Chapter 15 Econ

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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.

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

As interest rates​ decline, stocks become a

​more; rise

Congress broadened the​ Fed's responsibility since

the 1930s as a result of the Great Depression.

As the interest rate​ increases,

​consumption, investment, and net exports​ decrease; aggregate demand decreases.

When the Fed conducts monetary​ policy, the most relevant interest rate is the

​short-term nominal interest rate.

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.

Is there an economic connection between the​ president's desire for a weaker dollar and his desire that the Federal Reserve keep interest rates​ low? Briefly explain.

Yes, when the Federal Reserve keeps interest rates​ low, it makes the dollar weaker because investing in the United States is less attractive.

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 currencies

Does the​ Fed's dual mandate require it to attain a zero percent unemployment​ rate? Briefly explain.

​No, because even when the economy is at full​ employment, there is still a natural rate of unemployment.

Does the​ Fed's dual mandate require it to attain a zero percent inflation​ rate? Briefly explain.

​No, because price stability is sufficient.

A student says the​ following: ​"I understand why the Fed uses expansionary policy but I​ don't understand why it would ever use contractionary policy. Why would the government ever want the economy to​ contract?"

above potential GDP and the price level is rising.

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 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.

In terms of the​ economy, "just as the party gets​ going" refers to a situation in which real GDP

is greater than potential​ GDP, which will result in an increase in the inflation rate.

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.

​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.

In early​ 2017, according to the Wall Street Journal President Donald Trump​ said: "the U.S. dollar​ 'is getting too​ strong' and he would prefer the Federal Reserve keep interest rates​ low." The article also quoted the president as​ saying: "It's​ very, very hard to compete when you have a strong​ dollar..." ​Source: Gerard​ Baker, Carol E.​ Lee, and Michael C.​ Bender, "Trump Says Dollar​ 'Getting Too​ Strong,' Won't Label China a Currency​ Manipulator," Wall Street Journal​, April​ 12, 2017. What did President Trump mean by a​ "strong dollar"?

. A​ "strong dollar" is when it takes more units of a foreign currency to buy a dollar.

What is a banking​ panic?

A situation in which many banks experience runs at the same time.

Why would a strong dollar make it hard for U.S. firms to​ compete?

A strong dollar raises the cost of U.S. goods to buyers in foreign countries.

Why would a cut in the Selic rate be an appropriate policy action at a time when the inflation rate was falling and the economy was​ struggling?

A. Lowering the Selic rate would decrease other interest​ rates, which would increase aggregate demand and stimulate the economy.

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 ​(Point A to Point ​C)​? MD1->MD2 Right

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 money—currency and checking account deposits—that individuals hold.

What is the advantage of holding​ money?

Money can be used to buy​ goods, services, or financial assets.

If the Federal Reserve is late to recognize a recession and implements an expansionary policy too​ late, the result could be an increase in inflation during the beginning of the next phase. Even though the goal had been to reduce the severity of the​ recession, the poor timing caused another​ problem: inflation. This is an example of what type of​ policy?

Procyclical policy

The European Central Bank​ (ECB) issued the following statement after its June 2017 monetary policy meeting on monetary​ policy: Regarding​ non-standard monetary policy​ measures, the Governing Council confirms that the net asset​ purchases, at the current monthly pace of euro60 ​billion, are intended to run until the end of December​ 2017, or​ beyond, if​ necessary, and in any case until the Governing Council sees a sustained adjustment in the path of inflation consistent with its inflation aim. ​Source: European Central​ Bank, "Monetary Policy​ Decisions," Press​ Release, June​ 8, 2017,​ www.ecb.europa.eu/press/pr/date/2017/html/ecb.mp170608.en.html. What is this​ non-standard monetary policy of net asset purchases​ called? The Federal Reserve

Quantitative easing. has attempted to use this​ non-standard monetary policy of net asset purchases you identified above.

Which one of the following is not one of the monetary policy goals of the​ Fed?

Reduce income inequality.

A column in the Wall Street Journal referred to policy actions aimed at​ "fulfilling both sides of the​ Fed's dual​ mandate." ​Source: Steven​ Russolillo, "The Key to a More Hawkish​ Fed," Wall Street Journal​, December​ 14, 2016. Which of the following gave the Fed a dual​ mandate?

The Employment Act of 1946.

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.

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.

Why does the​ Fed's actions to increase or decrease the rate you identified above attract so much​ attention?

This rate ultimately has a substantial effect on many other interest rates.

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.

The Fed now needs to rely on these two new policy tools to change the federal funds rate because

banks were not loaning out excess reserves.

William McChesney​ Martin, who was Federal Reserve chairman from 1951 to​ 1970, was once quoted as​ saying, ​"The role of the Federal Reserve is to remove the punchbowl just as the party gets​ going." When he said​ "to remove the​ punchbowl," he meant to engage in

contractionary policy.

