Economics Today The Macro View Ch. 16 Money, Stabilization, and Growth
Assume that the following conditions exist: a. All banks are fully loaned up- there are no excess reserves, and desired excess reserves are always zero. b. The money multiplier is 5. c. The planned investment schedule is such that at a 4 percent rate of interest, Investment =$1380 billion. At 5 percent, investment is $1370 billion. d. The investment multiplier is 3. e. The initial equilibrium level of real GDP is $12 trillion. f. The equilibrium rate of interest is 4 percent Now the Fed engages in contractionary monetary policy. It sells $1billion worth of bonds, which reduces the money supply, which in turn raises the market rate of interest by 1 percentage point. Calculate the decrease in money supply after FED's sale of bonds: $___billion. Equilibrium GDP decreases by: $___billion. Calculate the new equilibrium level of real GDP: $___trillion. (Round your answer to two decimal places.)
1) 5 billion ( 1bn x 5 = 5) 2) 30 billion (1370 - 1380 = negative 10; 10 x 3 = 30) [NOTE: you can not post the negative sign, thus your answer is 30 (but remember its a negative for the next question)]. 3) 11.97 trillion (12tr + negative 30 bn = 11.97)
Suppose that each 0.1 percentage point decrease in the equilibrium interest rate induces a $10 billion increase in real planned investment spending by businesses. In addition, the autonomous spending multiplier is 5 and the money multiplier is equal to 3. Furthermore, every $20 billion increase in the money supply brings about a 0.1 percentage point reduction in the equilibrium interest rate. 1) How much must real planned investment increase if the Fed desires to bring about a $200 billion increase in real GDP? A. $40 billion. B. $200 billion. C. $1,000billion. D. $67 billion. 2) What dollar amount of open market operations must the Fed undertake to bring about the money supply change you calculated in the previous question? A. $67 billion. B. $27 billion. C. $200 billion. D. $80 billion.
1) A. $40 billion. ($200/5) ----- 2) A. $67 billion. ($200/3 = 66.66 rounded to 67)
1) Contractionary monetary policy causes the A. amount of government spending to increase. B. dollar value of real GDP to increase. C. interest rate to increase. D. price level to increase. 2) The net export effect of contractionary monetary policy predicts that a country's A. exports decrease as the money supply contracts. B. imports decrease as the money supply contracts. C. value of currency depreciates as the money supply contracts. D. experience will include all of the above.
1) C. interest rate to increase. 2) A. exports decrease as the money supply contracts.
1) Contractionary monetary policy causes the A. dollar value of real GDP to increase. B. amount of government spending to increase. C. interest rate to increase. D. price level to increase. 2) The net export effect of contractionary monetary policy predicts that a country's A. imports decrease as the money supply contracts. B. value of currency depreciates as the money supply contracts. C. exports decrease as the money supply contracts. D. experience will include all of the above.
1) C. interest rate to increase. 2) C. exports decrease as the money supply contracts.
Which of the following is a true statement? A. The direct effect of an expansionary monetary policy is to increase aggregate supply and the indirect effect is to increase aggregate demand. B. The direct effect of an expansionary monetary policy is to increase consumption spending and the indirect effect is to increase interest rates. C. The direct effect of an expansionary monetary policy is to increase aggregate demand and the indirect effect is to increase aggregate supply. D. Both the direct and the indirect effects of an expansionary monetary policy are to increase aggregate demand. The indirect effect of an increase in the money supply works through A. an increase in the stock exchange index indicating an improvement in investors' optimism increasing investment. B. an improvement in consumers' expectations causing aggregate demand to increase. C. a decrease in the interest rate increasing investment and consumption. D. an increase in consumption due to increases in household money balances.
1) D. Both the direct and the indirect effects of an expansionary monetary policy are to increase aggregate demand. 2) C. a decrease in the interest rate increasing investment and consumption.
Suppose that each 0.1 percentage point decrease in the equilibrium interest rate induces a $10 billion increase in real planned investment spending by businesses. In addition, the autonomous spending multiplier is 3 and the money multiplier is equal to 2. Furthermore, every $20 billion increase in the money supply brings about a 0.1 percentage point reduction in the equilibrium interest rate. 1) How much must real planned investment increase if the Fed desires to bring about a $300 billion increase in real GDP? A. $150 billion. B. $900 billion. C. $300 billion. D. $100 billion. 2) What dollar amount of open market operations must the Fed undertake to bring about the money supply change you calculated in the previous question? A. $100 billion. B. $300 billion. C. $200 billion. D. $150 billion.
1) D. $100 billion. (300 / 3 = 100) Change in investment = (desired change in real GDP)/(autonomous multiplier) 2) A. $100 billion.
