Chapter 26 Monetary Policy
Which of the following is not a correct comparison between an expansionary monetary policy in the basic aggregate demand and aggregate supply model and in the dynamic aggregate demand and aggregate supply model?
A The dynamic model assumes that potential GDP is constantly growing while the basic model assumes that it is static. B. If the economy is below full employment, expansionary monetary policy will cause an increase in the price level in both models. C. In the dynamic model, expansionary policy would be used when demand does not grow sufficiently; in the basic model, expansionary policy would be used when demand falls.
Consider the following choices and determine the correct definition for the monetary rule.
A monetary rule is a plan for increasing the money supply at a constant rate regardless of the prevailing economic condition.
What is a banking panic?
A situation in which many banks experience runs at the same time.
Which of the following was the Fed's objective in using "quantitative easing" and "Operation Twist"?
A. To increase aggregate demand. B. To keep interest rates on mortgages low. C. To keep interest rates on 10-year Treasury notes low.
Even though the federal government earned a profit on its investment in AIG, economists and policymakers who opposed the bailout were
A. not necessarily wrong, because it was an expensive and risky solution.
In the graph of the money market shown on the right, what could cause the money demand curve to shift from MD1 to MD2? (MD1 shifts to the right to MD2)
An increase in the price level An increase in real GDP.
Who borrows money and who lends money at this "target interest rate"?
Banks borrow and banks lend
Which of the following are benefits that the economy might gain from an explicit inflation target even if the target chosen is not a zero rate of inflation?
. Improved accountability for the Fed More accurate expectations of future inflation Better communication between the Fed and the public
The Fed expects that controlling that one interest rate would allow it to meet its goals for inflation and unemployment because lower short-term interest rates
. encourage lending and stimulate economic activity.
Which of these variables are the main monetary policy targets of the Fed?
. the money supply and the interest rate
Support for a monetary rule of the kind advocated by Friedman declined since 1980 because
. the Fed's performance since 1980 has been excellent even without a formal inflation target.
As the interest rate increases,
consumption, investment, and net exports decrease; aggregate demand decreases.
Which of the following is not a correct comparison between a contractionary monetary policy in the basic aggregate demand and aggregate supply model and in the dynamic aggregate demand and aggregate supply model? A. In the dynamic model, contractionary policy would be used when demand grows too slowly; in the basic model, expansionary policy would be used when demand increases. B. If the economy is above full employment, contractionary monetary policy will cause a decrease in the price level in the static but not the dynamic model. C. The static model assumes that potential GDP is constantly growing while the dynamic model assumes that it is static. D. All of the above are correct statements about the two models. E. None of the above are correct statements about the two models.
E. None of the above are correct statements about the two models.
During 2005, the FOMC was concerned that the inflation rate would begin to accelerate due to the continued boom in the housing market, so the Fed started decreasing the target for the federal funds rate.
False
For the Fed to succeed in reducing the severity of business cycles, it must act precisely when a recession or an acceleration of inflation can be seen in the economic data.
False
Which of the following were important developments in the mortgage market that took place during the 1970s?
Fannie Mae and Freddie Mac began to act as intermediaries between investors and home buyers. Banks began to resell mortgages on the secondary market rather than holding them in their portfolios.
For more than 20 years, the Fed has used the federal funds rate as its monetary policy target. It has not targeted money supply at the same time because the
Fed cannot target both at the same time: It has to choose between targeting an interest rate and targeting the money supply.
What is a "subprime mortgage," and would a subprime borrower be likely to pay a higher or a lower interest rate than a borrower with a better credit history?
Loans granted to borrowers with flawed credit histories; a higher interest rate.
Which one of the following are the monetary policy goals of the Fed?
Maintain price stability. Maintain high employment. Maintain stability of financial markets and institutions.
Beginning in 2008, the Federal Reserve and the U.S. Treasury Department responded to the financial crisis by intervening in financial markets in unprecedented ways. Which of the following is one of the unprecedented actions of the Fed?
Making loans to primary dealers and holders of mortgage-backed securities.
What is the advantage of holding money?
Money can be used to buy goods, services, or financial assets.
Which one of the following is not one of the monetary policy goals of the Fed?
Reduce income inequality.
In the graph of the money market shown on the right, what could cause the money supply curve to shift from MS1 to MS2? (MS1 shifts to the left to MS2)
The Fed decreases the money supply by deciding to sell U.S. Treasury securities.
Why would the Fed intentionally use contractionary monetary policy to reduce real GDP?
The Fed intends to reduce inflation, which occurs if real GDP is greater than potential GDP.
Which of the following statements is true about the Fed's monetary policy targets?
