Unit 4

Economists have struggled to reach agreement about how to define and measure money, however. There are two basic approaches:

the transactions approach, which stresses the role of money as a medium of exchange, and the liquidity approach, which stresses the role of money as a temporary store of value.

Habit formation

An inclination for household choices, such as decisions to purchase goods and services, to become automatic, or habitual, through frequent repetition.

Money is an ___.

asset

Gross public debt

All federal government debt irrespective of who owns it.

During periods of economic booms, the overall unemployment rate can go below the natural rate. At such times, cyclical unemployment is ___.

negative

The cost of holding money, its ___ ___, is measured by the alternative interest yield obtainable by holding some other asset.

opportunity cost

The Federal Reserve purchases ​$12 million in U.S. Treasury bonds from a bond​ dealer, and the​ dealer's bank credits the​ dealer's account. The required reserve ratio is 15 ​percent, and the bank typically lends any excess reserves immediately. Assuming that no currency leakage​ occurs, calculate how much will the bank be able to lend to its customers following the​ Fed's purchase. $___ (Enter your response rounded to two decimal​ places.)

$10.20 million.

In reality, more than one interest rate matters for Fed policymaking. Three interest rates are particularly relevant.

1 . The Federal Funds Rate. 2. The Discount Rate. 3. The Interest Rate on Reserves.

In the short run, an unexpected increase in aggregate demand causes the price level to rise and the unemployment rate to fall. Conversely, in the short run, an unexpected decrease in aggregate demand causes the price level to fall and the unemployment rate to rise. Two additional points are true:

1 . The greater the unexpected increase in aggregate demand, the greater the amount of inflation that results in the short run, and the lower the unemployment rate. 2. The greater the unexpected decrease in aggregate demand, the greater the deflation that results in the short run, and the higher the unemployment rate.

Potential money multiplier formula

1 / reserve ratio

Three arguments support the Federal Reserve's credit policy:

1. Giving Banks Time to Recover from the Financial Meltdown. 2. Making Financial Markets and Institutions More Liquid and Solvent. 3. Contributing to International Financial Liquidity.

Structural unemployment results from factors including these:

1. Government-imposed minimum wage laws, laws restricting entry into occupations, and welfare and unemployment insurance benefits that reduce incentives to work 2. Union activity that sets wages above the equilibrium level and also restricts the mobility of labor. Such factors reduce individuals' abilities or incentives to choose employment rather than unemployment.

Rational expectations hypothesis This hypothesis has two key elements:

1. Individuals base their forecasts (expectations) about the future values of economic variables on all readily available past and current information. 2. These expectations incorporate individuals' understanding about how the economy operates, including the operation of monetary and fiscal policy.

Arguments against the Federal Reserve's credit policy:

1. Providing an Incentive for Institutions to Operate Less Efficiently. 2. Reducing Incentives to Screen and Monitor in Order to Limit Asymmetric Information Problems. 3 . Making Monetary Policy Less Effective.

Assume a 1 percent required reserve ratio​, zero excess​ reserves, and no currency leakages. Calculate the potential money multiplier. ___ ​(Enter your response as an integer value​). If the Federal Reserve purchases ​$6 million in U.S. government​ securities, calculate the change in total deposits in the banking system as a whole. $___million.

100; $600 million

According to some New Keynesian​ theories, one possible rationale for active policy making is A. bounded rationality Your answer is correct.B. flexible prices. C. real business cycles. D. growing competition in U.S. product markets.

A

Consider the following​ statement: "In an important​ sense, the term policy irrelevance proposition is misleading because even if the rational expectations hypothesis is​ valid, economic policy actions can have significant effects on real GDP and the unemployment​ rate." This statement is A. correct because unanticipated government policy can influence real GDP and the rate of unemployment. This is the correct answer.B. incorrect because fully anticipated government policy can influence real GDP and the rate of unemployment. C. correct because all government policies can always influence real GDP and the rate of unemployment. D. incorrect because government policy can no longer influence real GDP and the rate of unemployment.

A

New Keynesians argue that A. appropriate activist policies can dampen cyclical fluctuations. Your answer is correct.B. appropriate activist policies will increase the length of cyclical fluctuations. C. appropriate activist policies will have an known effect on the length of cyclical fluctuations. D. none of the above.

A

The actual rate of unemployment is A. greater than the natural rate of unemployment when cyclical unemployment is positive. Your answer is correct.B. always equal to the natural rate of unemployment. C. greater than the natural rate of unemployment when cyclical unemployment is zero. D. less than the natural rate of unemployment when cyclical unemployment is positive.

A

The natural rate of unemployment in the U.S. A. is the rate of unemployment that exists in the long run after everyone in the economy has fully adjusted to changes that have occurred. Your answer is correct.B. is equal to frictional unemployment plus cyclical unemployment. C. has increased steadily and with out interruption since the conclusion of World War II. D. is equal to cyclical unemployment plus structural unemployment.

A

Which of the following arguments is used in support of undertaking passive​ policymaking? A. Aggregate demand shocks play little or no role in the economy in the short run. This is the correct answer.B. Pure competition is not typical in most markets as imperfect competition dominates the economy. C. Wage flexibility is uncommon because of efficiency wages. D. The Phillips curve varies with inflation expectations.

A

Which of the following is an argument in favor of active ​policymaking? A. Aggregate demand shocks lead to changes in real GDP in the short run and possibly in the long run. Your answer is correct.B. Prices are usually flexible because firms react immediately to demand changes. C. The Phillips curve relationship varies with inflation expectations and is nonexistent in the long run. D. Aggregate supply shocks cause movements in real GDP and explain most business cycles.

A

​"Rational expectations" means that A. people base their expectations on all readily available past and current information. Your answer is correct.B. people make systematic errors in forming expectations about the economy. C. people correctly anticipate all changes in the economy. D. people base their expectations only on what has happened in the past.

A

As a consequence of the inverse relationship between the price of existing bonds and the interest rate, the Fed is able to influence the interest rate by engaging in open market operations.

A Fed open market sale that reduces the equilibrium price of bonds brings about an increase in the interest rate. A Fed open market purchase that boosts the equilibrium price of bonds generates a decrease in the interest rate.

The Interest-Rate-Based Money Transmission Mechanism

A change in monetary policy > A change in excess reserves > A multiple change in the money supply > A change in the interest rate > A change in investment > A multiple change in real GDP

FOMC Directive

A document that summarizes the Federal Open Market Committee's general policy strategy, establishes near-term objectives for the federal funds rate, and specifies target ranges for money supply growth.

Effects of dollar depreciation

A dollar depreciation tends to boost net exports because it makes our exports cheaper in terms of foreign currency and imports more expensive in terms of dollars. Foreign residents demand more of our goods and services, and we demand fewer of theirs.

Federal Deposit Insurance Corporation (FDIC)

A government agency that insures the deposits held in banks and most other depository institutions. All U.S. banks are insured this way.

Transactions approach

A method of measuring the money supply by looking at money as a medium of exchange.

Federal funds market

A private market (made up mostly of banks) in which banks can borrow reserves from other banks that want to lend them. Federal funds are usually lent for overnight use.

Stagflation

A situation characterized by lower real GDP, lower employment, and a higher unemployment rate during the same period that the rate of inflation increases.

Rational expectations hypothesis

A theory stating that people combine the effects of past policy changes on important economic variables with their own judgment about the future effects of current and future policy changes.

Read through the descriptions below to correctly match the action and the type of policy undertaken. A. Active policy​ making: Fed buying U.S. government securities in response to a​ recession; Passive policy​ making: Unemployment compensation paid out by the government. B. Active policy​ making: Fed buying U.S. government securities in response to a​ recession; Passive policy​ making: Congress increasing government spending. C. Active policy​ making: Unemployment compensation paid out by the​ government; Passive policy​ making: Fed buying U.S. government securities in response to a recession. D. Active policy​ making: The U.S. progressive tax​ system; Passive policy​ making: A decrease in the marginal tax rates approved by Congress and the President.

A. Active policy​ making: Fed buying U.S. government securities in response to a​ recession; Passive policy​ making: Unemployment compensation paid out by the government. The Fed is attempting to react to a current or potential future economic problem. Unemployment compensation is an automatic stabilizer and this spending changes by rule.

Which of the following statements is correct when considering the choice between active and passive policy​ making? A. Economists believing that markets are stable and efficient support passive policy​ making; economists that believe that there are rigidities in markets support active policy making. B. Economists believing that markets are stable and efficient support contractionary policy​ making; economists that believe that there are rigidities in markets support expansionary policy making. C. Economists believing that markets are stable and efficient support monetary​ policy; economists that believe that there are rigidities in markets support fiscal policy. D. Economists believing that markets are stable and efficient support active policy​ making; economists that believe that there are rigidities in markets support passive policy making.

A. Economists believing that markets are stable and efficient support passive policy​ making; economists that believe that there are rigidities in markets support active policy making. Stable markets that efficiently arrive at equilibrium will allow the economy to self​ correct, implying there is no need for an active policy. Markets that have sticky prices and wages need active policy to get the economy to equilibrium.

Which of the following economic theories is most likely to support active​ policymaking? A. New Keynesian model. B. Real business cycle theory. C. Monetarism. D. New classical model.

