Suppose that as the economic recovery strengthened consumer expectations of annu

Question

Suppose that as the economic recovery strengthened consumer expectations of annual inflation increased from 2% to 3.5 % and, at the same time, the expected real rate of return required to equate investor demand to the existing supply of 1 year Treasury notes increased from 1% to 1.5%. What would you expect to happen to the nominal yields on 1-year T-notes during the period over which these changes in inflation expectations and required real yields occurred? (Give a numerical answer if possible) Explain your reasoning.

B) Draw a supply/demand diagram of the US Treasury bond market to illustrate the effects on it of the developments cited in part A. Label your diagram clearly!

Explanation / Answer

Nominal yields would go up. Generally the rate of return is 1% more than the rate of inflation, but in the past couple of years people have not so much wanted a return on their investment as a return of their investment.

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