Monetary Policy
which of the following does the FED carefully monitor?
bank reserves
Which of the following statements is correct?
The prime rate involves longer, more risky loans than the federal funds rate.
Which of the following statements best describes what occurs when monetary authorities sell government securities?
The size of commercial banks' excess reserves decreases, the money supply decreases, and the interest rates rise, thereby causing a decrease in investment spending and real GDP.
in the real world, the actual money multiplier tends to be smaller than 1/rr because
banks do not loan out all of their excess reserves and people hold some loaned money as cash
if one bank doesn't have enough reserves, they
borrow from another bank
raising the discount rate, banks will
borrow less and make fewer loans, causing the money supply to decrease (contract)
if the Fed's lower the interest rate, the banks will
borrow more reserves and make additional loans, increasing the money supply (expansion)
the federal funds rate is determined by the supply and demand for
borrowed reserves
banks can expand reserves, and make more loans by
borrowing from the FED and attracting deposits and encouraging saving
Assume that the MPC is 0.9 and the reserve requirement is 0.2. If the Federal Reserve needs to increase aggregate demand by $100 billion at each price level to move the economy back to full employment and the current interest rate is 6%, then the Federal Reserve should _________ bonds on the open market equal to ________.
buy, $2 billion
how do banks hope to make a profit?
by charging interest on loans
how does monetary policy affect the economy?
by either encouraging or discouraging investment in new capital
An expansionary monetary policy _____.
can reduce the length of a recession
The major purpose of the Federal Reserve buying government securities in open market operations is to _____.
allow banks to increase their lending
federal funds market
allows banks that fall short of the reserve requirement to borrow funds from banks with excess reserves
The Federal Reserve System regulates the money supply primarily by _____.
altering the reserves of commercial banks, largely through sales and purchases of government bonds
expansionary monetary policy
an increase in the money supply designed to stimulate economic activity
how can banks expand reserves and make more loans?
attracting deposits and encouraging saving; borrowing from the Federal Reserves
An expansionary monetary policy may be less effective than a restrictive monetary policy because ______.
commercial banks may not be able to find good loan customers
lending bank earns extra income (interest rate), which the borrowing bank
complies with reserve requirements
one of the key interest rates in the economy is called the
federal funds rate
fewer reserves =
fewer loans
When there is a liquidity trap, the money demand curve is _____.
flat
If the Fed were to decrease the discount rate, banks will borrow
more reserves, causing an increase in lending and the money supply
increase =
multiply
Because of policy lags in monetary policy, the Fed _____.
must try to anticipate changes in the economy before they happen
there's a ________ relationship between interest rate and the quantity of investment demanded
negative
the Fed directly sets
neither the federal funds rate not the prime rate
buying bonds creates
new money and additional reserves, which expands the money supply, causing interest rates to fall
The commercial banking system borrows from the Federal Reserve Banks. As a result, the checkable deposits _____.
of commercial banks are unchanged, but their reserves increase
The purchase and sale of government securities by the Fed is called _____.
open market operations
the Federal Reserve often uses
open market operations
To adjust the targeted federal funds rate, the Federal Reserve will need to make:
open market sales, decreasing reserves in the banking system
selling bonds takes money
out of the economy and reduces reerves, which contracts the money supply, causing interest rates to rise
the ______ rate is generally equal to the federal funds rate plus 3%
prime
as the interest rate falls
quantity demanded will rise from uppercase I1 to uppercase I2
at a higher interest rate, some investment projects are no longer profitable, so the
quantity of I demanded falls from I1 to I3
The purpose of a contractionary monetary policy is to ______.
raise interest rates and restrict the availability of bank credit
The discount rate is the interest _____.
rate at which the Federal Reserve Banks lend to commercial banks
Y =
real GDP
A newspaper headline reads: "Fed Raises Discount Rate for Third Time This Year." This headline indicates that the Federal Reserve is most likely trying to _____.