A. New Keynesian model. Due to this​ theory's belief of sticky wages and prices

Which of the following events caused Congress to begin seriously looking at setting up the Federal Reserve​ system? A. Some severe banking crises at the end of the 19th century and early 20th century. B. World War I. C. The need to control inflation. D. The American​ people's loss of confidence in the​ nation's currency.

A. Some severe banking crises at the end of the 19th century and early 20th century. It was created to counter periodic panics in the banking industry.

Which of the following events would be likely to increase the supply of​ money? A. The Fed decreases the discount rate relative to the federal funds rate. B. The Fed increases reserve requirements for banks. C. The Fed conducts an open market sale of bonds. D. Banks perceive loans to be more risky and wish to hold more excess reserves.

A. The Fed decreases the discount rate relative to the federal funds rate.

Which of the following statements about the policy irrelevance proposition is not​ true? A. The policy irrelevance proposition implies that the there is a short run change in real​ GDP, but no long run change in real GDP. B. The policy irrelevance proposition implies that any anticipated policy will have no effect on the level of real GDP. C. The policy irrelevance proposition is associated with the natural rate of unemployment. D. he policy irrelevance proposition assumes that people​ don't make the same mistakes in forecasting the future.

A. The policy irrelevance proposition implies that the there is a short run change in real​ GDP, but no long run change in real GDP. According to the policy irrelevance proposition there would be no change in either short or​ long-run real GDP.

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? A. 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. B. There is an indirect relationship between the growth of the money supply and the price​ level; and an indirect relationship between the growth of the money supply and GDP growth. C. There is a​ direct, albeit​ loose, relationship between the growth of the money supply and the price​ level; and an indirect relationship between the growth of the money supply and GDP growth. D. There is an indirect relationship between the growth of the money supply and the price​ level; and a direct​ (but not​ perfect) relationship between the growth of the money supply and GDP growth.

A. 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.

Bank X had a reputation for asking few questions when it provided loans. Five years​ later, the majority of the loans were not repaid. This is because the bank had failed to address the A. adverse selection problem. B. ​free-rider problem. C. moral hazard problem. D. contrary selection problem.

A. adverse selection problem.

Asymmetric information is a situation in which A. information possessed by one party in a transaction is not known by another party. B. the government has information that it chooses to pass along to private firms. C. information possessed by one party in a transaction is also known by another party. D. private firms have information that they choose to pass along to the government.

A. information possessed by one party in a transaction is not known by another party.

Obviously financial intermediaries need to collect money from a variety of sources so they can redirect it where it can be used efficiently. The primary source of funds for a financial intermediary are known as its A. liabilities. B. income. C. capital controls. D. assets.

A. liabilities. Liabilities are the funds that financial intermediaries collect. They owe this money back to the households and businesses that place their money in the institution.

In order to induce private banks to maintain substantial reserve deposits with the Federal Reserve​ banks, since 2008 the Fed has A. paid banks an interest rate that is higher than the federal funds rate on their reserves. B. raised the legal reserve ratio that the banks have to maintain. C. paid banks an interest rate that is lower than the federal funds rate. D. paid banks an interest rate that is equal to the federal funds rate.

A. paid banks an interest rate that is higher than the federal funds rate on their reserves.

The type of policy making that is not in response to actual or potential changes in overall economic activity is called A. passive policy making. B. discretionary policy making. C. discriminatory policy making. D. active policy making.

A. passive policy making. These are responses carried out according to a rule.

The largest component of M2 is A. savings and money market deposits at depository institutions. B. M1. C. retail money market mutual fund shares. D. overnight repurchase agreements and Eurodollars.

A. savings and money market deposits at depository institutions.

The Fed acts like a government agency when it A. supplies the economy with fiduciary currency. B. acts as the​ government's fiscal agent. C. holds a depository​ institution's reserves. D. provides​ payment-clearing services.

A. supplies the economy with fiduciary currency.

The largest component of the M1 money supply is A. transactions deposits. B. currency. C. ​traveler's checks. D. money market mutual fund shares.

A. transactions deposits.

Consider a bank balance​ sheet, with​ "Assets" on the left and​ "Liabilities" on the right side. Identify where the following items belong. I. Deposits this bank holds in an account with another private bank. II. Borrowings from another bank in the interbank loan market. A. ​I: assets;​ II: liabilities. B. Both liabilities. C. Both assets. D. ​I: liabilities;​ II: assets.

A. ​I: assets;​ II: liabilities.

The new Keynesian​ model, using the theories of sticky prices and efficiency​ wages, suggests that the A. ​short-run aggregate supply curve is horizontal. B. ​short-run aggregate supply curve has a steep positive slope. C. the aggregate demand curve is downward sloping. D. ​long-run aggregate supply is vertical.

A. ​short-run aggregate supply curve is horizontal. The new Keynesians promote the idea of sticky prices which can be modeled by a horizontal SRAS curve.

Active (discretionary) policymaking

All actions on the part of monetary and fiscal policymakers that are undertaken in response to or in anticipation of some change in the overall economy.

Liabilities

Amounts owed; the legal claims against a business or household by nonowners.

Assets

Amounts owned; all items to which a, business or household holds legal claim.

Taylor rule

An equation that specifies a federal funds rate target based on an estimated long-run real interest rate, the current deviation of the actual inflation rate from the Federal Reserve's inflation objective, and the gap between actual real GDP per year and a measure of potential real GDP per year.

Government budget surplus

An excess of government revenues over government spending during a given period of time.

Trading Desk

An office at the Federal Reserve Bank of New York charged with implementing monetary policy strategies developed by the Federal Open Market Committee.

Medium of exchange

Any item that sellers will accept as payment.

Money

Any medium that is universally accepted in an economy both by sellers of goods and services as payment for those goods and services and by creditors as payment for debts.

The Fed acts as the "lender of last resort."

As lender of last resort, the Fed stands ready to lend to any temporarily illiquid but otherwise financially healthy banking institution. In this way, the Fed seeks to prevent illiquidity at a few banks from leading to a general loss of depositors' confidence in the overall soundness of the banking system.

Financial Intermediary: Commercial banks, savings and loan associations, savings banks, and credit unions

Assets: Car loans and other consumer debt, business loans, government securities, home mortgages Liabilities: Transactions deposits, savings deposits, various other time deposits

Financial Intermediary: Money market mutual funds

Assets: Short-term credit instruments such as large-denomination certificates of deposit, Treasury bills, and high-grade commercial paper Liabilities: Fund shares with limited checking privileges

Financial Intermediary: Pension and retirement funds

Assets: Stocks, bonds, mortgages, time deposits Liabilities: Pension plans

Bank run

Attempt by many of a bank's depositors to convert transactions and time deposits into currency out of fear that the bank's liabilities may exceed its assets.

Examples of M1 and M2

A​ $1,000 balance in a transactions deposit at a mutual savings bank. This item is counted in both M1 and M2. A​ $100,000 certificate of deposit issued by a New York bank. This item is counted in neither M1 nor M2. A​ $10,000 time deposit an elderly widow holds at her credit union. This item is counted in M2 only. A​ $50 traveler's check. This item is counted in both M1 and M2. A​ $50,000 money market deposit account balance. This item is counted in M2 only.

If inflationary expectations​ rise, the Phillips curve A. becomes flatter. B. shifts up. Your answer is correct.C. shifts down. D. becomes steeper.

B

Suppose the economy is in equilibrium when there is a change in environmental policy that bans all pesticides and herbicides on farmland. We would expect to observe A. a decrease in aggregate supply and an increase in aggregate demand. B. a decrease in real output and an increase in the price level. Your answer is correct.C. a decrease in both real output and the natural rate of unemployment. D. a decrease in real output and an increase in the natural rate of unemployment.

B

When Alan Greenspan was nominated for his third term as chair of the Federal​ Reserve's Board of​ Governors, a few senators held up his confirmation. One of them explained their joint action to hinder his confirmation by​ saying, "Every time growth starts to go​ up, they​ [the Federal​ Reserve] push on the​ brakes, robbing working families and businesses of the benefits of faster​ growth." This statement is based on A. the adaptive expectations theory. B. the​ trade-off as shown by the​ short-run Phillips curve. Your answer is correct.C. the​ trade-off as shown by the​ long-run Phillips curve. D. the rational expectations theory.

B

When the economy is operating at a level of real GDP that is greater than its potential​ level, we know that A. the actual unemployment rate is greater than the natural rate of unemployment. B. the cyclical rate of unemployment is negative. Your answer is correct.C. the frictional unemployment is zero. D. the structural rate of unemployment is negative.

B

Which of the following is a major reason why financial​ intermediaries, such as​ banks, exist? A. Financial intermediaries exist because they provide a medium of exchange for their customers. B. The existence of asymmetric information makes financial intermediaries more efficient in channeling money to its most efficient use. C. Banks create near monies. D. Banks exist to facilitate exchanges through barter.

B. The existence of asymmetric information makes financial intermediaries more efficient in channeling money to its most efficient use. The bank has better information than what an individual possesses when dealing with loans to other firms. This reduces the risk to the household or individual.

