BOND YIELDS AND INTEREST RATES
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I understand that the only way the fed/central bank can influence interest rates (fed funds rate) is via OMO. As i understand it -
To increase rates, fed sells bonds (that were previously issued) which pushes the price of bonds in the market down , which leads to higher yields on bonds for those who buy them ... My first question comes here
those who buy the bonds now - are they buying bonds newly issued by the governemnt or bonds already in existence - does it matter?
ok so bond yields are up which means banks will be more inclined to invest in bonds - leading to a decrease in supply of reserves leading to higher price of credit.
Second question: I do not understand however why the bank has to pay out more interest (to savers ) just because the price of borrowing has gone up. Also, at this higher rate of interest, does the govt issue new bonds paying this new interest? do they take an average of interest rates to determine the yields on newly issued bonds?
As you can tell i am quite confused with this whole issue , i hope you can help clarify.
Thank you.
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To increase rates, fed sells bonds (that were previously issued) which pushes the price of bonds in the market down , which leads to higher yields on bonds for those who buy them ... My first question comes here
those who buy the bonds now - are they buying bonds newly issued by the governemnt or bonds already in existence - does it matter?
The purpose of the bond issue is to increase the market interest rates and so it does not matter if the government issues new bonds or bonds already in existence but are with the government. Please note that the purpose of issuing the bonds is to mop up funds in the system. That is the funds with those who buy these bonds. Once these bonds are purchased the money comes to the government and it can lock up the money away from circulation. The net result is that the bondholders do not deposit their money with banks and the funds available for lending with the banks goes down. However, the issuing of bonds has no effect on the demand for funds with the banks. So, to ration the scarce funds among ...
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