Econ Unit 4 Test: Monetary Policy

Name a type of money that serves primarily as medium of exchange?

Currency, coin, debit cards, or checkable accounts

Definition of medium of exchange

Money is accepted by people when they buy and sell goods and services.

What might cause velocity to change?

Some factors that might cause velocity to change are changes in how money is transferred (institutional changes), changes in interest rates and changes in the price level.

When the Fed sells bonds, the money supply: a) expands b) contracts c) selling bonds does not have any effect on the money supply d) sometimes rises and sometimes falls

b) contracts

Why must the Fed continue to develop new ways to track the money supply?

Because of technological innovation in the financial services industry and profit maximizing behavior on the part of commercial banks, the Fed must find new measures for tracking the money supply to assist monetary policy.

Assume the initial economy is an intersection of AD and SRAS below full employment. What is the effect on Treasury security (bond) prices?

Bond prices should rise

Suppose that initially the economy is at the intersection of AD and SRAS beyond full employment. What is the effect on Treasury security (bond) prices?

Bond prices will decline.

Which of the following characteristics of money could be found in bars of gold? A)Portability, uniformity, and stability in value B) Portability and acceptability C) Uniformity, acceptability, and stability in value D)Uniformity and durability E) Portability and stability in value

D)Uniformity and durability

Why do observers pay close attention to the federal funds rate?

It is an early indicator of monetary policy and provides a forecast of the direction for other interest rates and for Fed policy.

If the required reserve ratio were 0%, then money supply expansion would be infinite. Why don't we want an infinite growth of the money supply?

It would result in hyperinflation.

What is the difference in the value of M1 velocity and M2 velocity? Explain why they are different.

M1 velocity is much larger than M2 velocity. M1 is used for transactions, whereas a significant proportion of M2 is used for saving so it does not change on a daily or weekly basis.

Checkable deposits......................$850 Currency..................$200 Large time deposits........................$800 Noncheckable savings deposits........................$302 Small time deposits...............................$1,745 Institutional money market mutual funds................$1,210 M2=

M2= 1050+1745+302= 3097

M1 includes items that are generally used as a ____________ ___ _____________.

Medium of exchange

What is monetary policy?

Monetary policy is action by the Federal Reserve to increase or decrease the money supply to influence the economy.

Definition of measure of value

Money is like a yardstick. People use it to compare the worth of things that they buy and sell.

Monetary policy´s influence on real output and interest rates are ?

Mostly short-term and not highly predictable

How do banks set their nominal interest rate?

They set it equal to its expected real interest rate plus the expected inflation rate.

As a result of legislative and regulatory reform through the 1980s and 1990s, banks and other financial institutions began paying interest on a significant proportion of the checkable deposits in the M1 definition of the money supply. Explain how these changes might be expected to affect the velocity of M1.

Velocity would decrease. People would be more willing to hold (not spend) M if it paid interest.

A financial market in which financial assets having a maturity of more than one year are bought and sold is called a: a) money market b) capital market c) commercial paper market d) commercial bank market

b) capital market

The demand deposits in a bank would go on: a) the asset side of its balance sheet b) the liabilities side of its balance sheet c) the net worth part of its balance sheet d) on both sides of its balance sheet

b) the liabilities side of its balance sheet

Assuming individuals hold no cash, the reserve requirement is 10 percent, and banks keep no excess reserves, an increase in an initial of $300 into the banking system will cause an increase in total money of: a) $30 b) $300 c) $3,000 d) $30,000

c) $3,000

The Federal funds rate is the interest rate: a) the government charges banks for Fed funds b) the Fed charges banks for Fed funds c) the banks charge individual investors for Fed funds d) the banks charge each other for Fed funds

d) the banks charge each other for Fed funds

When money is used as a standard of value, a person is a)earning more money than before b)purchasing a necessity c)making a financial transaction d)making price comparisons among products e)writing a check for groceries

d)making price comparisons among products

Banks use money to

make money

The relationship between the nominal interest rate, the real interest rate, and the inflation rate can be written as: (FISHER EQUATION)

r= i-π

Reserve requirements are:

randomly adjusted

M2 and M3 include

savings accounts and other time deposits

Monetary policy´s long term influence on prices is ?

strong and predictable

What is r in the Fisher equation?

