Money and Banking Chp.19

Velocity is defined as

(P × Y)/M.

If nominal GDP is $10 trillion, and velocity is 10, the money supply is

1 trillion

If the money supply is $2 trillion and velocity is 5, then nominal GDP is

10 trillion

The quantity theory of inflation indicates that if the aggregate output is growing at 3% per year and the growth rate of money is 5%, then inflation is

2%

If nominal GDP is $8 trillion, and the money supply is $2 trillion, velocity is

4

If the money supply is $20 trillion and velocity is 2, then nominal GDP is

40 trillion

If nominal GDP is $10 trillion, and the money supply is $2 trillion, velocity is

5

If the money supply is $600 and nominal income is $3,000, the velocity of money is

5

If the money supply is $500 and nominal income is $3,000, the velocity of money is

6

If the money supply is $600 and nominal income is $3,600, the velocity of money is

6

If the money supply is $500 and nominal income is $4,000, the velocity of money is

8

Methods of financing government spending are described by an expression called the government budget constraint, which states the following equation

A) DEFICIT = (G - T) = ΔMB + ΔBONDS.

________ quantity theory of money suggests that the demand for money is purely a function of income, and interest rates have no effect on the demand for money.

Fisher's

Methods of financing government spending are described by an expression called the government budget constraint, which states the following

the government budget deficit must equal the sum of the change in the monetary base and the change in government bonds held by the public.

The quantity theory of inflation indicates that the inflation rate equals

the growth rate of the money supply minus the growth rate of aggregate output.

In Irving Fisher's quantity theory of money, velocity was determined by

the institutions in an economy that affect individuals' transactions.

The quantity theory of money is a theory of how

the nominal value of aggregate income is determined

Because Treasury bills pay a higher return than money and have no risk

the speculative demand for money may be zero.

Of the three motives for holding money suggested by Keynes, which did he believe to be the most sensitive to interest rates?

the speculative motive

The Baumol-Tobin analysis suggests that

the transactions component of the demand for money is negatively related to the level of interest rates.

In the equation of exchange, the concept that provides the link between M and PY is called

the velocity of money.

The speculative demand for money may not exist because

there are alternative riskless assets paying higher returns than the return on money.

Keynes argued that the precautionary component of the demand for money was primarily determined by the level of people's ________, which he believed were proportional to ________.

transactions; income

Keynes argued that the transactions component of the demand for money was primarily determined by the level of people's ________, which he believed were proportional to ________.

transactions; income

The average number of times that a dollar is spent in buying the total amount of final goods and services produced during a given time period is known as

velocity.

The classical economists' conclusion that nominal income is determined by movements in the money supply rested on their belief that ________ could be treated as ________ in the short run.

velocity; constant

Researchers at the Federal Reserve found that M2 money demand functions performed ________ in the 1980s, with M2 velocity moving ________ with the opportunity cost of holding M2.

well; closely

Cutting the money supply by one-third is predicted by the quantity theory of money to cause

a decline in the price level by one-third.

In the liquidity trap a small change in interest rates produces ________ change in the quantity of money demanded.

a very large

Only when budget deficits are financed by money creation does the increased government spending lead to ________ in the ________.

an increase; monetary base

The absence of money illusion means that

as the price level doubles, the demand for money doubles.

The Keynesian theory of money demand predicts that people will increase their money holdings if they believe that

bond prices are about to fall.

In the Baumol-Tobin analysis of the demand for money, either an increase in ________ or an increase in ________ increases money demand.

brokerage fees; income

The finance of government spending through a Treasury sale of bonds which are then purchased by the Fed

causes both reserves and the monetary base to rise.

If the deficit is financed by selling bonds to the ________, the money supply will ________, increasing aggregate demand, and leading to a rise in the price level.

central bank; rise

If the deficit is financed by selling bonds to the ________, the money supply will ________, causing aggregate demand to ________.

central bank; rise; increase

The classical economists' contention that prices double when the money supply doubles is predicated on the belief that in the short run velocity is ________ and real GDP is ________.

constant; constant

Keynes argued that when interest rates were low relative to some normal value, people would expect bond prices to ________ so the quantity of money demanded would ________.

decrease; increase

The Baumol-Tobin analysis suggests that a decrease in the brokerage fee for buying and selling bonds will cause the demand for money to ________ and the demand for bonds to ________.

decrease; increase

If initially the money supply is $2 trillion, velocity is 5, the price level is 2, and real GDP is $5 trillion, a fall in the money supply to $1 trillion

decreases the price level to 1.

