Fiscal and Monetary Policy Mini TEST 1/6/22

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Liquid assets

An asset that can be converted into cash quickly and with minimal impact to the price received.

How are members of the Fed chosen?

Appointed by the POTUS; confirmed by the Senate

What are the two jobs of most central banks?

First: Regulate and Oversee commercial banks by making sure that banks have enough money in their reserve to avoid Bank runs. Second: Conduct monetary policy which is increasing or decreasing the money supply to speed up or slow down the overall economy.

Fiscal policy

Fiscal Policy is the spending and taxing policies used by Congress and the President.

Monetary policy

Monetary policy is the tools used by the Federal Open Market Committee to influence the availability of credit and the money supply.

Monetary Tool #3: Open Market Operations

Open market operations are the buying and selling of government securities in order to alter the supply of money. A security is a financial document, such as a stock certificate or bond, that represents ownership of corporate shares or the promise of repayment by a company or government. Today open market operations are by far the most important—and most often used—tool employed by the Fed to implement U.S. monetary policy.

4. What are the tools used to implement fiscal policy?

The tools used to implement fiscal policy are changes in government spending and changes in tax rates and rules.

7. Explain the monetary policy actions used to stimulate the economy during a recession. What is this type of monetary policy called?

To stimulate the economy during a recession, Expansionary Monetary Policy is used to stimulate the economy during a recession. This policy uses the tools of buying government securities, lowering the reserve requirement, lowering the discount rate, and lowering interest paid on required and excess reserves. The effect of these tools is increased GDP, price level and employment.

11. An asset that can be converted into cash quickly and with minimal impact to the price received

b. Liquid Assets

Contractionary monetary policy

slow down the economy, decrease money supply - increase interest rates. This leads to less borrowing and spending.

Interest Rates

the price of borrowing money

If the Fed decreases the money supply,

there will be less money to loan out. Therefore, banks will try and get the highest interest rate possible.

What makes the Fed and Fed Chair so influential?

Monetary Policy

What is the purpose of a price?

The purpose of a price is to create a common form of communication in the marketplace. A price stabilizes things by sending signals and providing incentives. For example, a price can show the scarcity of products and convince the consumer to buy depending on how low or high the price is.

8. The minimum interest rate set by the Federal Reserve for lending to other banks

c. Discount Rate

Short answer question: How do you know if is a recession? What are your economic indicators? Explain how fiscal or monetary policy can help this.

-A slowdown in consumer spending. A spike in unemployment. The slowing of manufacturing activity. A drop in personal income through job loss. -FALLING GDP -BUSINESS CYCLE - a significant decline in economic activity that is spread across the economy and lasts more than a few months. -DECLINE IN REAL INCOME Expansionary fiscal policy is used to fix recessions. the use of fiscal policy to contract the economy by decreasing aggregate demand, which will lead to lower output, higher unemployment, and a lower price level. Contractionary fiscal policy is used to fix booms. Monetary policy can offset a downturn because lower interest rates reduce consumers' cost of borrowing to buy big-ticket items such as cars or houses. For firms, monetary policy can also reduce the cost of investment.

1. What are interest rates?

1. Interest rates are how much the lender charges the borrower and how much more the buyer has to pay along with the original amount borrowed.

1. What is meant by "dual role of prices?"

1. The dual role of prices signifies the two purposes of a price (signals and incentives).

There are ______ district federal reserve banks

12

2. How is the equilibrium price of a good or service determined?

2. The equilibrium price of a good or service is determined by whether demand and supply are equal.

2. What happens when the Federal Reserve System raises interest rates?

2. When the Federal Reserve System raises interest rates, more people and businesses choose to save more, decreasing the money supply and lowering prices.

3. What happens when the Federal Reserve System lowers interest rates?

3. When the Federal Reserve System lowers interest rates, more people borrow and invest, adding more money to the economy and stabilizing purchase power.

3. What happens if there is too much or too little of a good?

3. When there is too much or too little of a good, there are surpluses and shortages

4. How does the Fed use interest rates to keep prices stable?

4. The Fed uses interest rates to keep prices stable to control inflation and economic activity. Interest rates effectively work against inflation and recessions and are a simple way to add and take money from the economy.

4. Why might the government get involved in setting prices?

4. The government might get involved in setting prices because of politics, or to set a price ceiling or a price floor.

5. What is the relationship between monetary policy and financial stability?

5. Monetary policy affects financial stability because it improves financial conditions by using interest rates to encourage borrowing/ spending to raise/lower prices. Monetary policy relates to financial stability because it can help decrease high inflation and unemployment and can help businesses and consumers be able to buy and sell what they want.

Suppose you have a checkbook that allows you to write as many checks as you wish for any amount you desire. You don't need to worry about the balance in your account, and the checks will always be cashed, no matter how much you spend. Most people don't have accounts like that. However, the Federal Reserve comes close.

By using its monetary policy tools, the Federal Reserve System affects the nation's money supply. The Fed has the power to increase or decrease the amount of money in the United States. The Fed manipulates the money supply in order to stabilize the American economy.

How does the Central Bank change the money supply?

Changing the Reserve Requirement. This is when the Fed changes the percent of deposits a bank must keep. Changing the Discount Rate (interest rate it charges banks).

Money Creation

Coins and paper bills are manufactured in facilities like this. But it is the Federal Reserve that puts money in circulation through the process of money creation.

What keeps the banking system healthy?

Confidence and Liquidity

Who is responsible for fiscal policy?

Congress and the President are responsible for fiscal policy.

6. Explain the fiscal policy actions used to stimulate the economy during a recession. What is this type of fiscal policy called?

