GS ECO 2301 CH 15 Monetary Policy (HW Study)

D. housing prices rise by more than the value of housing​ services, as measured by rental prices. A housing bubble occurs when housing prices rise by more than the value of housing​ services, as measured by rental prices.

A housing bubble occurs when A. the value of housing​ services, as measured by rental​ prices, rises by more than housing prices. B. there is an increase in the number of buyers who do not intend to live in the houses they​ purchase, but are using them as investments. C. rental prices rise by more than the value of housing services. D. housing prices rise by more than the value of housing​ services, as measured by rental prices.

Changes in interest rates affect aggregate demand. Which of the following is affected by changes in interest rates​ and, as a​ result, impacts aggregate​ demand? ​(Mark all that​ apply.) A. The value of the dollar B. Consumption of durable goods C. Business investment projects D. Government spending

A. The value of the dollar B. Consumption of durable goods C. Business investment projects Changes in interest rates affect total spending in the​ economy, or aggregate demand. Interest rates affect only three of the four components of aggregate​ demand, since interest rates have no effect on government purchases. 1. Consumption. When interest rates increase​ (decrease), consumption of consumer durable goods tends to fall​ (rise). Since many consumers finance the purchase of​ big-ticket durable​ goods, such as appliances and​ cars, higher​ (lower) interest rates increase​ (decrease) the cost of borrowing. 2. Investment. When interest rates increase​ (decrease), the cost of borrowing money for new investment increases​ (decreases). Further, since the purchase of new homes is included in this​ category, higher​ (lower) interest rates will decrease​ (increase) the number of mortgages sought by households. 3. Net exports. When the interest rates in the U.S. rise​ (fall) relative to interest rates in other​ countries, investing in U.S. assets becomes more​ (less) desirable. This increases​ (decreases) demand for U.S. dollars and increases​ (decreases) the value of the dollar. As the value of the dollar increases​ (decreases), net exports will fall​ (rise) because U.S. goods and services are now relatively more​ (less) expensive. Changes in interest rates affect total spending in the​ economy, or aggregate demand. Interest rates affect only three of the four components of aggregate​ demand, since interest rates have no effect on government purchases. 1. Consumption. When interest rates increase​ (decrease), consumption of consumer durable goods tends to fall​ (rise). Since many consumers finance the purchase of​ big-ticket durable​ goods, such as appliances and​ cars, higher​ (lower) interest rates increase​ (decrease) the cost of borrowing. 2. Investment. When interest rates increase​ (decrease), the cost of borrowing money for new investment increases​ (decreases). Further, since the purchase of new homes is included in this​ category, higher​ (lower) interest rates will decrease​ (increase) the number of mortgages sought by households. 3. Net exports. When the interest rates in the U.S. rise​ (fall) relative to interest rates in other​ countries, investing in U.S. assets becomes more​ (less) desirable. This increases​ (decreases) demand for U.S. dollars and increases​ (decreases) the value of the dollar. As the value of the dollar increases​ (decreases), net exports will fall​ (rise) because U.S. goods and services are now relatively more​ (less) expensive. Changes in interest rates affect total spending in the​ economy, or aggregate demand. Interest rates affect only three of the four components of aggregate​ demand, since interest rates have no effect on government purchases. 1. Consumption. When interest rates increase​ (decrease), consumption of consumer durable goods tends to fall​ (rise). Since many consumers finance the purchase of​ big-ticket durable​ goods, such as appliances and​ cars, higher​ (lower) interest rates increase​ (decrease) the cost of borrowing. 2. Investment. When interest rates increase​ (decrease), the cost of borrowing money for new investment increases​ (decreases). Further, since the purchase of new homes is included in this​ category, higher​ (lower) interest rates will decrease​ (increase) the number of mortgages sought by households. 3. Net exports. When the interest rates in the U.S. rise​ (fall) relative to interest rates in other​ countries, investing in U.S. assets becomes more​ (less) desirable. This increases​ (decreases) demand for U.S. dollars and increases​ (decreases) the value of the dollar. As the value of the dollar increases​ (decreases), net exports will fall​ (rise) because U.S. goods and services are now relatively more​ (less) expensive.