If there is a recessionary gap in the short run, the Federal Reserve can eliminate the gap in the short run by undertaking a policy action that raises aggregate demand. But, if Federal Reserve chooses not to close the gap in the short run, the economy will eventually get back to full employment in the long run. Because when there is a recessionary gap in the short run, then in the long run a new equilibrium will arise as input prices and expectations adjust downward, causing the aggregate supply to shift downward and to the right and pushing equilibrium real GDP back to its long-run potential value. 1) A monetary policy action that could eliminate a recessionary gap in the short run is ___. 2) If Fed implements the short run monetary policy option instead of simply waiting for the long -run adjustments to take place, then it A. harms the society by lowering unemployment. B. benefits the society by lowering inflationary pressures. C. benefits the society as unemployment is reduced quickly. D. harms the society by interfering with the economy's natural process.
1) a decrease in the required reserve ratio 2) C. benefits the society as unemployment is reduced quickly.
Suppose that each 0.1 percentage point decrease in the equilibrium interest rate induces a $10 billion increase in real planned investment spending by businesses. In addition, the autonomous spending multiplier is 3 and the money multiplier is equal to 2. Furthermore, every $20 billion increase in the money supply brings about a 0.1 percentage point reduction in the equilibrium interest rate. 1. How much must real planned investment increase if the Fed desires to bring about a $400 billion increase in real GDP? $___billion. (Round your answer to a whole number.) 2. What dollar amount of open market operations must the Fed undertake to bring about the money supply change necessary to bring about a $400 billion increase in real GDP? $___billion. (Round your answer to a whole number.)
1. 133 billion (400 / 3 = 133.33 round to 133) 2. 133 billion (20 x 0.1 = 2; 2 x 133 = 266; 266 / 2 money multiplier = 133)
Suppose that each 0.1 percentage point decrease in the equilibrium interest rate induces a $10 billion increase in real planned investment spending by businesses. In addition, the autonomous spending multiplier is 5 and the money multiplier is equal to 4. Furthermore, every $20 billion increase in the money supply brings about a 0.1 percentage point reduction in the equilibrium interest rate. 1. How much must real planned investment increase if the Fed desires to bring about a $300 billion increase in real GDP? A. $75 billion. B. $60 billion. C. $1,500 billion. D. $300 billion. 2. What dollar amount of open market operations must the Fed undertake to bring about the money supply change you calculated in the previous question? A. $30 billion. B. $75 billion. C. $120 billion. D. $300 billion.
1. B. $60 billion. (300 / 5 = 60) 2. A. $30 billion. (60 billion investment; 20 x 0.1 = 2 x 60 = 120 billion increase in money supply is needed. Now apply the money multiplier (4) such that: Change in open market operations = (change in the money supply 120 / 4 money multiplier = 30)
What dollar amount of open market operations must the fed undertake to bring about the supply change necessary to bring about a $100 billion increase in real GDP?
100/ spending MULTIPLER # times the # of increased investment money dived by the money multiplier. example 100/3 x 2 = 66/5 = 13.2
Consider the following data. The money supply is $1 trillion, the price level equals 3, the real GDP is $6 trillion in base-year dollars. Calculate the income velocity of money.___. (Enter your response rounded to the nearest whole number.)
18 (price level 3 x 6 the real GDP = 18)
If real GDP is 2.0 trillion, the money supply is $500 billion, and the price level is 2.00, we know the velocity is
2.0 x 2.0 / 0.5 = 8
If real GDP is 2.5 trillion, the money supply is $400 billion, and the price level is 2.00, we know the velocity is
2.00 x 2.5 /0.4 = 12.5
Suppose that each 0.1-percentage-point increase in the equilibrium interest rate induces a $4 billion decrease in real planned investment spending by businesses. In addition, the investment multiplier is equal to 4, and the money multiplier is equal to 5. Furthermore, every $10 billion decrease in the money supply brings about a 0.1-percentage-point increase in the equilibrium interest rate. Use this information to answer the following questions under the assumption that all other things are equal. Calculate by how much the real planned investment must decrease if the Federal Reserve desires to bring about an $100 billion decrease in equilibrium real GDP. $___billion. (Enter your response rounded to one decimal place.) Calculate by how much must the money supply decrease for the Fed to induce the change in real planned investment to bring about an $100 billion decrease in equilibrium real GDP. $___billion. (Enter your response rounded to one decimal place.) Calculate the dollar amount of open market operations that the Fed must undertake to bring about the money supply decrease required for an $100 billion decrease in equilibrium real GDP. $___billion. (Enter your response rounded to one decimal place.)
