CHP.16 Monetary Policy

An increase in the money supply will An increase in the money supply will

)D. All of the above. (A. move the equilibrium point along the​ short-run aggregate supply curve. Your answer is not correct. B. shift the aggregate demand curve outward and to the right. C. not change the​ long-run aggregate supply curve but ultimately will only raise the price level in​ long-run equilibrium price level.) D. All of the above. (A. create a direct effect of an increase in consumption due to higher money balances. B. increase the price level. C. create an indirect effect of increased consumption and investment through increased saving and loans.

According to the quantity theory of​ money, the growth of the money supply is positively related to NGDP. The quantity theory of money is given by the​ equation: Upper M equals StartFraction 1 Over Upper V EndFraction times PYM=1V×PY where M is a measure of money​ supply, (1/V) is the inverse of the income velocity and is considered constant by the monetarist​ economist, and PY is the price level​ (P) times real output​ (Y), equal to NGDP. ​Directions: click on the graph in the window on the right and select Multiple Time Series to graph the annual growth rate of the money supply and nominal gross domestic product​ (NGDP) for the years​ 1960-2004. For Y1 select M2 Rate of Growth and for Y2 select NGDP Rate of Growth. Roll your cursor over the plotted lines to identify the data. Use the graph to help determine which of the following statements are​ true:

There exists a positive relationship between the growth rate of M2 and​ inflation, although not a very strong one. This relationship starts breaking down in the early​ 1990's.

Suppose that initially the money supply is ​$1 trillion, the price level equals 3​, the real GDP is ​$5 trillion in​ base-year dollars, and income velocity of money is 15. Then the money supply increases by ​$100 ​billion, while real GDP and income velocity of money remain unchanged. a. According to the quantity theory of money and pricesLOADING...​, calculate the new price level after the increase in money​ supply: b. Calculate the percentage increase in money​supply: c. Calculate the percentage change in the price​ level: d. The percentage changes in the money supply is______percentage changes in the price level.

a. P= Ms x V/ Y=3.3 b. The new value of ms- initial value of Ms/ initial value of ms x 100= 10% c. 10% d. equal to the

If there is an inflationary gap in the short​ run, the Federal Reserve can eliminate the gap in the short run by undertaking a policy action that reduces aggregate demand.​ But, if Federal Reserve chooses not to close the gap in the short​ run, the economy will eventually get back to full employment in the long run. Because when there is an inflationary gap in the short​ run, then in the long run a new equilibrium will arise as input prices and expectations adjust​ upward, causing the aggregate supply to shift upward and to the left and pushing equilibrium real GDP back to its​ long-run potential value. a. A monetary policy action that could eliminate an inflationary gap in the short run is b. If Fed implements the short run monetary policy option instead of simply waiting for the​ long-run adjustments to take​ place, then it

a. an open market sale of government securities b.benefits the society as the inflationary pressures are removed quickly.

If there is an inflationary gap in the short​ run, the Federal Reserve can eliminate the gap in the short run by undertaking a policy action that reduces aggregate demand.​ But, if Federal Reserve chooses not to close the gap in the short​ run, the economy will eventually get back to full employment in the long run. Because when there is an inflationary gap in the short​ run, then in the long run a new equilibrium will arise as input prices and expectations adjust​ upward, causing the aggregate supply to shift upward and to the left and pushing equilibrium real GDP back to its​ long-run potential value. a. A monetary policy action that could eliminate an inflationary gap in the short run is b. If Fed implements the short run monetary policy option instead of simply waiting for the​ long-run adjustments to take​ place, then it

a. an open market sale of government securities b. benefits the society as the inflationary pressures are removed quickly

A contractionary monetary policy lowers equilibrium real GDP in the short​ run, by increasing the interest rate. In an open​ economy, the net export effect

reinforces the effect of a contractionary monetary policy since the increase in the interest​ rate, increases the value of​ dollar, lowers U.S. exports and causes the real GDP to fall.

If the source of economic instability is generally variations in​ spending, then the Fed should

set money supply targets.

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.