Suppose the economy is initially in​ long-run equilibrium. The Fed enacts a policy to buy bonds. In the​ short-run, this expansionary monetary policy will​ cause: A. A shift from AD 2 to AD 1 and a movement to point​ C, with a lower price level and the same output. B. A shift from SRAS 2 to SRAS 1 and a movement to point​ D, with a higher price level and lower output. C. A shift from AD 1 to AD 2 and a movement to point​ B, with a higher price level and higher output. D. A shift from SRAS 1 to SRAS 2and a movement to point​ B, with a lower price level and higher output.

C. A shift from AD 1 to AD 2 and a movement to point​ B, with a higher price level and higher output.

As the figure to the right​ indicates, the Fed can affect both the money supply and interest rates.​ However, in recent​ years, the Fed targets interest rates in monetary policy more often than it does the money supply. Which interest rate does the Fed​ target? A. The discount rate B. The​ long-term nominal interest rate C. The federal funds rate D. The​ short-term real interest rate

C. The federal funds rate Though the Fed can affect both the money supply and the interest​ rate, it has generally focused more on interest rates. In​ July, 1993, then Fed Chairman Alan Greenspan informed the U.S. Congress that the Fed would rely less on M1 and M2 money supply targets and more on interest rates.​ Specifically, the Fed targets the federal funds rate.

In the figure to the​ right, when the money supply increased from MS 1 to MS 2​, the equilibrium interest rate fell from​ 4% to​ 3%. Why? A. Increased demand for Treasury securities drives up their prices. B. Increased demand for Treasury securities drives down their interest rate. C. ​Initially, firms hold more money than they want relative to other financial assets. D. All of the above.

D. All of the above. Impact of a change in the money supply on the interest​ rate: 1. When the Fed increases the money​ supply, households and firms will initially hold more money than they​ want, relative to other financial assets. 2. Households and firms often buy Treasury bills with the additional money they do not want to hold. 3. The increase in demand drives up the price of these assets and drives down their interest rates. 4.​ Eventually, interest rates will drop enough that households and firms will be willing to hold the extra money the Fed has created. 5. The reverse is true in the event of a decrease in the money supply. To​ summarize: When the Fed increases the money​ supply, the​ short-term interest rate must fall until it reaches a level at which firms and households are willing to hold the extra money.

B. mirror the ups and downs of house​ prices; they rise as house prices rise and fall as house prices fall. During a housing​ bubble, the numbers of new homes sold mirror the ups and downs of house​ prices; they rise as house prices rise and fall as house prices fall.

During a housing​ bubble, the numbers of new homes sold A. mirror the pattern of sales of existing​ homes; sales of both new and existing homes remain largely unaffected. B. mirror the ups and downs of house​ prices; they rise as house prices rise and fall as house prices fall. C. move in the opposite direction of house​ prices; they fall as house prices rise and rise as house prices fall. D. follow a different pattern than do sales of existing​ homes; they rise at the start of a bubble and then fall when the bubble​ bursts, while sales of existing homes remain largely unaffected.

Consider the figures below and determine which is the best description of what causes the shift from AD 1 to AD 2. A. Example A shows a contractionary monetary policy. The price level and real GDP both fall. B. Example B shows an expansionary monetary policy. The price level and real GDP both rise. C. Both examples show expansionary monetary policy. The price level and real GDP both rise. D. Example A shows an expansionary monetary policy. The price level rises and real GDP falls. E. Both A and B.

E. Both A and B. In each​ figure, we assume that the economy is in​ short-run equilibrium at point​ A, where aggregate​ demand, AD 1​, intersects​ short-run aggregate​ supply, SRAS. Contractionary Monetary​ Policy: In example​ A, short-run equilibrium​ (actual real GDP given by​ y1) occurs at a point greater than potential GDP​ (given by the​ long-run aggregate​ supply, LRAS,​ curve). In this​ case, the economy experiences rising wages and​ prices, which makes a contractionary policy appropriate. A contractionary monetary policy- an increase in the reserve​ requirement, an increase in the discount​ rate, or an open market sale of government securities- shifts AD 1 to AD 2​, decreasing real GDP and lowering the price level from P1 to P2. Expansionary Monetary​ Policy: In example​ B, short-run equilibrium​ (actual real GDP given by​ y1) occurs at a point less than potential GDP​ (given by the​ long-run aggregate​ supply, LRAS,​ curve). In this​ case, the economy experiences a​ recession, which makes an expansionary policy appropriate. An expansionary monetary policy- a decrease in the reserve​ requirement, a decrease in the discount​ rate, or an open market purchase of government securities- shifts AD 1 to AD 2​, increasing real GDP and raising the price level from P1 to P2.