25 billion. (100 / 4 = 25) 62.5 billion ( 10bn decrease / 4bn decrease = 2.50; 25bn / 1 x 2.50 = 62.5) 12.5 ( 25 / 2 = 12.5)
Suppose that to finance its credit policy, the Fed pays an annual interest rate of 0.25 percent on bank reserves. During the course of the current year, banks hold $1.4 trillion in reserves. What is the total amount of interest the Fed pays banks during the year? The Fed pays banks $___billion of interest during the year. (Enter your response rounded to two decimal places.)
3.5 ----------------- $1.4 x 0.25/100 =0.0035 (round 2 decimal for 3.5 billion).
In an economy, the growth rate of GDP is known to be 4%, the growth rate of the money supply is 8%, and the velocity of money is constant. According to the quantity theory of money and prices, in this economy, the inflation rate must be ___%.
4%
How much must real planned investment increase if the fed desires to bring about $400 billion increase in real GDP? What dollar amount of open market operations must the fed undertake to bring about the money supply change you calculated in the previous question?
400/ 5 = 80... 80 billion. 400/5 = 80 80 * 2 = 160 160/4= 40 40 billion.
Suppose that initially the money supply is $4 trillion, the price level equals 4, the real GDP is $6 trillion in base-year dollars and income velocity of money is 6. Then suppose that the quantity of money in circulation remain fixed but the income velocity of money doubles. If real GDP remains at its long-run potential level, calculate the equilibrium price level. ___.
8 (price is 4, thus doubles) ---------- This problem shows the relationship between the quantity of money in circulation and the price level through the equation of exchange. MsV = PY where Ms is the quantity of money in circulation, P is the equilibrium price level, Y is the real GDP and V is the income velocity of money. In this case, Ms remains fixed, and Y remains at its long-run potential level, but the income velocity of money is doubled. Thus, the price level P will double as well.
A personal bond sells for $1000 and will pay $99 a year forever. The fed changes its policy and the interest rate changes to 8 percent. The price of the bond is now $ ______
99/0.08 = $ 1237.5
The indirect effect of an increase in the money supply works through
A decrease in the interest rate increasing investment and consumption.
If there is an recessionary gap in the short run, the federal reserve can eliminate the gap in the short run by undertaking a policy action that raises aggregate demand. But, if federal reserve chooses not to close the gap in the short run, the economy will eventually get back to full employment in the long run. Because when there is an inflationary gap in the short run, then in the long run a new EW will arise as input prices and expectations adjust downward causing the aggregate supply to shift upward and to the left and pushing EQ real GDP back to its long-run potential value. a. A monetary policy action that could eliminate an inflationary gap in the short run is ____________ b. If Fed implements the short run monetary policy option instead of simply waiting for the long-run adjustments to take place, then it _______
A decrease in the required reserve ratio Benefits the society as unemployment is reduced quickly.
What type of relationship exists between the growth of the money supply and changes in the inflation rate?
A direct relationship.
FOMC Directive
A document that summarizes the Federal Open Market Committee's general policy strategy, establishes near-term objectives for the federal funds rate, and specifies target ranges for money supply growth.
Federal funds market
A private market (made up mostly of banks) in which banks can borrow reserves from other banks that want to lend them. Federal funds are usually lent for overnight use.
Assume that the following conditions exist. a. All banks are fully loaned up-there are no excess reserves, and desired excess reserves are always zero. b. The money multiplier is 3. c. The planned investment schedule is such that at a 6 percent rate of interest, investment is $1200 billion; at 5 percent, investment is $1230 billion. d. The investment multiplier is 3. e. The initial equilibrium level of real GDP is $11.00 trillion. f. The equilibrium rate of interest is 6 percent. Now the Fed engages in expansionary monetary policy. It buys $1 billion worth of bonds, which increases the money supply, which in turn lowers the market rate of interest by 1 percentage point. A) Calculate the increase in money supply: $___billion. B) Calculate the increase in real GDP: $___billion. C) Calculate the new equilibrium real GDP: $___trillion. (Round your answer to two decimal places.)
A) 3 billion. ($1 billion worth of bonds x 3 money multiplier = 3) B) 90 billion. (1230 -1200 = 30 billion increase investment x 3 investment multiplier = 90). C) 11.09 trillion. (initial equilibrium level of real GDP $11.00 trillion + 90 billion the increase in real GDP = 11.09) Hint*** use google calculator
According to the Keynesian approach, a decrease in the money supply increases real GDP by lowering interest rates, which increases investment. A. False B. True
A. False
Suppose that the Fed pursues an expansionary monetary policy. Which of the following statements best explains the transmission mechanism in an open economy? A. The decrease in interest rates will cause capital outflow comma lowering the value of the dollar and increasing net exports. B. The increase in interest rates will cause capital outflow comma increasing the value of the dollar and increasing net exports. C. The decrease in interest rates will cause capital inflow comma lowering the value of the dollar and decreasing net exports. D. The increase in interest rates will cause capital inflow comma increasing the value of the dollar and decreasing net exports.