Suppose you go shopping for a gift for a friend and also find a sweater that you want for yourself. You pay cash for the gift and write a check for the sweater. Your purchases are made with money holdings represented by

the transaction demand for money because you planned to buy the gift and the precautionary demand for money because you did not anticipate buying the sweater.

The bond market is depicted in the graph to the right. (D is going down and S is going straight up vertically) The supply curve of bonds is drawn vertically because Suppose that the Fed decides to buy bonds

the​ Fed's decision to buy or sell bonds is independent of bond prices. Move the S1 to the left vertically and the E1 new is now on the 700/15 line where D and S1 meets

The prices of all​ fixed-income assets​ (bonds)

vary inversely with the interest rate.

If the Fed increases the discount​ rate, relative to the federal funds​ rate, then this

would increase the cost of funds for institutions borrowing from the Fed.

Contractionary monetary policy by the Fed can be hampered by

the ability of U.S. citizens and businesses to obtain dollars from foreign sources.

Asset demand for money is holding money

as a store of value instead of other assets.

Which of the following is a function of the Federal Reserve​ System?

. Acting as a lender of last resort to commercial banks.

What is inflation​ targeting?

A. Committing the central bank to achieve an announced level of inflation.

The​ (FOMC) Federal Open Market Committee

All of the above. A. determines the target federal funds rate and the direction of open market operation policies. B. includes the Board of Governors and the presidents of the 12 Federal Reserve regional banks​ (though not all are voting​ members). C. makes decisions that are voted on by all 7 members of the Board of Governors but only 5 of the 12 regional bank presidents.

The graph to the right shows the supply and demand for bonds. Suppose that the Fed conducts an open market operation to INCREAE the money supply. ​1.) Using the line drawing tool​, show the effect on the bond market. Properly label your line. ​2.) Using the point drawing tool​, indicate the new equilibrium​ point, and label it . Carefully follow the instructions​ above, and only draw the required objects

As a result of this open market​ operation, the interest rate will FALL S 2 moved to the left and E 2 went up and is now at the intersection of D1 and S2

Monetary policy is defined​ as:

The actions the Federal Reserve takes to manage the money supply and interest rates.

Which of the following is a true​ statement?

Both the direct and the indirect effects of an expansionary monetary policy are to increase aggregate demand.

The graph to the right depicts the current state of the economy. Note that the current equilibrium real GDP and planned expenditure are found at point E0. a. Suppose that the central bank undertook a contractionary monetary policy. ​1.) Using the line drawing tool​, draw the new expenditure line. Label this​ line: ​'C+I1​+G+X'. ​2.) Using the point drawing tool​, identify and label the new equilibrium as ​'E1​'. Carefully follow the instructions​ above, and only draw the required objects b. Contractionary monetary policy will _______ interest rates

C+ Io+G+ X line moves down and hits the new equilibrium at 4 on the x axis raise

As of​ 1993, the Fed sets targets for which of the following in order to achieve price stability and high​ employment?

Federal funds rate

Using the line drawing tool​, draw a money demand curve on the graph indicating the relationship between the interest rate and the opportunity cost of holding money. Label the curve Md.

Md line goes down like the demand curve

Suppose that​ currently, the economy is overutilizing its resources. Which of the following correctly describes what type of monetary policy the Fed might choose and how the policy would change the​ economy?

The Fed could use a contractionary monetary policy to reduce aggregate demand and GDP

The Federal Reserve has multiple economic goals for monetary policy to​ achieve, ​ However, it can be difficult to manage all of the goals at once. Which of the following is not true regarding the multiple goals of the​ Fed?

The goal of financial market stability means that the Fed tries to ensure that asset​ prices, such as stock​ prices, increase at a very high rate so investors can make more money.

What effect does a contractionary monetary policy in the U.S. have on the foreign trade​ sector?

The higher value of the dollar will decrease exports and increase imports.

Which of the following is not a viable monetary policy target for the​ Fed?

The money demand.

What is the basic structure of the Federal Reserve​ Bank? Which of the following events caused Congress to begin seriously looking at setting up the Federal Reserve​ system?

There are 12 district​ banks, a Board of Governors and a Federal Open Market Committee. Some severe banking crises at the end of the 19th century and early 20th century.

