Macro Economics Final

L

short term liquid financial assests

Which of the following Fed actions will increase bank lending? LO3 Select one or more answers from the choices shown. a. The Fed raises the discount rate from 5 percent to 6 percent. b. The Fed raises the reserve ratio from 10 percent to 11 percent. c. The Fed buys $400 million worth of Treasury bonds from commercial banks. d. The Fed lowers the discount rate from 4 percent to 2 percent.

the fed buys $400 million worth of Treasury bonds from commercial banks the fed lowers the discount rate from 4% to 2%

In January, the interest rate is 5 percent and firms borrow $50 billion per month for investment projects. In February, the federal government doubles its monthly borrowing from $25 billion to $50 billion. That drives the interest rate up to 7 percent. As a result, firms cut back their borrowing to only $30 billion per month. Which of the following is true? LO6 a. There is no crowding-out effect because the government's increase in borrowing exceeds firm's decrease in borrowing. b. There is a crowding-out effect of $20 billion. c. There is no crowding-out effect because both the government and firms are still borrowing a lot. d. There is a crowding-out effect of $25 billion

there is a crowding-out effect of $20 billion 50 - 30 = 20

What is the role of deposit insurance in a fractional reserve system?

used to avoid bank runs as it guarantees everyone will get their money so there is no need to try an withdraw it before everyone else

When a commercial bank makes loans, it creates money; when loans are repaid, money is destroyed." Explain

when a loan is made a checkable deposit is also made of equal value which increases M1. Since the bank doesn't have to hang on to all the money some can be loaned out while staying the same amount at the actual bank. It keeps happening so M1 keeps increasing. When a check is written to pay off a loan it decreases checkable deposits

Suppose that a small country currently has $4 million of currency in circulation, $6 million of checkable deposits, $200 million of savings deposits, $40 million of small denominated time deposits, and $30 million of money market mutual fund deposits. From these numbers we see that this small country's M1 money supply is ____________, while ____________ its M2 money supply is

$10 million, $280 million

A meal at a McDonald's restaurant in New York costs $8. The identical meal at a McDonald's restaurant in London costs £4. According to the purchasing-power-parity theory of exchange rates, the exchange rate between U.S. dollars and British pounds should tend to move toward

$2 = £1

A bank currently has $100,000 in checkable deposits and $15,000 in actual reserves. If the reserve ratio is 20 percent, the bank has ___________ in money-creating potential. If the reserve ratio is 14 percent, the bank has ___________ in money-creating potential

-$5,000; $1,000 100,000 x.2 = 20000, 15000-20000=-5000, 100,000x.14=14000, 15000-14000 = 1000

Assume that Jimmy Cash has $2,000 in his checking account at Folsom Bank and uses his checking account card to withdraw $200 of cash from the bank's ATM machine. By what dollar amount did the M1 money supply change as a result of this single, isolated transaction?

0 because the cash is still part of M1

If the required reserve ratio is 10 percent, what is the monetary multiplier? If the monetary multiplier is 4, what is the required reserve ratio

1/.1 = 10% 1/.25 = 4

The Third National Bank has reserves of $20,000 and checkable deposits of $100,000. The reserve ratio is 20 percent. Households deposit $5000 in currency into the bank and that currency is added to reserves. What level of excess reserves does the bank now have?

5000 x .2 = 1000 5000 - 1000 = 4000

Which of the following is not a function of the Fed? a. Setting reserve requirements for banks. b. Advising Congress on fiscal policy. c. Regulating the supply of money. d. Serving as a lender of last resort.

Advising congress on fiscal policy

Explain how built-in (or automatic) stabilizers work. What are the differences between proportional, progressive, and regressive tax systems as they relate to an economy's built-in stability

As taxes rise so does GDP but the rising taxes also dampen GDP, in a recession GDP drops and so do taxes but the drop in taxes softens the drop of GDP Proportional - rate stays the same, cant offset the changes if both proportional Progressive - most stabilizing, tax rate increases as income increases Regressive - least stabilizing, rate increases as income decreases

Why is the banking system in the United States referred to as a fractional reserve bank system?

