Inter Macro 3rd Exam - HW 10

The widely noted practice of "quantitative easing" refers to a monetary authority's;

- Use of its lending facilities - Expansion of its balance sheet - Purchase of private assets

The monetary authorities can also lower financial frictions and the real interest rate for investments by lowering credit spreads through the purchase of private assets (bonds). The reduction in credit spreads happens because:

Bond prices and bond yields move INVERSELY TO one another.

As a nonconventional monetary policy tool, management of expectations operates upon the economy through changes in...

Both AD and AS

A central bank's use of its lending facilities to provide liquidity to impaired markets is viewed as a

DIRECT way to bring down financial frictions and therefore lower the real interest rate investments.

What is true of the real interest rate?

It can be negative, but must be larger than minus expected inflation.

Since the real interest rate for investments is POSITIVELY related to financial frictions, an obvious way to encourage investment and increase aggregate demand is to,

LOWER those frictions.

Management of expectations is a third way that a monetary authority can lower financial frictions and the real interest rate for investments, and requires from the central bank a commitment to keep the policy rate:

Low for a long period of time

A negative demand shock at the zero lower bound can cause a deflationary spiral because:

Lower inflation expectations cause the real interest rate to rise and output to fall further.

Whether monetary policy is conventional or not, its goal when it comes to expanding the economy is to:

Lower the real interest rate for investments.

If a bond offers a nominal interest rate of 1% and inflation is expected to be 2%, what is the real interest rate associated with the bond?

Nominal - Expected = -1%

If a bond offers a nominal interest rate of 3% and inflation is expected to be 2%, what is the real interest rate associated with the bond?

Nominal - Expected = 1%

The zero lower bound on nominal interest rates exists because:

People have the option to hold currency, which always offers a zero nominal return.

A negative demand shock has a larger effect on output and inflation at the zero lower bound because:

The Fed cannot lower the real interest rate as far as it would like

When monetary authorities encounter the so-called zero lower bound, conventional EXPANSIONARY monetary policy becomes ineffective because...

The policy rate employed by the authorities to alter aggregate demand CANNOT BE LOWERED.