What is the basic structure of the Federal Reserve​ Bank? A. There is one major bank located in Washington D.C. with branch banks located in every major city. B. There are 12 district​ banks, a Board of Governors and a Federal Open Market Committee. C. It is the combination of all private banks in the U.S. excluding Savings and Loans banks. D. There is one major bank with 25 branches.

B. There are 12 district​ banks, a Board of Governors and a Federal Open Market Committee. This is the structure of the Fed.

Which one of the following is included in M2 but NOT in​ M1? A. coins and currency B. a savings deposit C. transaction deposits D. ​large-denomination time deposits

B. a savings deposit

If the economy is underutilizing its economic​ resources, the Fed should A. contract the money supply to decrease aggregate demand. B. expand the money supply to increase aggregate demand. C. decrease aggregate supply. D. discourage investment spending.

B. expand the money supply to increase aggregate demand.

The net export effect of contractionary monetary policy predicts that a​ country's A. imports decrease as the money supply contracts. B. exports decrease as the money supply contracts. C. value of currency depreciates as the money supply contracts. D. experience will include all of the above.

B. exports decrease as the money supply contracts. As the money supply​ decreases, interest rates​ rise, causing an appreciation of the domestic currency and thereby reducing exports.

Adverse selection refers to the A. possibility that the borrower may engage in riskier behavior after the loan is obtained. B. likelihood that a potential borrower may use the funds that he receives for​ unworthy, high risk projects. C. use of statistical discrimination in making loans. D. possession of information by one party in a financial transaction not known by the other party.

B. likelihood that a potential borrower may use the funds that he receives for​ unworthy, high risk projects.

In an open​ economy, the net export effect A. may enhance an expansionary fiscal policy and an expansionary monetary policy. B. may offset an expansionary fiscal policy but enhance an expansionary monetary policy. C. may offset an expansionary monetary policy but enhance an expansionary fiscal policy. D. may offset an expansionary fiscal policy and an expansionary monetary policy.

B. may offset an expansionary fiscal policy but enhance an expansionary monetary policy.

Suppose the actual federal funds rate is above the rate implied by a particular inflation goal. In this​ situation, the Taylor rule implies that A. monetary policy is neither expansionary or contractionary. B. monetary policy is contractionary. C. monetary policy is expansionary. D. fiscal policy is expansionary.

B. monetary policy is contractionary.

Keynesians argue that expansionary monetary policy during recessions will cause A. government spending to increase. B. people to accumulate money. C. banks to increase their interest rates. D. investors to increase their investments greatly.

B. people to accumulate money.

The Federal Open Market Committee engages in contractionary monetary policy by A. buying bonds. B. selling bonds. C. creating excess reserves. D. lowering interest rates.

B. selling bonds.

The Federal Reserve System LOADING... is divided into 12​ districts, each served by one of the Federal Reserve district​ banks, located in the following​ cities: Boston,​ MA; New​ York, N.Y.;​ Philadelphia, PA;​ Washington, D.C.;​ Richmond, VA;​ Atlanta, GA; St.​ Louis, MO;​ Dallas, TX;​ Cleveland, OH;​ Chicago, IL;​ Minneapolis, MN; Kansas​ City, MO; and San​ Francisco, CA.​ Today, the U.S. population is centered just west of the Mississippi River long dash that​ is, about half of the population is either to the west or the east of a line running roughly just west of this river. The current locations of Fed districts and banks are structured this way because A. the Fed districts were redesigned in 1965 to best serve the population at that​ time; these have remained the same. B. the Fed districts were designed in 1913 to best serve the population at that​ time; these have remained the same. C. the Fed districts have been redesigned only once in 1973 to best serve the population at that time. D. the original Fed districts were designed in​ 1913, but have been redesigned many times since then.

B. the Fed districts were designed in 1913 to best serve the population at that​ time; these have remained the same. Consider the map of the locations of the Federal Reserve districts and their headquarters.​ Today, the U.S. population is centered just west of the Mississippi River long dash that​ is, about half of the population is either to the west or the east of a line running roughly just west of this river. The current locations of Fed districts and banks are structured this way because the Fed districts were designed in 1913 to best serve the population at that​ time; these have remained the same.

The policy relevance of new Keynesian inflation dynamics based on the theory of small menu costs and sticky prices depends on the exploitability of the implied relationship between inflation and real GDP. Consider the reasons why the average time between price adjustments by firms is a crucial determinant of whether policymakers can actively exploit this relationship to try to stabilize real GDP. Consider the reasons why the average time between price adjustments by firms is a crucial determinant of whether policymakers can actively exploit this relationship to try to stabilize real GDP. If the average interval between​ firms' price adjustments is relatively long A. the horizontal new Keynesian aggregate supply curve will remain in position for a longer interval and there will be less opportunity to exploit the relationship between inflation and real GDP to stabilize the economy. B. the horizontal new Keynesian aggregate supply curve will remain in position for a longer interval and there is a greater opportunity to exploit the relationship between inflation and real GDP to stabilize the economy. C. speedier adjustments of prices will automatically tend to dampen movements in real GDP and the unemployment rate and there will be less opportunity to exploit the relationship between inflation and real GDP to stabilize the economy D. speedier adjustments of prices will automatically tend to dampen movements in real GDP and the unemployment rate and there is a greater opportunity to exploit the relationship between inflation and real GDP to stabilize the economy.

B. the horizontal new Keynesian aggregate supply curve will remain in position for a longer interval and there is a greater opportunity to exploit the relationship between inflation and real GDP to stabilize the economy. New Keynesian approaches suggest that firms facing costs of adjusting their prices may be slow to change prices in the face of variations in demand. Since prices and wages are sufficiently inflexible in the short run that there is an exploitable​ trade-off between inflation and real GDP. By​ "exploitable," economists mean a relationship that is sufficiently predictable and​ long-lived to allow enough time for policymakers to reduce unemployment or to push up real GDP when economic activity falls below its​ long-run level. At the heart of this issue is just how often firms adjust their prices. If the average interval between​ firms' price adjustments is relatively​ long, then the horizontal new Keynesian aggregate supply curve will remain in position for a longer interval. As a​ result, a decline in aggregate demand will have a​ longer-lasting negative effect on real GDP. Then there will be a greater potential scope for activist policymaking to be able to boost aggregate demand and stabilize real GDP and unemployment. In​ contrast, if the average interval between changes in prices is​ short, then prices will adjust relatively quickly to a change in aggregate demand. There will be less scope for activist policies to stabilize the​ economy, because speedier adjustments of prices will automatically tend to dampen movements in real GDP and the unemployment rate.

Checkable and debitable accounts in commercial banks and other financial institutions are classified as money because A. they are not liabilities of the banks. B. they are generally acceptable in the payment of debt. C. they sometimes earn an interest income for the depositor. D. banks hold currency in their vaults equal to the value of demand deposits.

B. they are generally acceptable in the payment of debt.

Real business cycle theory assumes that A. prices are sticky downward. B. wages and prices are perfectly flexible. C. the LRAS curve remains stationary. D. unemployment always is equivalent to the natural rate of unemployment.

B. wages and prices are perfectly flexible. Flexible prices and wages allow the economy to​ re-establish itself at full employment.

According to the policy irrelevance​ proposition, monetary policy can affect real variables A. as long as the policy is fully anticipated. B. in both the short run and the long run. C. only in the short run when the policy is unanticipated. Your answer is correct.D. in the long run only.

C

During the​ 1960s, many Keynesian economists felt that by studying the Phillips​ curve, A. policymakers could eliminate even frictional unemployment in the economy. B. policymakers could dispense with the Federal​ Reserve's open-market operations. C. policymakers could​ fine-tune the economy by selecting policies that would produce the exact mix of unemployment and inflation that suited current government objectives. Your answer is correct.D. the President and Congress did not need to attempt to balance the budget.

C

In new Keynesian models of aggregate economic​ activity, "sticky" prices and wages are explained by A. ​supply-side factors such as technology and changes in the composition of the labor force. B. monetary disturbances in the aggregate economy. C. the small​ menu-cost and efficiency wage​ theories, respectively. Your answer is correct.D. inaccuracies in​ people's forecasts of the future.

C

Most economists agree with which of the​ following? A. active policymaking is likely to exert sizable​ long-run effects on real GDP. B. passive policymaking is likely to exert sizable​ long-run effects on real GDP. C. active policymaking is unlikely to exert sizable​ long-run effects on real GDP. Your answer is correct.D. none of the above

C

The Board of Governors of the Federal Reserve System has A. 12 members serving 14 year terms. B. 7 members serving 4 year terms. C. 7 members serving 14 year terms. D. 12 members serving 4 year terms.

C. 7 members serving 14 year terms.

Which of the following arguments is used in support of undertaking passive​ policymaking? A. The Phillips curve varies with inflation expectations. B. Pure competition is not typical in most markets as imperfect competition dominates the economy. C. Aggregate demand shocks play little or no role in the economy in the short run. D. Wage flexibility is uncommon because of efficiency wages.

C. Aggregate demand shocks play little or no role in the economy in the short run. If aggregate demand is believed to have little impact on the economy there is no reason to pursue an active policy to correct for disturbances created by aggregate demand shocks.