Expansionary Fiscal Policy is used to stimulate the economy during a recession. To get out of a recession, governments often lower taxes or increase government spending to increase consumer spending and Business investments. Also, the GDP, price level, and employment will increase.

Monetary Tool #2: The Discount Rate

In the past, the Fed lowered or raised the discount rate to increase or decrease the money supply. The discount rate is the interest rate the Federal Reserve charges on loans to financial institutions. Today, the discount rate is primarily used to ensure that sufficient funds are available in the economy. Interest rates determine the return bank customers earn on money they deposit and the cost they pay for money they borrow.

9. Explain the monetary policy actions used to stabilize the economy in times of inflation. What is this type of monetary policy called?

In times of inflation, the Contractionary Monetary Policy is used and it involves selling government securities, increasing reserve requirement, increasing the discount rate, and increasing the interest paid on required and excess reserves. As a result, consumer spending, business investments, GDP, price level and employment decrease.

Creating Money

Money is created as banks loan out money not kept in reserve. How would an increase in the reserve requirement affect money creation in this example?

8. Explain the fiscal policy actions used to stabilize the economy in times of inflation. What is this type of fiscal policy called?

The Contractionary Fiscal Policy is used to stabilize the economy in times of inflation and it either increases taxes or lowers spending. The results of using this policy are decreased consumer spending, business investments, GDP, price level and employment.

Federal Reserve Easy Money Policy

The Easy Money Policy is when the Fed wants to increase the money supply which will lower the interest rates. When this happens, the Fed allows the cash to build up in the banking system, then they lower interest rates. Consumers are more willing to take out loans when interest rates are lower. Short run effect of easy money policy - lower interest rates Long term effect - inflation. Why? If there's more money flowing, people can start to charge more which will drive prices up.

3. Who is responsible for monetary policy?

The Federal Open Market Committee is responsible for monetary policy.

What is the Fed?

The Federal Reserve is the central bank of the United States.

10. What are the common goals of both fiscal and monetary policy?

The common goals of both fiscal and monetary policy are to influence and stabilize the economy, promote price stability, and promote maximum sustainable employment.

Monetary Tool #1: Reserve Requirements

The simplest way for the Fed to adjust the amount of reserves in the banking system is to change the required reserve ratio. The Fed's Board of Governors has sole responsibility over changes in reserve requirements. However, changing the reserve requirement is not the Fed's preferred tool.

5. What are the tools used to conduct monetary policy?

The tools used to conduct monetary policy are open market operations reserve requirement, interest on required and excess reserves, buying and selling bonds, 3% or 10% of demand deposits, and a discount rate.

What do Federal Reserve Banks do?

These banks gather information from all over the country to help the Fed make decisions

Open-Market Operations

This is when the Federal Reserve buys and sells short term government bonds -if the Fed buys these bonds from banks, it increases money supply -If the Fed issues more bonds, it decreases the money supply.

Recession Solution

Whenever a country enters a recession, there are two classes of responses available: fiscal and monetary policy responses. Fiscal policy responses focus on taxation and spending while monetary policy responses refer to Central Bank activity. In the United States, fiscal policy is administered by the Federal Reserve. The Fed is responsible for influencing the quantity of money and credit in the economy. During the Covid-19 pandemic, the Federal Reserve was responsible for issuing treasury bonds to finance fiscal policy decisions.

FOMC (Federal Open Market Committee)

a group of people who decide how many bonds to buy or sell. This group is also the Fed's primary monetary policy-making body.

2. Expands the money supply more slowly than usual or even shrinks it

a. Contractionary Monetary Policy

What effect would a reduction in the required reserve rate have on banks?

a. They could lend and create more money.

Which of the following is today the Fed's preferred monetary policy tool?

b. using open market operations

When interest rates are high,

borrowers borrow less and therefore spend less

When interest rates are low,

borrowers will find it easier to pay back loans so they will borrow more and spend more

What action does the Federal Open Market Committee take if it wants to decrease the money supply?

c. It sells government securities to bond dealers.

In the US, the Fed CANNOT change interest rates. However they can manipulate interest rates, by

changing the money supply

Fiat

currency that a government has declared to be legal tender, but it is not backed by a physical commodity. -Money that is not backed by anything of real value -US is not on gold standard, our money is not backed by gold

12. In the US, the committee who decides how many bonds to buy or sell.

d. Federal Open Market Committee

How do banks create money by going about their ordinary business?

d. by making loans from a portion of customers' deposits

increasing the reserve requirement

decreases the money supply

7. This is when the federal reserve buys or sells short term government bonds

e. Open Market Operations

Decreasing the discount rate makes it

easier for banks to borrow; more money supply

6. The amount of money that banks are free to loan out

f. Excess Reserves

4. Changing the money supply

g. Monetary Policy

5. Changing government spending or taxes

h. Fiscal Policy

Increasing the discount rate makes it

harder for banks to borrow; less money supply

Lower money supply leads to ____________ interest rates.

higher

3. The price of borrowing money

i. Interest Rate

decreasing the reserve requirement

increases the money supply

9. A bank that offers services to the general public and to companies

j. Commercial Bank

1. Increases the total supply of money in the economy more rapidly than usual

k. Expansionary Monetary Policy

10. The amount of funds that a depository institution must hold in reserve against specified deposit liabilities

l. Reserve Requirement

Higher money supply leads to _______ interest rates

lower

The Fed's goal is

maximum employment and stable prices

Commodity Money

money that has intrinsic value intrinsic value- item has value even if it is not used as money

Expansionary monetary policy

speed up the economy, increase money supply- decrease interest rates. This leads to more borrowing and spending.

If the Fed increases the money supply,

there will be plenty of money for banks to lend out. Consumers have more choices which creates competition. Banks will lower their interest rates to try and win over the customer.