The Fed is forced to choose between the interest rate and the money supply as its monetary policy target.
Which of the following is a monetary policy response to the economic recession of 2007-2009 and the accompanying financial crisis?
The Fed purchased large amounts of mortgage-backed securities. The Fed provided loans directly to corporations by purchasing commercial paper. The Fed expanded the eligibility for discount loans to firms other than commercial banks.
What is the discount rate?
The discount rate is the rate at which the Fed lends to banks.
Which of the following statements is correct?
The effect of a change in the federal funds rate on long-term interest rates is usually smaller than it is on short-term interest rates. Changes in the federal funds rate usually will result in changes in both short-term and long-term interest rates on financial assets. A majority of economists support the Fed's choice of the interest rate as its monetary policy target, but some economists believe the Fed should concentrate on the money supply instead.
In 2015, Richard Fuld, the last CEO of Lehman Brothers, gave a talk in which according to an article in the Wall Street Journal, "He outlined what he called the 'perfect storm' of events that led to the financial crisis, saying 'it all started with the government' and policies that subsidized cheap loans for people to buy homes in order to help them chase the American dream." Source: Maureen Farrell, "Lehman's Fuld Says It Wasn't His Fault," Wall Street Journal, May 28, 2015. The events that led to the financial crisis include
a burst in a housing bubble in 2006 which led to mortgage defaults, and a disruption of the financial system resulting from the creation of complex packagings of mortgages.
Which of the following is not one of the monetary policy goals of the Federal Reserve ("the Fed")?
a high foreign exchange rate of the U.S. dollar relative to other currencie
According to the Taylor Rule, if the Fed reduces its target for the inflation rate, the result will be
a higher target federal funds rate.
"Price stability" means
a low and stable inflation rate.
The government would want the economy to contract when real GDP is
above potential GDP and the price level is rising.
What is the purpose of the Taylor rule? The Taylor rule is used to
analyze and predict how the Fed targets the federal funds rate.
The decline in housing prices that began in 2006 led to rising defaults among which borrowers?
borrowers who had made only small down payments borrowers with adjustable-rate mortgages alt-A and subprime borrowers
If the Federal Open Market Committee (FOMC) decides to increase the money supply, it orders the trading desk at the Federal Reserve Bank of New York to A. sell stocks. B. sell U.S. Treasury securities. C. buy U.S. Treasury securities. D. buy stocks.
buy U.S. Treasury securities.
What is "quantitative easing"? Quantitative easing involved the Fed's
buying longer term Treasury securities that are not usually involved in open market operations.
If the Fed decides to carry out an expansionary monetary policy because it believes aggregate demand will not increase enough to keep the economy at potential GDP, the inflation rate will most likely be lower than it would have been without the policy.
false
If the Fed would no longer have a specific target for the money supply, it would be targeting the
federal funds rate.
The interest rate that banks charge each other for overnight loans is called the
federal funds rate.
The short-term interest rate the article is referring to is the
federal funds rate.
To affect economic variables such as real GDP or the price level, the monetary policy target the Federal Reserve has generally focused on is the
federal funds rate.
While Paul Volcker was chairman, the Fed did not target both the rate of inflation and interest rates because
if the Fed targets interest rates, they have to accept that inflation will fluctuate significantly, and Volker's goal was to reduce inflation.
The Federal Reserve releases transcripts of its Federal Open Market Committee (FOMC) meetings only after a five-year lag in order to preserve the confidentiality of the discussions. When the transcripts of the FOMC's 2008 meetings were released, one member of the Board of Governors was quoted as saying in an April 2008 meeting, "I think it is very possible that we will look back and say, particularly after the Bear Stearns episode, that we have turned the corner in terms of the financial disruption." Source: Jon Hilsenrath, "New View into Fed's Response to Crisis," Wall Street Journal, February 21, 2014. This member's analysis turned out to be
incorrect. The economic situation worsened throughout 2008.
"Pushing up the value of the currency" means
increasing the exchange rate between the dollar and other currencies.
When the central bank commits to conducting policy in a manner that achieves the goal of holding inflation to a publicly announced level, it is using
inflation targeting.
If the Fed is too slow to react to a recession and applies an expansionary monetary policy only after the economy begins to recover, then
inflation will be higher than if the Fed had not acted.
By increasing U.S. interest rates, the Fed would cause the value of the currency to increase because
international investors will demand more U.S. dollars to buy U.S. financial assets that now pay higher interest rates.
A countercyclical policy is one that
is used to attempt to stabilize the economy.