Real interest rate

FDIC is an acronym for: a) major banks in the US b) major banks in the world c) US government program that guarantees deposits d) types of financial instruments

c) US government program that guarantees deposits

The textbook author's view of government guarantees of deposits is: a) they don't make sense b) stronger ones are needed c) it depends d) it should be a private guarantee program

c) it depends

Monetary policy is: a) a variation of fiscal policy b) undertaken by the Treasury c) undertaken by the Fed d) the regulation of monetary institutions

c) undertaken by the Fed

The Fed most directly controls a) M1 b) M2 c)the monetary base d)the amount of credit in the economy

c)the monetary base

The real interest rate is simply stated as the a) Price of borrowed money in the future b) Inflation rate minus CPI c) nominal interest rate over time d) Nominal interest rate minus the expected inflation rate e) Nominal interest rate plus the expected inflation rate

d) Nominal interest rate minus the expected inflation rate

Deposit expansion multiplier is:

1/reserve requirement

What are the three main functions of money?

A medium of exchange, a standard of value, and a store of value.

Expansionary money policy results in which of the following in the short run? I. The money supply increases II. The nominal interest rate decreases III. The real interest rate decreases IV. Bond prices decrease A) I and II only B) I, II and III only C) I,II and IV only D) III and IV only E) IV only

B) I, II and III only

How do banks make money?

By loaning money

Expansion of the money supply=

Deposit expansion multiplier x excess reserves

True Statements about expansionary monetary policy in the long run include which of the following? I. Price level increases to match the increase in the money supply II. The nominal interest rate equals the real interest rate plus the expected inflation rate. III. The real output level has not permanently increased. A) I only B) II only C) III only D) I and II only E) I, II and III only

E) I, II and III only

Buying bonds on the open market by the Fed is __________policy.

Expansionary

Assume the initial economy is an intersection of AD and SRAS below full employment. What monetary policy should the Fed implement to move the economy to full-employment output?

Expansionary monetary policy

V=

GDP/M

A very low discount rate may encourage banks to borrow from the Federal Reserve because

If banks are able to borrow from the federal reserve at a low interest rate and make loans at a higher rate the banks will earn a profit and hence have an incentive to use the discount window.

If the Fed increases the reserve requirement and velocity remains stable, what will happen to nominal GDP? Why?

If the Federal Reserve increases reserve requirements, the money supply will decrease. nominal GDP will decrease based on the equation of exchange (MV=PQ=nominal GDP): If M decreases, V stays constant, and then PQ must decrease.

Describe the conditions under which an increase in the money supply would be inflationary

If the money supply increases at a rate faster than output is increasing, it will be inflationary.

What are the effects if the money supply grows too rapidly?

If the money supply is growing too quickly it can lead to inflation

What are the effects if they money supply grows too slowly?

If the money supply is growing too slowly the likelihood of recession increases because the demand for money will increase which drives up interest rates. As interest rates rise, investment declines, slowing the growth rate of real output.

Which money demand curve, more elastic or inelastic, makes the interest rate fluctuate more?

Inelastic demand curve

The demand for money is determined by _____________, _______, and the ______________.

Interest rates, income, and the price level

The product of velocity and the money supply equals PQ. How can PQ be defined?

It can be defined as nominal GDP; Q is the current output of current prices (P).

Suppose the demand for money increases. If the Fed wants to maintain a constant interest rate when the demand for money increases explain what policy the Fed needs to follow and why.

It must increase the money supply to meet the increase in the demand for money.

What does the reserve requirement do?

Limits the amount of money banks can create

Banks are in the business to:

Make money

MV=

PQ

Name a type of money that serves primarily as store of value?

Savings accounts or money market mutual fund accounts

What has the real interest rate not been constant?

The actual real interest rate has not been constant because the inflation rate has changed often. The money supply growth rate has also changed during the period shown in the graph.

MV+PQ What is M?

The amount of money in circulation

MV+PQ What is P?

The average price level

What is the actual real interest rate?

The change in your purchasing power

MV+PQ What is V?

The income velocity of money

What role does the money multiplier play in enabling the Fed to conduct monetary policy?

The money multiplier times the change in excess reserves yields change in the money supply. Thus, if the Fed wants to change the money supply by a given amount, the money multiplier indicates by how much the excess reserves need to be changed.

What is the purpose of monetary policy?

To promote effectively the goals of maximum employment, stable prices, and moderate long-term interest rates.

What trends are velocity over time?

Velocity increases slowly.