Banks don't have to hold onto all the money deposited to them so they cannot pay back every withdrawal at once, i.e. a bank run

Define the cyclically-adjusted budget, explain its significance, and state why it may differ from the actual budget. Suppose the full-employment, noninflationary level of real output is GDP3 (not GDP2) in the economy depicted in Figure 13.3. If the economy is operating at GDP2, instead of GDP3, what is the status of its cyclically-adjusted budget? The status of its current fiscal policy? What change in fiscal policy would you recommend? How would you accomplish that in terms of the G and T lines in the figure?

Cyclically adjusted budget - measures what Federal deficit or surplus would be at full employment with current tax and spending policies. Balanced means there is no expansionary or contractionary policies Actual budget - deficit or surplus from revenues and expenditures that happen over a year not at full employment Cyclically adjusted is contractionary since a surplus would exist. To move to full employment cut taxes or increase spending. Raise G or lower T until they intersect at GDP3

Explain why the U.S. demand for Mexican pesos is down sloping and the supply of pesos to Americans is up sloping.

Down sloping - When the peso depreciates goods and services become cheaper so the us demands more of them and thus more pesos Up sloping - when the peso appreciates mexico demands more us goods and services so buy more dollars which supplies more pesos

Which group votes on the open-market operations that are used to control the U.S. money supply and interest rates?

FOMC the federal open market committee

Assume that a hypothetical economy with an MPC of .8 is experiencing severe recession. By how much would government spending have to rise to shift the aggregate demand curve rightward by $25 billion? How large a tax cut would be needed to achieve the same increase in aggregate demand? Determine one possible combination of government spending increases and tax increases that would accomplish the same goal without changing the amount of outstanding debt

Increased G change in gov spending x spending multiplier = change in AD Spending multiplier 1/MPS 1/(1-.8) = 1/.2 = 5 25/5 = 5 billion Decreased T Change in T x MPC x spending multiplier = change in AD .8 x 5 = 4 25/4 = 6.25 billion Combining the two effects

Why does the Federal Reserve require commercial banks to have reserves? Explain why reserves are an asset to commercial banks but a liability to the Federal Reserve Banks. What are excess reserves? How do you calculate the amount of excess reserves held by a bank? What is the significance of excess reserves?

It is a way to control the money supply because it is done by increasing or decreasing reserves. Reserves are cash that belong to commercial bank and are a claim they have against the fed. Reserves deposited at the fed are funds they owe/ claims commercial banks have against them

M2

M1 plus savings deposits, small denomination time deposits (CDs), money market mutual fund shares

Explain the links between changes in the nation's money supply, the interest rate, investment spending, aggregate demand, real GDP, and the price level

Money supply and price level/ inflation are inversely related. Interest rate and investment spending are inversely related. Investment spending is part of aggregate demand so those move together with GDP. Less spending (AD) reduces inflationary pressure and reduce prices

What are government's fiscal policy options for ending severe demand-pull inflation? Which of these fiscal options do you think might be favored by a person who wants to preserve the size of government? A person who thinks the public sector is too large? How does the "ratchet effect" affect anti-inflationary fiscal policy

Reduce government spending, increase taxes, or combo. Tax increase that preserves government spending programs. Cut government spending since it would reduce government. Ratchet effect - prices are rigid downward

Suppose that you are a member of the Board of Governors of the Federal Reserve System. The economy is experiencing a sharp rise in the inflation rate. What change in the Federal funds rate would you recommend? How would your recommended change get accomplished? What impact would the actions have on the lending ability of the banking system, the real interest rate, investment spending, aggregate demand, and inflation?

