THE ECONOMICS OF MONEY,BANKING, AND FINANCIAL MARKETS 130

98

PA R T I I

Financial Markets

to the left because wealth decreased during the business cycle contraction, we
have seen in the preceding application that the demand curve would shift less than
the supply curve. Thus, the bond price rose and interest rates fell (the opposite
outcome to that in Figure 5-6, page 96).
Usually, we think that low interest rates are a good thing because they make it
cheap to borrow. But the Japanese example shows that just as there is a fallacy in
the adage You can never be too rich or too thin (maybe you can t be too rich, but
you can certainly be too thin and do damage to your health), there is a fallacy in
always thinking that lower interest rates are better. In Japan, the low and even
negative interest rates were a sign that the Japanese economy was in real trouble,
with falling prices and a contracting economy. Only when the Japanese economy
returns to health will interest rates rise back to more normal levels.

APP LI CAT IO N

Have Low Savings Rates in Canada
Led to Higher Interest Rates?
Since 1980, Canada has experienced a sharp drop in personal savings rates, with
record lows in recent years. Many commentators, including high officials of the Bank
of Canada, have blamed the profligate spending habits of the Canadian public for
high interest rates. Are they right?
Our supply and demand analysis of the bond market indicates that they could
be right. The decline in savings means that the wealth of Canadian households is
lower than would otherwise be the case. This smaller amount of wealth decreases
the demand for bonds and shifts the demand curve to the left from B d1 to B d2 , as

shown in Figure 5-8. The result is that the equilibrium bond price drops from P1
Price of Bonds, P
B s1

1
P1
P2

2

Bd2

B d1

Quantity of Bonds, B

FIGURE 5-8

Response to a Lower Savings Rate

With a lower savings rate, all other things equal, wealth decreases, and the demand curve
shifts from B d1 to B d2. The equilibrium moves from point 1 to point 2, with the result that the
equilibrium bond price drops from P1 to P2 and the equilibrium interest rate rises.