In the long run, increases in the money supply will result in...

an increase in the price level and the nominal interest rate

If the legal reserve requirement is 25 percent, the value of the simple deposit expansion multiplier is a)2 b)4 c)5 d)10 e)1.0

b) 4

In the short run if the Fed undertakes contractionary monetary policy, the effect wil be to shift the: a) AD curve out to the right b) AD curve in to the left c) SAS curve up d) SAS curve down

b) AD curve in to the left

Which of the following does the Federal Reserve use most often to combat a recession? a) Selling securities b) Buying securities c) Reducing the reserve requirement d) Increasing the discount rate e) Increasing the federal funds rate

b) Buying securities

If you are depositing money at a bank, the bank is likely: a) an investment bank b) a commercial bank c) a municipal bank d) a government bank

b) a commercial bank

if banks hold excess reserves whereas before they did not, the money multiplier: a) will become larger b) will become smaller c) will be unaffected d) might increase or might decrease

b) will become smaller

Using economic terminology, when an individual buys a bond, that individual is a)investing b)saving c)buying a financial liability d)increasing that individual's equities

b)saving

Money is created when

banks make loans.

Assuming the ration of money people hold in cash to the money they hold in deposits is .3, the reserve requirement is 20 percent, and that banks keep no excess reserves, an increase of an initial $100 into the banking system will cause an increase in total money of approximately: a) $50 b) $100 c) $200 d) $500

c) $200

The Fed ____________ target both interest rates and money supply.

cannot

Assuming individuals hold no cash, the reserve requirement is 20 percent, and banks keep no excess reserves, an increase in an initial inflow of $100 into the banking system will cause an increase in the money supply of: a) $20 b) $50 c) $100 d) $500

d) $500

In the short run, increases in the money supply...

decrease the nominal interest rate and real interest rate

If the Fed decided to implement a policy action designed to increase the money supply, in which direction would bank reserves and the federal funds rate change and why?

if the Fed wants to increase the money supply, it will institute a policy to increase excess reserves (giving banks an increased ability to make loans).Banks have more money to loan to other banks, businesses, and consumers. So, the federal funds rate is likely to decrease.

Velocity is

the number of times a year that the money supply is used to make payments for final goods and services

M3 includes items that are generally used as a ____________ ___ _____________.

unit of account

MV+PQ What is Q?

Real GDP or real value of all final goods and services

Assume the initial economy is an intersection of AD and SRAS below full employment. If the Fed is going to use open market operations, it should ________ Treasury securities.

Buy

Suppose that initially the economy is at the intersection of AD and SRAS beyond full employment. What monetary policy should the Fed implement to move the economy to full-employment output?

Contractionary monetary policy

What economic goal might the Federal Reserve try to meet by reducing the money supply?

Price stability.

What does M1 consist of?

Checkable deposits, traveler's checks, and currency.

Has the actual real interest rate stayed constant?

NO

PQ is

Nominal GDP

Suppose the economy is experiencing rising unemployment, slowing increases in real GDP and modest inflation. The Federal Reserve decides to follow an expansionary policy. Describe what this policy might include.

The Federal Reserve could be buying bonds on the open market, reducing the discount rate, or reducing the reserve requirement. Each of these actions is designed to stimulate an economy that is showing signs of entering a recession.

What is π in the Fisher equation?

The inflation rate

What is the nominal interest rate?

The rate the bank pays you (the advertised rate) or the rate that appears on our bond or car loan

Assuming c=.2 and r=.1, the approximate real world money multiplier would be: a) 1.33 b) 2.33 c) 3.33 d) 4.33

c) 3.33

The reserve requirement for the banking system is 20%. Currently Third National bank has no excess reserves. Then Behroz deposits $100 in her checking account at Third National. What are 2 limitations of the process of redistributing and growing the money?

1) The bank willingly holds excess reserves 2) Customers do not want to borrow 3) Cash leaking

Many economists think that moving from short-run equilibrium to long-run equilibrium may take several years. List three reasons why the economy might not immediately move to long-run equilibrium.

1) Wages will adjust slowly to changes in prices (inflation) because of wage contracts 2)Prices adjust slowly because business is slow to change prices to maintain customer loyalty 3)Both labor and firms have inaccurate expectations about inflation

The three main tools that the Fed uses to control the money supply are:

1)Reserve Requirement 2)Discount Rate 3)Selling government bonds on the open market (Open Market Operations)

The money multiplier is

100/ The reserve requirement

Suppose the Federal Reserve increases the money supply by buying Treasury securities. Explain what happens to loans and interest rates as the Fed increases the money supply.

As the Federal Reserve buys Treasury securities from the public, demand deposits in financial institutions increase. Thus financial institutions have more money to make loans. To encourage people to take out the loans, the financial institutions lower the interest rate.

Why do banks hold excess reserve, which pay no interest?

Banks are required by law to hold required reserves; they hold some excess reserves as a precaution in case of sudden withdrawals or changes in economic conditions.

Discuss why it is unlikely that a new deposit of $1000 to a checking account would result in the money supply fully increasing as indicated by the deposit expansion multiplier

Banks may choose to hold excess reserves, or borrowers may want fewer loans than banks have available. Or people may not redeposit the money in the banking system.

