Chapter 26
When the Federal Open Market Committee (FOMC) decides to increase the money supply, it U.S. Treasury securities. If the FOMC wishes to decrease the money supply, it U.S. Treasury securities.
Buys and sells
What is inflation targeting?
Committing the central bank to achieve an announced level of inflation.
Consider the figures below and determine which is the best description of what causes the shift from AD1 to AD 2
Example A shows a contractionary monetary policy. The price level and real GDP both fall. AND Example B shows an expansionary monetary policy. The price level and real GDP both rise
The figure to the right illustrates a dynamic AD-AS model. Suppose the economy is in equilibrium in the first period at point A. In the second period, the economy reaches point B. We would expect the Fed to pursue what type of policy in order to move AD2 to AD Subscript 2 comma policy AD2, policy and reach equilibrium (point C) in the second period? If the Federal Reserve Bank's policy is successful, what is the effect on the following macroeconomic indicators? In the dynamic AD-AS model we assume: 1. The economy experiences inflation and, 2. the economy experiences long run growth. That is, the LRAS curve shifts to the right each year. In addition, the AD and the SRAS curves also shift to the right each year.
Expansionary monetary policy Actual real GDP: increases Potential real GDP: does not change Price level: increases Unemployment: decreases
Why did the Fed help JP Morgan Chase buy Bear Stearns?
Failure of Bear Stearns would lead to a larger investment bank failure AND Commercial banks would be reluctant to lend to investment banks.
In the figure to the right, which of the following events is most likely to cause a shift in the money demand (MD) curve from MD1 to MD2 (Point A to Point C)?
Increase in real GDP or increase in the price level
In the figure to the right, when the money supply increased from MS1 to MS2, the equilibrium interest rate fell from 4% to 3%. Why?
Increased demand for Treasury securities drives up their prices. AND Initially, firms hold more money than they want relative to other financial assets. AND Increased demand for Treasury securities drives down their interest rate.
How do investment banks differ from commercial banks? (Mark all that apply.)
Investment banks do not take deposits AND Investment banks generally do not lend to households.
Which of the following is NOT a monetary policy goal of the Federal Reserve bank (the Fed)? Monetary policy-The actions the Federal Reserve takes to manage the money supply and interest rates to pursue its macroeconomic policy goals.
Low prices
Consider the figure to the right. Can the Fed achieve a $900 billion money supply (MS) AND a 5% interest rate (point C)?
No. The Fed cannot target both the money supply and the interest rate simultaneously.
Suppose the economy is in equilibrium in the first period at point A. In the second period, the economy reaches point B. What policy would the Fed likely pursue in order to move AD2 to AD Subscript 2 comma policy AD2, policy and reach equilibrium (point C) in the second period? (What policy will increase the price level and increase actual real GDP?)
Open market purchase of government securities
The figure to the right illustrates a dynamic AD-AS model Suppose the economy is in equilibrium in the first period at point A. In the second period, the economy reaches point B. What policy would the Fed likely pursue in order to move AD2 to AD Subscript 2 comma policy AD2, policy and reach equilibrium (point C) in the second period? In the dynamic AD-AS model we assume: 1. The economy experiences inflation and, 2. the economy experiences long run growth. That is, the LRAS curve shifts to the right each year. In addition, the AD and the SRAS curves also shift to the right each year.
Open market purchase of government securities. Your answer is correct.
If the Federal Reserve is late to recognize a recession and implements an expansionary policy too late, the result could be an increase in inflation during the beginning of the next phase. Even though the goal had been to reduce the severity of the recession, the poor timing caused another problem: inflation. This is an example of what type of policy?
Procyclical policy
The Fed uses monetary policy to offset the effects of a recession (high unemployment and falling prices when actual real GDP falls short of potential GDP) and the effects of a rapid expansion (high prices and wages). Can the Fed, therefore, eliminate recessions?
The Fed can only soften the magnitude of recessions, not eliminate them.
Nobel laureate Milton Friedman and his followers belong to a school of thought known as monetarism. What do the monetarists argue the Fed should target?
The Fed should target the money supply, not the interest rate, and that it should adopt the monetary growth rule.
What can we expect from the Federal Reserve Bank if it seeks to move the economy in the direction of long-run macroeconomic equilibrium?
The Fed will pursue an expansionary monetary policy. If the Fed's policy is successful, what is the effect on the following indicators? Actual real GDP: increases Potential real GDP: does not change Price level: increases Unemployment: decreases
As the figure to the right indicates, the Fed can affect both the money supply and interest rates. However, in recent years, the Fed targets interest rates in monetary policy more often than it does the money supply. Which interest rate does the Fed target?
The federal funds rate
According to the Taylor rule , what is the federal funds target rate under the following conditions? ≻Equilibrium real federal funds rate equals 3% follows ≻Target rate of inflation equals 3% follows ≻Current inflation rate equals 2% follows ≻Real GDP is 2% below potential real GDP
The federal funds target rate equals 3.5%. (Enter your response rounded to one decimal place.)
According to the Taylor rule , what is the federal funds target rate under the following conditions? ≻Equilibrium real federal funds rate equals 2% follows ≻Target rate of inflation equals 2% follows ≻Current inflation rate equals 1% follows ≻Real GDP is 1% below potential real GDP Taylor Rule A rule developed by John Taylor that links the Fed's target for the federal funds rate to economic variables.
The federal funds target rate equals 2.0%
Changes in interest rates affect aggregate demand. Which of the following is affected by changes in interest rates and, as a result, impacts aggregate demand? (Mark all that apply.) Aggregate Demand-The total level of spending the economy, comprised of four components: consumption, investment, government purchases, and net exports.
The value of the dollar AND Consumption of durable goods AND Business investment projects
The figure to the right illustrates the economy using the Dynamic Aggregate Demand and Aggregate Supply Model If actual real GDP in 2006 occurs at point B and potential GDP occurs at LRAS06, we would expect the Federal Reserve Bank to pursue monetary policy. If the Fed's policy is successful, what is the effect of the policy on the following macroeconomic indicators? Aggregate Demand and Aggregate Supply Model An extension of the basic AD-AS model that introduces the following conditions: 1. The economy experiences continuing inflation, with the price level rising every year. 2. The economy experiences long-run economic growth, with the LRAS curve shifting to the right every year.
a contractionary Actual real GDP decreases Potential real GDP does not change Price level decreases Unemployment increases
In the figure to the right, the opportunity cost of holding money when moving from Point A to Point B on the money demand curve. Opportunity cost-The highest-valued alternative that must be given up to engage in an activity.
decreases
The federal funds rate
is the rate that banks charge each other for short-term loans of excess reserves
The is considered the most relevant interest rate when conducting monetary policy.
short-term nominal interest rate
What two institutions did Congress create in order to increase the availability of mortgages in a secondary market?
"Fannie Mae" and "Freddie Mac"