Money & Banking 15, 19, 20, 21 (& some of 22, 23)

With excess supply of reserves, the federal funds rate _____

falls

Depository Institutions Deregulation and Monetary Control Act of 1980 sets the reserve requirement

the same for all depository institutions.

The government affects aggregate demand in two ways:

through its purchases and taxes

__% of checkable deposits over $48.3 million

10

__% of the first $48.3 million of checkable deposits

3

When the autonomous consumption expenditures increases, AD curve shifts to the

right

Shifts in the MP curve

- An autonomous tightening of monetary policy, that is a rise in real interest rate at any given inflation rate, shifts the aggregate demand curve to the left - Similarly, an autonomous easing of monetary policy shifts the aggregate demand curve to the right

Two types of monetary policy actions that affect interest rates:

- Automatic (Taylor principle) changes as reflected by movements along the MP curve - Autonomous changes that shift the MP curve

Changes in autonomous spending also affect the IS curve

- Autonomous consumption - Autonomous investment spending - Autonomous net exports

Shifts in the IS curve

- Autonomous consumption expenditure - Autonomous investment spending - Government purchases - Taxes - Autonomous net exports

Nonconventional Monetary Policy Tools During the Global Financial Crisis

- Discount Window Expansion - Term Auction Facility - New Lending Programs

The AD curve is derived from

- The MP curve - The IS curve

Why do individuals hold money? Three motives

- Transactions motive - Precautionary motive - Speculative motive

Other factors that affect the demand for money

- Wealth - Risk - Liquidity of other assets

The total quantity demanded of an economy's output is the sum of 4 types of spending

-Consumption expenditure (C) -Planned investment spending (I ) -Government purchases (G ) -Net exports (NX )

The Fed can vary the 10% requirement between __% to __%.

8 and 14

Aggregate Output =

Aggregate Output = Consumption Expenditure + Planned Investment Spending + Government Purchases + Net Exports

the total amount of output demanded in the economy

Aggregate demand

Repurchase agreements

An arrangement whereby the Fed or another party purchases securities with the understanding that the seller will repurchase them in a short period of time, usually less than a week.

Matched sale-purchase agreements

An arrangement whereby the Fed sells securities and the buyer agrees to sell them back to the Fed in the near future

Primary dealers

Approved by the government to sell government bonds and securities.

Lender of last resort to prevent financial panics

Creates moral hazard problem

Large-scale asset purchases

During the crisis the Fed started three new asset purchase programs to lower interest rates for particular types of credit: - Government Sponsored Entities Purchase Program - QE2 - QE3

Secondary credit

Given to banks that are in financial trouble and are experiencing severe liquidity problems. The interest rate is set at 50 basis points about the discount rate

Investment that is panned

Interest rates and expectations

Defensive open market operations

Intended to offset movements in other factors that affect the monetary base (such as changes in the Treasury deposits with the Fed or changes in float)

Equation of Exchange

M ´V = P ´Y

Open market operations have ____ effect on the federal funds rate when intersection occurs at the flat section of the demand curve

No

TRAPS (Trading Room Automated Processing System)

Notifies each dealer of which propositions have been chosen (how much government is selling, etc)

Monetary Policy Tools of the European Central Bank

Open market operations - Main refinancing operations - Longer-term refinancing operations Lending to banks - Marginal lending facility/marginal lending rate - Deposit facility Reserve Requirements - 2% of the total amount of checking deposits and other short-term deposits - Pays interest on those deposits so cost of complying is low

Study Quantity Theory of Money equation

P x Y = M x V

Quantity Theory and the Price Level

P= (Mx V)/Y

the total amount of spending on domestically produced goods and services that households, businesses, the government, and foreigners want to make

Planned expenditure

Keynes also recognized that people hold money as a cushion against unexpected wants.

Precautionary Motive

To stabilize inflation, central banks must raise nominal interest rates by more than any rise in expected inflation, so that r rises when rises.

Taylor principle

Discount window

The Federal Reserve facility at which discount loans are made to banks

Liquidity provision

The Federal Reserve implemented unprecedented increases in its lending facilities to provide liquidity to the financial markets

Keynes initially accepted the quantity theory view that the transactions component is proportional to income.

Transactions Motive

T/F If the intersection of supply and demand occurs on the vertical section of the supply curve, a change in the discount rate will have no effect on the federal funds rate.

True

T/F The aggregate demand curve represents the relationship between the inflation rate and aggregate demand when the goods market is in equilibrium.

True

Dynamic open market operations

When the Fed is increasing or decreasing the Money supply (monetary policy). Selling bonds reduce the Ms and buying bonds increases the Ms

One of the most extreme examples of hyperinflation throughout world history occurred recently in

Zimbabwe

Any factor that shifts the IS curve shifts the ________ ________ curve in the same direction

aggregate demand

Hyperinflations

are periods of extremely high inflation of more than 50% per month

Net exports is made up of two components

autonomous net exports and the part of net exports that is affected by changes in real interest rates

IS curve is the relationship between

equilibrium aggregate output and the interest rate.