As interest rates rise, the expected absolute return of money ________, money's expected return relative to bonds ________.

does not change; decrease

If people expect nominal interest rates to be higher in the future, the expected return to bonds ________, and the demand for money ________.

falls; increases

This method of financing government spending is frequently called printing money because high-powered money (the monetary base) is created in the process.

financing government spending through a Treasury sale of bonds that are then purchased by the Fed

For the classical economists, the quantity theory of money provided an explanation of movements in the price level. Changes in the price level result

from proportional changes in the quantity of money.

In the liquidity trap, monetary policy

has no impact on interest rates

Financing government spending by selling bonds to the public, which pays for the bonds with currency,

has no net effect on the monetary base.

Financing government spending with taxes

has no net effect on the monetary base.

The financing of government spending by issuing debt

has no net effect on the monetary base.

Because Keynes assumed that the expected return on money was zero, he argued that people would

hold money as a store of wealth when the expected return on bonds was negative.

Empirical evidence shows that the quantity theory of money is a good theory of inflation

in the long run, but not in the short run.

The theory of portfolio choice indicates that factors affecting the demand for money include

income, nominal interest rate, liquidity of other assets, and riskiness of money

Keynes hypothesized that the precautionary component of money demand was primarily determined by the level of

income.

Keynes hypothesized that the transactions component of money demand was primarily determined by the level of

income.

In the Baumol-Tobin analysis of transactions demand for money, either an increase in ________ or a decrease in ________ increases money demand.

income; interest rate

Fisher's quantity theory of money suggests that the demand for money is purely a function of ________, and ________ no effect on the demand for money.

income; interest rates have

Keynes argued that when interest rates were high relative to some normal value, people would expect bond prices to ________, so the quantity of money demanded would ________.

increase; decrease

The Baumol-Tobin analysis suggests that an increase in the brokerage fee for buying and selling bonds will cause the demand for money to ________ and the demand for bonds to ________.

increase; decrease

If the government finances its spending by selling bonds to the central bank, the monetary base will ________ and the money supply will ________.

increase; increase

If there are economies of scale in the transactions demand for money, as income increases, money demand

increases less than proportionately.

If initially the money supply is $1 trillion, velocity is 5, the price level is 1, and real GDP is $5 trillion, an increase in the money supply to $2 trillion

increases the price level to 2.

If people expect nominal interest rates to be lower in the future, the expected return to bonds ________, and the demand for money ________.

increases; decreases

According to the quantity theory of money demand

interest rates have no effect on the demand for money

According to Keynes's theory of liquidity preference, velocity increases when

interest rates increase.

The Keynesian theory of money demand emphasizes the importance of

interest rates on the demand for money.

Keynes hypothesized that the speculative component of money demand was primarily determined by the level of

interest rates.

Keynes's liquidity preference theory indicates that the demand for money

is a function of both income and interest rates.

The reason that economists are so interested in the stability of velocity is because if the demand for money is not stable, then steady growth of the money supply

is an ineffective way to conduct monetary policy.

In the liquidity trap, the money demand curve

is horizontal

In the Baumol-Tobin analysis of transactions demand, scale economies imply that an increase in real income increases the quantity of money demanded ________, while an increase in the price level increases the quantity of money demanded ________.

less than proportionately; proportionately

The theory of portfolio choice indicates that higher interest rates make money ________ desirable, and the demand for real money balances ________.

less; falls

Because interest rates have substantial fluctuations, the ________ theory of the demand for money indicates that velocity has substantial fluctuations as well.

liquidity preference

Keynes's liquidity preference theory indicates that the demand for money is

negatively related to interest rates.