reduce inflationary pressures in the economy
higher interest rate __________ the quantity of investment demanded
reduces
The Federal Reserve can increase aggregate demand by _____.
reducing the discount rate
rr =
reserve requirements
shift in AD causes price levels to ______OR______
rise OR fall
a "bank run" occurs when depositors
rush, in mass, to withdraw their funds from a bank
When the Federal Reserve seeks to raise the targeted federal funds rate, it _____.
sells government securities to decrease the excess reserves available for overnight loans
when rr increases, the money multipler is
smaller
difference =
spread
open market operations
the Federal Reserve buys or sells government debt in the open market to influence the money supply and interest rates
Changes in interest rates, all else held constant, cause a shift in _____.
the aggregate demand curve, but not the investment demand curve
Monetary policy is determined by ______.
the central bank (the Fed)
When a commercial bank borrows from a Federal Reserve Bank, _____.
the commercial bank's lending ability is increased
If the Fed wants to maintain current interest rates, it would be buying government bonds in the open market when _____.
the demand for money increases
spread
the difference between the interest rate a bank earns on a loan and the interest rate it pays
The interest rate that the Fed charges on loans made directly to banks is called _____.
the discount rate
what three aspects are all related?
the dollar value of reserves held by banks, the reserve requirement, and the money supply are all related
Assume that there is a 25% reserve requirement and that the Federal Reserve buys $4 billion worth of government securities. This action has the potential to increase the money supply by a maximum of ______.
$16 billion
If demand for overnight funds in the graph should increase by $50 billion at each and every point on the demand curve, but the Federal Reserve wants to keep the target rate at 5.0%, what will be the new equilibrium quantity of reserves?
$200 billion
three parts of OMO
1. Federal Reserve 2. Banks 3. People
if the fed decides to sell debt to households paying with checkable deposits, it will lead to ______ reserves in the banking system and ______ money in circulation
1. fewer 2. less
what are the two factors that determines in households or firms invest or not?
1. interest rate 2. expected rate of return
if the fed wants to increase money supply, make an ____________. to find total money supply use the ________
1. open market purchase 2. change in Ms
money multiplier =
1/rr
If the reserve requirement is 10% and the Fed increases reserves by $20 billion, what is the total increase in the money supply? (rr = 10% and multiplier = 10)
200
Which of the following represents the chain of causation for expansionary policy?
An increase in the money supply reduces the interest rate, which increases investment, which increases real GDP.
Which of the following best describes the cause-and-effect chain of an expansionary monetary policy?
An increase in the money supply will lower the interest rate, increase investment spending, and increase aggregate demand and GDP.
Which of the following is an example of an economic investment?
Building a new bank office
Which of the following Fed actions increases the excess reserves of commercial banks?
Lower the reserve requirement
Which of the following is a monetary policy intended to rein in inflation?
Decreasing the money supply to shift the aggregate demand curve leftward
gross investment =
I
The purchase and sale of government securities by the Fed is called _____.
OMOs
. Suppose the Federal Reserve wants to increase the money supply. What should it do to accomplish this goal? (rr=15%)
The Fed could make an open market purchase of $30 billion, resulting in a total increase in the money supply of $ 200 billion.
suppose the Fed wants to decrease the money supply. What should it do to accomplish this goal?
The Fed could make an open market sale of $40 billion, resulting in a total decrease in the money supply of $267 Correct billion.
the Federal Reserve decides to sell $250 million in government debt to households paying with checkable deposits. The current reserve requirement is 10%.
The Fed decision will lead to fewer reserves in the banking system and less money in circulation; The money supply will decrease by a maximum of $2,500 million.
The Federal Reserve decides to buy $550 million in government debt. The current reserve requirement is 25%.
The Fed decision will lead to more reserves in the banking system and more money in circulation; The money supply will increase by a maximum of $2,200 million.
which of the following statements is true?
The Federal Reserve does not set the federal funds rate, but it influences it through the use of its open-market operations.
