Chapter 15 Macro

FOMC orders a contractionary policy (without monetary policy)

1. The money supply decreases, and interest rates rise. 2. Investment consumption, and net exports all decrease. 3. The AD curve shifts to the left. 4. Real GDP and the price level fall.

FOMC orders expansionary policy (without monetary policy)

1. The money supply increases, and interest rates fall. 2. Investment, consumption, and net exports all increase 3. The AD curve shifts to the right. 4. Real GDP and the price level rise

The Fed pursues four main monetary policy goals:

1.Price stability 2.High employment 3.Stability of financial markets and institutions 4.Economic growth

What two institutions did Congress create in order to increase the availability of mortgages in a secondary​ market? A. ​"Fannie Mae" and​ "Freddie Mac" B. The Bank Oversight Committee and the Department of the Interior C. The National Bureau of Economic Research​ (NBER) and the Bureau of Labor Statistics​ (BLS) D. The Federal Open Market Committee​ (FOMC) and the Federal Deposit Insurance Corporation​ (FDIC)

A

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.) A. Consumption of durable goods B. Government spending C. The value of the dollar D. Business investment projects

A, C, D

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? A. Fiscal policy B. Procyclical policy C. Tight policy D. Countercyclical policy

B

Which of the following is NOT a monetary policyLOADING... goal of the Federal Reserve bank​ (the Fed)? A. Stable financial markets B. Low prices C. Higher living standards D. Low unemployment

B

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? A. The​ long-term nominal interest rate B. The discount rate C. The federal funds rate D. The​ short-term real interest rate

C

Consider the figure. Can the Fed achieve a​ $900 billion money supply​ (MS) AND a​ 5% interest rate​ (point C)? A. Yes. Controlling the money supply sets the interest rate. B. No. The Fed does not control the money supply. C. No. The Fed cannot target both the money supply and the interest rate simultaneously. D. Yes. The Fed can target the money supply or the interest rate.

C

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? A. The Fed can eliminate recessions by properly anticipating the economic events that cause them. B. The Fed is only concerned with the money supply and interest rates. C. The Fed can only soften the magnitude of​ recessions, not eliminate them. D. The Fed​ can, but choses not​ to, eliminate recessions.

C

The federal funds rate A. is set by the Federal Reserve Bank. B. equals the discount rate. C. is the rate that banks charge each other for​ short-term loans of excess reserves. D. only matters to banks and has very little impact on individual consumers.

C

What is inflation​ targeting? A. A policy that attempts to reduce inflation to zero. B. A target that links the​ Fed's target for the federal funds rate to inflation. C. Committing the central bank to achieve an announced level of inflation. D. Another name for contractionary monetary policy.

C

How do investment banks differ from commercial​ banks? ​(Mark all that​ apply.) A. Investment banks take deposits. B. Commercial banks do not lend to households. C. Investment banks generally do not lend to households. D. Investment banks do not take deposits. E. Commercial banks are financial advisors to firms issuing stocks.

C, D

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? A. ​Initially, firms hold more money than they want relative to other financial assets. B. Increased demand for Treasury securities drives down their interest rate. C. Increased demand for Treasury securities drives up their prices. D. All of the above.

D

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? A. The Fed should target BOTH the interest rate and the money supply. B. The Fed should target the interest​ rate, not the money​ supply, and that it should adopt the monetary growth rule. C. The Fed should target NEITHER the interest rate nor the money supply. D. The Fed should target the money​ supply, not the interest​ rate, and that it should adopt the monetary growth rule.

D

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 AD2, policy and reach equilibrium​ (point C) in the second​ period? ​ (What policy will increase the price level and increase actual real​ GDP?) A. Decrease taxes B. Increase the reserve requirement C. Increase the discount rate D. Open market purchase of government securities

D

The Fed buys and sells bonds as a part of its policy to reach all of the following objectives​ except: A. Stability of financial markets and institutions. B. Price stability. C. Economic growth. D. High unemployment.

D

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 AD2, policy and reach equilibrium​ (point C) in the second​ period? A. Increase the reserve requirement. B. Raise the discount rate. C. Decrease taxes. D. Open market purchase of government securities.

D

Why did the Fed help JP Morgan Chase buy Bear​ Stearns? A. Failure of Bear Stearns would lead to a larger investment bank failure. B. JP Morgan Chase is an influential partner with the Fed. C. Commercial banks would be reluctant to lend to investment banks. D. All of the above. E. A and C only.

E

law that assigned to the federal government the responsibility for promoting full employment and price stability

Employment Act of 1946

is the estimate of the inflation-adjusted federal funds rate that would be consistent with maintaining real G D P at its potential level in the long run.

Equilibrium real federal funds rate

the interest rate banks charge each other for overnight loans.

Federal funds rate

•is the difference between current inflation and the Fed's target rate of inflation (could be positive or negative)

Inflation gap

A framework for conducting monetary policy that involves the central bank announcing its target level of inflation.

Inflation targeting

Why does the Fed use their monetary tools?

It uses these tools to try to keep both the unemployment and inflation rates low.

The actions the Federal Reserve takes to manage the money supply and interest rates to pursue macroeconomic policy goals.

Monetary Policy

We saw in the previous chapter that the Fed alters the money supply by buying and selling U.S. Treasury securities----

Open market operations

is the difference between current real G D P and potential G D P (could be positive or negative)

Output gap

in mortgages was made possible by the formation of the Federal National Mortgage Association ("Fannie Mae") and the Federal Home Loan Mortgage Corporation ("Freddie Mac").