Reduce inflation = raise federal funds. Increase interest rates including the federal funds rate. Can be accomplished by contractionary policy, raise the discount rate, sell bonds, increasing Federal Reserve requirement. The restrictive monetary policy would decrease ability to make loans, investment, demand, inflation while increasing interest rates

Suppose the government misjudges the natural rate of unemployment to be much lower than it actually is, and thus undertakes expansionary fiscal and monetary policies to try to achieve the lower rate. Explain why these policies might at first appear to succeed. Explain the long-run outcome of these policies

Short run - Aggregate demand shifts out because of expansionary monetary of fiscal policy. GDP increases employment increases, over employment raises the price level (inflation) Long run - leads to wanting higher wages meaning aggregate supply shifts back to potential (full employment) GDP and creates a little more inflation End up at equilibrium but with a slightly higher price level than starting

Why might economists be quite concerned if the annual interest payments on the U.S. public debt sharply increased as a percentage of GDP?

Size of debt can be weighted by noting the size of interest payments in relation to GDP. Either the debt has drastically increased (or it's interest rate) or GDP has dropped

Suppose that an economy begins in long-run equilibrium before the price level and real GDP both decline simultaneously. If those changes were caused by only one curve shifting, then those changes are best explained as the result of

The AD curve shifting left

Explain why a single commercial bank can safely lend only an amount equal to its excess reserves but the commercial banking system as a whole can lend by a multiple of its excess reserves.

When money is loaned it is spent and so the first bank's excess loans will end up at another bank so they cannot loan out more than the excess reserves otherwise they would be below the required level. the bank loses the reserves but the system doesn't. Each bank needs to keep the required reserves but can loan out the rest. What is loaned out at each bank after the 1st loan is an increase to the money supply. example: the reserve ratio is 20%, A loans 100, b loans 80, c loans 64 meaning 244 has been created.

Diagram a market in which the equilibrium dollar price of 1 unit of fictitious currency zee (Z) is $5 (the exchange rate is $5 =Z1). Then show on your diagram a decline in the demand for zee. LO4 a. Referring to your diagram, discuss the adjustment options the United States would have in maintaining the exchange rate at $5 = Z1 under a fixed-exchange-rate system b. How would the U.S. balance-of-payments surplus that is caused by the decline in demand be resolved under a system of flexible exchange rates

a. There is a surplus of Zs so either demand has to shift right or supply needs to shift left. Shift demand - government buys zs with dollars, policies to increase imports to US, expansionary policy to increase domestic output so imports from Z increases b. The surplus causes Zs to depreciate and the dollar to appreciate until the surplus is eliminated at the 4 = Z, Us imports more, Z imports less

Assuming a system of flexible exchange rates between Mexico and the United States, indicate whether each of the following would cause the Mexican peso to appreciate or depreciate, other things equal: LO3 a. The United States unilaterally reduces tariffs on Mexican products b. Mexico encounters severe inflation c. Deteriorating political relations reduce American tourism in Mexico d. The U.S. economy moves into a severe recession. Depreciate e. The United States engages in a high-interest-rate monetary policy f. Mexican products become more fashionable to U.S. consumers g. The Mexican government encourages U.S. firms to invest in Mexican oil fields h. The rate of productivity growth in the United States diminishes sharply

a. appreciate b. depreciate c. depreciate d. depreciate (less imports) e. depreciate f. appreciate g. appreciate h. appreciate

Explain: "U.S. exports earn supplies of foreign currencies that Americans can use to finance imports." Indicate whether each of the following creates a demand for or a supply of European euros in foreign exchange markets: LO1 a. A U.S. airline firm purchases several Airbus planes assembled in France. b. A German automobile firm decides to build an assembly plant in South Carolina. c. A U.S. college student decides to spend a year studying at the Sorbonne in Paris. d. An Italian manufacturer ships machinery from one Italian port to another on a Liberian freighter. e. The U.S. economy grows faster than the French economy. f. A U.S. government bond held by a Spanish citizen matures, and the loan amount is paid back to that person. g. It is widely expected that the euro will depreciate in the near future

a. demand b. supply c. demand d. supply e. demand f. demand g. supply

How would a decrease in the reserve requirement affect the (a) size of the money multiplier, (b) amount of excess reserves in the banking system, and (c) extent to which the system could expand the money supply through the creation of checkable deposits via loans?

