Econ, chapter 14

If the interest rate is 13 percent per​ year, the price of a bond that promises to pay ​$100 next year will be equal to ​

$88.50 (1.13 x $88.50 = 100)

An Increase in the Riskiness of the Stock Market. If investors began to think the stock market is becoming more ​risky, how will this belief affect the demand for​ money? 1. The demand for money will 2. This would have

*** increase since people will prefer assets that have a more certain value. *** more affect on M1 since money is a larger component of M1 than of M2. (When stock market is more ​risky, individuals will shift towards less​ risky, more certain assets such as currency or money and the demand for money will increase since people will prefer assets that have a more certain value.)

Flea Markets and the Demand for Money. People often like to visit flea markets to look for unexpected opportunities. Flea markets also typically use cash. This is an example of the liquidity demand for money because

cash purchases are​ expected, and cash is the most liquid asset. (People hold money so they can make transactions on quick​ notice, this is called the liquidity demand for money.)

To increase the level of output in the short​ run, the Fed​ should

conduct an open market purchase.

When the Federal Reserve purchases bonds on the open​ market, it leads to _____ levels of investment and output in the economy.

higher

The quantity of money demanded will _____ as the interest rate falls.

increase

Open market sales lead to falling bond​ prices, which cause interest rates to

increase.

For the​ Fed, which lag tends to be shorter?​

inside lags

The types of lags in policy are

inside lags​ (the time it takes for policymakers to recognize and implement policy​ changes) and outside lags​ (the time it takes for policy to actually​ work).

We measure the opportunity cost of holding money​ with

the interest rate.

Are Federal Reserve Chairmen Too​ Powerful? Economic research has shown that the chairman of the Federal Reserve is more​ powerful, relative to other committee​ members, than the head of the central bank in other countries. Fed chairpersons have much more influence over actual decisions than other members. Recall Professor​ Blinder's findings that committees make better decisions than individuals and that leaders of​ groups, per​ se, do not matter for the quality of decision making. Which of the statements below correctly relates​ Blinder's findings to the argument that the tradition of a strong chairman in the United States reduces the effectiveness of monetary​ policy?

A strong Fed chairman will cause the Board to act more like an​ individual, thereby reducing the ability to distinguish between trends and random events - a necessity for effective monetary policy.

Compared to fiscal​ policy, the outside lag for monetary policy is longer for monetary policy.

True

Which of the following explains the liquidity demand for​ money?

The need to hold money to make transactions on quick notice.

Which principle suggests that the demand for money should increase as prices​ increase?

The​ real-nominal principle.

Which of the following is one way that the Fed cannot change the supply of​ money

the process of printing money (The Fed can determine the supply of money through open market purchases and​ sales, changing reserve​ requirements, changing the discount​ rate, or increasing lending to banks and other institutions. Open market operations are the primary tool the Fed uses to implement monetary policy.)

To increase the supply of​ money, the Fed should _____ bonds.

purchase

Interest rates typically rise in a recession because the demand for money increases when real income falls.

False

The Fed directly controls​ long-term interest rates.

False

Through its effect on money​ demand, a decrease in prices will increase interest rates

False

​China's Increase in Reserve Requirements. The Chinese government purchased U.S. dollars in the foreign exchange market with Chinese currency. During the same​ period, the Chinese sharply raised the reserve requirement on banks because they wanted to prevent the money supply from expanding too rapidly. The effect of the Chinese​ government's purchase of U.S. dollars in the foreign exchange market with Chinese currency would be to _____ the supply of Chinese currency. Since the Chinese wanted to prevent the money supply from expanding too​ rapidly, they raised the reserve requirement on​ banks, _____ the ability of banks to make​ loans, thereby _____ the Chinese money supply.

Increase reducing, decreasing

Which of the following will decrease the supply of​ money?

Increasing reserve requirements.

A decrease in the supply of money will cause a​ country's currency to

appreciate.

Rates on​ Two-Year Bonds and​ One-Year Bonds. Suppose the interest rate on a​ two-year bond was higher than the interest rate on a​ one-year bond. The market must believe that next year​ one-year interest rates will

be above the current​ year's one-year bond rate. (Long-term interest rates are an average of the current​ short-term interest rate and expected future​ short-term rates. If the interest rate on a​ two-year bond was higher then the interest rate on a​ one-year bond, the interest rate on next​ year's one-year bond must exceed the interest rate on this​ year's one-year bond.)

If the Federal Reserve wishes to increase the money supply to stimulate the​ economy, it

buys government bonds from the private sector in open market purchases. (If the Federal Reserve wishes to increase the money supply to stimulate the economy​ (perhaps it is operating too​ sluggishly), it buys government bonds from the private sector in open market purchases. If the Fed wishes to decrease the money supply to slow the economy down​ (perhaps it is growing too quickly and inflation is​ occurring), it sells government bonds to the private sector in open market sales.)

An open market sale will _____ the supply of​ money, which will cause the interest rate to _____​, which will _____ ​investment, which results in _____ in output.

decrease increase decrease a decrease

Banks borrow from the Fed at​ the

discount rate.

Banks trade reserves with one another in​ the

federal funds market.

Open Economies and Outside Lags in Monetary Policy. Research suggests the effects of monetary policy through interest​ rates, exchange​ rates, and net exports are more rapid than the effects of monetary policy on investment. The less open an economy​ is, the _____ the outside lag related to monetary policy.

longer (Outside lags are the time it takes for policy to actually work. Research suggests the effects of monetary policy through interest​ rates, exchange​ rates, and net exports are more rapid than the effects of monetary policy on investment. These factors​ (interest rates, exchange​ rates, and net​ exports) are related to international exchanges. The less open an​ economy, the less important these factors​ become, and the longer will be the outside lag.)

The demand for money arising from individual and business use in ordinary business is the

transaction demand.

​Long-term interest rates are an average of the current​ short-term interest rate and expected future​ short-term rates.

true