Secondary market

believing that prices will rise even higher and buying the asset intending to sell it before prices fall.

Speculation

is a rule developed by John Taylor of Stanford University that links the Fed's target for the federal funds rate to economic variables.

Taylor rule

What are the two models of the interest rate The two interest rates are closely related one increases this will result in another one to increase also

The loanable funds model The money market model

The troubled in the banking system led Congress to pass the _________________, providing funds to banks in exchange for stock—another unprecedented action.

Troubled Asset Relief Program (T A R P)

Many economists were critical of the Fed underwriting Bear Stearns, as managers would now have less incentive to avoid risk:

a moral hazard

When the Federal Reserve was created in the 19 13, its main responsibility was to prevent

bank runs

in a market refers to a situation in which prices are too high relative to the underlying value of the asset.

bubble

To increase the money supply, the Fed ________ those securities

buys

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

buys, sells

How Interest Rates Affect Aggregate Demand

consumption, investment, and net exports

If real G D P growth was faster than expected, the policy would be

contractionary

increasing interest rates to reduce inflation.

contractionary monetary policy

monetary policy would serve to destabilize the economy; the monetary growth rule would provide stability instead.

countercyclical

•Banks became less willing to lend, and the resulting __________ further depressed the housing market.

credit crunch

In the​ figure, the opportunity cost of holding money ▼ increases decreases remains the same when moving from Point A to Point B on the money demand curve.

decreases

In 2008, the Fed temporarily made these ___________ available to investment banks also, in order to ease their ___________ problems.

discount loans; liquidity

Price stability and high employment are often referred to as the ________________ of the Fed.

dual mandate

If real G D P growth slowed, the policy would be

expansionary

when it takes actions to decrease interest rates to increase real G D P.

expansionary monetary policy

There are many different interest rates in the economy; the Fed targets the

federal funds rate

Stable and efficient ___________ are essential to a growing economy.

financial markets

Good policy requires accurate

forecasts

The Fed tries to set policy according to what it ___________ the state of the economy will be in the future.

forecasts

The Fed makes ________ available to banks in times of crisis, ensuring confidence in those banks.

funds

•sell bonds to investors and use the funds to purchase mortgages from banks.

government-sponsored enterprise (GSEs)

•failing to correctly evaluate the value of the asset and instead relying on other people's apparent evaluations; and/or

herding behavior

•The market for securities based on these loans became very _____—few people or firms were willing to buy them, and their prices fell quickly.

illiquid

•With a smaller down payment, you are said to be highly ___________, exposed to large potential changes in the value of your investment.

leveraged

the Fed was unable to push rates any lower to encourage investment.

liquidity trap

Expansionary is sometimes called ______ or _____ monetary policy

loose, easy

increasing the money supply at about the long-run rate of real G D P growth.

monetary growth rule

Since WWII, the Fed has carried out an active _________________

monetary policy

By the 2000s, investment banks had started buying mortgages also, packaging them as ___________ and reselling them to investors.

mortgage-backed securities

Other economists and policymakers have suggested that the Fed should adopt

nominal G D P targeting.

Fed's #1 goal is

price stability

Decreasing the money supply would require _____ securities.

selling

•The Fed does not _______ the federal funds rate, but rather affects the supply of bank reserves through open market operations.

set

The ▼ long-term real interest rate short-term nominal interest rate is considered the most relevant interest rate when conducting monetary policy.

short-term nominal interest rate

Economic growth, particularly __________ economic growth, encourages long-run investment, which is itself necessary for growth.

stable

The high prices resulted in high levels of investment in new home construction, along with optimistic

sub-prime loans

Contractionary monetary policy is "_____________" monetary policy.

tight

What could cause the money demand curve to shift?

•A change in the need to hold money, to engage in transactions.

Dynamic aggregate demand and aggregate supply model. Recall that this features:

•Annual increases in long-run aggregate supply (potential G D P) •Typically, larger annual increases in aggregate demand •Typically, smaller annual increases in short-run aggregate supply •Typically, therefore, annual increases in the price level

The loanable funds model

•Concerned with long-term real rate of interest •Relevant for long-term investors (firms making capital investments, households building new homes, etc.)

The money market model

•Concerned with short-term nominal rate of interest •Most relevant for the Fed: changes in money supply directly affect this interest rate

The Fed's two monetary policy targets are related in an important way:

•Higher interest rates result in a lower quantity of money demanded.

Arguments for Inflation Targeting

•Makes it clear that the Fed cannot affect real G D P in the long run. •Easier for firms and households to form expectations about future inflation, improving their planning. •Promotes Fed account-ability—provides a yardstick against which performance can be measured.

The Fed has three monetary policy tools at its disposal:

•Open market operations •Discount policy •Reserve requirements

Arguments against inflation targeting

•Reduces the Fed's flexibility to address, and accountability for, other policy goals. •Assumes the Fed can correctly forecast inflation rates, which may not be true. •Increased focus on inflation rate may result in Fed being less likely to address other beneficial goals.

When the interest rate is high, alternatives to holding money begin to look attractive—like U.S. Treasury bills.

•So the opportunity cost of holding money is higher when the interest rate is high.

It does this (at least, in "normal" times) by directly influencing its monetary policy targets:

•The money supply •The interest rate (primary monetary policy target of the Fed)

But with more money flowing into mortgage markets, "worse" loans started to be made to people:

•With worse credit histories (sub-prime loans) •Without evidence of income ("Alt-A" loans) •With lower down-payments •Who couldn't initially afford traditional mortgages (adjustable-rate mortgages start with low interest rates)