In the figure to the​ right, the opportunity cost LOADING... of holding money ▼ when moving from Point A to Point B down ward on the money demand curve.

decreases

Figure C illustrates (MD1->MD2 left)

more widespread use of mobile wallets.

The​ Fed's two new policy tools are

paying interest on bank reserve holdings and paying interest on repurchase and reverse repurchase agreements.

Figure A illustrates (MD1->MD2 Right)

real GDP increases.

The federal funds rate is

the interest rate that banks charge each other for overnight loans.

What is​ "Operation Twist"?

the​ Fed's program to purchase​ $400 billion in​ long-term Treasury securities while selling an equal amount of​ shorter-term Treasury securities.

Which of these variables are the main monetary policy targets of the​ Fed?

the money supply and the interest rate

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

In​ 2017, one article in the Wall Street Journal had the​ headline: "Federal Reserve Expected to Deliver Rate​ Increase." ​Source: David​ Harrison, "Federal Reserve Expected to Deliver​ Rate," Wall Street Journal​, June​ 14, 2017. What rate was the headline likely referring​ to?

Federal funds rate.

In response to the severity of the financial​ crisis, the Fed started to rapidly reduce the target range for the federal funds rate in September 2007​ and, from December 2008 to December​ 2015, held the target range between​ 0% and​ 0.25%.

The Fed successfully held the actual federal funds rate within that target range over the​ seven-year period by conducting open market operations to increase or decrease bank reserves quickly.

The reason for this may have been a lack of

borrowers

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.

The​ Fed's strategy of increasing the money supply and lowering interest rates in order to increase real GDP is called

expansionary monetary policy.

An article in the Wall Street Journal notes that before the financial crisis of 2007minus​2009, the Fed​ "managed just one​ short-term interest rate and expected that to be enough to meet its goals for inflation and​ unemployment" ​Source: Jon​ Hilsenrath, "Easy-Money Era a Long Game for​ Fed," March​ 17, 2013 The​ short-term interest rate the article is referring to is the

federal funds rate.

The interest rate that banks charge each other for overnight loans is called the

federal funds rate.

real GDP increases. (MS1 <- MS2 left)

he Fed selling Treasury securities.

But the real problem was that banks were not

lending the reserves.

The article also notes that after the financial​ crisis, "the Fed is working through a broader spectrum of interest​ rates."

longer term Treasury rates and mortgage rates.

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.

The difference between what was expected and what actually occurred illustrates that the formulation of economic policy

relies on economic forecasting that is subject to frequent revisions and errors.

With a​ __________, the Fed buys a security from a financial​ firm, which promises to buy it back from the Fed the next day.

repurchase agreement

The Fed gave up targeting the money supply because

the relationship between monetary aggregates and other economic variables was becoming unreliable.

How can investment banks be subject to liquidity​ problems?

they often borrow short​ term, sometimes as short as​ overnight, and invest the funds in​ longer-term investments.

In​ mid-2017, an article in the Wall Street Journal noted​ that: ​"The Federal​ Reserve's interest-rate increases​ aren't having the desired effect of cooling off Wall​ Street's hot streak...where stocks have rallied to records this​ year..." ​Source: David​ Harrison, "Fed's Effort to Guide Markets​ Falls," Wall Street Journal​, June​ 11, 2017. Is cooling off rapid increases in stock prices part of the​ Fed's dual​ mandate? Are such increases a concern for the​ Fed? Briefly explain.

​No, this is not part of the​ Fed's dual mandate of price stability and high employment. Yes, rapidly rising stock prices could be a concern for the Fed because it has a goal of stable financial markets.

Which of the following statements is​ correct?

A. Changes in the federal funds rate usually will result in changes in both​ short-term and​ long-term interest rates on financial assets. B. 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. C. 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. D. All of the above are true.

An investment blog said about Fed Chair Janet​ Yellen, "She is arguably the​ world's most powerful​ woman, and perhaps the most powerful person in the world. Can you name anybody with more​ might"? ​Source: Barbara​ Friedberg, "Fed Chief Janet​ Yellen: The Most Powerful Woman in the​ World," log.personalcapital.com​, September​ 17, 2014. This assessment

A. is generally accepted by economists because of the influence the Fed chair has on monetary policy and the effect monetary policy has on​ inflation, employment, and financial stability.

Based on the European Central​ Bank's statement do you expect that the inflation rate is above or below the​ ECB's inflation​ target? Briefly explain.

A. ​Below, because the​ ECB's use of this​ non-standard monetary policy is intended to increase the money supply.

An article in the Wall Street Journal in 2017 discussed the decision by​ Brazil's central bank to cut the Selic​ rate, which is the equivalent in Brazil of the federal funds rate in the United States. According to the​ article, the cut occurred​ "as the​ country's inflation rate continues to fall quickly and the economy still​ struggles." ​Source: Jeffrey T.​ Lewis, "Brazil Cuts Its Benchmark Rate a Full Percentage​ Point," Wall Street Journal​, April​ 12, 2017. In what sense do you think the Brazilian economy was​ "struggling" when this article was​ published?

