The Fed Did It article of March 19, 2009

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Mathieu Posted: Thu, Mar 19 2009 10:50 AM

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First let me point out that I am a total newbie to Economics.

Now to my problem. I am having difficulty understanding the relation between an expansion of goods and assets (causing prices to fall in an unchanged pool of dollars) and the upward pressure on explicit and implicit yields. Would somebody be kind enough to explain the mechanisms involved here?

Thank you in advance.

Mathieu G.

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DougM replied on Tue, Mar 24 2009 7:12 PM

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I was a little confused when I first read your question, so I'm going to directly quote the section of Shostak's article that I think you are referring to before answering this question. Shostak says:

"However, if the accumulated dollars of emerging economies are only invested in US Treasuries, then it is tempting to suggest that a sustained fall in long-term rates without an expansion in the pool of dollars is possible.

We suggest that this is highly unlikely. If the pool of dollars remains unchanged while the quantity of goods and assets continues to expand, then this will lead to the fall in the average price. (Remember, a price is the number of dollars per unit of a good or asset.)

This means that explicit and implicit yields will come under upward pressure. (As a result, investors from emerging markets are likely to shift their funds from less-yielding Treasuries to a higher-yielding asset if the pool of dollars remains fixed, thus pushing yields on Treasuries higher.)"

It is clear from the context of this comment that when he refers to "goods and assets" he is referring to US Treasuries. These are government bonds. When bonds are first issued, they are sold for a particular price and carry a particular interest rate. For example, a bond might be sold for $100 and have an interest rate of 5%, meaning that the buyer would receive $5 in interest per year. When this same bond is sold in the secondary market, the price of the bond varies with supply and demand but the amount of the interest remains the same. If the price of the bond falls to $50, then the interest on the bond is still $5.00 but the yield on the bond has increased to ($5/$50=) 10%.

I think that this answers your question. Let me know if you need any further clarification.

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Mathieu replied on Wed, Apr 1 2009 12:40 AM

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Oh yes sir, you have shed light on the matter! Thank you very much.

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DougM replied on Sun, Apr 19 2009 1:32 PM

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You're more than welcome. Welcome to the forum.