If a recessionary gap occurs in the short​ run, then in the long run a new equilibrium arises when input prices and expectations adjust​ downward, causing the​ short-run aggregate supply curve to shift downward and to the right and pushing equilibrium real GDP per year back to its​ long-run value. The Federal Reserve can eliminate a recessionary gap in the short run by undertaking a policy action that increases aggregate demand. Which of the following is one monetary policy action that could eliminate the recessionary gap in the short​ run? A. The Fed can increase the money supply through an open market sale of Treasury securities. B. The Fed can decrease the money supply through an open market purchase of Treasury securities. C. The Fed can increase the money supply through an open market purchase of Treasury securities. D. The Fed can lower taxes.

C. The Fed can increase the money supply through an open market purchase of Treasury securities.

A system in which depository institutions hold reserves that are less than the amount of total deposits is A. a ratio reserve banking system. B. a legal reserve banking system. C. a fractional reserve banking system. D. a percentage reserve banking system.

C. a fractional reserve banking system.

During the late​ 1970s, prices quoted in terms of the Israeli​ currency, the​ shekel, rose so fast that grocery stores listed their prices in terms of the U.S. dollar and provided customers with​ dollar-shekel conversion tables that they updated daily. Although people continued to buy goods and services and make loans using​ shekels, many Israeli citizens converted shekels to dollars to avoid a reduction in their wealth due to inflation.​ Thus, the U.S. dollar functioned as money in Israel during this period A. as a medium of exchange. B. as a credit card. C. as a store of value. D. as a standard of deferred payment.

C. as a store of value.

What is a primary determinant of the asset demand for​ money? I. the interest rate II. the opportunity cost of holding money III. the supply of money A. both II and III B. I only C. both I and II D. III only

C. both I and II

As the interest rate or yield on U.S. bonds​ increases, foreigners A. buy fewer U.S. bonds and fewer U.S. goods and services. B. buy more U.S. bonds and more U.S. goods and services. C. buy more U.S. bonds and fewer U.S. goods and services. D. buy fewer U.S. bonds and more U.S. goods and services.

C. buy more U.S. bonds and fewer U.S. goods and services. They act as​ substitutes, the U.S. exports of goods and services and US bonds.

The accumulation of borrowing by all federal government agencies is referred to as the A. gross private debt. B. net public debt. C. gross public debt. D. net private debt.

C. gross public debt.

Suppose the economy currently has some underutilized resources. The Fed engages in expansionary monetary policy. The impact of expansionary monetary policy will be to A. increase aggregate​ demand, increase prices and decrease real GDP. B. increase​ short-run aggregate​ supply, decrease in prices and decrease in real GDP. C. increase aggregate​ demand, increase prices and increase real GDP. D. increase​ short-run aggregate​ supply, decrease prices and increase real GDP.

C. increase aggregate​ demand, increase prices and increase real GDP.

Suppose 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, then the Fed will engage in A. open market​ sales, decreasing the reserve​ requirement, and increasing the discount rate. B. open market​ purchase, increasing the reserve​ requirement, and increasing the discount rate. C. open market​ sales, increasing the reserve​ requirement, and increasing the discount rate. D. open market​ purchase, increasing the reserve​ requirement, and decreasing the discount rate.

C. open market​ sales, increasing the reserve​ requirement, and increasing the discount rate.

When the Fed conducts open market​ operations, it A. is engaging in fiscal policy. B. also raises taxes at the same time. C. purchases or sells government bonds issued by the U.S. Treasury. D. shifts the demand for money curve.

C. purchases or sells government bonds issued by the U.S. Treasury.

A contractionary monetary policy lowers equilibrium real GDP in the short​ run, by increasing the interest rate. In an open​ economy, the net export effect A. has no effect on real GDP since changes in exports and imports cancel each other. B. reinforces the effect of a contractionary monetary policy since the increase in the interest​ rate, increases the value of​ dollar, lowers U.S. imports and causes the real GDP to fall. C. reinforces the effect of a contractionary monetary policy since the increase in the interest​ rate, increases the value of​ dollar, lowers U.S. exports and causes the real GDP to fall. D. weakens the effect of a contractionary monetary policy since the increase in the interest​ rate, increases the value of​ dollar, increases U.S. exports and causes the real GDP to increase.

C. reinforces the effect of a contractionary monetary policy since the increase in the interest​ rate, increases the value of​ dollar, lowers U.S. exports and causes the real GDP to fall. A contractionary monetary policy lowers equilibrium real GDP in the short​ run, by increasing the interest rate. In an open​ economy, the net export effect reinforces the effect of a contractionary monetary policy since the increase in the interest​ rate, increases the value of​ dollar, lowers U.S. exports and causes the real GDP to fall.

Since​ 2001, more often than​ not, the U.S. federal government has A. run a balanced budget. B. run a budget surplus. C. run a budget deficit. D. decreased its borrowing.

C. run a budget deficit. We have experienced budget deficits since 2002.

By serving as the lender of last​ resort, A. the Fed aids in the sale of government securities. B. the Fed supervises depository institutions. C. the Fed can prevent bank failures. D. the Fed provides check clearing services.

C. the Fed can prevent bank failures.

The natural rate of unemployment depends on factors that affect the behavior of both workers and firms. All the following are likely to influence the natural rate of​ unemployment, except A. the training and skill level of the workers. B. the extent of government taxation and regulation on the firms. C. the burden of government debt on the general public. D. the access to information and the degree of competition in product markets.

C. the burden of government debt on the general public. The natural rate of unemployment depends on factors that affect the behavior of both workers and firms. All the following are likely to influence the natural rate of unemployment except the burden of government debt on the general public.

The supply curve of bonds is drawn vertically because A. government bonds do not bear interest. B. the Fed is buying or selling bonds in order to set the price of the bond. C. the​ Fed's decision to buy or sell bonds is independent of bond prices. D. the price of bonds is influenced by interest rates and the graphs do not include interest rates.

C. the​ Fed's decision to buy or sell bonds is independent of bond prices. The Fed is deciding how it wants to affect the money supply when it buys or sells bonds.

The function of money that allows individuals a method to compare the relative value of goods and services is A. medium of exchange. B. store of value. C. unit of accounting. D. liquidity.

C. unit of accounting.

The reserve ratio equals 2 percent. The Fed buys​ $1 million in U.S. government securities. The most the money supply can increase is A. ​$10 million. B. ​$40 million. C. ​$50 million. D. ​$100 million.

C. ​$50 million.

Suppose that each​ 0.1-percentage-point increase in the equilibrium interest rate induces a ​$4 billion decrease in real planned investment spending by businesses. In​ addition, the investment multiplier is equal to 3​, and the money multiplier is equal to 3. ​Furthermore, every ​$10 billion decrease in the money supply brings about a​ 0.1-percentage-point increase in the equilibrium interest rate. Use this information to answer the following questions under the assumption that all other things are equal. Calculate by how much the real planned investment must decrease if the Federal Reserve desires to bring about an ​$100 billion decrease in equilibrium real GDP. ​$___ billion. ​(Enter your response rounded to one decimal​ place.) Calculate by how much must the money supply decrease for the Fed to induce the change in real planned investment to bring about an ​$100 billion decrease in equilibrium real GDP. ​$___ billion. ​(Enter your response rounded to one decimal​ place.) Calculate the dollar amount of open market operations that the Fed must undertake to bring about the money supply decrease required for an ​$100 billion decrease in equilibrium real GDP. ​$___ billion. ​(Enter your response rounded to one decimal​ place.)

Calculate by how much the real planned investment must decrease if the Federal Reserve desires to bring about an ​$100 billion decrease in equilibrium real GDP. ​$33.0 billion. ​(Enter your response rounded to one decimal​ place.) Calculate by how much must the money supply decrease for the Fed to induce the change in real planned investment to bring about an ​$100 billion decrease in equilibrium real GDP. ​$82.5 billion. ​(Enter your response rounded to one decimal​ place.) Calculate the dollar amount of open market operations that the Fed must undertake to bring about the money supply decrease required for an ​$100 billion decrease in equilibrium real GDP. ​$27.5 billion. ​(Enter your response rounded to one decimal​ place.)

Expansionary monetary policy ___.

Causes interest rates to fall. Such a decrease will induce international outflows of funds, thereby reducing the international value of the dollar and making U.S. goods more attractive abroad. The net export effect of expansionary monetary policy will be in the same direction as the monetary policy effect, thereby amplifying the effect of such policy.

Change in investment x multiplier​ = change in real GDP

Change in investment x multiplier​ = change in real GDP

Transactions deposits

Checkable and debitable account balances in commercial banks and other types of financial institutions, such as credit unions and savings banks. Any accounts in financial institutions from which you can easily transmit debit-card and check payments without many restrictions.

Rational inattention

Choosing to acquire information infrequently and to make decisions based on incomplete knowledge of the state of the economy during the intervals between updates.

Small menu costs

Costs that deter firms from changing prices in response to demand changes—for example, the costs of renegotiating contracts or printing new price lists. These include the costs of renegotiating contracts, printing price lists (such as menus), and informing customers of price changes.

According to Friedman and​ Phelps, which of the following statements is a correct characterization of unemployment and inflation in the United States since the​ 1950s? A. The relationship between inflation and unemployment is very different from the Phillips curve. A positive relationship is evident rather than an inverse relationship. B. A​ trade-off between inflation and unemployment as pictured in the Phillips curve existed over the entire time period. C. A​ trade-off between inflation and unemployment as pictured in the Phillips curve existed in the 1970s and​ 1980s, but not over the entire period. D. There is no clear relationship between unemployment and inflation.