D. shift the money supply curve to the right. D. where the new money supply curve intersects the original money demand curve.

Imagine a graph shows equilibrium in the money market. The equilibrium interest rate is determined at point E where the​ downward-sloping money demand and vertical money supply curves intersect. Suppose the Fed wants to lower the equilibrium interest rate. To lower the equilibrium interest​ rate, the Fed will take actions that will A. shift the money supply curve to the left. B. shift the money demand curve to the right. C. shift the money demand curve to the left. D. shift the money supply curve to the right. The new equilibrium will be A. anywhere along the new money supply curve. B. where the new money supply curve intersects a new money demand curve. C. where the original money supply curve intersects the original money demand curve. D. where the new money supply curve intersects the original money demand curve.

D. All of the above In reaction to an economy that is producing beyond its​ capacity, the Fed conducts contractionary monetary policy. When the Fed enacts a contractionary monetary policy-increasing the reserve​ requirement, increasing the discount​ rate, or conducting an open market sale of government securities- the money supply contracts and interest rates increase. As a​ result, spending by firms and households falls and the aggregate demand curve decreases​ (shifts left). The Fed pursues this type of policy in order to achieve price stability. In this​ example, the economy is initially at equilibrium at point A in the first period.​ However, by the second​ period, spending is increasing faster than the economy​ (AD shifts by more than LRAS in the second​ period), and inflation results. Actual real GDP​ (given by point​ B) is greater than potential GDP​ (given by LRAS 2​). After the Fed​ acts, AD 2 shifts to AD 2 policy​, and the price level​ "falls" and actual real GDP​ "falls," ceteris paribus. In​ reality, price increases by less than it would have without the policy.

In the figure to the​ right, the economy experiences inflation in the second period. What would be the​ Fed's reaction if actual real GDP occurs at point B and potential GDP occurs at LRAS 2​? A. Contractionary policy B. Increase interest rates C. Open market sale of government securities D. All of the above

D. The federal funds rate. D. Banks borrow and banks lend. B. The discount rate is the rate at which the Fed lends to banks.

In​ 2015, one article in the Wall Street Journal discussed the possibility of​ "a September​ quarter-point increase in the​ Fed's range for overnight target​ rates," while another article​ noted, "the U.S. central​ bank's discount rate...has been set at​ 0.75% since February​ 2010." ​Sources: Justin​ Lahart, "Jobs Give Fed Green​ Light; Inflation Sets Speed​ Limit," Wall Street Journal​, August​ 7, 2015; and Ben​ Leubsdorf, "Five Regional Fed Banks Asked to Raise Discount​ Rate," Wall Street Journal​, July​ 14, 2015. What is the name of the​ "target interest​ rate" mentioned in this​ article? A. The mortgage rate. B. The prime rate. C. The discount rate. D. The federal funds rate. Who borrows money and who lends money at this​ "target interest​ rate"? A. Banks borrow and the Fed lends. B. The Fed borrows and banks lend. C. Banks borrow and investors lend. D. Banks borrow and banks lend. What is the discount​ rate? A. The discount rate is the rate at which auto loans and mortgages are made. B. The discount rate is the rate at which the Fed lends to banks. C. The discount rate is the rate at which banks lend to their best customers. D. The discount rate is the rate at which banks lend to each other.

C. The actions the Federal Reserve takes to manage the money supply and interest rates.

Monetary policy is defined​ as: A. The actions Congress takes to manage tax policy and interest rates. B. The actions the Federal Reserve takes to manage tax policy and interest rates. C. The actions the Federal Reserve takes to manage the money supply and interest rates. D. The actions Congress takes to manage the money supply and interest rates.

A. High unemployment.

The Fed buys and sells bonds as a part of its policy to reach all of the following objectives​ except: A. High unemployment. B. Price stability. C. Stability of financial markets and institutions. D. Economic growth.

