Question

If assets are imperfect substitutes, then an increase in the amount of domestic currency bonds held by the public will ________ the risk premium and ________ the amount of domestic currency bonds held by the central bank.

Answer 1

If assets are imperfect substitutes, an increase in the amount of domestic currency bonds held by the public will decrease the risk premium and increase the amount of domestic currency bonds held by the central bank.

Step-by-step explanation:

If assets are imperfect substitutes, an increase in the amount of domestic currency bonds held by the public will decrease the risk premium and increase the amount of domestic currency bonds held by the central bank.

When assets are imperfect substitutes, an increase in the amount of domestic currency bonds held by the public indicates a higher demand for these bonds. As a result, investors are willing to accept a lower risk premium, which is the additional return they require to hold a riskier asset. On the other hand, the central bank would hold more domestic currency bonds to meet the increased demand and support the bond market.