If government spending and taxes increase at the same time, what happens to output and the interest rate? Is monetary policy more or less e ective during a liquidity trap? Consider a bond that promises to pay $100 in one year. (a) What is the interest rate on the bond if its price today is $85? (b) What is the relation between the price of the bond and the interest rate?

If government spending and taxes increase at the same time, what happens to output and the interest rate?

Is monetary policy more or less e ective during a liquidity trap?

Consider a bond that promises to pay $100 in one year.
(a) What is the interest rate on the bond if its price today is $85?
(b) What is the relation between the price of the bond and the interest rate?

 

 

Answer:

(a) The interest rate of the bond if its price today is $85 =[ (100 – 85)/ 85] * 100

= 17.65%

(b) The price of the bond and the interest rate is inversely related, as the price increases interest rate decreases and as the price decreases the interest rate increases.

Asked on February 15, 2018 in economics.
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