B. The Fed can only soften the magnitude of​ recessions, not eliminate them. Although the Fed can use expansionary monetary policy to increase aggregate demand during times of​ recession, it can do very little to actually eliminate recessions. While its policy tools are the interest rate and the money​ supply, it is generally charged with generating price stability and a healthy financial system. The Fed can only hope to reduce the severity of​ recessions, it cannot eliminate the effects of the business cycle.

The Fed uses monetary policy to offset the effects of a recession​ (high unemployment and falling prices when actual real GDP falls short of potential​ GDP) and the effects of a rapid expansion​ (high prices and​ wages). Can the​ Fed, therefore, eliminate​ recessions? A. The Fed can eliminate recessions by properly anticipating the economic events that cause them. B. The Fed can only soften the magnitude of​ recessions, not eliminate them. C. The Fed​ can, but choses not​ to, eliminate recessions. D. The Fed is only concerned with the money supply and interest rates.

B. Interest rates.

The Federal Reserve cannot affect real GDP ​directly; therefore, the Fed typically uses the following as its policy​ target: A. Government expenditures. B. Interest rates. C. Inflation. D. Taxes.

A. The goal of financial market stability means that the Fed tries to ensure that asset​ prices, such as stock​ prices, increase at a very high rate so investors can make more money.

The Federal Reserve has multiple economic goals for monetary policy to​ achieve, ​ However, it can be difficult to manage all of the goals at once. Which of the following is not true regarding the multiple goals of the​ Fed? A. The goal of financial market stability means that the Fed tries to ensure that asset​ prices, such as stock​ prices, increase at a very high rate so investors can make more money. B. As the Fed tries to ensure economic​ growth, it can also focus on financial market stability because efficient financial markets make it easier for investment to occur and create additional economic growth. C. Achieving the goals of price stability and economic growth can be difficult because often the forces that lead to economic growth also can make prices increase at a rate higher than the Fed would desire. D. Having dual goals of high employment and economic growth does not create many issues because most of the time when the economy experiences economic​ growth, the economy also achieves higher rates of employment.

B. The interest rate on discount loans issued by​ Rumblen's central bank was recently decreased. A fall in interest rates on discount loans would increase the reserves held by the commercial​ banks, thereby increasing the availability of loanable funds. This in turn is likely to boost economic growth and therefore would weaken her claim.

The economy of country Rumblen was hit by a banking crisis which has led to a recession. Jason​ Wallace, a real estate​ agent, says that the economy will recover soon because the government is taking various measures to counter the recession. According to​ him, the flow of credit will soon return to​ pre-crisis levels. His wife Anna Wallace disagrees with him. She says that the situation may not improve​ soon, given the substantial increase in unemployment. Which of the​ following, if​ true, will weaken​ Anna's claim that the situation is not likely to improve in the short​ term? A. The required reserve ratio in Rumblen has remained unchanged over the last two years. B. The interest rate on discount loans issued by​ Rumblen's central bank was recently decreased. C. Inflation in the economy declined to 4 percent this year. D. Prior to the current​ crisis, Rumblen enjoyed a​ decade-long economic expansion. E. Leading economists in the country feel that the central bank should have more autonomy.

B. is the rate that banks charge each other for​ short-term loans of excess reserves. Federal funds rate The interest rate banks charge each other for overnight loans. Banks are required to hold​ 10% of their checking account deposits as​ reserves, and since banks earn no interest on​ reserves, they have an incentive to lend out any excess reserves. Banks loan money to households and firms in the form of consumer and business​ loans, respectively. Banks loan to the government in the form of Treasury securities and banks loan money to other banks in the federal funds market. Even though the federal funds rate is determined by the forces of supply of and demand for excess​ reserves, the Fed can influence the amount of reserves in the banking system.​ Therefore, it sets a target for the federal funds rate and has been very successful at hitting that mark.

The federal funds rate A. only matters to banks and has very little impact on individual consumers. B. is the rate that banks charge each other for​ short-term loans of excess reserves. C. is set by the Federal Reserve Bank. D. equals the discount rate.

D. All of the above.

The introduction of Fannie Mae and Freddie Mac into the​ mortgage-backed securities market by the government A. assisted in separating mortgage loans from​ credit-worthiness standards because banks could sell the loans to Fannie Mae and Freddie Mac instead of keeping them on their balance sheets. B. allowed the secondary mortgage market to expand greatly by getting funds from investors and using them to purchase mortgages from banks. C. created additional moral hazard problems as banks could make riskier loans because they could simply sell loans to Fannie Mae and Freddie Mac as soon as the loans were made. D. All of the above. E. Only A and B.