The Fed uses policy targets of interest rate and/or money supply because
it can affect the interest rate and the money supply directly and these in turn can affect unemployment, GDP growth, and the price level.
What is the Taylor rule?
it is a rule that links the Fed's target for the federal funds rate to the current inflation rate, real equilibrium federal funds rate, inflation gap and output gap.
The choice of the price index the Federal Reserve uses to measure inflation can affect monetary policy because
one goal of monetary policy is price stability and, if the price index used to measure inflation is consistently wrong, monetary policies based on that information will be wrong.
Milton Friedman would have liked the Fed to follow a monetary rule where the
money supply is increased every year by a percentage rate equal to the long-run growth rate of real GDP.
As interest rates decline, stocks become a __________ attractive investment relative to bonds, which causes the demand for stocks and their prices to __________.
more; rise
Problems of credit availability would affect a homebuilder such as Hovnanian Enterprises because
most potential homeowners need mortgages to buy homes.
When the article refers to "credit availability," it means the ability of
people to obtain credit.
Congress broadened the Fed's responsibility since
the 1930s as a result of the Great Depression.
Which of the following events was an important cause of the 2007-2009 recession?
the collapse of a housing bubble
Economists and policymakers might disagree over the best rule to guide monetary policy because
of differing views about the significance of inflation and unemployment.
The Fed gave up targeting the money supply because
the relationship between monetary aggregates and other economic variables was becoming unreliable.
The member's prediction may have seemed reasonable at the time because
there was a crisis atmosphere in April 2008, and once the crisis was resolved, it was reasonable to expect things to improve.
How can investment banks be subject to liquidity problems? Investment banks can be subject to liquidity problems because
they often borrow short term, sometimes as short as overnight, and invest the funds in longer-term investments.
What is "Operation Twist"? "Operation Twist" refers to
the Fed's program to purchase $400 billion in long-term Treasury securities while selling an equal amount of shorter-term Treasury securities.
When Congress established the Federal Reserve in 1913, its main responsibility was
to make discount loans to banks suffering from large withdrawals by depositors.
"Maximum sustainable employment" means the economy is producing at its potential where
unemployment includes frictional and structural unemployment.
If the Fed believes the inflation rate is about to increase, it should
use a contractionary monetary policy to increase the interest rate and shift AD to the left.
If the Fed believes the economy is about to fall into recession, it should
use an expansionary monetary policy to lower the interest rate and shift AD to the right.
Additionally, the federal funds rate is
very important for the Fed's monetary policy because the Fed uses the federal funds rate as a monetary policy target since it can control the rate through open market operations.
What is the disadvantage of holding money?
Money, in the form of currency or checking account deposits, earns either no interest or a very low rate of interest.
With an expansionary monetary policy, investment, consumption, and net exports all ________, which results in the aggregate demand curve shifting to the ________, increasing real GDP and the price level.
increase; right
If the Taylor rule was changed to have a higher coefficient on the output gap, then during a recession the federal funds rate would be
lower, because more weight would be given to the output gap.
During the expansion and deflation of the housing bubble, new home sales rose by
60 percent between January 2000 and July 2005 and then fell by 80 percent between July 2005 and May 2010.
Suppose you buy a house for $150,000. One year later, the market price of the house has risen to $170,000. If you made a down payment of 20 percent and took out a mortgage loan for the other 80 percent, the return on your investment in the house is nothing%. (Enter your response as an integer.) If you made a down payment of 10 percent and borrowed the other 90 percent, the return on your investment in the house is
67%; 133%
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 MD 1 to MD 2 (shifts to the right)(Point A to Point C)?
Increase in real GDP or increase in the price level
Which of the following is a monetary policy target used by the Fed?
Interest rate.
What do economists mean by the demand for money?
It is the amount of moneylong dash—currency and checking account depositslong dash—that individuals hold.
The Taylor rule for federal funds rate targeting does which of the following?
It links the Fed's target for the federal funds rate to economic variables.
At the beginning of 2005, Robert Toll, CEO of Toll Brothers, argued that the United States was not experiencing a housing bubble. Instead, he argued that higher house prices reflected restrictions imposed by local governments on building new houses. He argued that the restrictions resulted from "NIMBY"long dash—"Not in My Back Yard"long dash—politics. Many existing homeowners are reluctant to see nearby farms and undeveloped land turned into new housing developments. As a result, according to Toll, "Towns don't want anything built." Source: Shawn Tully, "Toll Brothers: The New King of the Real Estate Boom," Fortune, April 5, 2005. Why would the factors mentioned by Robert Toll cause housing prices to rise?
It would keep the supply of housing from increasing.