Keynes's liquidity preference theory indicates that the demand for money is ________ related to ________.

negatively; interest rates

In a liquidity trap, monetary policy has ________ effect on aggregate spending because a change in the money supply has ________ effect on interest rates.

no; no

The velocity of money is defined as

nominal GDP divided by the money supply.

The view that velocity is constant in the short run transforms the equation of exchange into the quantity theory of money. According to the quantity theory of money, when the money supply doubles

nominal income doubles.

The equation of exchange states that the quantity of money multiplied by the number of times this money is spent in a given year must equal

nominal income.

Evidence suggests that a liquidity trap is possible when

nominal interest rates are at zero.

If the government finances its spending by issuing debt to the public, the monetary base will ________ and the money supply will ________.

not change; not change

Keynes's theory of the demand for money implies that velocity is

not constant but fluctuates with movements in interest rates.

Starting in 1974, the conventional M1 money demand function began to severely ________ the demand for money. Stephen Goldfeld labeled this phenomenon "the case of the missing ________."

overpredict; money

Conventional money demand functions tended to ________ money demand in the middle and late 1970s, and ________ velocity beginning in 1982.

overpredict; overpredict

Tobin's model of the speculative demand for money improves on Keynes's analysis by showing that

people will hold a diversified portfolio.

Keynes's model of the demand for money suggests that velocity is

positively related to interest rates.

Keynes's model of the demand for money suggests that velocity is ________ related to ________.

positively; interest rates

The portfolio theories of money demand state that the demand for real money balances is ________ related to income and ________ related to the nominal interest rate.

positively; negatively

The demand for money as a cushion against unexpected contingencies is called the

precautionary motive.

The classical economists believed that if the quantity of money doubled

prices would double.

Keynes's theory of the demand for money is consistent with

procyclical movements in velocity.

Keynes's theory of the demand for money is consistent with ________ movements in ________.

procyclical; velocity

Irving Fisher's view that velocity is fairly constant in the short run transforms the equation of exchange into the

quantity theory of money.

Tobin's model of the speculative demand for money shows that people hold money as a store of wealth as a way of

reducing risk.

The portfolio theories of money demand state that when income (and therefore, wealth) is higher, the demand for the money asset will ________ and the demand for real money balances will be ________.

rise; higher

Tobin's model of the speculative demand for money shows that people can reduce their ________ by ________ their asset holdings.

risk; diversifying

In one of the earliest studies on the link between interest rates and money demand using United States data, James Tobin concluded that the demand for money is

sensitive to interest rates.

The evidence on the interest sensitivity of the demand for money suggests that the demand for money is ________ to interest rates, and there is ________ evidence that a liquidity trap exists.

sensitive; little

Starting in 1974, the conventional M1 money demand function began to

severely overpredict the demand for money.

n the early 1990s, M2 growth underwent a dramatic ________, which some researchers believe ________ be explained by traditional money demand functions.

slowdown; cannot

Irving Fisher took the view that the institutional features of the economy which affect velocity change ________ over time so that velocity will be fairly ________ in the short run.

slowly; stable

In the late 1990s, M2 velocity ________, suggesting a ________ normal relationship between M2 and macroeconomic variables.

stabilized; more

The speculative motive for holding money is closely tied to what function of money?

store of wealth

Tobin's model of the speculative demand for money shows that people hold money as a ________ as a way of reducing ________.

store of wealth; risk

Comparing Tobin's model of the speculative demand for money with Keynesian speculative demand

the Tobin model implies individuals diversify their asset holdings, while the Keynesian model predicts that individuals hold only money or only bonds.

The velocity of money is

the average number of times that a dollar is spent in buying the total amount of final goods and services.

Because the quantity theory of money tells us how much money is held for a given amount of aggregate income, it is also a theory of

the demand for money.

The equation of exchange is

M x V = P x Q

The Keynesian demand for real balances can be expressed as

Md/P = f(i,Y).

Describe what the liquidity trap is

The liquidity trap describes the situation in which the demand for money is insensitive to changes in interest rates (i.e., the money demand curve is infinitely elastic). In this case, monetary policy has no direct affect on aggregate spending because a change in the money supply will not affect interest rates.