A. The decrease in interest rates will cause capital outflow comma lowering the value of the dollar and increasing net exports.
Many traditional Keynesians argue that fighting recession with monetary policy is likely to be relatively ineffective. A. True B. False
A. True
According to Keynesian theory, it would take _______ decrease in the interest rate to increase investment to the desired level to eliminate the recessionary gap. A. a large B. a small C. a proportionate D. a 100%
A. a large (In order to achieve a large enough decrease in the interest rate it would take an enormous change in the money supply.)
Increases in output and increases in the inflation rate have been linked to A. increases in the money supply. B. discretionary government spending. C. higher rates of interest. D. discretionary tax policy.
A. increases in the money supply.
Many economists believe that the growth of the money supply is A. positively related to the growth of real GDP. B. not related to output growth. C. directly related to interest rate growth. D. inversely related to the price level.
A. positively related to the growth of real GDP.
Suppose you go shopping for a gift for a friend and also find a sweater that you want for yourself. You pay cash for the gift and write a check for the sweater. Your purchases are made with money holdings represented by A. the transaction demand for money because you planned to buy the gift and the precautionary demand for money because you did not anticipate buying the sweater. B. the transaction demand for money because you paid for the gift with cash. C. your supply of money to the economy. D. the asset demand for money because you used money for both purchases.
A. the transaction demand for money because you planned to buy the gift and the precautionary demand for money because you did not anticipate buying the sweater.
Holding money as a medium of exchange to make payments is known as A. transactions demand. B. asset demand. C. aggregate demand. D. precautionary demand.
A. transactions demand.
In the figure at right, if the economy is at EQ at E1, the FED would most likely
Adopt an expansionary monetary policy
Suppose that the economy currently is in long-run EQ. Explain the short- and long - run adjustments that will take place in an aggregate demand-aggregate supply diagram if the fed expands the quantity of money in circulation.
Aggregate demand curve shifts to the right; in the short-run both price level and real GDP increase. Over the long run the short-run aggregate supply curve shifts upward to the left and a new long-run EQ is reached at the initial EQ GDP but at higher price level.
Taylor rule
An equation that specifies a federal funds rate target based on an estimated long-run real interest rate, the current deviation of the actual inflation rate from the Federal Reserve's inflation objective, and the gap between actual real GDP per year and a measure of potential real GDP per year.
Trading Desk
An office at the Federal Reserve Bank of New York charged with implementing monetary policy strategies developed by the Federal Open Market Committee.
Since the financial meltdown of the late 2000s the Fed has launched a credit policy which consists of
Auctioning funds to banking institutions Purchasing some of the debts of auto finance companies. Providing short-term emergency financing arrangements for nonfinancial firms.
Suppose that currently, the economy is underutilizing its resources. Which of the following correctly describes what type of monetary policy the Fed might choose and how the policy would change the economy? A. The Fed could use a contractionary monetary policy to reduce short minus run aggregate supply and GDP. B. The Fed could use an expansionary monetary policy to increase aggregate demand and GDP. C. The Fed could use a contractionary monetary policy to reduce aggregate demand and GDP. D. The Fed could use an expansionary monetary policy to increase short minus run aggregate supply and GDP.
B. The Fed could use an expansionary monetary policy to increase aggregate demand and GDP.
Which of the following events would be likely to increase the supply of money? A. Banks perceive loans to be more risky and wish to hold more excess reserves. B. The Fed decreases the discount rate relative to the federal funds rate. C. The Fed conducts an open market sale of bonds. D. The Fed increases reserve requirements for banks.
B. The Fed decreases the discount rate relative to the federal funds rate.
According to the Keynesian approach, an increase in the money supply increases real GDP by lowering interest rates, which increases investment. A. False B. True
B. True
In order to induce private banks to maintain substantial reserve deposits with the Federal Reserve banks, since 2008 the Fed has A. raised the legal reserve ratio that the banks have to maintain. B. paid banks an interest rate that is higher than the federal funds rate on their reserves. C. paid banks an interest rate that is lower than the federal funds rate. D. paid banks an interest rate that is equal to the federal funds rate.
B. paid banks an interest rate that is higher than the federal funds rate on their reserves.
Suppose that economy is initially long-run and short-run EQ. If the FED decided to pursue a contractionary monetary policy we will see
Bond prices fall interest rates rise, aggregate demand falls as investment and consumption spending decrease, and real GDP and the price level decreasing in the short run, but only the price level decreasing in the long run.
Which of the following is a true statement?
Both the direct and indirect effects of an expansionary monetary policy are to increase aggregate demand.
As a result of monetary policy of the Fed, the dollar appreciated and the amount of exports decreased. Which of the following Fed policies could have caused this outcome? A. A decrease in the reserve requirement ratio. B. A Fed purchase of bonds from banks. C. A Fed sale of bonds to brokers and banks. D. A decrease in the discount rate.