Why would securitization give mortgage borrowers access to a deeper pool of capital?
Since banks could resell mortgages to investors, they had access to more funds than just their own deposits.
Which of the following best explains how the Federal Reserve acts to help prevent banking panics?
The Fed acts as a lender of last resort, making loans to banks so that they can pay off depositors.
Explain whether you agree with this argument: If the Fed actually ever carried out a contractionary monetary policy, the price level would fall. Because the price level has not fallen in the United States over an entire year since the 1930s, we can conclude that the Fed has not carried out a contractionary policy since the 1930s.
The statement is false. A contractionary policy could result in a lower rate of inflation rather than a fall in the price level.
What is the relationship between the federal funds rate falling and the money supply increasing?
To decrease the federal funds rate, the Fed must increase the money supply.
How does lowering the target for the federal funds rate "pour money" into the banking system?
To increase the money supply, the Fed buys bonds on the open market, which increases bank reserves.
It would be possible to decide whether these factors or a bubble was the cause of rising housing prices by looking at the number of new home units sold. If the number of new home units sold rose noticeably over time, then the evidence supports the bubble argument.
True
Two government-sponsored enterprises that stand between investors and banks that grant mortgages are the Federal National Mortgage Association and the Federal Home Loan Mortgage Corporation.
True
An increase in the value of the currency would contribute to a slowdown in the growth of the U.S. economy because
U.S. exports will fall and imports from other countries will rise, reducing net exports and aggregate demand.
The Fed's strategy of increasing the money supply and lowering interest rates in order to increase real GDP is called
expansionary monetary policy.
In late 2012, the U.S. Treasury sold the last of the stock it purchased in the insurance company AIG. The Treasury earned a profit on the $22.7 billion it had invested in AIG in 2008. An article in Wall Street Journal noted that: "This step in AIG's turnaround, which essentially closes the book on one of the most controversial bailouts of the financial crisis, seemed nearly unattainable in 2008, when the insurer's imminent collapse sent shockwaves through the global economy." . Source: Jeffrey Sparshott and Erik Holm, "End of a Bailout: U.S. Sells Last AIG Shares," New York Times, December 11, 2012. The federal government bailed out AIG because
it was the largest insurance company in the nation and the government feared the repercussions of a failure of AIG.
The government bailout was controversial because
it was expensive, and other companies suffered through bankruptcy and failure.
If the economy moves into recession, monetarists argue that the Fed should
keep the money supply growing at a constant rate.
When interest rates on Treasury bills and other financial assets are low, the opportunity cost of holding money is _________, so the quantity of money demanded will be _________.
low; high
Why is the Fed sometimes said to have a "dual mandate"? The Fed is said to have a" dual mandate" because
maintaining price stability and high employment are the two most important goals of the Fed that are explicitly mentioned in the Employment Act of 1946.
Suppose that when the Fed decreases the money supply, households and firms initially hold less money than they want to, relative to other financial assets. As a result, households and firms will _________ Treasury bills and other financial assets, thereby _________ their prices, and _________ their interest rates.
sell; decreasing; increasing
An increase in interest rates affects aggregate demand by
shifting the aggregate demand curve to the left, reducing real GDP and lowering the price level.
When the Fed conducts monetary policy, the most relevant interest rate is the
short-term nominal interest rate.
August 2017 was the sixty-fourth consecutive month that the rate of inflation as measured by the core personal consumption expenditures (PCE) price index was below the Federal Reserve's target of 2 percent. The consumer price index (CPI) might yield a rate of inflation different from that found using the core PCE price index because
the core PCE does not measure food and energy prices, which are measured by the CPI.
Government policies that could have been said to have been subsidizing cheap loans included
the creation of a secondary mortgage market through Fannie Mae and Freddie Mac, and the low interest rates following the 2001 recession.
What caused this change in the sources of mortgage finance? What would be the likely consequence of this change for the interest rates borrowers have to pay on mortgages? The primary reason for this change in the sources of mortgage finance was _____; the consequence of this change was also _____ in mortgage rates.
the development of a secondary mortgage market; a decrease
Hovnanian was suffering losses because
the economy was slowing down and about to head into a severe recession.
The federal funds rate is
the interest rate that banks charge each other for overnight loans.
If the price level decreases,
the money demand curve shifts to the left
If real GDP increases,
the money demand curve shifts to the right.
If the FOMC orders the trading desk to sell Treasury securities,
the money supply curve will shift to the left, and the equilibrium interest rate will rise.
One of the goals of the Federal Reserve is price stability. For the Fed to achieve this goal,
the rate of inflation should be low, such as 1% to 3%, and should be fairly consistent.