What policy tool of the Federal Reserve relies on bank borrowing to be effective?
The discount rate
delta Ms =
[1/rr] x change in reserves
Which of the following will increase the total amount of reserves banks are holding?
a bank borrows reserves from the Fed; a bank attracts new customers depositing funds into their checkable deposits
bond
a financial instrument that obligates a borrower to repay money, with interest, to a lender
contractionary monetary policy
a reduction in the money supply to slow down economic activity
liquidity trap
a situation where increasing the money supply does not lower interest rates, due to a flattening of the money demand curve
Financial markets pay close attention to changes in the federal funds rate because these changes _____.
affect other interest rates in the economy
excess reserves are lent,
creating new checkable deposits and additional excess reserves, which are then used to create additional loans, further increasing the money supply through the money multiplier
Suppose that, for every 1 percentage point decline of the discount rate, commercial banks collectively borrow an additional $2 billion from Federal Reserve Banks. Also assume that the reserve requirement is 20%. If the Fed increases the discount rate from 4.0% to 4.25%, bank reserves will _____.
decline by $0.5 billion and the money supply will decline by $2.5 billion
if consumers _____ the amount of spending, AD shifts to the left
decrease
In the graphs, the numbers in parentheses near the AD1, AD2, and AD3 labels indicate the level of investment spending associated with each curve, respectively. All numbers are in billions of dollars. The interest rate and the level of investment spending in the economy are at point D on the investment demand curve. To achieve the long-run goal of a noninflationary full-employment output of Qf in the economy, the Fed should try to _____.
decrease aggregate demand by increasing the interest rate from 4% to 6%
Assume that the reserve requirement is 25%. If the Federal Reserve sells $120 million in government securities to the general public, the money supply will immediately _____.
decrease by $120 million with this transaction, and the decrease in money supply could eventually reach a maximum of $480 million
fewer reserves and fewer loans =
decrease in money supply
In order to increase interest rates, the Federal Reserve will need to
decrease the money supply
Assume the economy is operating at less than full employment. An expansionary monetary policy will cause interest rates to ________, which will _____ ______ investment spending.
decrease; increase
raising the rr ________ the money multiplier and ________ the money supply
decreases
An increase in the reserve requirement _____.
decreases the money supply by decreasing excess reserves and decreasing the monetary multiplier
overall change in money supply =
delta Ms
how many loans a bank can make
depends on the value of the reserves on hand that are not needed to satisfy the Fed's rr
banks can expand reserves, and make more loans, by attracting
deposits
required reserves =
deposits x rr
The interest rate at which the Federal Reserve Banks lend to commercial banks is called the _____.
discount rate
decrease =
divide
the demand curve for federal funds is...
downward-sloping, because higher interest rates discourage commercial banks from borrowing federal funds, but lower rates encourage borrowing
A newspaper headline reads: "Fed Cuts Federal Funds Rate for Fifth Time This Year." This headline indicates that the Federal Reserve is most likely trying to _____.
ease monetary policy
The time between when a policy is enacted and when it affects the economy is the _____lag.
effectiveness
if a bank wants to increase its lending, it has to increase
excess reserves
When investment demand shifts to the left, _____.
expansionary monetary policy will shift aggregate demand to the right by less than before.
the actions taken by a country's central bank to expand the money supply and lower interest rates is called
expansionary monetary policy; easy money
reduction in AD causes the price level and real GDP to _____
fall
what will cause consumption to fall?
falling wealth, repayments of loans, higher taxes
In order to reach the new money market equilibrium, the Federal Reserve will need to target a:
higher federal funds rate
interest rates =
i
Suppose the Fed reduces the interest rate from 6% to 4%. As a result of this decrease in the interest rate, using column (2) investment will _____.
increase by $20 billion
higher investment spending causes AD to ________
increase, shifting from AD1 to AD2 (expansionary monetary policy)
When the reserve requirement is decreased, the excess reserves of member banks are _____.