Why is it difficult for the Fed to get an accurate measure in the money supply?

Because of the volume of transactions in the US which can range into the trillions on a daily basis, getting an accurate measure can be an arduous task. The inputs are constantly changing as banks make new loans and people repay loans ahead of schedule.

Why does the Fed rarely use the reserve requirement as an instrument of monetary policy?

Changes in the required reserve ratio cause radical or strong changes in the monetary system. It is difficult for financial institutions to adjust to changes in the required reserve ratio. In general, the Fed uses the tools of monetary policy to adjust the economy in small increments.

What are the four types of money?

Commodity money, representative money, fiat money, and checkbook money

Selling bonds on the open market by the Fed is _____ policy.

Contactionary

With the use of credit cards becoming more prominent and the availability of credit broader than ever, why are credit cards not included in the Ms?

Credit cards are short-term loans/ Payment is not directly subtracted from checking accounts. They are NOT counted as money. If they were and the payment was also counted, one economic transaction would be double-counted in the money supply.

For a given money supply growth, a(n) _________________ in velocity with _____________ inflationary pressure.

Decrease/ decrease

When a loan is repaid, money is _____________.

Destroyed

Which of the following combinations of monetary policy actions would definitely cause a decrease in aggregate demand? Discount Rate OMO Reserve Require. A) Decrease Buy Bonds Decrease B) Decrease Sell Bonds Decrease C) Increase Buy Bonds Increase D) Increase Sell Bonds Decrease E) Increase Sell Bonds Increase

Discount Rate OMO Reserve Require. E) Increase Sell Bonds Increase

Suppose that initially the economy is at the intersection of AD and SRAS (on LRAS). Now the Fed decides to implement expansionary monetary policy to increase the level of employment. In the short run, what happens to employment and nominal wages?

Employment increases and nominal wages remain the same. Employment increases because firms now have to produce more goods and services and they need people to do this. Nominal wages stay the same because people do not realize that the average price level has increased.

Suppose that initially the economy is at the intersection of AD and SRAS (on LRAS). Now the Fed decides to implement expansionary monetary policy to increase the level of employment. In the long run, what happens to employment and nominal wages?

Employment is at full employment and nominal wages will have risen so that the real income of people has remained the same. To induce labor to work at the higher new level, firms must increase the nominal wage.

Define: Interest rate banks charge one another for federal funds.

Federal funds rate

In a short paragraph, summarize the long-run impact of an expansionary monetary policy on the economy.

In the long run, increases in the money supply translate into increases in the price level and no long-term increase in output. This is known as the neutrality of money. In the short run, nominal and real interest rates decline. In the long run, nominal interest rates follow the fisher Equation and equal the real rate plus the inflation rate. Real interest rates return to their long-run level: the rate people require to forego consumption now for consumption in the future.

Suppose that initially the economy is at the intersection of AD and SRAS (on LRAS). Now the Fed decides to implement expansionary monetary policy to increase the level of employment. In the long run, what happens to the nominal interest rate and the real interest rate?

In the long run, the real interest rate goes to the long-run level and the nominal interest rate is the real interest rate plus the inflation rate.

Suppose that initially the economy is at the intersection of AD and SRAS (on LRAS). Now the Fed decides to implement expansionary monetary policy to increase the level of employment. In the long run, what happens to real output?

In the long run, the real output will be at the full-employment level. So real output will fall relative to the level of output in the short run. As employment increases, nominal wages increase which raises the cost of production and the SRAS curve shifts to the left. The price level increases, and real output will fall back toward its original level.

Suppose that initially the economy is at the intersection of AD and SRAS beyond full employment. In the short run, what is the effect on nominal interest rates?

In the short run, nominal interest rates will increase. When the public buys bonds, they pay for them by reducing their demand deposits, decreasing the supply of money, which means the interest rate will increase.

Suppose that initially the economy is at the intersection of AD and SRAS beyond full employment. In the short run, what happens to real output? Explain how the Fed's action results in a change in real output.

In the short run, real output will decline. As a result of the Fed's actions, interest rates have increased; therefore the interest-sensitive components of aggregate demand (consumption and investment) will decrease, and thus, decrease aggregate demand. With a reduced aggregate demand, firms will experience an increase in inventories, which in turn leads to a decrease in production. Output decreases.

Suppose that initially the economy is at the intersection of AD and SRAS (on LRAS). Now the Fed decides to implement expansionary monetary policy to increase the level of employment. In the short run, what happens to nominal interest rates and real interest rates?

In the short run, the nominal and real interest rates decrease.

