On September 7, Daniel Kruger reported for the Wall Street Journal that, “U.S. g

Question

On September 7, Daniel Kruger reported for the Wall Street Journal that, “U.S. government bond prices fell Friday after a Labor Department report showed that wages rose more than expected in August...Investors have been looking for signs that the tight labor market is causing wages to rise, which could accelerate inflation.”

Using the economics of Theory of Portfolio Choice, explain why bond prices fell Friday, and support your statement with a diagram of the bond market. Label thoroughly for full credit.

Explanation / Answer

A rise in the wages of labour means that the amount of money in the hands of the general public has risen, which means that this could lead to a rise in inflation. Now, in order to keep a check on inflation, the US govt. will encourage the public to save more by investing in its bonds. Thus, in order to provide higher rate of return on bonds, which is only possible when interest rates rise, the govt. is going to reduce the prices of govt. bonds.

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