Loanable Funds Problems

1. Loanable Funds Problems Previous Exams

2. Beginning of the Great Recession According to the National Bureau of Economic Research (NBER), the recession in the US officially began in December 2007. During the winter of 2008, US Treasury prices soared and equity prices declined. The unemployment rate grew as significant numbers of workers lost their jobs. Leading and coincident indicators fell rapidly. Retail sales declined and consumer confidence plummeted. The core rate of inflation declined slightly and the dollar fell relative to the euro.

3. Initial Recovery from Great Recession During the past few days, general bond market yields have increased for almost all maturities and risk levels. During this time period, we have learned that GDP grew by a robust 5.7% during the fourth quarter. President Obama announced that the US Government deficit is expected to be at least $1.6 trillion. Finally, Ben Bernanke was reappointed as Chairman of the Federal Reserve Board of Governors, an event that seemed to calm uneasy equity markets.

4. Stagflation Some fear that increasing energy prices occurring jointly with a slowing economy could result in stagflation, simultaneous high unemployment and high inflation. These fears could cause the yields on longer term US Treasury Bonds to increase significantly.

5. FED reacts to potential recession During the past few weeks the FOMC lowered the target federal funds by 125 basis points. The recent labor market report indicated that the total number of nonagricultural jobs decreased by 17,000 during January and the Institute of Supply Chain Management indicated that the manufacturing sector declined significantly during January. The short term result was a significant decline in equity share prices and increase in US Treasury security prices.

6. Unexpectedly Robust Economy Last Wednesday, January 30, the market for US Treasuries processed three important news releases. First, the FOMC kept the target federal funds rate constant at 5.25%. Second, GDP grew 3.5% during the fourth quarter of 2006, a rate much higher than expected. Finally, the core rate of inflation was measured at 2.1%, a rate much lower than expected. The result was a rise in the yield to maturity for most maturities of Treasuries.

7. Stronger than Expected Labor Market After the Federal Open Market Committee lowered the target federal funds rate by 50 basis points on September 18, almost the entire US Treasury yield curve has increased. Since the FOMC meeting, labor market statistics suggest a stronger labor market than previously indicated since the number of nonagricultural jobs increased during August and September rather than suffering a decline as previously reported.

8. High Jobs growth rate Last Friday, the Bureau of Labor Statistics announced that during January the unemployment rate dropped to 4.7% and 190,000 new jobs were created. This caused US Treasury yields to rise significantly.

9. Bond Market Rally The front page in a recent Wall Street Journal stated: “In one of the bigger surprises in financial markets this year, a growing consensus that the economy is slowing and inflation receding is fueling a rally in the nation’s bond markets, pushing Treasury-bond yields to their lowest levels in months.”