Checkable deposits......................$850 Currency..................$200 Large time deposits........................$800 Noncheckable savings deposits........................$302 Small time deposits...............................$1,745 Institutional money market mutual funds................$1,210 M1=

M1= 850+200= 1050

Checkable deposits......................$850 Currency..................$200 Large time deposits........................$800 Noncheckable savings deposits........................$302 Small time deposits...............................$1,745 Institutional money market mutual funds................$1,210 M3=

M3= 3097+800+1210= 5107

Suppose velocity remains constant, while the money supply increases. Explain how this would affect nominal GDP.

Nominal GDP (PQ) would increase. If the economy is not at full employment, both P and Q increase. If at full employment, only P would increase. This action could lead to extreme inflation if the economy is at full employment.

What is i in the Fisher equation?

Nominal interest rate

How do you calculate real interest rate?

Nominal interest rate minus inflation rate

Assume the initial economy is an intersection of AD and SRAS below full employment. In the short run, what is the effect on nominal interest rates?

Nominal interest rates should fall because financial institutions have more funds to lend out because people have sold their Treasury securities to the Fed.

In a foreign country, the reserve requirement is 100 percent. What will be the deposit expansion multiplier?

One

If velocity were extremely volatile, why would this complicate the job of making monetary policy?

One of the roles of monetary policy is stabilization of the price level. Thus, based on the equation of exchange (MV=PQ), changes in the money supply will yield a given change in PQ if velocity (V) is constant. If velocity is volatile, changes in the money supply may be either too small or too large, leading to inflation.

What is the most frequently used tool by the Fed?

Open market operations because they permit the Fed to make small changes in the money supply and can be implemented immediately.

What are the six characteristics of money?

Portability, uniformity, acceptability, durability, divisibility, and stability in value

Suppose that initially the economy is at the intersection of AD and SRAS (on LRAS). Now the Fed decides to implement expansionary monetary policy to increase the level of employment. In the short run, what happens to real output?

Real output should increase. With the decrease in interest rates because of the expansionary monetary policy, the interest rate sensitive components of aggregate demand (consumption and investment) will increase, thereby increasing output.

Assume the initial economy is an intersection of AD and SRAS below full employment. In the short run, what happens to real output?Explain how the Fed's action results in a change in real output.

Real output should increase. With the decrease in interest rates, the interest-rate sensitive components of aggregate demand (consumption and investment) will increase, thereby increasing output.

The Fed rarely changes the _______________ __________.

Reserve Requirements

Suppose that initially the economy is at the intersection of AD and SRAS beyond full employment. If the Fed is going to use open market operations, it should ______ Treasury securities.

Sell

M2 includes items that are generally used as a ____________ ___ _____________.

Store of value

Why does the Fed currently target the federal funds rate rather than the money supply?

The Fed uses changes in reserves to affect the federal funds rate. It targets the federal funds rate because the Fed believes that this rate is closely tied to economic activity.

If the Federal Reserve is trying to get the economy out of a recession, which money demand curve would it want to represent the economy?

The Fed would prefer the more inelastic money demand curve because a given increase in the money supply will lead to a greater decrease in interest rates, which should stimulate the economy.

Who determines the supply of money?

The Federal Reserve

Assume the initial economy is an intersection of AD and SRAS below full employment. In the short run, what happens to the price level? Explain how the Fed's action results in a change in pricel level.

The average price level increases because the increase in demand can be met only if firms have the incentive to produce more. An increasing price level provides this incentive.

The reserve requirement for the banking system is 20%. Currently Third National bank has no excess reserves. Then Behroz deposits $100 in her checking account at Third National. Explain, without using a mathematical formula, why Behroz's deposit can lead to an increase in the money supply that is greater than $100.

The bank may make loans (or buy securities) based on excess reserves (80% of Behroz's deposit). The bank does make loans (or buy securities) based on excess reserves, and the deposit created by the loan is redeposited in the banking system (fractional reserves).

What does it mean to say that the Fed changes the discount rate mostly as a signal to markets?

The discount rate has no impact if banks do not borrow from the Federal Reserve; banks do not have to borrow because if they need funds, they can always go to the federal funds market. It signals to the banks and others how the Fed would like the money supply to change.

π^e is

The expected inflation rate

What is the interest rate a bank charges when it lends excess reserves to other banks called?

The federal funds

What happens to the fed funds rate if the Fed follows a expansionary (easy money) policy?

The federal funds rate decreases.

What happens to the fed funds rate if the Fed follows a contractionary (tight money) policy?

The federal funds rate increases.

What is the expected real interest rate?

The increase in purchasing power the lender wants to receive to forego consumption now for consumption in the future.

Suppose the Federal Reserve increases the money supply by buying Treasury securities. What happens to the interest rate?

