Chapter 26

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When the Federal Open Market Committee​ (FOMC) decides to increase the money​ supply, it U.S. Treasury securities. If the FOMC wishes to decrease the money​ supply, it U.S. Treasury securities.

Buys and sells

What is inflation​ targeting?

Committing the central bank to achieve an announced level of inflation.

Consider the figures below and determine which is the best description of what causes the shift from AD1 to AD 2

Example A shows a contractionary monetary policy. The price level and real GDP both fall. AND Example B shows an expansionary monetary policy. The price level and real GDP both rise

The figure to the right illustrates a dynamic AD-AS model. Suppose the economy is in equilibrium in the first period at point A. In the second​ period, the economy reaches point B. We would expect the Fed to pursue what type of policy in order to move AD2 to AD Subscript 2 comma policy AD2, policy and reach equilibrium​ (point C) in the second​ period? If the Federal Reserve​ Bank's policy is​ successful, what is the effect on the following macroeconomic​ indicators? In the dynamic​ AD-AS model we​ assume: 1. The economy experiences inflation​ and, 2. the economy experiences long run growth. That​ is, the LRAS curve shifts to the right each year. In​ addition, the AD and the SRAS curves also shift to the right each year.

Expansionary monetary policy Actual real​ GDP: increases Potential real​ GDP: does not change Price​ level: increases ​Unemployment: decreases

Why did the Fed help JP Morgan Chase buy Bear​ Stearns?

Failure of Bear Stearns would lead to a larger investment bank failure AND Commercial banks would be reluctant to lend to investment banks.

In the figure to the​ right, which of the following events is most likely to cause a shift in the money demand​ (MD) curve from MD1 to MD2 ​(Point A to Point ​C)​?

Increase in real GDP or increase in the price level

In the figure to the​ right, when the money supply increased from MS1 to MS2​, the equilibrium interest rate fell from​ 4% to​ 3%. Why?

Increased demand for Treasury securities drives up their prices. AND ​Initially, firms hold more money than they want relative to other financial assets. AND Increased demand for Treasury securities drives down their interest rate.

How do investment banks differ from commercial​ banks? ​(Mark all that​ apply.)

Investment banks do not take deposits AND Investment banks generally do not lend to households.

Which of the following is NOT a monetary policy goal of the Federal Reserve bank​ (the Fed)? Monetary policy-The actions the Federal Reserve takes to manage the money supply and interest rates to pursue its macroeconomic policy goals.

Low prices

Consider the figure to the right. Can the Fed achieve a​ $900 billion money supply​ (MS) AND a​ 5% interest rate​ (point C)?

No. The Fed cannot target both the money supply and the interest rate simultaneously.

Suppose the economy is in equilibrium in the first period at point A. In the second​ period, the economy reaches point B. What policy would the Fed likely pursue in order to move AD2 to AD Subscript 2 comma policy AD2, policy and reach equilibrium​ (point C) in the second​ period? ​ (What policy will increase the price level and increase actual real​ GDP?)

Open market purchase of government securities

The figure to the right illustrates a dynamic AD-AS model Suppose the economy is in equilibrium in the first period at point A. In the second​ period, the economy reaches point B. What policy would the Fed likely pursue in order to move AD2 to AD Subscript 2 comma policy AD2, policy and reach equilibrium​ (point C) in the second​ period? In the dynamic​ AD-AS model we​ assume: 1. The economy experiences inflation​ and, 2. the economy experiences long run growth. That​ is, the LRAS curve shifts to the right each year. In​ addition, the AD and the SRAS curves also shift to the right each year.

Open market purchase of government securities. Your answer is correct.

If the Federal Reserve is late to recognize a recession and implements an expansionary policy too​ late, the result could be an increase in inflation during the beginning of the next phase. Even though the goal had been to reduce the severity of the​ recession, the poor timing caused another​ problem: inflation. This is an example of what type of​ policy?

Procyclical policy

The Fed uses monetary policy to offset the effects of a recession​ (high unemployment and falling prices when actual real GDP falls short of potential​ GDP) and the effects of a rapid expansion​ (high prices and​ wages). Can the​ Fed, therefore, eliminate​ recessions?

The Fed can only soften the magnitude of​ recessions, not eliminate them.

Nobel laureate Milton Friedman and his followers belong to a school of thought known as monetarism. What do the monetarists argue the Fed should​ target?

The Fed should target the money​ supply, not the interest​ rate, and that it should adopt the monetary growth rule.

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. 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

As the figure to the right​ indicates, the Fed can affect both the money supply and interest rates.​ However, in recent​ years, the Fed targets interest rates in monetary policy more often than it does the money supply. Which interest rate does the Fed​ target?

The federal funds rate

According to the Taylor rule ​, what is the federal funds target rate under the following​ conditions? ≻Equilibrium real federal funds rate equals 3​% follows ≻Target rate of inflation equals 3​% follows ≻Current inflation rate equals 2​% follows ≻Real GDP is 2​% below potential real GDP

The federal funds target rate equals 3.5​%. ​(Enter your response rounded to one decimal​ place.)

According to the Taylor rule ​, what is the federal funds target rate under the following​ conditions? ≻Equilibrium real federal funds rate equals 2​% follows ≻Target rate of inflation equals 2​% follows ≻Current inflation rate equals 1​% follows ≻Real GDP is 1​% below potential real GDP Taylor Rule A rule developed by John Taylor that links the​ Fed's target for the federal funds rate to economic variables.

The federal funds target rate equals 2.0%

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.) Aggregate Demand-The total level of spending the​ economy, comprised of four​ components: consumption,​ investment, government​ purchases, and net exports.

The value of the dollar AND Consumption of durable goods AND Business investment projects

The figure to the right illustrates the economy using the Dynamic Aggregate Demand and Aggregate Supply Model If actual real GDP in 2006 occurs at point B and potential GDP occurs at LRAS06​, we would expect the Federal Reserve Bank to pursue monetary policy. If the​ Fed's policy is​ successful, what is the effect of the policy on the following macroeconomic​ indicators? Aggregate Demand and Aggregate Supply Model An extension of the basic​ AD-AS model that introduces the following​ conditions: 1. The economy experiences continuing​ inflation, with the price level rising every year. 2. The economy experiences​ long-run economic​ growth, with the LRAS curve shifting to the right every year.

a contractionary Actual real GDP decreases Potential real GDP does not change Price level decreases Unemployment increases

In the figure to the​ right, the opportunity cost of holding money when moving from Point A to Point B on the money demand curve. Opportunity cost-The​ highest-valued alternative that must be given up to engage in an activity.

decreases

The federal funds rate

is the rate that banks charge each other for​ short-term loans of excess reserves

The is considered the most relevant interest rate when conducting monetary policy.

short-term nominal interest rate

What two institutions did Congress create in order to increase the availability of mortgages in a secondary​ market?

​"Fannie Mae" and​ "Freddie Mac"


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