Ch. 36 Interest Rates and Monetary Policy

John Taylor's rule of thumb builds on the belief that in order to help the economy to produce at potential output, central banks are willing to tolerate

positive rates of inflation

The ______ interest rate and the Federal funds rate closely track one another.

prime

Because it works more subtly, what policy is more desirable?

monetary

What has become the dominant component of U.S. national stabilization policy?

monetary policy

What was the problem that the Fed faced when attempting to increase the federal funds rate after the mortgage crisis?

non-bank-to-bank lending

Once the Fed acts, an _________ lag of 3 to 6 months affects monetary policy because that much time is required for interest rate changes to have their full impacts on investment, aggregate demand, real GDP, and the price level.

operation

The benchmark interest rate used by banks as a reference point for a wide range of interest rates charged on loans to businesses and individuals is called what?

prime interest rate

The amount of investment that will be forthcoming in this economy at equilibrium is

$500

Which of the following are lags facing fiscal policy?

- administrative lag - operational lag - recognition lag

What are the consequences of a negative interest rate?

- banks would have less money to loan - balances left in the bank will shrink over time - people would not want to leave their money in their checking accounts.

Which of the following are functions of restrictive monetary policy?

- curtail the expansion of aggregate demand - increase the interest rate

Which of the following are tools of monetary control that the Fed can use to alter the reserves of commercial banks?

- discount rate - interest on reserves - reserve ratio - open-market operations

Critics of the Fed's actions during the financial crisis and severe recession argue that:

- interest rates were held too low - the Fed contributed to the borrowing frenzy

Which of the following actions did the Fed take in response to the mortgage debt crisis?

- lowered the federal funds rates. - lowered the discount rate.

Which of the following actions reduce the money supply in an economy?

- lowering check-able deposits - increasing the required reserves

Restrictive monetary policy is expected to:

- reduce aggregate demand - decrease the money supply - decrease borrowing in the economy - lower inflation

Why did the Fed implement a zero interest rate policy (ZIRP) in 2008?

- stimulate the economy - keep interest rates near zero

Which of the following are directly controlled by the Fed in an economy?

- the money supply - interest rates

Which actions did the Fed plan in order to engage in restrictive monetary policy after the mortgage crisis?

- use reverse repos - increase the interest paid on reserves at the Fed

In order to fully control the federal funds rate, what actions did the Fed take?

- use reverse repos with non-banks - increase interest paid on reserves

The Taylor rule assumes that the Fed is willing to tolerate a "target rate of inflation" at what level?

2%

As a result of a lower federal funds rate, what was the lowest prime interest rate level between October 2008 and September 2009?

3.25%

As a result of a lack of demand for excess reserves and a large increase in the supply of reserves during the financial crisis led to:

A federal funds rate near zero

By lowering the interest rate to bolster borrowing and spending to increase aggregate demand, the Fed is instituting which type of monetary policy?

Expansionary

True or False: The Fed has official allegiance to the Taylor Rule.

False

The FOMC directs the Federal Reserve Bank of ______ to undertake the necessary open-market operations to achieve and maintain the targeted Federal funds rate.

New York

________ _______ increased the reserves of the banking system while keeping interest rates at the same level.

Quantitative easing

_______ and reserves repos are additional tools for the Fed to alter the money supply.

Repos

Who meets regularly to choose a desired Federal funds rate?

The FOMC

Monetary policy faces a recognition lag and an operational lag, but avoids the _________ lag that hinders fiscal policy.

adminstrative

When implementing expansionary monetary policy, the Fed will _____ gov. securities.

buy

The Federal Reserve mandates banks to deposit a certain percentage of their ________ as required reserves at their regional Federal Reserve Bank.

checking account deposits

Securities are mainly bought and sold to influence the ability of _________ to create money by lending.

commercial banks

Lowering the reserve ratio enhances the ability of banks to:

create new money

Economist say that monetary policy may suffer from ______ asymmetry.

cyclical

Suppose the Federal Reserve Banks sell $2 billion of government bonds to the public, which pays for them by drawing checks. As a result, commercial bank reserves will:

decrease by $2 billion

The numbers in parentheses after the AD1, AD2, and AD3 labels indicate the levels of investment spending associated with each curve. All figures are in billions, if aggregate demand is AD3 and the monetary authorities desire to reduce it to AD2, they should

decrease the money supply from $120 to $100

To the extent that people want to hold money as an asset, there is an asset ________ for money.

demand

The interest rate that Federal Reserve Banks charge on loans they grant to commercial banks is called the:

discount rate

Combining the demand for money and the supply of money determines the ____ rate of interest.

equilibrium

The intersection of demand and supply determines the ____________ price for money.

equilibrium

Businesses can frustrate the intentions of the Fed by not borrowing ________ reserves.

excess

The federal funds rate is the rate of interest that banks charge one another on overnight loans made from what?

excess reserves

After 2008 the Fed introduced quantitative easing in an attempt to increase banks' _______ reserves thereby stimulating _________ demand.

