econ 102 final exam

what really happened during the great depression (explain with terms from new chapter)

1) once people realized what was going on they started to withdraw their money from banks which led 3,000 banks to fail 2) if everyone is withdrawing money the money supply is obviously going to decrease because of a decrease in the money multiplier- not because of the fed (which was claimed by milton friedman and anna schwartz) 3) a decrease in the money multiplier leads to an increase in the currency drain ratio and the required reserve ratio which makes it harder for banks to make loans etc. 4) there was also a decrease in monetary base (which is made up of currency and the banks reserves) because people were withdrawing their money because of the financial crisis (causing many banks to fail)

Reserves consist of the currency in the​ _____ plus the balance on its​ _____ account at​ _____.

banks vaults; reserve; a federal reserve bank

the supply-side effect of an increase in taxes ______ employment and ______ real GDP

decreases; decreases

when the fed sells securities in the open market the monetary base _____ and the interest rate _____

decreases; rises

an increase in public investment

increases aggregate demand because investment is a component of aggregate demand, and in the long run increases capital, which increases potential GDP and aggregate supply

by lowering the interest rate the Fed makes it ______ costly for banks to borrow monetary base and the interest rate ______

less; falls

what are the objectives of monetary policy?

maximum employment, stable prices, and moderate long-term interest rates

what is the money multiplier

(1+ (C/D))/(R/D)+(C/D))

what is the second way to lower the federal funds rate (show all steps)

1) other short term and long term interest rates 2) real long term and short term interest rates decrease 3) this increases borrowing by HH and firms 4) this increases consumption and investment 5) this increases real GDP and inflation

monetary policy transmission mechanism (expansionary monetary policy example)

1) target federal funds rate 2) fed buys bonds (government securities) 3) this increases the excess reserves of banks 4) this now increases the amount of lending that banks can do 5) then borrowing increases by households and firms 6) consumption expenditure increases, investment increases, AD increases 7) this then increases real GDP and inflation

what are the goals of interest rates on reserves?

1) to reduce fluctuations in excess reserves (most important) 2) to improve implementations of MP (monetary policy) 3)encourage banks to hold excess reserves so that depositors view their deposits as safe

automatic fiscal policy

Changes in government expenditures and/or taxes that occur automatically without (additional) congressional action.

discretionary fiscal policy

Changes in taxes or spending that are the result of deliberate changes in government policy.

when a bank makes a loan, _____. The amount of loans and new deposits that a bank can create is limited by _____.

It creates a new deposit for the person who receives the loan; the banks excess reserves, the desired reserve ratio; and the currency drain ratio

what is the quantity of money or M, made up of?

M= D+C (deposits and currency)

what is the monetary base or MB made up of?

MB= R+C (desired reserves and currency)

what would be the overall impact on the money multiplier and the money supply if the banks decided to hold more excess reserves than before?

R/D increases, money multiplier goes down and m1 decreases (increase in excess reserves means a decrease in loans that are lent out)

can the fed change the discount rate?

The Fed would most likely not change the discount rate because it​ doesn't directly affect the money multiplier.

What is the Fed and what is the​ FOMC?

The fed regulates financial institutions and the FOMC meets every 6 weeks to discuss the review the state of the economy

limiting the Feds independence could result in

a congressional bias toward persistently increasing money growth to increase real GDP growth, resulting in higher inflation and higher interest rates in the long run

quantitative easing or large scale asset purchases (LSAP)

a large scale open market purchase at a low or possibly zero federal funds rate -this lowers long term interest + mortgage rates (doesn't mean people are going to go out and buy houses but they will be more active in the market) -also eases credit condition

The shoe leather costs of inflation include all of the following EXCEPT: A. the lost purchasing power of cash. B. the extra costs incurred to avoid holding cash. C. the cost of more frequent trips to the bank. D. the installation of a new cash management system

a. the lost purchasing power of cash

what happens if there is a low interest rate to increase interbank loans?

aggregate demand is affected which then creates an overheating of the economy since there is too much credit in the economy

the shoe leather costs of inflation are costs that arise from

an increase in the velocity of circulation of money

a decrease in tax revenues in a recession is _______ fiscal policy additional government expenditure to upgrade highways is ______

automatic; discretionary

forward guidance

communication by the central bank about future policy prospects (likely future course of monetary policy)

when the Fed raises the federal funds rate,

consumption expenditure, investment, and net exports decrease up to a year later

what is monetary base made up of?

currency in circulation and bank reserves

what is money supply made up of?

currency in circulation and checkable deposits

when the economy is at full employment what is there none of?

cyclical unemployment but there can be structural, seasonal, and frictional unemployment

increase in excess reserves due to an increase in the required reserve ratio...

decrease in loans lent out call back loans decrease in money supply

when reserves in the banking system ____. Banks _____loans.

decrease; call in

if the government cuts its outlays but tax revenue is unchanged, explain the effects on saving, investment, the real interest rate, and growth of real GDP the real interest rate ____ Private saving ____, and total saving ____ Investment ____ and the growth rate of real GDP ______.

falls decreases; increases decreases; decreases increases; increases

the government cuts the income rax rate. The real wage rate paid by employers ____, and the real wage rate received by employees ____

falls; rises

the government cuts the income tax rate. As a result, the supply of labor _____ and the demand for labor ____.

increases; does not change

the government cuts the income tax rate. The equilibrium level of employment ____ potential GDP _____.