D. The money supply and interest rates Since the Fed cannot affect unemployment and inflation​ directly, it uses targets that it can affect directly and​ that, in​ turn, affect variables like unemployment and inflation. The​ Fed's two main policy targets are the money supply and interest rates.

What are the​ Fed's main monetary policy​ targets? A. High employment and economic growth B. Taxes and government spending C. Price stability and economic growth D. The money supply and interest rates

D. ​"Fannie Mae" and​ "Freddie Mac" Congress wanted to make it easier for borrowers to obtain a mortgage by creating a secondary market in mortgages.​ (When a financial asset is​ resold, that constitutes to a secondary​ market.) The process worked in the following​ manner: A bank grants a mortgage and then resells the mortgage to an investor​ (secondary market). The bank could use the funds received from the investor to grant another mortgage. Most​ investors, however, were unwilling to buy mortgages because of the risk. To reassure​ investors, Congress created the Federal National Mortgage Association​ ("Fannie Mae") and the Federal Home Loan Mortgage Corporation​ ("Freddie Mac"). These two institutions would stand between the investor and the bank by selling bonds to investors and then using the funds to purchase mortgages from banks.

What two institutions did Congress create in order to increase the availability of mortgages in a secondary​ market? A. The Federal Open Market Committee​ (FOMC) and the Federal Deposit Insurance Corporation​ (FDIC) B. The Bank Oversight Committee and the Department of the Interior C. The National Bureau of Economic Research​ (NBER) and the Bureau of Labor Statistics​ (BLS) D. ​"Fannie Mae" and​ "Freddie Mac"

• buys securities from banks increases • see chart • decrease

When the Fed conducts an open market​ purchase, the Fed ▼______ and the money supply ▼ _____. Pt 2 Show the effect of the open market purchase on the money market and interest rate on the graph to the right. ​1.) Use the line drawing tool to show the change in the money supply or money demand when an open market purchase is conducted. Properly label this line. ​2.) Use the point drawing tool to show the new equilibrium interest rate in the money market. Label this point​ 'B'. Carefully follow the instructions​ above, and only draw the required objects. Pt 3 When the Fed conducts an open market​ purchase, the interest rate should ▼ _______

buys sells The Federal Open Market Committee​ (FOMC) meets eight times per year. If the FOMC decides to increase the money​ supply, it instructs the New York branch of the Federal Reserve to buy U.S. Treasury securities. People and banks sell the securities and deposit the money in banks. ​ Banks' reserves​ increase, loans​ increase, and checkable deposits rise. This expands the money supply. If the FOMC wishes to decrease the money​ supply, it sells U.S. Treasury securities.

When the Federal Open Market Committee​ (FOMC) decides to increase the money​ supply, it ▼_____ U.S. Treasury securities. If the FOMC wishes to decrease the money​ supply, it ▼ _____ U.S. Treasury securities.

B. A decrease in the money supply and an increase in the interest rate.

When the Federal Reserve sells bonds as a part of a contractionary monetary​ policy, there​ is: A. A decrease in the money supply and a decrease in the interest rate. B. A decrease in the money supply and an increase in the interest rate. C. An increase in the money supply and an increase in the interest rate. D. An increase in the money supply and a decrease in the interest rate.

C. The money demand.

Which of the following is not a viable monetary policy target for the​ Fed? A. The money supply. B. The inflation rate. C. The money demand. D. The interest rate.

E. A and C Only The Fed helped Bear Stearns to survive because it believed that if the firm went​ bankrupt, other investment banks would also fail. In​ addition, the Fed worried that the failure of Bear Stearns would make commercial banks reluctant to lend to investment banks. This is similar to a bank run on a commercial bank. The Fed helped JP Morgan Chase buy Bear Stearns and guaranteed losses that JP Morgan Chase suffered on Bear Stearns holdings of​ mortgage-backed securities up to​ $29 billion.

Why did the Fed help JP Morgan Chase buy Bear​ Stearns? A. Commercial banks would be reluctant to lend to investment banks. B. JP Morgan Chase is an influential partner with the Fed. C. Failure of Bear Stearns would lead to a larger investment bank failure. D. All of the above. E. A and C only.