The interest rate decreases.

Suppose the demand for money increases. What happens to the interest rate?

The interest rate increases.

What is the fed funds rate?

The interest rate that financial institutions change other financial institutions for short-term borrowing.

The Federal Reserve determines that it is currently appropriate to follow a contractionary policy. Would the monetary policy be to increase or decrease the money supply?

The policy would be to reduce the money supply. By reducing the money supply, interest rates would rise and investment spending and other interest rate sensitive components of aggregate demand would decrease, reducing the upward pressure on prices.

What happens when the money supply goes up?

The price level increases (inflation)

Suppose that initially the economy is at the intersection of AD and SRAS (on LRAS). Now the Fed decides to implement expansionary monetary policy to increase the level of employment. In the short run, what happens to the price level?

The price level increases because the increase in demand can only be met if firms have the incentive to produce more. An increasing price level provides this incentive.

Suppose that initially the economy is at the intersection of AD and SRAS beyond full employment. In the short run, what happens to price level? Explain how the Fed's action results in a change to the price level.

The price level will fall as firms attempt to clear out inventory by reducing prices, having a sale.

Suppose the Federal Reserve increases the money supply by buying Treasury securities. What happens to the quantity of money demanded?

The quantity of money demanded increases.

Suppose the demand for money increases. What happens to the quantity of money supplied?

The quantity of money supplied remains the same, as shown by the vertical money supply curve.

Why is it important for the Fed to know the size and rate of growth of the money supply?

The size of the money supply and the rate at which it is growing can have a significant impact on the economic well being of the country.

What is the primary goal of monetary policy?

To stabilize prices (prevent inflation)

Suppose the demand for money increases. Why might the Fed want to maintain a constant interest rate?

To stabilize the amount of investment in the economy.

What might one infer from the changes of the 1980s and 1990s about the classical assumption that institution factors determine velocity?

V does not remain constant when institutional factors change.In fact, it is increasing.

During the past 30 years, the use of credit cards has increased, and banks and financial institutions increasingly use computers for transactions. Explain how these changes might affect velocity.

V would increase. A given stock of M could ¨work harder¨ and finance more transactions more quickly.

Explain the effect of the change in the money supply on consumption, investment, real output and prices. Would there be a difference in the effects under the two different money demand curves? If so, explain.

With either demand curve, the increase in supply will cause interest rates to decline and investment and consumption-and thus real output-to increase. AD increases, so prices are likely to increase. For the interest-sensitive component of consumption and investment, there will be a greater increase (or decrease) with a greater decrease (or increase) in the interest rate. For example, a larger decrease in interest rates will usually lead to a greater increase in investment. The increase in investment will increase aggregate demand. Thus, the increase in the money supply will lead to an increase in AD, which will lead to an increase in real output and in the price level.

Why does the Fed use open market operations the most?

With open market operations, the Fed has more immediate and more controlled influence on the money supply. If the money supply increases at a rate faster than output is increasing, it will be inflationary.

If expansionary monetary policy increases real income by 4 percent and nominal income by 6 percent, the price level will rise by: a) 2 percent b) 4 percent c) 6 percent d) 10 percent

a) 2 percent

In the short run if the Fed undertakes expansionary monetary policy, the effect will be to shift the: a) AD curve out to the right b) AD curve in to the left c) SAS curve up d) SAS curve down

a) AD curve out to the right

Which of the following actions by the Federal Reserve will result in an increase in banks' excess reserves? a) Buying bonds on the open market b) Selling bonds on the open market c) Increasing the discount rate d) Increasing the reserve requirement e) Increasing the federal funds rate

a) Buying bonds on the open market

If the Fed wants to increase the money supply, it should: a) buy bonds b) sell bonds c) pass a law that interest rates rise d) pass a law that interest rates fall

a) buy bonds

For every financial asset there is a: a) corresponding financial liability b)corresponding financial liability if the financial asset is financed c)real liability d)corresponding real asset

a) corresponding financial liability

Using a credit card creates a financial: a) liability for the holder and a financial asset for the issuer b) asset for the holder and a financial liability for the issuer c) liability for both the holder and issuer d) asset for both the holder and issuer

a) liability for the holder and a financial asset for the issuer

Two bonds, one a 30 year bond and the other a one year bond have the same interest rate. If the interest rate in the economy falls, the value of the: a) long-term bond rises by more than the value of the short-term bond rises b) short-term bond rises by more than the value of the long-term bond rises c) long-term bond falls by more than the value of the short-term bond falls d) short-term bond falls by more than the value of the long-term bond falls

