Chapter 15 - Quiz 4
Suppose you buy a house for $200,000. One year later, the market price of the house has risen to $210,000. If you made a down payment of 20 percent and took out a mortgage loan for the other 80 percent, the return on your investment in the house is If you made a down payment of 10 percent and borrowed the other 90 percent, the return on your investment in the house is
25% 50%
Based on the Taylor Rule use the following information to calculate the target federal funds rate Variable Value Target inflation rate 2 % Current inflation rate 3 % Real equilibrium federal funds rate 2 % Output gap 5 % In this case, the Federal funds target rate is:
8.0 % Inflation gap = 3 - 2 = 1 =3 + 2 + (.5 x 1) + (.5 x 5) = 8.0
Output Gap
= % Real GDP - Potential GDP
Inflation Gap
= Current Inflation - Target Rate
Federal funds target rate
= Current inflation rate + Real equilibrium federal funds rate + ((Weight for inflation gap)×Inflation gap) + ((Weight for output gap)×Output gap)
When the Federal Reserve increases the required reserve ratio as a part of a contractionary monetary policy, there is:
A decrease in the money supply and an increase in the interest rate.
Suppose the economy is initially in long-run equilibrium. The Fed enacts a policy to decrease the required reserve ratio. In the short-run, this expansionary monetary policy will cause:
A shift from AD 1 to AD 2 and a movement to point B, with a higher price level and higher output.
Suppose the economy is initially in long-run equilibrium. The Fed decides to increase the required reserve ratio. In the short-run, this contractionary monetary policy will cause:
A shift from AD 2 to AD 1 and a movement to point D, with a lower price level and lower output.
If the Fed's policy is successful, what is the effect on the following indicators?
Actual real GDP: increases Potential real GDP: does not change Price level: increases Unemployment: decreases
Stock prices rose rapidly in 2005, as did housing prices in many parts of the country. By 2008, both stock prices and housing prices were declining sharply. Some economists have argued that rapid increases and decreases in the prices of assets such as shares of stock or houses can damage the economy. Currently, stabilizing asset prices is not one of the Federal Reserve's policy goals. In what ways would a goal of stabilizing asset prices be different from the four goals listed in this chapter?
Asset prices deal with a specific type of wealth that carries risk associated with individual firms.
Changes in interest rates affect aggregate demand. Which of the following is affected by changes in interest rates and, as a result, impacts aggregate demand? (Mark all that apply.)
Business investment projects The value of the dollar Consumption of durable goods
Given that the weight for the inflation gap is 1.30 and the weight for the output gap is 0.50, using the Taylor rule one can determine that if the output gap is less than ____ percent, the federal funds target rate becomes negative. (Enter your response rounded to two decimal places.) −0.80
Federal funds target rate =1+2+(1.30×(1−3)) +(0.50×g) = 3−(2×1.30)+0.50g. By rearranging, one can conclude that the federal funds target rate will be negative if 3+0.50g < (2×1.30) or g < (2 x 1.30) - 3 = -0.4 / 0.50 = -0.80
^Given that the weight for the inflation gap is 1.30 and the output gap is −3 percent, using Taylor rule one can determine that if the weight for the output gap exceeds ____ , the federal funds target rate becomes negative.(Enter your response rounded to two decimal places.) .13
Federal funds target rate equals=1+2+(1.30×(1−3))+(b×−3) =3−(2×1.30)−3b. By rearranging, one can conclude that the federal funds target rate will be negative if b >3−(2×1.30)= .4 / 3 = .13
Glenn Rudebusch, an economist at the Federal Reserve Bank of San Francisco, argues that if the Fed had followed the Taylor rule during the recession of 2007−2009, then by the end of 2009 the target for the federal funds rate would have been −5 percent. Suppose the current inflation rate is 1 percent, the target inflation rate is 3 percent, and the real equilibrium federal funds rate is 2 percent.
Given that the weight for the output gap is 0.50 and the output gap is −3 percent, using the Taylor rule one can calculate that if the weight for the inflation gap exceeds _____, the federal funds target rate becomes negative. (Enter your response rounded to two decimal places.) .75 Federal funds target rate = 1+2+(a×(1−3))+(0.50×−3) =3−2a−(0.50×3). The federal funds target rate will be negative if a>3−(0.50×3)= 1.5 / 2 =.75
The Fed changes the discount rate as a part of its policy to reach all of the following objectives except:
High unemployment.
The hypothetical information in the following table shows what the situation will be in 2017 if the Fed does not use monetary policy. Year Potential Real GDP Real GDP Price Level 2016 $17.7 trillion $17.7 trillion 110.0 2017 $18.1 trillion $18.3 trillion 115.5 If the Fed's policy is successful in keeping real GDP at its potential level in 2017, state whether each of the following will be higher, lower, or the same as it would have been if the Fed had taken no action:
If the Fed wants to keep real GDP at its potential level in 2017, it should use a *contractionary policy. The trading desk should be *selling T-bills. Real GDP will be *lower than it would have been if the Fed had taken no action. Full-employment real GDP will be *the same as it would have been if the Fed had taken no action. The inflation rate will be *lower than it would have been if the Fed had taken no action. The unemployment rate will be *higher than it would have been if the Fed had taken no action.