B. The cut in the Selic rate suggests that Brazilian real GDP was below its potential.

Who is able to borrow and lend at that​ rate?

Banks are able to borrow and lend from each other at that rate.

What is​ "quantitative easing"?

What is​ "quantitative easing"?

In response to problems in financial markets and a slowing​ economy, the Federal Open Market Committee​ (FOMC) began lowering its target for the federal funds rate from 5.25 percent in September 2007. Over the next​ year, the FOMC cut its federal funds rate target in a series of steps. Writing in the New York Times​, economist Steven Levitt​ observed, ​"The Fed has been pouring more money into the banking system by cutting the target federal funds rate to 0 to 0.25 percent in December​ 2008." ​Source: Steven D.​ Levitt, "The Financial Meltdown Now and​ Then," New York Times​, May​ 12, 2009. 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.

The following appears in a Federal Reserve​ publication: ​"In practice, monetary policymakers do not have​ up-to-the-minute, reliable information about the state of the economy and prices. Information is limited because of lags in the publication of data. ​ Also, policymakers have​ less-than-perfect understanding of the way the economy​ works, including the knowledge of when and to what extent policy actions will affect aggregate demand. The operation of the economy changes over​ time, and with it the response of the economy to policy measures. These limitations add to uncertainties in the policy process and make determining the appropriate setting of monetary policy...more​ difficult." ​Source: Board of Governors of the Federal Reserve​ System, The Federal Reserve​ System: Purposes and Functions​, ​Washington, DC, 1994. If the Fed itself admits that there are many obstacles in the way of effective monetary​ policy, why does it still engage in active monetary policy rather than use a monetary growth​ rule, as suggested by Milton Friedman and his​ followers? Policymakers at the Fed believe that

although it is not​ perfect, active monetary policy is still a stabilizing force in the economy

According to an article in the New York Times​, an official at the Bank of Japan had the following explanation of why monetary policy LOADING... was not pulling the country out of​ recession: ​"Despite recent major increases in the money​ supply, he​ said, the money stays in​ banks." Source: James​ Brooke, "Critics Say​ Koizumi's Economic Medicine Is a Weak​ Tea," New York Times​, February​ 27, 2002. In the​ quote, when the official says​ "the money stays in​ banks," he is referring to

an increase in the reserves in banks.

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

buy U.S. Treasury securities.

Each​ year, the​ president's Council of Economic Advisers prepares and sends to Congress The Economic Report of the President. The report published in February 2008 contained the following summary of the economic​ situation: "Economic growth is expected to continue in 2008. Most market forecasts suggest a slower pace in the first half of​ 2008, followed by strengthened growth in the second half of the​ year."

decreased

An article in the New York Times in 1993 stated the following about Fed Chairman Alan​ Greenspan's decision to no longer announce targets for the​ money: ​"Since the late​ 1970's, the Federal Reserve has made many of its most important decisions by setting a specific target for growth in the money supply ... and often adjusted interest rates to meet​ them." 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

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.

Since​ 1950, the annual inflation rate in the U.S.

has typically been​ positive, but it has also varied​ substantially, peaking around​ 1980, and becoming negative for several months in early 2009 due to the effects of the Great Recession.

Consider the following​ statement: ​"The Fed has an easy job. Say it wants to increase real GDP by​ $200 billion. All it has to do is increase the money supply by that​ amount." The statement is

incorrect because an increase in the money supply does not affect real GDP directly.

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.

Which of the following was the​ Fed's objective in using​ "quantitative easing" and​ "Operation Twist"?

o keep interest rates on mortgages low. B. To keep interest rates on​ 10-year Treasury notes low. C. To increase aggregate demand. D. All of the above.

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.

A former Federal Reserve official argued that at the​ Fed, ​"the objectives of price stability and low​ long-term interest rates are essentially the same​ objective."

stable prices make it easier to plan for the​ future, so expectations can be​ stable, which makes it less costly to make loans.

Figure D illustrates (MS1->MS2) right

the Fed decreasing the required reserve ratio.

An article in the Wall Street Journal in 2015 reported that the interest rate on​ five-year German government bonds had become​ negative: "The negative yield means investors are effectively paying the German state for holding its​ debt." The article quoted an investment analyst as​ saying: "The negative yield is not scaring investors​ away." ​Source: Emese Bartha and Ben​ Edwards, "Germany Sells​ Five-Year Debt at Negative Yield for First Time on​ Record," Wall Street Journal​, February​ 25, 2015. The interest rate on German government bonds became negative when nvestors were willing to buy bonds with a negative interest rate because

the inflation rate exceeded the nominal interest rate. they believed there was no chance that the government would default.

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.

When Congress established the Federal Reserve in​ 1913, its main responsibility was

to make discount loans to banks suffering from large withdrawals by depositors.


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