D

Historical evidence suggests that A. shifts in​ long-run aggregate supply do not affect real output. B. inflation rates are lowest when unemployment rates are also low. C. the Phillips curve is horizontal. D. once policy makers attempted to exploit a​ short-run Phillips curve​ trade-off, it disappeared.

D

Suppose a constitutional amendment is passed that mandates a balanced federal budget every year and the President and Congress consistently carry this mandate out. This would be an example of A. decisive policymaking. B. active policymaking. C. cooperative policymaking. D. nondiscretionary policymaking.

D

There is greater support for active policymaking when A. wage flexibility is common. B. price flexibility is common. C. pure competition is common. D. None of the above.

D

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. A decrease in the discount rate. B. A Fed purchase of bonds from banks. C. A decrease in the reserve requirement ratio. D. A Fed sale of bonds to brokers and banks.

D. A Fed sale of bonds to brokers and banks. This reduces the reserves of banks and increases the interest rate.

Which of the following are failures of the real business cycle​ theory? A. It cannot explain all facets of the business cycle. B. It fails to explain the rigidity of wages and prices in the economy. C. It cannot explain the Great Depression. D. All of the above are failures of the real business cycle theory. E. None of the above are​ failures, as the real business cycle model addresses all these issues.

D. All of the above are failures of the real business cycle theory.

According to the rational expectations​ hypothesis, a policy cannot have a​ long-run effect on real GDP or the unemployment rate because A. people do not persistently make the same mistakes in forecasting the future. B. in the long​ run, people's expectations will correctly anticipate the effects of any policy action and the public will react in such a way as to nullify the impact of policy. C. the policy will not contain unsystematic qualities in the long run and thus the public will be able to accurately forecast the actions and consequences of policy makers. D. All of the above. E. A and C only.

D. All of the above.

An increase in the money supply will A. increase the price level. B. create an indirect effect of increased consumption and investment through increased saving and loans. C. create a direct effect of an increase in consumption due to higher money balances. D. All of the above.

D. All of the above.

In what way might society gain if the Fed implements an​ anti-recessionary policy instead of simply permitting​ long-run adjustments to take​ place? A. The​ Fed's policy can shorten the adjustment period. B. The​ Fed's policy can reduce unemployment sooner. C. The​ Fed's policy can move the economy to​ long-run equilibrium sooner. D. All of the above.

D. All of the above.

An increase in the money supply will A. not change the​ long-run aggregate supply curve but ultimately will only raise the price level in​ long-run equilibrium price level. B. move the equilibrium point along the​ short-run aggregate supply curve. C. shift the aggregate demand curve outward and to the right. D. All of the above.

D. All of the above. Each of these occur as a result of an increase in the money supply.

A credit card is not considered money because A. it simply defers rather than completes transactions that ultimately involve the use of money. B. it is not a store of value. C.it is not a unit of accounting. D. All of the above.

D. All of the above. The use of a credit card initiates a new loan and creates a new debt. It does not decrease​ one's debt. The card itself is not​ exchanged, therefore credit cards are not a medium of exchange.​ Finally, a credit card is a piece of plastic that facilitates the loan​ process, it is not an asset. It has no possibility of increasing in value.

An example of a fiduciary monetary system is A. gold coins. B. paper money that can be converted into gold at a fixed price. C. silver coins. D. American​ one-dollar bills.

D. American​ one-dollar bills.

Which of the following best represents the equation of​ exchange? A. M x P ​= V x Y B. M x Y x V​ = P C. M x Y ​= P x V D. M x V ​= P x Y

D. M x V ​= P x Y

Which of the following economic theories is most likely to support active​ policymaking? A. Monetarism. B. New classical model. C. Real business cycle theory. D. New Keynesian model.

D. New Keynesian model. Due to this​ theory's belief of sticky wages and prices.

Suppose that​ currently, the economy is overutilizing its resources. Which of the following correctly describes what type of monetary policy the Fed might choose and how the policy would change the​ economy? A. The Fed could use a contractionary monetary policy to reduce short minus run aggregate supply and GDP. B. The Fed could use an expansionary monetary policy to increase aggregate demand and GDP. C. The Fed could use an expansionary monetary policy to increase short minus run aggregate supply and GDP. D. The Fed could use a contractionary monetary policy to reduce aggregate demand and GDP.

D. The Fed could use a contractionary monetary policy to reduce aggregate demand and GDP.

If you live in​ Atlanta, Georgia, and you purchase a computer in Los​ Angeles, California, while there on​ vacation, which of the following paths would your check take before it finally​ clears? A. The check goes into the computer​ store's bank and is then sent to your bank directly. B. The check goes from the computer​ store's bank to the Federal Reserve bank in San​ Francisco, and then directly to your bank. C. The check goes from the computer​ store's bank right to the Atlanta Federal Reserve and then back to your bank. D. The check goes from the computer​ store's bank to the Federal Reserve bank in San​ Francisco, then to the Federal Reserve bank in​ Atlanta, and then to your bank.

D. The check goes from the computer​ store's bank to the Federal Reserve bank in San​ Francisco, then to the Federal Reserve bank in​ Atlanta, and then to your bank.

Which of the following statements is true when considering​ liquidity? A. Stocks have no transaction fees. B. Physical assets are the most liquid type of assets. C. Bonds have a guaranteed redemption value so there is no chance of a financial loss from their purchase. D. The most liquid assets typically earn no or little interest.

D. The most liquid assets typically earn no or little interest.

Which of the following statements is true concerning the potential money​ multiplier? A. The required reserve ratio and the potential money multiplier are positively related. B. The required reserve ratio and the potential money multiplier sum to one. C. The actual money multiplier and the potential money multiplier are inversely related. D. The required reserve ratio and the potential money multiplier are inversely related.

D. The required reserve ratio and the potential money multiplier are inversely related.

Which of the following is NOT a reason the Fed alters the rate of growth of the money​ supply? A. To influence the amount of consumption B. To influence aggregate demand C. To influence the amount of investment D. To shift the demand for money curve

D. To shift the demand for money curve

you know more about your driving skills than your auto insurance company does. This is an example of A. financial intermediation B. moral hazard C. adverse selection D. asymmetric information

D. asymmetric information

The financial intermediary with liabilities of shares and checkable deposits and assets that include consumer debt and long term mortgage loans is a A. commercial bank. B. money market mutual fund. C. insurance company. D. credit union.

D. credit union. These are the liabilities and assets of a credit union.

Suppose the dollar value of imports to the U.S. exceed the dollar value of exports from the US. This implies that A. U.S. citizens and firms have a surplus of foreign currency. B. foreigners have a shortage of dollars. C. U.S. government spending must increase further. D. foreigners are holding an excess supply of dollars.

D. foreigners are holding an excess supply of dollars. Since foreigners have not spent all the dollars they received from their exports on US goods and services they are holding an excess supply of dollars.

Contractionary monetary policy causes the A. amount of government spending to increase. B. price level to increase. C. dollar value of real GDP to increase. D. interest rate to increase.

D. interest rate to increase.

If the U.S. federal government operates with a budget deficit it must borrow. In order to entice people to lend money to finance this​ deficit, the U.S. government must A. increase the money supply. B. decrease taxes. C. retire previous debt first. D. pay a higher rate of interest on the bonds it sells.

D. pay a higher rate of interest on the bonds it sells. A higher interest rate or yield makes the purchase of Treasuries more competitive relative to other assets.

The Fed acts like a private banking institution when it A. supplies the economy with fiduciary currency. B. acts as the​ "lender of last​ resort." C. regulates the money supply. D. provides payment minus clearing services to depository institutions.

D. provides payment minus clearing services to depository institutions.

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 A. lower the interest​ rate, increase the inflows of international​ capital, increase the value of the​ dollar, decrease​ imports, and as a consequence real GDP will decline even further. B. raise the interest​ rate, decrease the inflows of international​ capital, decrease the value of the​ dollar, increase​ exports, and as a consequence real GDP will increase. C. lower the interest​ rate, increase the inflows of international​ capital, decrease the value of the​ dollar, decrease​ imports, and as a consequence real GDP will increase. D. 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.

D. 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. 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.

Contractionary monetary policy by the Fed can be hampered by A. international banking restrictions regulated by the International Monetary Fund. B. the increased isolation of central banks around the world. C. the inability of U.S. citizens to hold U.S. bank accounts denominated in foreign currencies. D. the ability of U.S. citizens and businesses to obtain dollars from foreign sources.

D. the ability of U.S. citizens and businesses to obtain dollars from foreign sources. If U.S. citizens can obtain dollars from alternative sources when the Fed is trying to restrict the number of​ dollars, this ability of citizens and businesses weakens the impact of the contractionary policy.

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 A. the asset demand for money because you used money for both purchases. B. the transaction demand for money because you paid for the gift with cash. C. your supply of money to the economy. D. 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.

D. 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. Transaction demand for money is used to make expected purchases. Precautionary demand for money is used for emergencies and unexpected purchases.

