The impact of a decrease in expected inflation in the bond market will have a relatively large effect on the prices of bonds prices because:

Question

Quizplus · Accepted Answer

A decrease in expected inflation will lead to an increase in the purchasing power of the money used to buy bonds. As a result, investors will demand more bonds, leading to a rightward shift in the bond demand curve. However, since expectations of inflation have decreased, bond issuers will want to issue fewer bonds, leading to a leftward shift in the bond supply curve. The net effect is a relatively large impact on bond prices. Therefore, the correct answer is B - the bond demand curve will shift right but the bond supply curve shifts left.

The Impact of a Decrease in Expected Inflation in the Bond