increases; increases

in the long run what is money growth equal to

inflation rate + real GDP growth rate

the fed uses it's policy tools to...

influence the interest rate and regulate the amount of money circulating the United States by adjusting the reserves in the banking system

interest rate on reserves

interest paid on required reserve balances and on excess reserve balances (when lend it out, earn interest, vs, if don't

discount rate

interest rate on loans from the central bank to commercial banks

besides the fed, who else can borrow money in the LF market>

investment banks (they can also do this in the private sector and other financial institutions)

what happens when the required reserve ratio increases?

it decreases the money multiplier

what happens to the discount rate when there is an increase in M1

it decreases therefore there can be an increase in 1) loans to commercial banks 2) reserves 3) lending from excess reserves

what happens to the discount rate when there is a decrease in M1

it increases

when the fed raises the federal funds rate,

it takes a few weeks to a few months for the quantity of money and supply of loanable funds to decrease

by increasing the required reserve ratio, the fed forces banks to hold a _____ quantity of monetary base and the interest rate _____

larger; rises

Lender of Last resort (liquidity provision)

lending to financial institutions purposes: enhance the stability of the financial system -promote credit availability

what happens when there is an increase in the currency drain ratio

money multiplier decreases and m1 decreases HH decrease deposits into banks HH withdraw money from banks reduce the amount of reserves in banks decrease loans lent out

can the fed change the currency drain?

no, that is determined by households and firms

real interest rate=

nominal interest rate - inflation rate

what are the shoe leather costs of inflation?

refers to the cost of time and effort that people spend trying to counter-act the effects of inflation, such as holding less cash and having to make additional trips to the bank.

What are the Fed's main policy tools?

required reserve ratios, discount rate, and open market operations

bank reserves

required reserves + excess reserves

the federal funds rate is the interest rate at which banks can borrow and lend _____ in the _____ market

reserves; federal funds

if the fed wants to decrease the quantity of money. It makes an open market _____.

sale

how can the fed indirectly control M1

since M1= m * MB they can "control" M1 by changing MB (they do this by purchasing bonds in the open mkt)

the rise in the U.S. interest rate and expectations that the European central bank will lower interest rates, _______

the demand for U.S. dollar increases and the supply of U.S. dollar decreases (think of it in terms of the fed decreasing the supply of money when they sell securities)

in an economy with hyperinflation vs. an economy with stable prices, which has a higher money growth rate and why?

the economy with hyperinflation has a higher growth rate because in the long run, money growth= inflation rate + real GDP growth rate

which economy has a higher velocity of circulation, one with hyperinflation or one with stable prices? how about more frequent wage payments?

the economy with hyperinflation would have a higher velocity of circulation and more frequent wage payments because the opportunity cost of money increases under hyperinflation

what is the fed's monetary policy instrument? a monetary policy instrument is...

the federal funds rate a variable that the fed can directly or closely target

required reserve ratio

the minimum percentage of checkable deposits a bank must hold as reserves

what happens to reserves when the fed buys government securities?

the money is transferred from securities to reserves and lowers the securities to increase the reserves

desired reserve ratio

the percentages of checkable deposits a bank holds as reserves

what is a required reserve ratio?

the portion of a deposit that a bank must keep on hand

what is an open market operation>

the purchase of gov. securities by the federal reserve system in the open market

if the fed raises the interest rates too late...

the recovery will be too strong and the inflation rate will be too high

if the fed raises the interest rate too soon...

the recovery will be too weak and the unemployment rate will be too high for too long

a deficit reduction plan that includes an increase in taxes on the wealthy might have serious supply-side consequences because _____

the wealthy will decrease their supply of labor and decrease their saving, which will decrease potential GDP

how does the fed lower long term interest rates

they buy LT bonds - this increases price of LT bonds and decreases LT interest rates

what happens when the Fed decreases the required reserve ratio?

they decrease the amount that banks need to hold in excess reserves which allows them to lend out more money

the higher the required reserve ratio means that banks will have to cut the amount of loans they can make because:

they have fewer excess reserves with which to make loans

what did the fed do during the great recession that they did not do during the great depression?

they increased the monetary supply by buying bonds in the open market M1= m(MB) (if money multiplier is decreasing during a time of economic turmoil then an increase in monetary base is needed to curb the effects)

what does it mean when there is a higher opportunity cost when there is higher inflation in the economy?

this means that you are loosing or gaining more depending on what you decide to do with your money- when there is high inflation people don't want to hold onto their money so they deposit it as soon as possible or try to invest it in order to not loose as much money as they would holding onto it

what is the purpose of forward guidance

to increase inflation expectations real int rate= nominal int rate- inflation (if inflation rate rises then real interest rate decreases) (if nom int rate=0- cannot go below this but they can jack up expectations of inflation rate if they are lowering real interest rate)

when the fed raises the federal funds rate, the inflation rate responds about

two years later

structural unemployment

unemployment resulting from industrial reorganization, typically due to technological change, rather than fluctuations in supply or demand.

explain what happens when the required reserve ratio increases and decreases.

when required reserve ratio increases: banks have to keep a larger portion of each deposit on hand therefore can make fewer loans (contractionary policy) when the required reserve ratio decreases: banks can keep a smaller portion of each deposit made and therefore can make more loans (expansionary policy)

credit easing

when the central bank buys private securities or make loans to financial institutions to stimulate their lending