The Federal​ Reserve's credit policy refers to A. a direct credit on bank​ depositors' saving and checking accounts. B. the​ Fed's direct lending to homeowners and students. C. regulations on terms on credit cards that banks issue. D. the​ Fed's direct lending to financial and nonfinancial firms.

D. the​ Fed's direct lending to financial and nonfinancial firms.

The disadvantage of holding money balances as an asset, of course, is the interest earnings forgone.

Each individual or business decides how much money to hold as an asset by looking at the opportunity cost of holding money. The higher the interest rate—which is the opportunity cost of holding money—the lower the money balances people will want to hold as assets. Conversely, the lower the interest rate offered on alternative assets, the higher the money balances people will want to hold as assets.

Quantitative easing

Federal Reserve open market purchases intended to generate an increase in bank reserves at a nearly zero interest rate.

Credit policy

Federal Reserve policymaking involving direct lending to financial and nonfinancial firms.

Depository Institutions

Financial institutions that accept deposits from savers and lend funds from those deposits out at interest.

___ unemployment arises because individuals take the time to search for the best job opportunities. Much unemployment is of this type, except when the economy is in a recession or a depression, when cyclical unemployment rises.

Frictional

___ unemployment and ___ unemployment both exist even when the economy is in long-run equilibrium—they are a natural consequence of costly information (the need to conduct a job search) and the existence of rigidities such as those noted above.

Frictional; structural

Noncontrollable expenditures

Government spending that changes automatically without action by Congress. Nondiscretionary expenditures unrelated to national defense that automatically change without any direct action by Congress.

Net public debt

Gross public debt minus all government interagency borrowing.

Transactions demand

Holding money as a medium of exchange to make payments. The level varies directly with nominal GDP.

Asset demand

Holding money as a store of value instead of other assets such as corporate bonds and stocks. People choose to hold money rather than other assets for two reasons: its liquidity and the lack of risk.

Precautionary demand

Holding money to meet unplanned expenditures and emergencies. The higher the rate of interest, the lower the precautionary money balances people wish to hold.

The equation of exchange states that the total amount of funds spent on final output, Ms*V, is equal to the total amount of funds received for final output, P*Y. Thus, a given flow of funds can be viewed from either the buyers' side or the producers' side. The value of goods purchased is equal to the value of goods sold.

If Y represents real GDP and P is the price level, P*Y equals the dollar value of national output of goods and services or nominal GDP. Thus, Ms*V = P*Y equals nominal GDP

Dollar depreciation

If residents of foreign countries decide that they want to purchase fewer U.S. government securities or other U.S. assets, they will require fewer U.S. dollars with which to purchase these U.S. assets. As a consequence, the demand for dollars decreases in foreign exchange markets. The international price of the dollar therefore falls. This is called a depreciation of the dollar.

The Demand for Money Curve

If we use the interest rate as a proxy for the opportunity cost of holding money balances, the demand for money curve, Md, is downward sloping, similar to other demand curves.

Each definition of the money supply, M1 or M2, will yield a different actual money multiplier.

In most years, the actual Ml multiplier has been in a range between 1 and 3 . The actual M2 multiplier showed an upward trend until recently, rising from 6.5 in the 1960s to over 12 in the mid-2000s. Since then, however, it has dropped to about 4.

New Keynesian inflation dynamics

In new Keynesian theory, the pattern of inflation exhibited by an economy with growing aggregate demand—initial sluggish adjustment of the price level in response to increased aggregate demand followed by higher inflation later. Consequently, an economy with growing aggregate demand should exhibit so-called new Keynesian inflation dynamics: initial sluggish adjustment of the price level in response to aggregate demand increases followed by higher inflation later on.

Reserves

In the U.S. Federal Reserve System, deposits held by Federal Reserve district banks for depository institutions, plus depository institutions' vault cash.

The fact that long-run equilibrium real GDP is unaffected in the face of increased government deficits has an important implication:

In the long run, higher government budget deficits have no effect on equilibrium real GDP per year. Ultimately, therefore, government spending in excess of government receipts simply redistributes a larger share of real GDP per year to government-provided goods and services.

M2

M1 plus (1) savings deposits at all depository institutions, (2) small-denomination time deposits, and (3) balances in retail money market mutual funds.

Money market mutual fund balances

Many individuals keep part of their assets in the form of shares in money market mutual funds- highly liquid funds that investment companies obtain from the public. All money market mutual fund balances except those held by large institutions (which typically use them more like large time deposits) are included in M2 because they are very liquid.

Ms*V = P*Y

Ms = actual money balances held by the non-banking public V = income velocity of money, which is the number of times, on average per year, each monetary unit is spent on final goods and services P = price level or price index Y = real GDP per year

Suppose that initially the money supply is ​$3 ​trillion, the income velocity of money is 5​, the price level equals 3​, and real GDP is ​$5 trillion in​ base-year dollars. Then suppose that the quantity of money in circulation remain fixed but the income velocity of money doubles. If real GDP remains at its​ long-run potential​ level, calculate the equilibrium price level.

Ms*V = P*Y 3 * 5 = 3 * 5 3 * 10 = P * 5 P = 6

Both the traditional Keynesian theory and the new Keynesian theory indicate that the​ short-run aggregate supply curve is horizontal. a. In terms of their ​short-run implications for the price level and real​ GDP, is there any difference between the two​ approaches? No b. In terms of their ​long-run implications for the price level and real​ GDP, is there any difference between the two​ approaches? Yes

No; Yes

There are two determinants of the size of this ratio.

One is the quantity of reserves that the Federal Reserve requires banks to hold, which are called required reserves. The other determinant of the reserve ratio is whatever additional amount of reserves that banks voluntarily hold, known as excess reserves.

Most nations, including the United States, have a banking system that encompasses two types of institutions.

One type consists of privately owned profit-seeking institutions, such as commercial banks and thrift institutions. The other type of institution is a central bank.

The Fed conducts monetary policy.

Perhaps the Fed's most important task is to regulate the nations money supply. To understand how the Fed manages the money supply, we must examine more closely its reserve-holding function and the way in which depository institutions aid in expansion and contraction of the money supply.

Passive (nondiscretionary) policymaking

Policymaking that is carried out in response to a rule. It is therefore not in response to an actual or potential change in overall economic activity.

The difference between real and monetary shocks

Some economists argue that real, as opposed to purely monetary, forces might help explain aggregate economic fluctuations. These shocks may take any of the following forms: . Technological advances that improve productivity . Changes in the composition of the labor force . Changes in prices of and availability of a key resource, such as oil and other key factors used in producing energy

Indirect Effect of an Increase in the Money Supply

Some people may wish to deposit a portion or all of those excess money balances in banks. Banks, however, cannot induce people to borrow more funds than they were borrowing before unless the banks lower the interest rate that they charge on loans. This lower interest rate encourages people to take out those loans. Businesses will therefore engage in new investment with the funds loaned. Individuals will engage in more consumption of durable goods such as housing, autos, and home entertainment centers. In both ways, the increased loans generate a rise in aggregate demand.

Money balances

Synonymous with money, money stock, money holdings.

The Federal Reserve performs several functions:

The Fed supplies the economy with fiduciary currency. The Fed holds depository institutions' reserves and pays interest on these reserves. The Fed acts as the government's fiscal agent. The Fed supervises depository institutions. The Fed conducts monetary policy. The Fed intervenes in foreign currency markets. The Fed acts as the "lender of last resort. " As lender of last resort.

Money supply

The amount of money in circulation.

How do increased government budget deficits affect the economy in the short run?

The answer depends on the initial state of the economy. When there is a recessionary gap, the increase in aggregate demand can eliminate the recessionary gap and push the economy toward its full-employment real GDP level. In the presence of a short-run recessionary gap, therefore, government deficit spending can influence both real GDP and employment. If the economy is at the full-employment level of real GDP, however, increased total planned expenditures and higher aggregate demand generated by a larger government budget deficit create an inflationary gap. Although greater deficit spending temporarily raises equilibrium real GDP above the full-employment level, the price level also increases.

Policy irrelevance proposition

The conclusion that policy actions have no real effects in the short run if the policy actions are anticipated and none in the long run even if the policy actions are unanticipated. Under the assumption of rational expectations on the part of decision makers in the economy, anticipated monetary policy cannot alter either the rate of unemployment or the level of real GDP Regardless of the nature of the anticipated policy, the unemployment rate will equal the natural rate, and real GDP will be determined solely by the economy long-run aggregate supply curve.

liquidity

The degree to which an asset can be acquired or disposed of without much danger of any intervening loss in nominal value and with small transaction costs. Money is the most liquid asset. We say that an asset is liquid when it can easily be acquired or disposed of without high transaction costs and with relative certainty as to its value.

Equation of exchange

The formula indicating that the number of monetary units (Ills) times the number of times each unit is spent on final goods and services (V) is identical to the price level (P) times real GDP (Y).

Quantity theory of money and prices

The hypothesis that changes in the money supply lead to equiproportional changes in the price level.

Federal funds rate

The interest rate that depository institutions pay to borrow reserves in the interbank federal funds market.

Discount rate

The interest rate that the Federal Reserve charges for reserves that it lends to depository institutions. It is sometimes referred to as the rediscount rate or, in Canada and England, as the bank rate.