On the other hand, a _________ in autonomous investment spending causes aggregate demand and equilibrium output to fall, shifting the IS curve to the left.

decrease

When the federal funds rate is above the rate paid on excess reserves, ior,as the federal funds rate ________, the opportunity cost of holding excess reserves ____ and the quantity of reserves demanded ______.

decreases, decreases, rises

If the intersection of supply and demand occurs on the horizontal section of the supply curve, a change in the discount rate shifts that portion of the supply curve and the federal funds rate may either rise or fall depending on the change in the _______ _________

discount rate

Lowering the discount rate shifts the supply curve _____ and lowers the federal funds rate because there is some discount lending

down

Lowering the discount rate shifts the supply curve _____ but does not lower the federal funds rate because there is no discount lending

down

The AD curve has a _________ slope: As inflation rises, the real interest rate _______, so that spending and equilibrium aggregate output _____.

downward, rises, falls

When the Federal Reserve lowers the federal funds rate, real interest rates ______

fall

At any given real interest rate, a rise in taxes causes aggregate demand and hence equilibrium output to _____, thereby shifting the IS curve to the _____.

fall, left

Conversely, a decline in autonomous consumption expenditure causes aggregate demand and equilibrium output to _____, shifting the IS curve to the _____

fall, left

Conversely, an autonomous _____ in net exports causes aggregate demand and equilibrium output to decline, shifting the IS curve to the ______

fall, left

An open market purchase causes the federal funds rate to _____ whereas an open market sale causes the federal funds rate to _____

fall, rise

Investment that is always planned

fixed investment

An _______ in financial frictions, as occurred during the financial crisis of 2007-2009, raises the real cost of borrowing to firms and hence causes investment spending and aggregate demand to _____

increase, fall

An autonomous increase in net exports leads to an _______ in equilibrium output at any given interest rate and shifts the IS curve to the _____

increase, right

An increase in autonomous investment spending ________ equilibrium output at any given interest rate, shifting the IS curve to the_____

increases, right.

The key reason for an upward sloping MP curve is that central banks seek to keep ________ stable.

inflation

The cost of holding deposits

interest rate that could have been earned minus the interest rate that is paid on these reserves

Investment that can be unplanned

inventory investment

When autonomous taxes increase, AD curve shifts to the

left

When financial frictions increase, AD curve shifts to the

left

When the autonomous monetary policy increases, AD curve shifts to the

left

A ______ shift of the demand curve lowers the Federal funds rate to a minimum of the interest rate on reserves.

leftward

Interest rates and planned investment spending AND interest rates and net exports both have a ________ relationship

negative

The velocity of money

nominal GDP (aggregate nominal income)/ the money supply

Supply in the Market for Reserves • Two components:

non-borrowed and borrowed reserves

During normal times, the Federal Reserve uses three tools of monetary policy referred to as conventional monetary policy tools. What are they?

open market operations, discount lending, and reserve requirements

Quantity Theory of Money says Changes in money supply affect only the ____ _____

price level

Quantity Theory of Money says Movement in the price level results solely from change in the _______ __ ______

quantity of money

There are two ways the government can pay for spending

raise revenue or borrow

A rise in autonomous consumption would _____ aggregate demand and equilibrium output at any given interest rate, shifting the IS curve to the ______.

raise, right

Cost-push inflation

results either from a temporary negative supply shock or a push by workers for wage hikes beyond what productivity gains can justify.

Demand-pull inflation

results from policy makers pursuing policies that increase aggregate demand.

When autonomous investment increases, AD curve shifts to the

right

When autonomous net exports increase, AD curve shifts to the

right

When government purchases increase, AD curve shifts to the

right

An open market purchase shifts the supply curve to the _____ causing the federal funds rate to _____ because it intersects at the _____ _____ part of the curve

right, fall, downward sloping

An open market purchase shifts the supply curve to the ______ but the federal funds rate cannot fall below the interest rate paid on reserves because it intersects at the _____ part of the curve

right, flat

Increasing the reserve requirement causes the demand curve to shift to the ____ and the federal funds rate _____

right, rises

A ________ shift of the demand curve raises the federal funds rate to a maximum of the discount rate.

rightward

When the Federal Reserve raises the federal funds rate, real interest rates _____

rise

Conversely, a cut in taxes at any given real interest rate increases disposable income and causes aggregate demand and equilibrium output to _____, shifting the IS curve to the _____

rise, right

With excess demand for reserves, the federal funds rate _______

rises

When the Fed raises reserve requirement, the federal funds rate ______ and when the Fed decreases reserve requirement, the federal funds rate _____

rises, falls

Quantity Theory of Money says velocity fairly constant in _____ run

short

Keynes also believed people choose to hold money as a store of wealth

speculative motive

Since the fall of 2008 the Fed has paid interest on reserves at a level

that is set at a fixed amount below the federal funds rate target

Primary credit

the discount lending that plays the most important role in monetary policy. The interest rate on these loans is the discount rate

Cost of borrowing from the Fed

the discount rate

The Fed of the United States conducts monetary policy by setting

the federal funds rate

What the IS curve tells us:

traces out the points at which the goods market is in equilibrium, aggregate output equals aggregate demand, assumes fixed price level where nominal and real quantities are the same

The MP curve is ______ sloping. Real interest rates _____ when the inflation rate rises.

upward, rise

If iff < id, then banks (will or will not) borrow from the Fed and borrowed reserves are _____ and the supply curve will be

will not, zero, vertical

As iff > id, banks (will or will not) borrow more and more at id, and relend at iff and the supply curve is

will, horizontal