Money and Banking Final
Liquidity Preference Theory
3 motives behind the demand for money
$400
A consol bond paying $20 annually when the interest rate is 5% has a price of
Taylor Rule
A monetary rule that would stipulate exactly how much the Federal Reserve System should change real interest rates in response to divergences of real GDP from potential GDP and divergences of actual rates of inflation from a target rate of inflation.
liquidity trap
A situation in a severe recession in which the central bank's injection of additional reserves into the banking system has little or no additional positive impact on lending, borrowing, investment, or aggregate demand.(when people don't put their savings in bonds because bond prices would go down as interest rates rise which means less profit)
short-term interest rates are expected to rise in the future
A steeply upward sloping yield curve indicates that
decreases; decreases; left
A tax increase ________ disposable income, ________ consumption expenditure, and shifts the IS curve to the ________, everything else held constant.
increase; decrease
According to aggregate demand and supply analysis, the rising oil prices coupled with the global financial crisis in 2007−2008 caused the unemployment rate to ________ and the level of real aggregate output to ________.
expected return, risk of other assets, liquidity of other assets, and wealth
According to the portfolio theories of money demand, what are the four factors that determine money demand?
the inflation rate is the growth rate of the money supply minus the growth rate of aggregate output.
According to the quantity theory of money, in the long run:
quantity of money lead to proportional changes in the price level.
According to the quantity theory, changes in the
an increase; reduce
All else the same, if a bank's liabilities are more sensitive to interest rate fluctuations than are its assets, then ____ in interest rates will ___ bank profits.
Federal Open Market Committee
Although reserve requirements and the discount rate are not actually set by the ___
take too much risk
Although the FDIC was created to prevent bank failures, its existence encourages banks to
zero lower bound
An expansionary monetary policy tool where a central bank lowers short-term interest rates to zero, if needed, to stimulate the economy. A central bank that is forced to enact this policy must also pursue other, often unconventional, methods of stimulus to resuscitate the economy. Causes a liquidity trap
rise; IS; right
An increase in government spending causes the equilibrium level of aggregate output to ________ at any given interest rate and shifts the ________ curve to the ________, everything else held constant.
quantitative easing
An unconventional monetary policy in which a central bank purchases government securities or other securities from the market in order to lower interest rates and increase the money supply. Try's to encourage banks to lend more but banks may hoard their new found money. Decreases yields and increases inflation/prices.
forward guidance
An unconventional policy in which the central bank communicates to the market about future policy prospects such as keeping interest rates low.
5%
Assuming the same coupon rate and maturity length, when the interest rate on a Treasury Inflation Indexed Security is 3 percent, and the yield on a nonindexed Treasury bond is 8 percent, the expected rate of inflation is
increases, reduces
Bank capital has both benefits and costs for the bank owners. Higher bank capital ___ the likelihood of bankruptcy, but higher bank capital ___ the return on equity for a given return on assets.
liability; asset
Banks may borrow from or lend to another bank in the federal funds market. A loan of excess reserves from one bank to another bank is recorded as a(n) _____ for the borrowing bank and a(n) ____ for the lending bank
contagion effect
Because of asymmetric information, the failure of one bank can lead to runs on other banks. This is the
a decline in real interest rates, an increase in planned investment spending, and an increase in aggregate output demanded
By analyzing aggregate quantity demanded through its component parts, we can conclude that, everything else held constant, a decline in the inflation rate causes
an asset
Collateral is ____ the lender receives if the borrower does not pay back the loan
currency, smaller
Decisions by depositors to increase their holdings of ___, or of banks to hold excess reserves will result in a ___ expansion of deposits than the simple model predicts.
increases; demand
Everything else held constant, an autonomous monetary policy easing ________ aggregate ________.
aggregate demand to decrease.
Everything else held constant, an autonomous tightening of monetary policy will cause
right; increase
Everything else held constant, an increase in autonomous consumer spending will cause the IS curve to shift to the ________ and aggregate demand will ________.
right; increase
Everything else held constant, an increase in autonomous planned investment spending will cause the IS curve to shift to the ________ and aggregate demand will ________.
aggregate demand to increase
Everything else held constant, an increase in government spending will cause ________.
increases; demand
Everything else held constant, an increase in government spending ________ aggregate ________.
