Macro Final
Four Monetarists Positions
1. Velocity changes in predictable way but does not change very much form one period to the next 2. Aggregate demand depends on the money supply and velocity 3. The SRAS curve is upward sloping 4. The economy is self regulating ( prices and wages are flexible)
If Real GDP is $8,000, the money supply is $3,100, and velocity is 4, then the price level is
1.55
The Monetarist Transmission Mechanism
Changes in the money market directly affect aggregate demand in the goods and services market
Monetary policy
Changes in the money supply, or in the rate of change of the money supply, to achieve particular macroeconomic goals
M1 money supply
Currency held outside banks , + checkable deposits and + travelers checks
The major policy making group within the fed
FOMC
M2 money supply
Is equal to M1, + savings deposits. ( including money market accounts) , + small denomination time deposits and + money market mutual funds (retail)
Real interest rate caculation
Nominal interest - expected inflation rate
Can continued declines in SRAScause continued inflation?
Not likely as it is not supported by recent history , and wages are not likely to increase as demand for labor decreases
Tools for increasing and decreasing the money supply
Open market operations, required reserve ratio and discount rate
Nominal interest rate caculation
Real interest rate + expected inflation rate
Demand for money
Represents the inverse relationship between the quantity demanded of money balances and the price of holding money balances , interest rate is the price (opportunity cost) of holding money balances
Excess reserves calculation
Reserves - required reserves
If bank A borrows $10 million from bank B, what happens to the reserves in bank A? What happens in the banking system?
Reserves in bank A rise; reserves in the banking system remain the same (bank B loses the reserves that bank A borrowed).
If bank A borrows $10 million from the Fed, what happens to the reserves in bank A? in the banking system?
Reserves in bank A rise; reserves in the banking system rise because there is no offset in reserves for any other bank.
Federal open market committee
The 12-member policy making group within the fed , a 7 member board of governors and 5 federal reserve district bank presidents
Money as a store of value
The ability of an item to hold value over time
Open market operations
The buying and selling of government securities by the fed
Open market purchase
The buying of U.S. government securities by the fed
Real interest rate
When the expected inflation rate is zero, the real interest rate equals nominal interest rate
Continued Inflation
a continued increase in the price level
Discount loan
a loan the fed makes to a commercial bank
Federal Funds Market
a market where banks lend reserves to one another, usually for short periods
One - Shot inflation
a one-time increase in the price level. an increase in the price level that is NOT continued
Money as a unit of account
A common measure in which relative values are expressed
Required reserves ratio (r)
A percentage of each dollar deposited that must be held on reserves (at the fed or in the banks vault )
Money
Any good that is widely accepted for purposes of exchange and in the repayment of debt
Excess reserves
Any reserves held beyond the required amount
Money as a medium of exchange
Anything that is generally acceptable in exchange for goods and services
Equilibrium in the Money Market
At an interest rate of i1, the money market is in equilibrium : There is neither an excess supply of money nor an excess demand for money
Reserves calculation equals
Banks deposits at the fed + vault cash
If checkable deposits in Bank A total $300 million and the required reserve ratio is 10 percent, then required reserves at Bank A equal
$30.0 million
If the federal reserve sets the legal reserve requirement at 1.00 then
all bank deposits would be held as required reserves
which of the following represents an action by the federal reserve that is designed to decrease the money supply?
an increase in the discount rate
If the fed buys government securities , then there is
an increase in the supply of money
What causes continued increases in aggregate demand?
continued increase in M and continued increase in AD -> continued inflation
What is the most important responsibility of the Fed?
the fed controls the money supply
Monetary policy - Contractionary
the fed decreases the money supply to address an inflationary gap
Federal Funds Rate
the interest rate in the federal funds market; the interest rate banks charge one another to borrow reserves
Discount rate
the interest rate the fed changes depository institutions that borrow reserves from it; the interest rate charged on a discount loan
Open market sale
the selling of U.S. government securities by the fed
The supply of Money
the supply curve of money is a vertical line at the quantity of money, which is largely, but not exclusively, determined by the Fed
A bank reduces its deposits at the fed by $5 million and increases its vault cash by $5 million. What happens to the banks reserves?
they remain constant
Why do banks borrow reserves
to increase loan making ability, and to meet required reserves requirements
an open-market sale of securities by the fed results in _____ in reserves and _____ in the supply of money
decrease;decrease
a decrease in the discount rate will most likely
increase the money supply
an open market purchase of securities by the fed results in _____ in reserves and ____ in the supply of money
increase; increase
when the fed lowers the required reserve ratio, the banks excess reserves _____ and the money supply ___
increase; increase
One-shot inflation can originate
on the demand side or the supply side of the economy.
The most commonly used tool in monetary policy is
open market operations
which of the following statements is true?
open market operations can be used by the federal reserves with some precision
Required reserves calculation equals
r x checkable deposits
What is the difference between the federal funds rate and the discount rate?
The federal funds rate is the interest rate that one bank charges another bank for a loan. The discount rate is the interest rate that the Fed charges a bank for a loan.
Board of governors
The governing body of the federal reserve system, they coordinates and control activities of the federal reserve system
Nominial interest rate
The interest rate actually charged ( or paid) in the market; the market interest rate
Requires reserves
The minimum amount of reserves a bank must hold against its checkable deposits as mandated by the fed
Federal open market committee II
The president of the federal reserves bank of New York holds a permanent seat on the FOMC and the other four positions are rotated among the federal reserve bank district bank presidents
Reserves
The sum of bank deposits at the fed and vault cash
Simple Quantity Theory of Money
The theory that assumes that velocity and Real GDP are constant and predicts that changes in the money supply lead to strictly proportional changes in the price level
How does the money supply change as a result of (a) an increase in the discount rate, (b) an open market purchase, (c) an increase in the required reserve ratio
a. the money supply falls. b. The money supply rises. c. The money supply falls.
If the federal reserve raises the legal reserve requirement from 0.10 to 0.20 then,
banks will reduce the loans they make and the money supply in the economy will fall
The fractional reserve banking system is one in which banks within the system
can lend out only a fraction of their reserves
The discount Window
fed sets discount rate below federal funds rate -> banks borrow from fed -> banks have more reserves -> banks may make more loans and checkable deposits -> money supply rises
Maximum change
in checkable deposits = (1/r)
Equation of exchange
money supply times velocity must be equal to the price level times Real GDP
If the Fed lowers the discount rate (relative to the federal funds rate), banks will (likely) borrow __________ from the Fed, which will __________ reserves in the banking system, and eventually __________ the money supply.
more, increase, raise
Monetary policy - Expansionary
the Fed increases the money supply to address a recessionary gap