscal policymakers must be concerned about inflation.

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Most popular questions from this chapter

One of the points made in this chapter is that inflation erodes investment returns. Go to http://www.moneychimp.com/articles/econ/inflation_calculator.htm and review how changes in inflation alter your real return using the second inflation calculator. What happens to the difference between the future value of an investment and its inflation-adjusted value as

a. inflation increases?

b. the investment horizon lengthens?

c. expected returns increase?

Using both the supply and demand for bonds and liquidity preference frameworks, show how interest rates are affected when the riskiness of bonds rises. Are the results the same in the two frameworks?

What will happen to the demand for Rembrandt paintings if the stock market undergoes a boom? Why?

Suppose Maria prefers to buy a bond with a 7% expected return and 2% standard deviation of its expected return, while Jennifer prefers to buy a bond with a 4% expected return and 1% standard deviation of its expected return. Can you tell if Maria is more or less risk-averse than Jennifer?

Explain why you would be more or less willing to buy long-term Delta Air Lines bonds under the following circumstances:

a. The company just released its financial statements, indicating that income decreased and liabilities increased.

b. You expect a bull market in stocks (stock prices are expected to increase).

c. You have analyzed your country’s monetary policy and expect interest rates to decrease.

d. Brokerage commissions on bonds fall.

e. Your income and wealth increased over the last two years.
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