According to the simple quantity theory of​ money, which of the following variables are considered either constant or relatively​ stable?

V and Y

The indirect effect of an increase in the money supply works through

a decrease in the interest rate increasing investment and consumption.

In the market for bank​ reserves, a reduction in the required reserve ratio will cause

all of the above. . (A.an increase in the equilibrium quantity of reserves. B. a reduction in the federal funds rate. C. a reduction in the demand for reserves.)

n the above​ figure, assume the aggregate demand of the economy is AD2 and the Fed actions move aggregate demand to AD1. In this​ situation, the Fed has practiced

contractionary monetary policy. bc Ad2 moves to the left to AD1

a. The state of the economy depicted at the right can be best described as b. Using the line drawing tool​, draw a scenario depicting an increase in the money supply which brings the economy to full employment. Properly label your line.

having a recessionary gap. ( LRAS is at 10 vertically, SRAs is starting at 70 and crosses at 10 on LRAS, AD starts at 110 and goes down to 14 and crosses LRAS at 10, they are not all at equilibrium) AD line shifts to the right and thats all

The Fed buys and sells bonds buys and sells bonds as a part of its policy to reach all of the following objectives​ except:

high unemployment.

Contractionary monetary policy causes the The net export effect of contractionary monetary policy predicts that a​ country's

interest rate to increase exports decrease as the money supply contracts

Contractionary monetary policy causes the The net export effect of contractionary monetary policy predicts that a​ country's

interest rate to increase. exports decrease as the money supply contracts

The Federal Reserve Bank of New York is always a voting member of the FOMC because

it carries out the policy directives of the FOMC.

Suppose that the Fed judges inflation to be the most significant problem in the economy and that it wishes to employ all three of its policy​ instruments, then the Fed will engage in

open market​ sales, increasing the reserve​ requirement, and increasing the discount rate.

The direct effect of an increase in the money supply is

people will spend the extra​ money, causing the aggregate demand curve to shift to the​ right, creating an increase in economic activity.

A perpetual bond sells for​ $1,000 and will pay ​$127 a year forever. The Fed changes its policy and the interest rate changes to 7 percent. The price of the bond is now

perpetual bond= periodic return/ interest rate 127/0.07= 1814.28 or 1814.3

According to the Keynesian​ theory, an increase in the money supply decreases the interest rate and increases investment spending. The result of this is that

real GDP increases by a larger amount than the change in investment.

If a recessionary gap occurs in the short​ run, then in the long run a new equilibrium arises when input prices and expectations adjust​ downward, causing the​ short-run aggregate supply curve to shift downward and to the right and pushing equilibrium real GDP per year back to its​ long-run value. The Federal Reserve can eliminate a recessionary gap in the short run by undertaking a policy action that increases aggregate demand. Which of the following is one monetary policy action that could eliminate the recessionary gap in the short​ run? In what way might society gain if the Fed implements an​ anti-recessionary policy instead of simply permitting​ long-run adjustments to take​ place?

The Fed can increase the money supply through an open market purchase of Treasury securities. All of the above (A. The​ Fed's policy can reduce unemployment sooner. B. The​ Fed's policy can move the economy to​ long-run equilibrium sooner. C. The​ Fed's policy can shorten the adjustment period.)

Since​ 2008, the Fed has conducted a policy that involves direct lending to private firms. Those actions of the Fed are called

credit policies.

f a bond sells for​ $1,000 and pays​ $100 per year in​ interest, the interest rate on the bond is

10 percent. bc 100/.10 = 1,000

The United States is divided into ____ Federal Reserve Districts. The Federal Reserve​ Bank's Board of Governors consists of ______ members appointed by the president of the U.S. to​ 14-year, ​ non-renewable terms. One of the board members is appointed to a _____ ​year, renewable term as the chairman.

12 7 4

Suppose that to finance its credit​ policy, the Fed pays an annual interest rate of 0.200 percent on bank reserves. During the course of the current​ year, banks hold ​$1.5 trillion in reserves. What is the total amount of interest the Fed pays banks during the​ year? The Fed pays banks

3.0 billion bc 1.5 (.20/1000=.003 trillion so it means 3 billion

As a result of monetary policy of the​ Fed, the dollar appreciated and the amount of exports decreased. Which of the following Fed policies could have caused this​ outcome?