C. A Fed sale of bonds to brokers and banks.
Which of the following is an example of the asset demand for money? A. Joan believes that gold is an excellent store of value. B. Carla keeps $ 2,000 in a bank account in case of emergencies. C. Since the stock market has been volatile lately, Jean holds most of her savings in a bank account. D. Marianne uses money in her checking account to buy groceries every week.
C. Since the stock market has been volatile lately, Jean holds most of her savings in a bank account.
Decreases in the money supply affect the economy indirectly because A. interest rates decrease causing planned investment to increase, which causes an increase in aggregate demand. B. people have insufficient money balances and thus aggregate demand decreases. C. interest rates increase, causing planned investment to decrease, which causes a decrease in aggregate demand. D. people spend excess money balances and thus, aggregate demand increases. E. There is no indirect effect of the money supply on the economy.
C. interest rates increase, causing planned investment to decrease, which causes a decrease in aggregate demand.
The demand for money A. is an upward sloping function of the interest rate. B. is positively related to the opportunity cost of holding money. C. is a downward sloping function of the interest rate. D. None of the above.
C. is a downward sloping function of the interest rate.
Suppose that the Fed judges inflation to be the most significant problem in the economy and that it wishes to employ all three of its policy instruments, then the Fed will engage in A. open market sales, decreasing the reserve requirement, and increasing the discount rate. B. open market purchase, increasing the reserve requirement, and decreasing the discount rate. C. open market sales, increasing the reserve requirement, and increasing the discount rate. D. open market purchase, increasing the reserve requirement, and increasing the discount rate.
C. open market sales, increasing the reserve requirement, and increasing the discount rate.
The linkage of the interest rate based transmission mechanism of monetary policy are summarized as follows:
Change in the money supply>change in interest rates>change in planned investment>change in aggregate demand.
An increase in the money supply will...
Create direct effect of an increase in consumption due to higher money balances. create an indirect effect of increased consumption and investment through increased saving and loans. increase the price level.
During an interval between 2010 and 2011 the federal reserve embarked on a policy it termed "quantitative easing" Total reserves in the banking system increased. Hence, the federal reserves liabilities to banks increased and at the same time its assets rose as it purchased more assets - many of which were securities with private markets values that had dropped considerably. The money multiplier declined, so the net increase in the money supply was negligible. Indeed, during a portion of the period, the money supply actually declined before rising near its previous value. The Feds quantitative easing can be best described as a
Credit policy action.
As a result of monetary policy of the Fed, the dollar appreciated and the amount of exports decreased. Which of the following Fed policies could have caused this outcome? A. A Fed purchase of bonds from banks. B. A decrease in the discount rate. C. A decrease in the reserve requirement ratio. D. A Fed sale of bonds to brokers and banks.
D. A Fed sale of bonds to brokers and banks.
The Fed's credit policy since 2008 has A. led to an expansion of asymmetric information problems by reducing banks' incentive to screen and monitor borrowers. B. provided banks more liquidity. C. given private banks more time to recover from the financial crisis. D. All of the above.
D. All of the above.
Which of the following is not a reason people choose to hold money balances? A. Reduced risk compared to other assets. B. Liquidity. C. Having cash to pay for unplanned expenditures and emergencies. D. Money holdings are good assets during periods of inflation.
D. Money holdings are good assets during periods of inflation.
If the Fed decreases the discount rate, relative to the federal funds rate, then this A. would increase the cost of funds for institutions borrowing from the Fed. B. would cause the money supply to decrease. C. would cause the required reserve ratio to increase. D. would decrease the cost of funds for institutions borrowing from the Fed.
D. would decrease the cost of funds for institutions borrowing from the Fed.
Quantitative easing
Federal Reserve open market purchases intended to generate an increase in bank reserves at a nearly zero interest rate.
Credit policy
Federal Reserve policymaking involving direct lending to financial and nonfinancial firms.
Suppose that the economy is depicted as shown to the right a. The state of the economy depicted at the right can be best described as
Having a recessionary gap Short-rune Real GDP falls short of the long-run aggregate supply curve.
Suppose that the economy is depicted at the right. a. State of the economy depicted at the right can be best described as
Having an inflationary gap.
Transactions demand
Holding money as a medium of exchange to make payments. The level varies directly with nominal GDP.
Asset demand
Holding money as a store of value instead of other assets such as corporate bonds and stocks.
Precautionary demand
Holding money to meet unplanned expenditures and emergencies.
Assume (other things constant) that the fed increases he money supply. The mechanism through which aggregate demand increases is according to interest rate based transmission mechanism, summarized as follows:
Increase in money supply> decrease in interest rates>increase in planned investment spending> increase in aggregate demand.