M1

The money supply, measured as the total value of currency plus transactions deposits plus traveler's checks not issued by banks.

Income velocity of money (V)

The number of times per year a dollar is spent on final goods and services; identically equal to nominal GDP divided by the money supply.

Money traditionally has four functions.

The one that most people are familiar with is money's function as a medium of exchange. Money also serves as a unit of accounting, a store of value or purchasing power, and a standard of deferred payment. Anything that could serve these four functions could be considered money.

Moral hazard

The possibility that a borrower might engage in riskier behavior after a loan has been obtained.

Relationship between the Price of Existing Bonds and the Rate of Interest

The price of existing bonds and the rate of interest are inversely related. The market price of existing bonds (and all fixed income assets) is inversely related to the rate of interest prevailing in the economy.

Natural rate of unemployment

The rate of unemployment that is estimated to prevail in long-run macroeconomic equilibrium, when all workers and employers have fully adjusted to any changes in the economy.

Direct Effect of an Increase in the Money Supply

The simplest thing that people can do when they have excess money balances is to go out and spend them on goods and services. Here they have a direct impact on aggregate demand. Aggregate demand rises because with an increase in the money supply, at any given price level people now want to purchase more output of real goods and services.

Adverse selection

The tendency for high-risk projects and clients to be over-represented among borrowers.

Public debt

The total value of all outstanding federal government securities.

Real GDP per year tends to return to the level implied by the long-run aggregate supply curve (LRAS).

Thus, whatever rate of unemployment the economy tends to return to in long-run equilibrium can be called the natural rate of unemployment.

In a​ bank's balance​ sheet, total assets equals total liabilities and net worth. In this​ case, we know how to calculate the​ bank's total assets. A bank has ​$269 million in total​ reserves, of which ​$10 million are excess reserves. The bank currently has ​$3.548 billion in​ loans, ​$1.081 billion in​ securities, and ​$141 million in other assets. The required reserve ratio for transactions deposits is 10 percent.

Total assets equals Total reserves + Loans + Securities + Other assets

Savings deposits

Total savings deposits—deposits with no set maturities—are the largest component of the M2 money supply.

Example of Equation of exchange formula: Consider a numerical example involving the entire economy. Assume that in this economy, the total money supply, M, is $15 trillion; real GDP, Y, is $20 trillion (in base year dollars); and the price level, F, is 1.5 (150 in index number terms).

Using the equation of exchange, Ms*V = P*Y $15 trillion X V = 1.5 x $20 trillion $15 trillion X V = $30 trillion v = 2.0 Thus, each dollar is spent an average of 2 times per year.

Income velocity of money (V) formula

V = (P*Y) / Ms

Suppose that the market rate of interest is 5 percent and at this interest rate you have decided to hold half of your financial wealth as bonds and half as holdings of​ non-interest bearing money. You notice that the market interest rate is starting to​ rise, however, and you become convinced that it will ultimately rise to 10 percent.

a. As the interest rate​ rises, the value of your bond holdings will decline. b. If you wish to prevent the value of your financial wealth from declining in the​ future, you will hold less bonds and more money.

Suppose that the government altered the computation of the unemployment rate by including people in the military as part of the labor force. a. How would this affect the actual unemployment​ rate? b. How would such a change affect estimates of the natural rate of​ unemployment? c. If this computational change were​ made, would it in any way affect the logic of the​ short-run and​ long-run Phillips curve analysis and its implications for​ policymaking? A. Yes B. No

a. decrease b. decrease c. B. No

According to the transactions approach to measuring money, the money supply consists of...

currency, transactions deposits, and traveler's checks not issued by banks.

Deviations of the actual unemployment rate from the natural rate are called ___ ___ because they are observed over the course of nationwide business fluctuations.

cyclical unemployment

Price of a bond Example: A bond sells for​ $1,000 and will pay ​$94 a year forever. The Fed changes its policy and the interest rate changes to 11 percent. The price of the perpetual bond is found by using the following​ relationship:

equals periodic return / interest rate Price of bond = 94 / 0.11 = $854.5

Recall that there are different types of unemployment:

frictional, cyclical, structural, and seasonal.

When the FED purchases bonds on the open market it will result in an ___ in the money supply. If it sells bonds on the open market, it will result in a ___ in the money supply. A purchase of bonds means the FED buys a government treasury bond from one of its primary dealers.

increase; decrease

Another way of describing money as a unit of accounting

is to say that it serves as a standard of value that allows people to compare the relative worth of various goods and services.

The U.S. currency is a ___ of the Federal Reserve System.

liability

Money is the most ___ asset.

liquid

According to the ___ ___, sticky prices strengthen the argument favoring active policymaking as a means of preventing substantial short-run swings in real GDP and, as a consequence, employment.

new Keynesians

When the Fed takes actions that alter the rate of growth of the money supply, it is seeking to influence investment, consumption, and total aggregate expenditures. In taking these monetary policy actions, the Fed in principle has four tools at its disposal:

open market operations, changes in the reserve ratio, changes in the interest rates paid on reserves, and discount rate changes.

Money is an asset—something of value—that accounts for part of personal wealth. Wealth in the form of money can be exchanged for ___ ___, ___, or ___.

other assets, goods, or services

During recessions, the overall unemployment rate exceeds the natural rate, so cyclical unemployment is ___.

positive

Increases in oil supplies, cuts in marginal tax rates, and deregulation during the 1980s and 1990s helped to prevent ___ episodes from occurring after the early 1980S.

stagflation

However, the U.S. experience shows that there is no clear relationship between the unemployment rate and the inflation rate. Since the 1950s data indicate that changes in the inflation rate have not altered the unemployment rate.​ Thus, empirical data provide evidence that the long run Phillips Curve is ___.

vertical The Phillips curve becomes vertical since there is no change in the unemployment rate in the​ long-run as inflation rate changes.

Central bank

A banker's bank, usually an official institution that also serves as a bank for a nation's government treasury. Central banks normally regulate commercial banks.

Unit of accounting

A measure by which prices are expressed; the common denominator of the price system; a central property of money. A unit of accounting is a way of placing a specific price on economic goods and services.

Liquidity approach

A method of measuring the money supply by looking at money as a temporary store of value.

Money multiplier

A number that, when multiplied by a change in reserves in the banking system, yields the resulting change in the money supply.

Standard of deferred payment

A property of an item that makes it desirable for use as a means of settling debts maturing in the future; an essential property of money.

Balanced budget

A situation in which the government's spending is exactly equal to the total taxes and other revenues it collects during a given period of time.

Balance sheet

A statement of the assets and liabilities of any business entity, including financial institutions and the Federal Reserve System. Assets are what is owned; liabilities are what is owed.

Fractional reserve banking

A system in which depository institutions hold reserves that are less than the amount of total deposits.

Fiduciary monetary system

A system in which money is issued by the government and its value is based uniquely on the public's faith that the currency represents command over goods and services and will be accepted in payment for debts.

The U.S. federal government has contemplated ways to reduce its national debt. Which of the following suggestions would best enable the government to achieve this​ goal? A. Reduce government​ spending, raise​ taxes, or both. B. Decrease the amount of government borrowing during the year. C. Increase the money supply or print money to pay these obligations. D. Double the marginal tax rates on wealthy households.

A. Reduce government​ spending, raise​ taxes, or both.

Which of the following statements is true regarding the national debt and federal government​ deficits? A. There is a positive relationship between the national debt and a federal government budget deficit. B. There is a positive relationship between the amount of borrowing and a federal government surplus. C. There is a positive relationship between the national debt and a federal government budget surplus. D. There is a positive relationship between the federal government budget surplus and a federal government budget deficit.

A. There is a positive relationship between the national debt and a federal government budget deficit.

A trade deficit implies that A. the number of items exported is larger than the number of items imported. B. the dollar value of exports exceeds the dollar value of imports. C. the dollar value of imports exceeds the dollar value of exports. Your answer is correct.D. the number of items imported is larger than the number of items exported. Generally a larger US trade deficit is accompanied by a A. a larger US federal government budget deficit. B. decreased borrowing by the US government. C. a smaller US national debt. D. a smaller US federal government budget deficit.

A. a larger US federal government budget deficit.

During the​ 1945-1946 Hungarian​ hyperinflation, when the rate of inflation reached 41.9 quadrillion percent per​ month, the Hungarian government discovered that the real value of its tax receipts was falling dramatically. To keep real tax revenues more​ stable, it created a good called a​ "tax pengö", in which all bank deposits were denominated for purposes of taxation. ​Nevertheless, payments for goods and services were made only in terms of the regular Hungarian​ currency, whose value tended to fall rapidly even though the value of a tax​ pengö remained stable. Prices were also quoted only in terms of the regular currency.​ Lenders, however, began denominating loan payments in terms of tax​ pengös. The tax​ pengö functioned as money in Hungary in 1945 and 1946 A. as a store of value. B. as a medium of exchange. C. As a unit of accounting. D. as a barter exchange.

A. as a store of value.

If the federal government has a budget deficit it can finance its spending by A. selling Treasury bonds. B. selling municipal bonds. C. selling corporate bonds. D. All the above.