a) long-term bond rises by more than the value of the short-term bond rises

In an advertisement for credit cards, the statement is made, "Think of a credit card as smart money." An economist's reaction to this would that a credit card is: a) not money b) dumb money c)Simply money d) actually better than money

a) not money

The primary tool of monetary policy is: a) open market operations b) changing the discount rate c) changing the reserve requirement d) imposing the credit controls

a) open market operations

An open market purchase: a) raises bond prices and reduces interest rates b) raises both bond prices and interest rates c) reduces bond prices and raises interest rates d) reduces both bond prices and interest rates

a) raises bond prices and reduces interest rates

If the interest rate falls, the value of a fixed rate bond a) rises b) falls c) remains the same d) cannot be determined as to whether it rises or falls

a) rises

The cash that a bank holds would go on a) the asset side of its balance sheet b) the liabilities side of its balance sheet c) the net worth part of its balance sheet d) on both sides of its balance sheet

a) the asset side of its balance sheet

Which of the following is most likely to increase the velocity of money? a)Higher frequency of paychecks b) Decrease in the price level c) Decrease in interest rates d) Decrease in personal income e) Increase in unemployment rate

a)Higher frequency of paychecks

The money market is definitely in equilibrium in which of the following cases? a) when velocity is constant b) When the quantity of money demanded equals the quantity of money supplied c) When the present value is equal to the interest rate d) When the present value is greater than the interest rate e) When the interest rate is equal to the price of bonds

b) When the quantity of money demanded equals the quantity of money supplied

Explicit functions of the Fed include all the following except: a) conducting monetary policy b) conducting fiscal policy c) providing banking services to the US government d) serving as a lender of last resort to financial institutions

b) conducting fiscal policy

The discount rate refers to the: a) lower price large institutions pay for government bonds b) rate of interest the Fed charges for loans to banks c) rate of interest the Fed charges for loans to individuals d) rate of interest the Fed charges for loans to government

b) rate of interest the Fed charges for loans to banks

The central bank of the US is: a) the Treasury b) the Fed c) the Bank of the United States d) Old Lady of Threadneedle Street

b) the Fed

Liquidity is: a) a property of water stocks b) the ability to turn an asset into cash quickly c) the ability to turn an asset into liquid quickly d) a property of over-the-counter markets

b) the ability to turn an asset into cash quickly

If the nominal interest rate is 2 percent and expected inflation is 1 percent, the real interest rate is a) 3 percent b) 2 percent c) 1 percent d) 0 percent

c) 1 percent

Aggregate demand and aggregate supply analysis suggest that, in the short run, an expansionary monetary policy will result in a) a shift in the aggregate demand curve to the left b) a shift in the aggregate supply curve to the left c) an increase in real GDP without much inflation when the economy is on the horizontal portion of the aggregate supply curve. d) an increase in real GDP with high inflation when the economy is on the horizontal portion of the aggregate supply curve. e) an increase in real GDP and no inflation when the economy is on the vertical portion of the aggregate supply curve.

c) an increase in real GDP without much inflation when the economy is on the horizontal portion of the aggregate supply curve.

Modern bankers: a) focus on asset management b) focus on liability management c) focus on both asset management and liability management d) are unconcerned with asset and liability management and instead are concerned with how to make money

c) focus on both asset management and liability management

A secondary financial market is a market in which: a) minor stocks are sold b) minor stocks and bonds are sold c) previously issued financial assets can be bought and sold d) small secondary mergers take place

c) previously issued financial assets can be bought and sold

Expected inflation is 4%; nominal interest rates are 7%; the real interest rate is: a) 1% b)2% c)3% d)7%

c)3%

Which of the following components is not including in the M2 definition of money? a) M1 b) Savings deposits c) Small-denomination time deposits d) Bonds

d) Bonds

To reduce inflation, the Federal Reserve could a) expand the money supply in order to raise interest rates, which increases investment b)expand the money supply in order to lower interest rates, which increases investment c) Contract the money supply in order to lower interest rates, which increases investment d) Contract the money supply in order to raise interest rates, which decreases investment e) buy bonds and decrease the discount rate to encourage borrowing

d) Contract the money supply in order to raise interest rates, which decreases investment