A Fed sale of bonds to brokers and banks.

A member of​ Congress, who has never had an economics​ course, has just been placed on a Money and Banking Committee. The official needs a briefing prior to the first meeting concerning the role of the money supply in the economy. Which of the following statements should you insist that the official remember when entering the first committee​ meeting?

B. There is a​ direct, albeit​ loose, relationship between the growth of the money supply and the price​ level; and a direct relationship between the growth of the money supply and GDP growth.

Suppose that each 0.1 percentage point decrease in the equilibrium interest rate induces a​ $10 billion increase in real planned investment spending by businesses. In​ addition, the autonomous spending multiplier is 2 and the money multiplier is equal to 4. ​Furthermore, every​ $20 billion increase in the money supply brings about a 0.1 percentage point reduction in the equilibrium interest rate. How much must real planned investment increase if the Fed desires to bring about a ​$400 billion increase in real​ GDP?

Using the spending​ multiple: 400 billion/ 3 equals= 133 (ANSWER 1) The amount of investment needed was ​$133 billion. Each​ 0.1% decrease in the interest rate increases investment by​ $10 billion.​ Thus, an 1.33 drop in the interest rate is needed. An increase of​ $20 billion in the money supply reduces the interest rate by​ 0.1%. For an 1.33 decrease in the interest rate a ​$ 266 billion increase in the money supply is needed. (BC 133x2=266) Now apply the money multiplier ​(4​) such​ that: 266/4= 67 billion (ANSWER 2)

​Directions: click on the graph in the window on the right and select Multiple Time Series to graph the​ 10-year moving averages for the rate of growth of M1 and the U.S. inflation rate for the years​ 1969-2004. For Y1 select Growth Rate of M1​ (10 YR Mov.​ Avg.) and for Y2 select​ % Change in GDP Deflator​ (10 YR Mov.​ Avg.). Roll your cursor over the plotted lines to identify the data. The​ 10-year moving average was created by finding the average growth rate over the ten years prior. For​ example, the 1969 value of the rate of growth for M1 is the average growth rate of M1 for the years​ 1959-1969, and the value of M1 for 1970 is the average rate of growth of M1 during​ 1960-1970. The​ 10-year moving averages of money supply and inflation are utilized because of the strong conviction of monetarist economists that changes in money supply affect prices in the economy with​ lags, and thus should be analyzed for the medium run. Use to the graph to help determine which of the following statements regarding the growth rate of M1 and inflation are true.

Y Axis1: Growth Rate of M1 (10 Yr Mov. Avg) Y Axis 2: M1 Growth Rate There exists a relationship between the growth of M1 and​ inflation, but not a very tight one. This implies that there may be additional variables other than M1 that may affect inflation.

f there is a recessionary gap in the short​ run, the Federal Reserve can eliminate the gap in the short run by undertaking a policy action that raises aggregate demand.​ But, if Federal Reserve chooses not to close the gap in the short​ run, the economy will eventually get back to full employment in the long run. Because when there is a recessionary gap in the short​ run, then in the long run a new equilibrium will arise as input prices and expectations adjust​ downward, causing the aggregate supply to shift downward and to the right and pushing equilibrium real GDP back to its​ long-run potential value. a. A monetary policy action that could eliminate a recessionary gap in the short run is b. If Fed implements the short run monetary policy option instead of simply waiting for the long​ -run adjustments to take​ place, then it

a decrease in the required reserve ratio benefits the society as unemployment is reduced quickly.

Assuming that the Fed judges inflation to be the most significant problem in the economy and that it wishes to employ all three of its policy instruments. It sells bonds in the open​ market, increases the discount​ rate, and increases the reserve ratio. The net export effect resulting from these monetary policy actions will

raise the interest​ rate, increase the inflows of international​ capital, increase the value of the​ dollar, decrease​ exports, and as a consequence real GDP will decline even further.