increased and the multiple by which the commercial banking system can lend is increased
reducing the rr ________ the money multiplier and _________ the money supply
increases
banks pay their expenses and hope to make a profit by charging
interest on loans
discount rate
interest rate at which banks can borrow reserves from the Federal Reserve
the discount rate is the
interest rate at which banks can borrow reserves from the Federal Reserve
a decrease in the money supply will cause the
interest rate to rise and the quantity of investment demanded to fall
monetary policy affects
interest rates paid on savings; interest rates charged on loans; and the price of goods, services, and resources
as interest rates rise,
investment spending falls
as interest rates fall,
investment spending rises
what does monetary policy's affect on interest rates affect
investment, economic growth, employment, inflation
A contractionary monetary policy _____.
is used when the inflation rate is high
If the Federal Reserve System buys government securities from commercial banks and the public, then _____.
it will be easier to obtain loans at commercial banks
If businesses are pessimistic, they are _____.
less likely to borrow and invest
Expansionary monetary policy should initially change gross investment by _____.
less than necessary to reach full employment
In an effort to stabilize the banking sector and keep banks lending, from October 2008 to September 2009, the Fed _____.
lowered the federal funds target rate
the Fed can increase or decrease the money supply by
lowering or raising the reserve requirement
In the graphs, the numbers in parentheses near the AD1, AD2, and AD3 labels indicate the level of investment spending associated with each curve, respectively. All numbers are in billions of dollars. The interest rate and the level of investment spending in the economy are at point C on the investment demand curve. To achieve the long-run goal of a noninflationary, full-employment output of Qf in the economy, the Fed should try to _____.
make no change in the interest rate
Lowering the discount rate has the effect of _____.
making it less expensive for commercial banks to borrow from central banks
rr is a
minimum
overall reduction in supply =
money multiplier
MS =
money supply
If the Fed were to decrease the discount rate, banks will borrow
more reserves, causing a increase in lending and the money supply
organizational safeguards put in place to prevent one government agency from creating money for another government office to spend include
the establishment of the federal reserve as independent from the federal government; the requirement that the federal reserve buy bonds from the institutions and people that have already bought bonds
the two factors that affect whether or not a firm chooses to invest in new equipment, machinery, or facilities are
the interest rate and the expected rate of return
federal funds rate
the interest rate at which banks make overnight loans to one another; the interest rates they pay; one of the key interest rates in the economy; helps determine the interest rates charged on other loans (like home and auto)
reduction in the money supply causes
the interest rate o rise from i1 to i3
the discount rate =
the interest rate set by the Fed's when banks borrow $
prime rate
the interest rate that banks charge their best customers; the lowest commercially available interest rate
when banks borrow from the Fed's
the interest rate they pay is set by the Fed
increase in supply of money will cause
the interest rate to fall from lowercase i1 to lowercase i2
the larger the rr,
the larger the money multiplier
the higher the reserve requirement,
the less money that can be loaned out and the less money that is created in the economy
Assuming that the Federal Reserve Banks sell $40 million in government securities to commercial banks and the reserve requirement is 20%, then the effect will be to reduce _____.
the money supply by potentially $200 million
the bigger the deposit =
the more loans the bank can make
the more loans a bank makes,
the more revenue it can generate
investment demand
the negative relationship between the quantity of new physical capital demanded by firms and the prevailing interest rate
Reserves borrowed at the federal funds rate are usually repaid _____.
the next day
money multiplier =
the overall change in the MS/the initial change in reserves
how can the Federal Reserve use monetary policy?
to influence interest rates and shape outcomes in the economy; trying to smooth out the business cycle and respond to inflation and unemployment; influence real GDP
frequently changing the rr would be
very disruptive to the banking sector and credit merkets
how does the Fed operate OMOs?
via the Domestic Trading Desk of Federal Reserve Bank of New York
excess reserves =
what the Fed's do not need to satisfy their rr
bank panic
when several banks experience bank runs simultaneously