Reserves, the money supply and interest rates are most likely to change in which of the following ways when the Federal Reserve sells bonds? Reserves Money Supply Interest Rates a)Increase Increase Increase b) Increase increase Decrease c) Decrease increase Decrease d) Decrease Decrease Increase e) Decrease Decrease Decrease

d) Decrease Decrease Increase

Which of the following is not a function of money? a) Medium of exchange b) Unit of account c) Store of wealth d) Equity instrument

d) Equity instrument

A sound bank will: a) always have enough cash on hand to pay all depositors in full b) never borrow short and lend long c) never borrow long and lend short d) keep enough cash on hand to cover noral cash inflows and outflows

d) keep enough cash on hand to cover noral cash inflows and outflows

Tools of monetary policy include all the following except: a) changing the reserve requirement b) changing the discount rate c) executing open market operations d) running deficits

d) running deficits

Which of the following money is not included in the M1 definition of money? a) checking accounts b) currency c) traveler's checks d) savings accounts

d) savings accounts

The real interest rate is 3%; the nominal interest rate is 7%. It is likel that one could deduce an expected inflation rate of a) 1% b)2% c)3% d)4%

d)4%

The M1 definition of money includes which of the following? I. Currency II. Demand deposits (checkable deposits) III. Savings accounts and small time deposits IV. Eurodollars a)I only b)II only c)III only d)I and II only e)II, III, and IV only

d)I and II only

Suppose the Federal Reserve buys $400,000 worth of sercurities from the securities dealers on the open market. If the reserve requirement is 20 percent and the banks hold no excess reserves, what will happen to the total money supply? a)It will be unchanged b) It will contract by $2,000,000 c) It will contract by $800,000 d)It will expand by $2,000,000 e) It will expand by $800,000

d)It will expand by $2,000,000

Which of the following are true statements about the federal funds rate> I. It is the same thing as the discount rate. II. It is the interest rate that banks charge each other for short-term loands III. It is influenced by open market operations a) I only b) II only c) III only d) I and II only e) II and III only

e) II and III only

The Federal Reserve determines that it is currently appropriate to follow a contractionary policy. Describe the policy the Fed is likely to take, and explain how its action achieves the goal of following a contractionary policy. Explain how policy would affect each of the following: i) Interest rates ii) investment iii) Output iv) Price level v) Employment

i) Any of these actions will cause interest rates to rise because the supply of money is decreasing ii) As interest rates rise, investment looks less profitable and thus declines iii) A decrease in investment leads to a decrease in AD. If the economy is on the upward-sloping portion of SRAS, output will decrease with the leftward shift of AD. iv) The goal of the policy is to lower the price level. On the upward-sloping SRAS, the price level will fall with less spending. v) If on the upward-sloping SRAS, employment will decline with the decline in output.

Suppose the economy is experiencing rising unemployment, slowing increases in real GDP and modest inflation. The Federal Reserve decides to follow an expansionary policy. If the policy is effective, explain the short-run effect it would have on each of the following i) Interest rates ii) Private investment iii) GDP iv) Employment

i) Reduce interest rates. More money is available for loas, and the price of this money would fall ii) With lower interest rates, investment and some consumption would increase. iii) With an increase in investment and consumption, aggregate demand will increase and GDP will increase iv) As a result of the increase in AD and in GDP, employment will also increase to produce the larger output.

The equation can be written as

i=r^e+π^e

The demand for money has an _________________ relationship with the interest rate.

inverse

The expected real interest rate is:

r^e=i-π^e

_______________ can serve as money!

Anything

Financials intermediaries:

Bring people who want to borrow funds together with people who want to lend funds.

What are a few example of financial intermediaries?

Commercial banks, savings banks, credit unions, money market mutual fund corps.

When banks loan somebody money they just ___________?

Created money

Define: What the fed charges banks for loans.

Discount rate

How would you describe, in economic terms, the difference between the two money demand curves?

MD1 is more interest inelastic than MD.

Why do many economists believe that central banks have more control over the price level than over real output?

Many economists believe that real output is determined by the leve lfo capital stock and the productivity of workers. Thus, changes in the money supply affect prices more than real output.

Definition of store of value

Money is a way of storing value from the time when people receive it until another time when they spend it.

The Fed uses changes in the discount rate as a _________________________.

Signal of a change in the direction of monetary policy.

Why might the money supply not expand by the amount predicted by the deposit expansion multiplier?

Several reasons: All money may not be deposited into the banking system; the banks may not be able to lend out all excess reserves because people do not want to borrow; banks may want to keep excess reserves as a precaution.

Changes in the reserve requirement can have ___________ economic effects.

Substantial

If the Federal Reserve wants to increase the money supply, should it raise or lower the reserve requirement? Why?

The Federal Reserve should lower the required reserve ratio. Banks would have more excess reserves to lend out and thus, the money supply could increase.

Money is _________________________!

What money does

Explain why the money supply and short-term interest rates are inversely related.

When the Fed buys Treasury securities from the public, bank reserves increase. To decrease excess reserves and make loans, banks lower the interest rate to entice customers and businesses to borrow.

One bank´s loan becomes another bank´s____________ ___________.

demand deposit