False
Financing a persistent deficit by bond purchases will lead to a sustained inflation. True or false
True
Financing a persistent deficit by money creation will lead to a sustained inflation. True or false
When the real interest rate is very low, the cost of funds is very low and the return on many of the firm's planned investments will exceed it. As the real interest rate rises, the return on fewer and fewer planned investments will exceed the cost of funds. Thus, planned investment spending falls as the real interest rate rises.
How and why do changes in the real interest rate affect planned investment spending?
try to eliminate the high unemployment by attempting to shift the aggregate demand curve to the right.
If aggregate output is below the natural rate level, activists of policies would recommend that the government
adverse selection
If bad credit risks are the ones who most actively seek loans then financial intermediaries face the problem of
falls, increases
If people expect nominal interest rates to be higher in the future, the expected return to bonds ___, and the demand for money ____.
4%
If the growth rate of the money supply is 10%, velocity is constant, and real GDP grows at 6% per year on average, then the inflation rate will be
6
If the money supply is $500 and nominal income is $3,000, the velocity of money is
no; no
In a liquidity trap, monetary policy has _____ effect on aggregate spending because a change in the money supply has _____ effect on interest rates.
decline, decreases
In the market for reserves, if the federal funds rate is between the discount rate and the interest rate paid on excess reserves, a ____ in the reserve requirement __ the demand for reserves, lowering the federal funds interest rate, everything else held constant.
rise, increases
In the market for reserves, if the federal funds rate is between the discount rate and the interest rate paid on excess reserves, a ____ in the reserve requirement ___ the demand for reserves, raising the federal funds interest rate, everything else held constant
The demand for money will increase because Keynes believed that people would require more money for more transactions.
In Keynes's analysis of the transactions demand for money, what will happen to money demand if people's incomes increase?
increase; decrease
Macroprudential supervision policies try to prevent a leverage cycle by changing capital requirements so that they ___ during an expansion and ___ during a downturn.
collateral
Property that is pledged to the lender in the event that a borrower cannot make his or her debt payment is called
currency; savings bonds; house
Ranking assets from most liquid to least liquid, the correct order is
Volker Rule
Regulation that aims to protect bank customers by preventing banks from making bad speculative investments.
Dodd-Frank Law
Regulation that increases transparency and prevents banks from taking on so much risk.
Basel 3
Regulation that provides a framework for capital and liquidity requirements to limit exposures and manage credit risk. It does this by requiring different levels of reserves for different forms of bank deposits and other borrowings. Additionally, it makes banks strengthen bank capital, increase liquidity, and decrease bank leverage.
decrease; increase
Risk premiums on corporate bonds tend to ___ during business cycle expansions and ___ during recessions, everything else held constant.
mortgage-backed securities and long-term Treasuries
The Fed's open market operations normally involve only the purchase of government securities, particularly those that are short-term. However, during the crisis, the Fed started new programs to purchase
quasi-public; private commercial banks in the district where the Reserve Bank is located
The Federal Reserve Banks are __ institutions since they are owned by the ___
increase; temporarily
The Federal Reserve will engage in a repurchase agreement when it wants to ___ reserves ___ in the banking system.
interest rates; investment spending; net exports
The IS curve slopes downward because higher ______________ lead to lower ___________ and ___________.
more; rise
The Taylor Principle states that central banks raise nominal rates by ________ than any rise in expected inflation so that real interest rates ________ when there is a rise in inflation.
credit spread
The ____, the difference between the interest rate on Baa corporate bonds and U.S. Treasury bonds. rose sharply during the Great Depression.
real; lowering
The aggregate demand curve is downward sloping because a higher inflation rate leads the central bank to raise ________ interest rates, thereby ________ the level of equilibrium aggregate output., everything else held constant.
the monetary policy authorities to raise real interest rates
The aggregate demand curve slopes downward because a rise in inflation leads:
arbitrage
___ occurs when market participants observe returns on a security that are larger than what is justified by the characteristics of that security and take action to quickly eliminate the unexploited profit opportunity
velocity
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
expansionary; a higher inflation rate; contractionary
The political business cycle refers to the phenomenon that just before elections, politicians enact ___ policies. After the elections, the bad effects of these policies (for example, ____) have to be counteracted with ____ policies.
2%
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
Securitization
____ is a process of bundling together smaller loans (like mortgages) into standard debt securities
8%
if the nominal interest rate is 2%, and the expected inflation rate is -10%, the real interest rate is
the central bank raises real interest rates when inflation rises.
