2. Bond maturity, yield curve, and consumer choice AaAa The Fed\'s open-market o
ID: 1225692 • Letter: 2
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2. Bond maturity, yield curve, and consumer choice AaAa The Fed's open-market operations can be used to not only influence the money supply, but also alter the composition of the Fed's portfolio (the ratio of longer-term to shorter-term securities). This allows the Fed to influence the shape of the economy's yield curve. In particular, the maturity extension program is designed to lower the yields on long-term bonds by means of purchasing longer-term Treasury securities while selling an equal amount of shorter-term Treasury securities The following graph shows the market for shorter-term government bonds. Suppose the FOMC decides to sell $400 billion worth of shorter-term Treasury securities. Adjust the graph by showing the positions of the supply and demand in response to the FOMC's action. Tool tip: Click and drag one or both of the curves. Curves will snap into position, so if you try to move a curve and it snaps back to its original position, just try again and drag it a little farther. PRICE OF SHORT-TERM GOVERNMENT BONDS Dollars] Supply Demand QUANTITY OF SHORT-TERM GOVERNMENT BONDS Recall that the yield curve plots the interest rates, at a certain point in time, of bonds having equal credit quality, but differing maturity dates, and is used as a benchmark for mortgage rates or bank lending rates. A normal yield curve is one in which longer maturity bonds have a higher yield compared to shorter-term bonds due to the risks associated with time. In an inverted yield curve, the shorter-term yields are higher than the longer-term yields, which can be a sign of recession. In a flat yield curve, the shorter- and longer-term yields are very close to each other, which is a predictor of an economic transition The black curve (X symbols) on the following graph shows the economy's yield curve in Period 1. Suppose that in Period 2, the Fed is able to keep longer-term rates fairly constant while selling $400 billion worth of shorter-term Treasury securities. Which of the other two lines, the blue line (circle symbols) or the orange line (square symbols), on the graph best describes the yield curve resulting from the Fed's actions in Period 2?Explanation / Answer
The blue line
As desribed in period 2 the fed sold bonds so you see that short term rates are lower anyway
Period 2, because shorter-term rates will decrease.
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