To implement a credit policy intended to expand liquidity of the banking system, the fed desires to increase its assets by lending to a substantial number of banks. How might the Fed adjust the interest rate that it pays banks on reserves in order to induce them to hold the reserves required for funding this credit policy action?
Increase the interest rate.
The decision to buy or sell bonds is
Independent of bond prices.
Increases in the money supply affect the economy indirectly because
Interest rates decrease, causing planned investment to increase, which causes an increase in aggregate demand.
The equation of exchange
Is an accounting identity and is always correct. states that the money supply times velocity equals nominal national income. states that expenditures by some people equal income received by others.
According to the equation of exchange, if velocity is constant and output is fixed at the full employment level, then any percentage increase in the money supply will.
Lead to an equal percentage increase in the price level. In this situation there is a direct transmission of an increase in the money supply to the price level.
According to the interest-rate-based monetary policy transmission mechanism, an increase in the money supply will
Lead to an increase in investment spending and an increase in real GDP which is greater than the increase in investment spending.
The Feds credit policy since 2008 has.
Led to a reduction in the money multiplier.
The bond market is depicted in the graph to the right.. a. The bond demand curve is downward sloping because. b. Suppose the fed decides to sell bonds. depict changes in the bond market. Properly label your line. Label the new EQ.
Lower bond prices translate into higher interest rates and returns.
Monetary economists are strong supporters of the quantity theory of money. If the growth rate of money supply is known then inflation and the rate of growth of nominal GDP according to this crude version of the quantity theory can be determined and forecasted.. Use the graph to help determine the monetary aggregate M1 or M2 monetarists will employ in order to correctly forecast inflation and or nominal GDP growth.
M2 since according to the graph income velocity based on M2 is practically constant.
Which of the following is an example of the transaction demand for money?
Marianne uses money in her checking account to buy groceries every week.
In an open economy, the next export effect
May offset an expansionary fiscal policy but enhance an expansionary monetary policy.
Suppose the actual EQ federal funds rate is below the rate implied by a particular inflation goal. In this situation, the Taylor rule implies that
Monetary policy is expansionary.
Which of the following is not a reason people choose to hold money balances.
Money holdings are good assets during periods of inflation.
which of the follow is NOT a reason people choose to hold money balances?
Money holdings are good assets during periods of inflation.l
If the fed sells US government securities, the
Money supply decreases, and the money supply curve shifts to the left.
Suppose that initially the money supply is $4 trillion, the price level equals 4, the real GDP is $6 trillion in base-year dollars and income velocity of money is 6. Then suppose that the fed cuts the money supply in half but the income velocity of money doubles. Calculate the price level after all three changes have taken place _____
New Price level = 2.0 x 12 / 6.0 = 4
In the above figure, suppose the economy is in short - run eq at point D. Which of the following is the best policy option for the fed?
Open market purchase of government securities
Price of a bond =
Periodic return / interest rate.
Assuming that the fed inflation to be the most significant problem in the economy and that it wishes to employ all three of its policy instruments. It sells bonds in the open market, increases the discount rate , and increases the reserve ratio. The next export effect resulting from these monetary policy actions will _________.
Raise the interest rate, increase the inflows of international capital, increase the value of the dollar, decrease exports, and as a consequence real QDP will decline even further.
The federal reserve finances its credit policy with
Reserve deposits that private banks hold with the fed.
If the fed wishes to contract the economy it will
Sell more bonds, taking reserves out of the banking system.
An increase in the money supply will
Shift the aggregate demand curve outward and to the right not change the long-run aggregate supply curve but ultimately will only raise the price level in long-run EQ price level Move the EQ point along the short run aggregate supply curve
Money balances
Synonymous with money, money stock, money holdings.
The federal reserve ( the fed) and the European central bank ( ECB) apply monetary policy by controlling interest rates: the federal funds rate , and the repo rate respectively. These two central banks apply expansionary policy by reducing the two interest rates and contractionary policy by raising the two target interest rates. Use the graph to help determine which of the following statements regarding the monetary policies of the fed and and the ECB are true.
The ECB followed a very passive monetary policy for a long period ( from June 2003 to December 2005 ).
Which of the following events would be likely to increase the supply of money?
The Fed decreases the discount rate relative to the federal funds rate.
The bond market is depicted in the graph to the right. a. The supply curve of bonds is drawn vertically because b. Suppose that the Fed decides to sell bonds. 1.) Using the line drawing tool, draw the changes in the bond market and the label the new line 'S1'. 2.) Using the point drawing tool, find and label the new equilibrium point 'E1'.
The Fed's decision to buy or sell bonds is independent of bond prices.
