Chapter 16
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?
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.
The indirect effect of an increase in the money supply works through
a decrease in the interest rate increasing investment and consumption.
Which of the following is not a reason people choose to hold money balances?
Money holdings are good assets during periods of inflation.
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.
According to the Keynesian theory a decrease in the money supply increases the interest rate and decreases investment spending. The result of this is that
real GDP decreases by a larger amount than the change in investment.
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 the economy is operating at less than full employment, expansionary monetary policy will shift the aggregate demand curve to the ________ and the price level will ________.
right; increase
If the Fed decreasesdecreases the discount rate, relative to the federal funds rate, then this
would decreasedecrease the cost of funds for institutions borrowing from the Fed.
The market price of existing bonds is directly related to the rate of interest.
false
With contractionary monetary policy, the net export effect results in a deprecaition of the dollar, where the international price of the dollar falls.
false
Keynesians believe that monetary policy applied during recessions
is ineffective since changes in the money supply have little impact on the interest rate.
Arguments supporting the Federal Reserve's credit policy include all of the following except
it increased incentives to screen and monitor in order to limit asymmetric information problems.
The determinants of the demand for money balances are the __________ demand, the __________ demand, and the __________ demand.
transactions; precautionary; asset.
According to the Keynesian approach, an increase in the money supply increases real GDP by lowering interest rates, which increases investment.
true
An expansionary monetary policy decreases the rate of interest, which in turn increases planned investment.
true
Federal Reserve policymaking which involves direct lending to financial and nonfinancial firms is called credit policy.
true
Many traditional Keynesians argue that fighting recession with monetary policy is likely to be relatively ineffective.
true
When the money supply increases, aggregate demand rises.
true
The state of the economy depicted at the right can be best described as
having a recessionary gap.
The demand for money
is a downward sloping function of the interest rate.
Contractionary monetary policy causes the
interest rate to increase.
Traditional Keynesian analysis suggests that decreases in the money supply shift the aggregate demand curve by decreasing
investment
Traditional Keynesian analysis suggests that increases in the money supply shift the aggregate demand curve through increasing
investment
If the economy is operating beyond full employment, contractionary monetary policy will shift the aggregate demand curve to the ________ and the price level will ________.
left; decrease
When the Fed makes an open market purchase, the supply curve for bonds in the private market shifts to the ________ and the price of bonds ________.
left; increases
In order to induce private banks to maintain substantial reserve deposits with the Federal Reserve banks, since 2008 the Fed has
paid banks an interest rate that is higher than the federal funds rate on their reserves.
Keynesians argue that expansionary monetary policy during recessions will cause
people to accumulate money.
Many economists believe that the growth of the money supply is
positively related to the growth of real GDP
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 interest rate that the Federal Reserve charges for reserves that it lends to depository institutions is called the
discount rate
The demand for money curve shows the relationship between the interest rate and the quantity of money demanded, and is
downward sloping.
What dollar amount of open market operations must the Fed undertake to bring about the money supply change you calculated in the previous question?
60 billion
Suppose that the economy currently is in long-run equilibrium. Explain the short- and long-run adjustments that will take place in an aggregate demand-aggregate supply diagram if the Fed expands the quantity of money in circulation.
Aggregate demand curve shifts to the right; in the short-run both price level and real GDP increase. Over the long run the short-run aggregate supply curve shifts upward to the left and a new long-run equilibrium is reached at the initial equilibrium GDP but at a higher price level.
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 55 and the money multiplier is equal to 22. 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 $300300 billion increase in real GDP?
60 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.
What type of relationship exists between the growth of the money supply and changes in the inflation rate?
A direct relationship.
According to the quantity theory of money and prices, a 22% change in the money supply, holding other variables constant, leads to
a 22% change in the price level.
According to Keynesian theory, it would take _______ decrease in the interest rate to increase investment to the desired level to eliminate the recessionary gap
a large
Suppose that, initially, the U.S. economy was in an aggregate demand-aggregate supply equilibrium at point A along the aggregate demand curve AD in the diagram. Now, however, the value of the U.S. dollar has suddenly appreciated relative to foreign currencies. This appreciation happens to have no measurable effects on either the short-run or the long-run aggregate supply curve in the United States. It does, however, influence U.S. aggregate demand..
a. As a result of the dollar appreciation, U.S. net export expenditures will decrease .b The aggregate demand curve that could represent the aggregate demand effect of the U.S. dollar's appreciation is AD2 The real GDP will decrease and the price level will decrease as a result of the dollar appreciation. c. Federal Reserve may take a certain policy action to prevent the dollar's appreciation from affecting equilibrium real GDP in the short run. Which one of the following is not a likely policy action that the Fed will take? Increasing government spending.
An increase in the money supply will
all the above
Since the financial meltdown of the late 2000s, the Fed has launched a credit policy which consists of
all the above
The equation of exchange
all the above
The Fed's credit policy since 2008 has
all the above
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 an open market sale of government securities b. If Fed implements the short run monetary policy option instead of simply waiting for the long-run adjustments to take place, then it
benefits the society as the inflationary pressures are removed quickly.
During an interval between mid-2010 and early 2011, the Federal Reserve embarked on a policy it termed "quantitative easing." Total reserves in the banking system increased. Hence, the Federal Reserve's liabilities to banks increased, and at the same time its assets rose as it purchased more assets - many of which were securities with private market values that had dropped considerably. The money multiplier declined, so the net increase in the money supply was negligible. Indeed, during a portion of the period, the money supply actually declined before rising near its previous value. The Fed's "quantitative easing" can be best described as a
credit policy action
If the Federal Reserve implements an expansionary monetary policy that reduces the market interest rate, this will tend to ________ foreign investment in U.S. financial assets and ________ U.S. net exports.
discourage; increase
The net export effect of contractionary monetary policy predicts that a country's
exports decrease as the money supply contracts.
According to the Keynesian approach, a decrease in the money supply increases real GDP by lowering interest rates, which increases investment.
false
When the money supply increases, interest rates also increase.
false
Increases in output and increases in the inflation rate have been linked to
increases in the money supply.
According to the equation of exchange, if velocity is constant and output is fixed at the full employment level, then any percentage increase in the money supply will
lead to an equal percentage increase in the price level.
he Fed's credit policy since 2008 has
led to a reduction in the money multiplier.
This is because Keynesians believe that if monetary authorities increase the money supply during a recession, individuals
make no significant change to their investment spending.
In an open economy, the net export effect
may offset an expansionary fiscal policy but enhance an expansionary monetary policy.
Expansion of the money supply during a recession, according to the Keynesians, will
result in virtually no change in investment and aggregate demand.
Contractionary monetary policy by the Fed can be hampered by
the ability of U.S. citizens and businesses to obtain dollars from foreign sources.
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. a. The supply curve of bonds is drawn vertically because
the Fed's decision to buy or sell bonds is independent of bond prices.
Holding money as a medium of exchange to make payments is known as
transaction demand