The upward slope of the MP curve indicates that
creates tight labor and product markets that cause inflation to rise.
The short-run aggregate supply curve slopes upward because an increase in output relative to potential output:
Asymettric Information
Typically, borrowers have superior information relative to lenders about the potential returns and risks associated with an investment project. This difference in information is called
the growth rate of dividends decreases
Using the Gordon growth model, a stock's current price decreases when
the dividend growth rate increases
Using the Gordon growth model, a stock's current price increases when
The demand for money increases when wealth or the risk associated with other assets increases, and it decreases when expected return or liquidity of other assets increases or when the risk of inflation increases.
What changes in these can increase the demand for money?
An inflation gap is negative when the current inflation rate is less than the inflation target
What does it mean for the inflation gap to be negative?
be generally accepted as payment for goods and services or in the repayment of debt
Whatever a society uses as money, the distinguishing characteristic is that it must
falls; less; rise
When interest rates fall in the United States (with the price level fixed), the value of the dollar ________, domestic goods become ________ expensive, and net exports ________.
higher; depress
When output is below potential and the policy rate has hit the floor of zero, the resulting fall in inflation leads to ________ real interest rates, which ________ output further, which causes inflation to fall further.
increase, increase
When the Federal Reserve purchases a government bond from a primary dealer, reserves in the banking system ____ and the monetary base ___, everything else held constant.
decrease, decrease
When the Federal Reserve sells a government bond to a primary dealer, reserves in the banking system ___ and the monetary base ____, everything else held constant
true
When the coupon bond is priced at its face value, the yield to maturity equals the coupon rate. True or false.
long-term interest rates are above short-term interest rates
When yield curves are steeply upward sloping
direct
With ____ finance, borrowers obtain funds from lenders by selling them securities in the financial markets.
moral hazard
an example of the ___ problem would be if Brian borrowed money from Sean in order to purchase a used car and instead took a trip to Atlantic City using those funds
investment grade; junk bonds
bonds with relatively low risk of default are called ___ securities and have a rating of Baa (or BBB) and above; bonds with ratings below Baa (or BBB) have a higher default risk and are called ___
interest rates, income, payment tech., wealth, riskiness of other assets, inflation risk, and liquidity of other assets
factors that affect the demand for money:
total amount of capital in the economy, total of labor supplied in the economy, available tech. that puts labor and capital together to produce goods and services, not impacted by temporary changes
factors that shift the long-run aggregate supply curve:
expected inflation, a persistent output gap, and inflation shocks
factors that shift the short-run aggregate supply curve:
increase; right
higher government deficits ___ the supply of bonds and shift the supply curve to the ___, everything else held constant
long-term; short-term
prices and returns for ___ bonds are more volatile than those for ___ bonds, everything else held constant.
no change, decrease
suppose the economy is producing at the natural rate of output. A decrease in consumer and business confidence will cause ___ in real GDP in the long run and a ____ in inflation in the long run, everything else held constant.
the inflation rate and the level of aggregate output supplied
the aggregate supply curve shows the relationship between
falls
the demand of money ___, when interest rates rise.
yield to maturity
the interest rate that equates the present value of payments received from a debt instrument with its value today is the
the natural rate of output
the long-run aggregate supply curve is a vertical line passing through
deposits
the primary liabilities of a commercial bank are
default risk
the risk that interest payments will not be made, or that the face value of a bond is not repaid when a bond matures is
the data lag
the time it takes for policy makers to obtain data indicating what is happening in the economy.
precautionary motive
the want to hold money as a cushion against unexpected opportunities
transaction motive
the want to hold money for everyday transactions, as payment tech. advanced (credit cards), the demand for money would likely decline relative to income
speculative motive
the want to hold money for store of wealth
gdp/ money supply, (price x income= gdp)
velocity of money=
bond; stock
when I purchase a corporate ___, I am lending the corporation funds for a specific time. When I purchase a corporation's ___, I become an owner in the corporation.
the value of the house fell below the amount of the mortgage
when housing prices began to decline after their peak in 2006, many subprime borrowers found that their mortgages were "underwater". This meant that
slack, below, shift downward, decreases, increase.
when the unemployment rate is above the natural rate of unemployment, there is a ____ in the labor market and output is ____ potential. This causes the short-run aggregate supply curve to ____. Hence inflation ___ and output ___ over time, until the economy reaches a long-run equilibrium.