Macroeconomics Final Exam Ch. 13

What happens in times of deep recession under the Keynesian Theory?

an increase in the money supply does not decrease interest rates causing monetary policy to be ineffective

Policy Dilemma of a Negative Supply Shock

- Expansionary monetary policy (Ms increase) a. decrease interest rates b. AD increases * y increases but P increases further - Contractionary AD policies (ms decrease) a. increase interest rates b. AD decreases *p decreases but y decreases even further

Negative Supply Shocks

- decrease in resources - increase in resource costs production cost increases AS curve shifts to the left, resulting in stagflation

Expansionary Monetary Policy

- used to boost AD - feds open market *purchases* of bonds - increase the money supply -decrease interest rates - increase c and I shift AD to the right

Contractionary Monetary Policy

- used when inflationary pressures build up to slow down AD -fed open market *sales* of bonds - decrease money supply - increase interest rates - decrease c and I shift AD to the left

What are the key elements of major financial crisis?

- widespread fall in asset prices (capital loss) - significant currency drain (short of reserves) - run on the bank (massive withdrawals of deposits)

The 2008 financial crisis is characterized by

1. widespread fall in asset 2. paralyzed credit markets 3. liquidity crisis of banks

Classical Theory: The long-run effect of money Quantity Theory of Money

MV = PQ money supply* velocity of money (avg # of times per year that a dollar is spent on final G&S) = price level* real GDP (income) changes in M will directly change P proportionately

How is QE different from the orthodox method of increasing the money supply?

Quantitative easing increases the money supply by purchasing assets with newly created bank reserves in order to provide banks with more liquidity.

Negative Supply Shock: Contractionary Monetary policy

SRAS moves to the left AD moves to the left

Negative Supply Shock: Expansionary monetary

SRAS moves to the left AD moves to the right

If the unemployment rate is 10% and the inflation rate is 2%, the Federal Reserve will most likely:

buy bonds

In times of economic downturn, the Federal Reserve will engage in _______ monetary policy by ______ bonds.

expansionary; buying

Which action by the Federal Reserve is NOT considered to be one of its normal monetary policy tools? a. buying treasury securities b. lowering the federal funds rate c. making loans to banks at the discount rate d. buying mortgage-backed securities

d. buying mortgage backed securities

An expansionary monetary policy would result in a(n) ______ in the interest rate, which shifts the aggregate demand curve ______ .

decrease; rightward

Monetary Policy Goals

economic growth with stable prices

Classical Model Graphically

economy is at full employment an increase in AD only results in higher prices at the same output

If the economy is in a recession, the Federal Reserve would most likely pursue______, which causes interest rates.

expansionary monetary policy; fall

In counteracting a negative supply shock, the Federal Reserve could achieve _____ by using ______ monetary policy.

full employment but not price stability; expansionary

Monetarist Model Graphically

increase in money supply results in higher output in the short run long run prices adjust, SRAS shifts left and the economy returns to long-run output at a higher price level

Monetarist Theory: The short-run effect of money

increase in money supply will - increase AD - price level and output increase - leads only to inflation in the long run fiscal policy is ineffective because of full crowding out

When current output is less than potential output, which monetary policy is the Federal Reserve likely to enact? and what would be the result?

increasing reserves to decrease interest rates resulting: increases in investment, aggregate demand, and long-run growth

The overheated housing market boom of 2004-2006 caused ______ pressures, leading the Federal Reserve to ________ interest rates.

inflationary; raise

What is Quantitative Easing

large scale purchases of financial assets including: a. government bonds b. private corporate bonds c. any other financial asset the central bank chooses

Quantitative easing is BEST described as monetary policy that:

makes certain that banks have enough liquidity to avoid collapse

Negative Demand Shocks

negative demand shocks - decrease in C, I, and exports - increase in imports AD curve shifts down Shift up with expansionary monetary policy causing a rise in employment and output

Monetarists believe in the short run, a change in the money supply can affect______, while in the long run, a change in the money supply will affect______.

output and the price level; the price level only

What were the policy actions taken by the Fed to deal with the recent financial crisis?

provided banks with: a. more reserves -through massive open market operations b. more security deposits- by expanding deposit insurance c. safe liquid assets in place of troubled assets- with the feds purchases of troubled assets from banks

Tight monetary policy refers to the Federal Reserve:

raising interest rates, usually to fight inflation

To slow down a high inflation rate, the Federal Reserve should use a(n)________ monetary policy by using open market _______.

restrictive; sales

Which action is the Federal Reserve MOST likely to take to curb inflation?

sell securities in the open market

Keynesian Theory

upward sloping AS curve - increase money supply - decrease in interest rates - AD increases output expands with upward sloping AS curve