a. increase (multiplier = 1/(1-required reserve ratio)) b. increase c. more loans can be made so potential money creation increases

What is the basic objective of monetary policy?

achieve full employment and non-inflationary level of output

The exchange rate between the U.S. dollar and the British pound starts at $1 = £0.5. It then changes to $1 = £0.75. Given this change, we would say that the U.S. dollar has _________ while the British pound has _____________.

appreciated, depreciated

Last year, while an economy was in a recession, government spending was $595 billion and government revenue was $505 billion. Economists estimate that if the economy had been at its full-employment level of GDP last year, government spending would have been $555 billion and government revenue would have been $550 billion. Which of the following statements about this government's fiscal situation are true? a. The government has a non-cyclically adjusted budget deficit of $595 billion. b. The government has a non-cyclically adjusted budget deficit of $90 billion. c. The government has a non-cyclically adjusted budget surplus of $90 billion. d. The government has a cyclically adjusted budget deficit of $555 billion. e. The government has a cyclically adjusted budget deficit of $5 billion. f. The government has a cyclically adjusted budget surplus of $5 billion

b. The government has a non-cyclically adjusted budget deficit of $90 billion e. The government has a cyclically adjusted budget deficit of $5 billion.

Refer to the table for Waxwania above. Suppose that Waxwania is producing $600 of real GDP, whereas the potential real GDP (or full-employment real GDP) is $700. How large is its budget deficit? Its cyclically adjusted budget deficit? Its cyclically adjusted budget deficit as a percentage of potential real GDP? Is Waxwania's fiscal policy expansionary or is it contractionary

budget deficit - 160 - 120 = 40 cyclically adjusted - 160 - 140 = 20 as a percentage - 20/700 = .02857 = 2.86% since running a cyclically adjusted deficit the fiscal policy is expansionary

M1

currency in the hands of the public, account balances, travelers checks

Distinguish between the federal funds rate and the prime interest rate. Why is one higher than the other? Why do changes in the two rates closely track one another?

federal funds rate - interest rate banks charge on overnight loans to make reserve requirements. Lower because loaned overnight so don't have to wait long for repayment since wouldn't generate interest if not loaned out. Less risky Prime interest rate - interest rate banks charge on loans to credit worthy customers Both are related to the scarcity of available reserves. If fewer reserves then higher interest to borrow them

What are the major strengths of monetary policy? Why is monetary policy easier to conduct than fiscal policy?

flexible, faster because the board of governors don't have to deal with politics and they have a good track record. monetary policy is made by the seven governors while fiscal policy needs approval by congress and the president

What is the monetary multiplier, and how does it relate to the reserve ratio?

if the reserve ratio is 20% the money multiplier is 1/(1-.8) = 1/.2 = 5. the multiplier is inversely related to the reserve ratio

Three functions of Money

medium of exchange, unit of account, store of value

City Bank is considering making a $50 million loan to a company named Sheet Oil that wants to commercialize a process for turning used blankets, pillowcases, and sheets into oil. This company's chances for success are dubious, but City Bank makes the loan anyway because it believes that the government will bail it out if Sheet Oil goes bankrupt and cannot repay the loan. City Bank's decision to make the loan has been affected by: a. Liquidity. b. Moral hazard. c. Token money. d. Securitization.

moral hazard

Suppose that Lady Gaga goes to Las Vegas to play poker and at the last minute her record company says it will reimburse her for 50 percent of any gambling losses that she incurs. Will Lady Gaga wager more or less as a result of the reimbursement offer? What economic concept does your answer illustrate?

more, moral hazard. since she will be reimbursed for half her losses she will gamble more