Shifts in the supply curve
Factors that shift the supply of bonds to the right lead to lower bond prices and higher bond yields, other
things equal. Such factors include:
1) Profitability of investment opportunities: Business cycle expansion, investment opportunities↑, B^s
shifts to the right.
2) Expected inflation: ∏^e↑, cost of borrowing (real interest rate = i - ∏^e) ↓, B^s shifts to the right.
3) GovernmentActivities: Deficits↑, B^s shifts to the right applications.
Changes in ∏^e: the fisher effect if ∏^e↑
1) Relative expected return on bonds↓ (compared to the return on real assets such as housing and gold),
B^d shifts to the left.
2) Cost of borrowing (real interest rate = i - ∏^e) ↓, B^s shifts to the right.
3) P↓, i↑ (unambiguously)
Price of bonds, P interest rate, i
(P increases ↑) (i increases ↓)
P1 1 i1
P2 2 i2
Quantity of Bonds, B
Figure 4, the fisher effect
When expected inflation rises, interest rates will rise.
This observation was made by Irving fisher and is named after him as the fisher effect. The empirical
evidence on the fisher effect is mixed. While the loose relationship described above
( i = r + ∝∏^e, o