excess; aggregate

When a bank's total reserves increases, it will find that it has _______ reserves, and will want to loan them out as soon as possible. But in the meantime, it will supply these funds overnight in the Federal ________ market.

excess; funds

With an __________ monetary policy, the Fed can create excess reserves but cannot guarantee that the banks will actually make additional loans and thus increase the supply of money.

expansionary

True or False: After the crisis, there was a large increase in bank-to-bank lending.

false

Banks find it beneficial to loan their excess reserves to other banks because they can earn interest on the loan equivalent to the _________ funds rate.

federal

The Fed will use open-market operations to buy bonds from banks and the public in order to lower the ______ rate.

federal funds

The money being lent and borrowed overnight are called "_________" because they are reserves that are required by the Fed to meet reserve requirements.

federal funds

The Federal Reserve focuses monetary policy on the interest rate that it can directly influence, called the:

federal funds rate

Greater reserves in the banking system cause the ______ funds rate to fall and the _______ supply to increase.

federal; money

Monetary policy is a subtler and more politically neutral measure than _______ policy.

fiscal

The Federal Reserve targets the _______ rate by manipulating the supply of reserves that are offered in the Federal market.

funds

There is a ________ relationship between the amount of money demanded as an asset and the rate of interest.

inverse

A severe recession may so undermine business confidence that the investment demand curve shifts to the ______ and frustrates __________ monetary policy.

left; expansionary

The efforts of the Fed will be pointless if commercial banks seek liquidity and are unwilling to:

lend

If pursued vigorously, a restrictive monetary policy could deplete commercial banking reserves to the point where banks would be forced to reduce the volume of _____

lending

The purchase of securities from the public increase the __________ ability of the commercial banking system.

lending

What was one of the primary reasons fiscal policy was used during the financial crisis and severe recession?

liquidity trap

The Fed can buy or sell securities from day to day and thus affect the ______ supply and _______ rates almost immediately.

money; interest

With a zero lower bound problem, the Fed risked ________ interest rates if the Fed continued to stimulate the economy.

negative

Which one of the Fed's instruments of monetary control is most important?

open-market operations

Purchasing U.S. gov. securities, debt issued by the U.S. gov. agencies, or government-based corporations are part of:

quantitative easing

One of the rules the FOMC follows when setting it's target for the Federal funds rate is that for each 1% increase of real GDP above potential GDP, the Fed should _______ the real Federal funds rate by 1/2 percentage point.

raise

In response to the 2008 mortgage debt crisis, the Fed started setting a target _____ for the federal funds rate instead of a target ______.

range; value

The rules of the FOMC are reversed for situations in which ______ GDP falls below ________ GDP or inflation falls below 2%.

real; potential

The desire to hold money for transactions purposes arises because

receipts of income and expenditures are not perfectly synchronized

What kinds of actions are part of open market operations?

the Fed buys and sells government bonds.

Because the prime interest rate involves longer, more risky loans than overnight loans between banks, which of the following is true?

the prime interest rate is higher than the Federal funds rate.

True or False: As a result of the Federal funds being near zero, the Fed had to adjust the way that they conducted monetary policy.

true

True or False: When the Fed buys securities from the public, people may choose to pay off existing loans with the money received, rather than increasing their spending on goods and services.

true

Why did the Fed implement quantitative easing?

zero bound problem

What is it called when the central bank is constrained in stimulating the economy because interest rates could drop below zero?

zero lower bound problem

For each 1% increase in the ________ rate about its 2% target rate, the Fed should raise the real Federal funds rate by .5%

inflation

One of the rules the FOMC follows is that when real GDP equals potential GDP and _______ is at 2%, the Federal funds target rate should be at 4%.

inflation

The members of the FOMC assess whether the current Federal funds rate remains appropriate for achieving low _________ and full __________.

inflaton; employment

One of the more recent tools for the Fed to alter the money supply is paying ________ on excess reserves held at the Fed.

interest

The rules of the FOMC are applied independently of each other so that if necessary, the Fed will apply all rules and raise real _______ rates in response to all factors.

interest

What is the name of the price that borrowers need to pay lenders for transferring purchasing power to the future?

interest

The Fed will initiate expansionary monetary policy when faced with

recession and unemployment

Assume that the legal reserve ratio is 20 percent. Suppose that the FED sells $500 of government securities to commercial banks and buys $500 of securities from individuals, who deposit the cash in checking accounts. As a result of the above transactions, reserves in the banking system will: A) remain unchanged. B) rise by $100. C) fall by $100. D) rise by $1000.

remain unchanged

The Fed can manipulate the __________ in order to directly influence the ability of commercial banks to lend.

reserve ratio

The Fed cannot be certain of achieving it's goal when it adds what to the banking system?

reserves

After the mortgage crisis, what did the Fed use to soak up money that the non-banks were lending to banks in the federal funds market?

reverse repos