Contractionary monetary policy by the fed can be hampered by
The ability of US citizens and businesses to obtain dollars from foreign sources.
In the figure at right, if the economy is in EQ at E1 then
The economy is underutilizing its resources.
What will happen to the Feds liabilities if it implements the policy action to induce banks to hold the reserves required for funding its credit policy?
The feds liabilities will increase
Equation of exchange
The formula indicating that the number of monetary units (Ms) times the number of times each unit is spent on final goods and services (V) is identical to the price level (P) times real GDP (Y).
Quantity theory of money and prices
The hypothesis that changes in the money supply lead to equiproportional changes in the price level.
Federal funds rate
The interest rate that depository institutions pay to borrow reserves in the interbank federal funds market.
Discount rate
The interest rate that the Federal Reserve charges for reserves that it lends to depository institutions. It is sometimes referred to as the rediscount rate or, in Canada and England, as the bank rate.
When the fed first began its credit policy programs in 2008, the M2 measure of aggregate money balances dipped and did not grow for several months. As a result.
The nominal federal funds rate remained close to zero., the estimated real federal funds rate rose
Income velocity of money (V)
The number of times per year a dollar is spent on final goods and services; identically equal to nominal GDP divided by the money supply.
In the figure at right, if we begin at S1 and the fed sells bonds,
The price of bonds falls and the interest rates rises.
when people want to hold money to make regular planned expenditures, this is
The transaction demand for money.
The 10-year moving average was created by finding the average growth rate over the ten years prior for example, the 1969 value of the rate of growth for M1 is the average growth rate of M1 for the years 1959 =1969, and the value of M1 for 1970 is the average rate of growth of M1 during the 1960-1970. The 10 years move average of money supply and inflation are utilized because of the strong conviction of monetarist economists that changes in money supply. Use the graph to help determine which of the following statements regarding the growth rate of M1 and inflation are true.
There exists a relationship between the growth of M1 and inflation but not a very tight one. This implies that there may be additional variables other than M1 that may affect inflation.
A member of congress, who has never has an economics course, has just been placed on a money and banking committee. The officials need a briefing prior to the first meeting covering the roles of the money supply in the economy. Which of the following statements should you insist that the official remember when entering the first committee meeting?
There is a direct, albeit loose, relationship between the growth of the money supply and the price level; and a direct relationship between the growth of the money supply and GDP growth.
Assume that the following conditions exist. a. all banks are fully loaned up- there are no excess reserves and desired excess reserves are always zero. b. the money multiplier is 4 c. the planned investment schedule is such that at a 8 percent rate of interest investment is 1200 billion at 5 percent investment is 1225 billion d. the investment multiplier is 3 e. The initial equilibrium level of real GDP is 11 trillion. f. The equilibrium rate of interest is 6 percent. Now the fed engages in expansionary monetary policy. It buys 2 billion worth of bond, which increases the money supply, which in turn lowers the market rate of interest by 1 percent point. Calculate the increase in money supply: _____ billion
Total increase in money supply = bond purchases by FED x Money multiplier = 2 x 4 = 8 billion. The increase in EQ real GDP can be calculated as follows: Increase in real GDP = increase in investment x investment multiplier= 25 x 3 = New level of GDP = initial level of GDP + increase in real GDP - 11000 + 75 = 11.08
The supply curve of bonds is
Vertical.
The Fed increase the discount rate, relative to the federal duns rate, then this
Would increase the cost of funds for institutions borrowing from the Fed. As the discount rate increases, relative to the federal funds rate, it increase the cost of barrowing form the fed.
According to the quantity theory of money and prices, a -3 % change in the money supply, holding other variables constant leads to
a -3 % change in the price level. There is a direct transmission of the change in the money supply to the rice level according to the quantity theory of money.
According to the quantity theory of money
a given proportionate increase in the money supply leads to an equal propionate increase in the price level.
Suppose that each 0.1-percentage-point increase in the equilibrium interest rate induces a $4 billion decrease in real planned investment spending by businesses. In addition, the investment multiplier is equal to 4, and the money multiplier is equal to 5. Furthermore, every $10 billion decrease in the money supply brings about a 0.1-percentage-point increase in the equilibrium interest rate. Use this information to answer the following questions under the assumption that all other things are equal. a) Calculate by how much the real planned investment must decrease if the Federal Reserve desires to bring about an $100 billion decrease in equilibrium real GDP. $___billion. (Enter your response rounded to one decimal place.) b) Calculate by how much must the money supply decrease for the Fed to induce the change in real planned investment to bring about an $100 billion decrease in equilibrium real GDP. $___billion. (Enter your response rounded to one decimal place.) c) Calculate the dollar amount of open market operations that the Fed must undertake to bring about the money supply decrease required for an $100 billion decrease in equilibrium real GDP. $___billion. (Enter your response rounded to one decimal place.)