While serving as the president of the Federal Reserve Bank of St. Louis, William Poole stated, "Although my own preference is for zero inflation properly managed, I believe that a central bank consensus on some other numerical goal of reasonably low inflation is more important than the exact number." Which of the following are benefits that the economy might gain from an explicit inflation target even if the target chosen is not a zero rate of inflation?
Inflation targeting Conducting monetary policy so as to commit the central bank to achieving a publicly announced level of inflation. More accurate expectations of future inflation Improved accountability for the Fed Better communication between the Fed and the public
The Federal Reserve cannot affect the price level directly; therefore, the Fed typically uses the following as its policy target:
Interest rates.
Which of the following is not an issue with using active monetary policy to reduce business cycles?
Real GDP and employment changes from monetary policy actions can move in a countercyclical manner.
The country Murell is in the midst of a recession. Firms have cut back on investment and consumer spending has fallen. Larry Summers, a market analyst, is discussing the economy's grim prospects with his journalist friend Michael Philips. Larry says that the recent open market purchases by the central bank will have a positive impact on consumer demand. Michael does not agree. He thinks that monetary policy will not be very effective and that policy makers should instead focus on fiscal policy measures to boost the economy. Which of the following, if true, would strengthen Larry's argument?
The Consumer Confidence Index compiled by a leading investment bank in Murell is now at its highest level since the recession began.
Consider the following table: Year Potential GD PReal GDP Price Level 2012 $14.9 trillion $14.9 trillion 110 2013 $15.3 trillion $15.2 trillion 112 What can we expect from the Federal Reserve Bank if it seeks to move the economy in the direction of long-run macroeconomic equilibrium?
The Fed will pursue an expansionary monetary policy.
Which of the following is not a correct comparison between an expansionary monetary policy in the basic aggregate demand and aggregate supply model and in the dynamic aggregate demand and aggregate supply model?
The dynamic model assumes that potential GDP is constantly growing while the basic model assumes that it is static. If the economy is below full employment, expansionary monetary policy will cause an increase in the price level in both models. In the dynamic model, expansionary policy would be used when demand does not grow sufficiently; in the basic model, expansionary policy would be used when demand falls.
Suppose that the equilibrium real federal funds rate is 66 percent and the target rate of inflation is 33 percent. Use the following information and the Taylor rule to calculate the federal funds rate target: Current inflation rate = 4 percent Potential real GDP = $14.98 trillion Real GDP = $14.11 trillion
The federal funds target rate is 7.60%
The economy of country Rumblen was hit by a banking crisis which has led to a recession. Jason Wallace, a real estate agent, says that the economy will recover soon because the government is taking various measures to counter the recession. According to him, the flow of credit will soon return to pre-crisis levels. His wife Anna Wallace disagrees with him. She says that the situation may not improve soon, given the substantial increase in unemployment. Which of the following, if true, will weaken Anna's claim that the situation is not likely to improve in the short term?
The interest rate on discount loans issued by Rumblen's central bank was recently decreased.
Opportunity cost
The highest-valued alternative that must be given up to engage in an activity.
Stabilizing asset prices should not be added to the list of the Fed's policy goals because they are more specific and deal mainly with individuals and firms. Each of these carry risk associated with them and the Fed should not be in the business of trying to make profit for individuals.
True
A student says the following: "I understand why the Fed uses expansionary policy but I don't understand why it would ever use contractionary policy. Why would the government ever want the economy to contract?" The government would want the economy to contract when real GDP is
above potential GDP and the price level is rising.
If the Fed would no longer have a specific target for the money supply, it would be targeting the
federal funds rate.
short-term interest rate and expected that to be enough to meet its goals for inflation and unemployment" The short-term interest rate the article is referring to is the The Fed expects that controlling that one interest rate would allow it to meet its goals for inflation and unemployment because lower short-term interest rates The article also notes that after the financial crisis, "the Fed is working through a broader spectrum of interest rates." The reference to "a broader spectrum of interest rates" means that the Fed began to focus on
federal funds rate. encourage lending and stimulate economic activity. longer term Treasury rates and mortgage rates.
If the Federal Reserve purchases $170 million worth of U.S. Treasury bills from the public, the money supply will
increase
If the Fed is too slow to react to a recession and applies an expansionary monetary policy only after the economy begins to recover, then
inflation will be higher than if the Fed had not acted.
A countercyclical policy is one that
is used to attempt to stabilize the economy.
Why is the Fed sometimes said to have a "dual mandate"?
maintaining price stability and high employment are the two most important goals of the Fed that are explicitly mentioned in the Employment Act of 1946.
Suppose that when the Fed decreases the money supply, households and firms initially hold less money than they want to, relative to other financial assets. As a result, households and firms will _________ Treasury bills and other financial assets, thereby _________ their prices, and _________ their interest rates.
sell; decreasing; increasing
Which of these variables are the main monetary policy targets of the Fed?
the money supply and the interest rate
The Fed gave up targeting the money supply because
the relationship between monetary aggregates and other economic variables was becoming unreliable.
If the Fed believes the inflation rate is about to increase, it should
use a contractionary monetary policy to increase the interest rate and shift AD to the left.
If the Fed believes the economy is about to fall into recession, it should
use an expansionary monetary policy to lower the interest rate and shift AD to the right.
Is it possible for the federal funds rate to be negative?
No, nominal interest rates have a lower bound of zero