A. selling Treasury bonds.

Entitlements in the U.S. are A. ​non-discretionary expenditures that have been legislated by Congress. B. a small fraction of the total amount of government expenditures. C. rights individuals possess that allow them the freedom to choose what they can purchase. D. payments that every citizen in the U.S. is entitled to receive.

A. ​non-discretionary expenditures that have been legislated by Congress. Sometimes this is referred to as mandatory spending.

Government budget deficit

An excess of government spending over government revenues during a given period of time. A government budget deficit exists if the government spends more than it receives in taxes during a given period of time.

Financial Intermediary: Government-sponsored financial institutions

Assets: Home mortgages Liabilities: Mortgage-backed securities issued to investors

Financial Intermediary: Insurance companies

Assets: Mortgages, stocks, bonds, real estate Liabilities: Insurance contracts, annuities, pension plans

Until​ 1946, residents of the island of Yap used large​ doughnut-shaped stones as financial assets. Although prices of goods and services were not quoted in terms of the​ stones, the stones were often used in exchange for particularly large​ purchases, such as payments for livestock. To make the​ transaction, several individuals would place a large stick through a​ stone's center and carry it to its new owner. A stone was difficult for any one person to​ steal, so an owner typically would lean it against the side of his or her home as a sign to others of accumulated purchasing power that would hold value for later use in exchange. Loans would often be repaid using the stones. These stones performed the following functions of money LOADING...​: A. medium of​ exchange, unit of​ accounting, and standard of deferred payment functions of money. B. medium of​ exchange, store of​ value, and standard of deferred payment functions of money. C. medium of​ exchange, unit of​ accounting, and store of value functions of money. D. unit of​ accounting, store of​ value, and standard of deferred payment functions of money.

B. medium of​ exchange, store of​ value, and standard of deferred payment functions of money.

The opportunity cost of money holdings is A. the reduction in purchasing power brought on by deflation. B. the alternative interest income foregone from not holding some other asset. C. the liquidity foregone from not holding some other asset. D. All of the above.

B. the alternative interest income foregone from not holding some other asset. The opportunity cost of holding money is the lost interest that could have been earned if an interest bearing asset were held instead of money.

When considering the gross public​ debt, one can argue that it is overstated because A. the gross public debt is the​ pre-tax debt. B. the federal government owes itself money. C. it includes household debt too. D. the government borrows more than it needs as a precautionary measure.

B. the federal government owes itself money. Interagency borrowing inflates the debt. It is like your right hand owing your left hand​ $10.

Barter

Barter is simply a direct exchange of goods for goods. The direct exchange of goods and services for other goods and services without the use of money. For this to occur, there has to be a high likelihood of a double coincidence of wants for each specific item to be exchanged.

Which of the following assets is the least​ liquid? A. Currency. B. A share of publicly traded stock. C. A house. D. A​ three-month Treasury bill.

C. A house. A house is the least liquid since it takes a longer time to convert into​ money, and there are larger transaction costs in selling a house compared to the other listed assets.

Which of the following is a reason for this resurgence in federal government budget​ deficits? A. Larger tax revenue with low government spending. B. Lower government spending but even lower tax receipts. C. Tax revenue not keeping pace with growth in spending. D. Higher interest rates.

C. Tax revenue not keeping pace with growth in spending.

If foreigners have an excess supply of dollars after trading goods and services they will likely A. sell more U.S. Treasury bonds. B. be able to sell more goods and services to the U.S. C. buy more U.S. Treasury bonds. D. sell more foreign bonds.

C. buy more U.S. Treasury bonds. Since foreigners have not spent all the dollars they received from their exports on US goods and services they are holding an excess supply of dollars.

A trade deficit implies that A. the number of items exported is larger than the number of items imported. B. the dollar value of exports exceeds the dollar value of imports. C. the dollar value of imports exceeds the dollar value of exports. D. the number of items imported is larger than the number of items exported.

C. the dollar value of imports exceeds the dollar value of exports. The trade deficit is defined by the dollar value of imported goods and services exceeding the dollar value of exported goods and services.

The Fed was established by the ___ ___ ___, signed on December 13, 1913, by President Woodrow Wilson.

Federal Reserve Act

The largest component of U.S. currency is paper bills called ___ ___ ___.

Federal Reserve notes

Thrift institutions

Financial institutions that receive most of their funds from the savings of the public. They include savings banks, savings and loan associations, and credit unions.

Traveler's checks

Financial instruments obtained from a bank or a nonbanking organization and signed during purchase that can be used in payment upon a second signature by the purchaser.

Entitlements

Guaranteed benefits under a government program such as Social Security, Medicare, or Medicaid. Entitlements, which are legislated federal government payments that anyone who qualifies is entitled to receive, are now the most important component of the federal budget. Entitlements are consequently often called noncontrollable expenditures, or nondiscretionary expenditures.

Asymmetric information

Information possessed by one party in a financial transaction but not by the other party.

Financial intermediaries

Institutions that transfer funds between ultimate lenders (savers) and ultimate borrowers.

Examples

Insurance companies offer safe driver discounts to encourage insured individuals to drive safely. This is an attempt to limit moral hazard. Pension funds tend to combine the retirement funds of many future retirees to lower management costs. Savings banks review loan applications to determine which of the potential borrowers carry high risk of default. This is an attempt to limit adverse selection. A manager of a savings and loan association responds to reports of a likely increase in federal deposit insurance coverage. She directs loan officers to extend mortgage loans to less creditworthy borrowers. This situation poses a moral hazard problem. A loan applicant does not mention that a legal judgment in his divorce case will require him to make alimony payments to his​ ex-wife. This situation poses an adverse selection problem. An individual who was recently approved for a loan to start a new business decides to use some of the funds to take a Hawaiian vacation. This situation poses a moral hazard problem. Stockbrokers monitor the companies after investing funds in​ them, in order to limit moral hazard. Commercial banks screen their borrowers before a loan can be​ approved, in order to limit adverse selection. Money market mutual funds combine the savings of many​ individuals, in order to lower management costs. An individual with several children who has just learned that she has lung cancer applies for life insurance but fails to report this recent medical diagnosis. This situation poses an adverse selection problem. A corporation that recently obtained a loan from several banks to finance installation of a new computer network instead directs some of the funds to executive bonuses. This situation poses a moral hazard problem. A​ state-chartered financial institution exempt from laws requiring it to have federal deposit insurance decides to apply for deposit insurance after experiencing severe financial problems that may bankrupt the institution. This situation poses an adverse selection problem.

The Fed intervenes in foreign currency markets.

Sometimes the Fed attempts to keep the value of the dollar from changing. It does this by buying and selling U.S. dollars in foreign exchange markets.

The Fed holds depository institutions' reserves and pays interest on these reserves.

The 12 Federal Reserve district banks hold the reserves (other than vault cash) of depository institutions. Depository institutions are required by law to keep a certain percentage of their transactions deposits as reserves. Since 2008, the Federal Reserve has paid institutions interest on all reserves held at the Federal Reserve banks at a rate set by the Board of Governors.

The Fed supervises depository institutions.

The Fed, along with the Comptroller of the Currency, the Federal Deposit Insurance Corporation, and the National Credit Union Administration, is a supervisor and regulator of depository institutions.

The Fed

The Federal Reserve System; the central bank of the United States.

The Fed supplies the economy with fiduciary currency.

The Federal Reserve banks supply the economy with paper currency called Federal Reserve notes, which are printed at the Bureau of Engraving and Printing in Washington, D.C. Each of these notes is an obligation, liability, of the Federal Reserve System, not the U.S. Treasury.

The Fed acts as the government's fiscal agent.

The Federal Reserve is the primary banker and fiscal agent for the federal government. Consequently, the U.S. Treasury has a transactions account with the Federal Reserve, which helps the government collect certain tax revenues and aids in the purchase and sale of government securities.

Lender of last resort

The Federal Reserve's role as an institution that is willing and able to lend to a temporarily illiquid bank that is otherwise in good financial condition to prevent the bank's illiquid position from leading to a general loss of confidence in that bank or in others.

Store of value

The ability to hold value over time; a necessary property of money. Money provides a way to transfer value (wealth) into the future.

Reserve ratio

The fraction of transactions deposits that banks hold as reserves.

Financial intermediation

The process by which financial institutions accept savings from businesses, households, and governments and lend the savings to other businesses, households, and governments. Banks and other financial institutions are all in the same business—transferring funds from savers to investors.

Open market operations

The purchase and sale of existing U.S. government securities, such as bonds, in the open private market by the Federal Reserve System.

Potential money multiplier

The reciprocal of the reserve ratio, assuming no leakages into currency. It is equal to 1 divided by the reserve ratio.

MZM aggregate

The so-called money-at-zero-maturity money stock. Obtaining MZM entails adding to M1 those deposits without set maturities, such as savings deposits, that are included in M2. MZM includes all money market funds but excludes all deposits with fixed maturities, such as small denomination time deposits.

Small-denomination time deposits

With a time deposit, the funds must be left in a financial institution for a given period before they can be withdrawn without penalty. To be included in the M2 definition of the money supply, time deposits must be less than $100,000—hence, the designation small-denomination time deposits.

Fiduciary

comes from the Latin fiducia, which means "trust" or "confidence."

S&Ls

savings and loan associations