a) 25 billion. (100 / 4 = 25) b) 62.5 billion. (decrease in money supply = decrease in real GDP (25bn) / investment multiplier (4) x 2.50; [0.1 x 25bn = 2.5; 0.1 x 10bn = 1]; 25bn / 1 x 2.50 = 62.5) c) 12.5 billion. ( 25 / 2 = 12.5) NOTE: this is DECREASING!!!
a. Calculate by how much real planned investment increase if the fed reserve desires to bring about a 100 billion increase in EQ real GDP b. Calculate by how much the money supply change for the fed to induce the change in real planned investment that is needed for a 100 billion increase in EQ real GDP c. Calculate the dollar amount of open market operations that the fed must undertake to bring about the money supply change needed for a 100 billion increase in EQ real GDP.
a. 100/5 = 20 b. 100/5 * 2 = 40 c. 40/5 =8
Suppose that each 0.1 percent- point decrease in the equilibrium interest rate induces a...
a. 120/4 = 30 b. 120/4 x 2.0 = 60 c. 60 / 5 = 12 a. 120/4 = 30 b = 120/4 * 6.0 = 180 c. 180/4 = 45
Suppose that each 0.1 percentage-point decrease in the equilibrium interest rate induces a $10 billion increase in real planned investment spending by businesses. In addition, the investment multiplier is equal to 5, and the money multiplier is equal to 4. Furthermore, every $20 billion increase in the money supply brings about a 0.1-percentage-point reduction in the equilibrium interest rate. Use this information to answer the following questions under the assumption that all other things are equal. a. Calculate by how much must real planned investment increase if the Federal Reserve desires to bring about a $80 billion increase in equilibrium real GDP $__ billion. b. Calculate by how much must the money supply change for the Fed to induce the change in real planned investment that is needed for a $80 billion increase in equilibrium real GDP $__ billion. c. Calculate the dollar amount of open market operations that the Fed must undertake to bring about the money supply change needed for a $80 billion increase in equilibrium real GDP $__ billion.
a. 16 (80 / 5 = 16) b. 32 (80 x 0.1 = 8; 8 x 4 = 32) c. 8
Suppose that initially the money supply is $ 2 trillion, the price level equals 4, the real GDP is 6 trillion in base-year dollars, and income velocity of money is 12 . Then the money supply increase by 200 billion. a. According to the quality theory of money and prices, calculate the new price level after the increase in money supply ______ b. Percentage increase in money supply = The new value of Ms - The initial Value of Ms / The initial Value of Ms. c. Percentage increase in price level = New price level - Initial price level / Initial price level. d. The percent changes in money supply is ____ percentage changes in the price level.
a. 2.20 x 12 / 6 = 4.4 b. 2.2-2.0/2 x 100 = 10.00 %. c. 4.4-4.0 / 4.0 x 100 = 10.00% d. equal to the
Suppose that each 0.1-percentage-point increase in the equilibrium interest rate induces a $5 billion decrease in real planned investment spending by businesses. In addition, the investment multiplier is equal to 5, and the money multiplier is equal to 4. Furthermore, every $10 billion decrease in the money supply brings about a 0.1-percentage-point increase in the equilibrium interest rate. Use this information to answer the following questions under the assumption that all other things are equal. a. Calculate by how much the real planned investment must decrease if the Federal Reserve desires to bring about an $100 billion decrease in equilibrium real GDP. $___ billion. (Enter your response rounded to one decimal place.) b. Calculate by how much must the money supply decrease for the Fed to induce the change in real planned investment to bring about an $100 billion decrease in equilibrium real GDP. $___ billion. (Enter your response rounded to one decimal place.) c. Calculate the dollar amount of open market operations that the Fed must undertake to bring about the money supply decrease required for an $100 billion decrease in equilibrium real GDP. $___ billion. (Enter your response rounded to one decimal place.)
a. 20 b. 40 c. 10
Suppose that each 0.1 percentage-point decrease in the equilibrium interest rate induces a $10 billion increase in real planned investment spending by businesses. In addition, the investment multiplier is equal to 4, and the money multiplier is equal to 4. Furthermore, every $10 billion increase in the money supply brings about a 0.1-percentage-point reduction in the equilibrium interest rate. Use this information to answer the following questions under the assumption that all other things are equal. a. Calculate by how much must real planned investment increase if the Federal Reserve desires to bring about a $80 billion increase in equilibrium real GDP $___billion. b. Calculate by how much must the money supply change for the Fed to induce the change in real planned investment that is needed for a $80 billion increase in equilibrium real GDP $___billion. c. Calculate the dollar amount of open market operations that the Fed must undertake to bring about the money supply change needed for a $80 billion increase in equilibrium real GDP $___billion.
a. 20 billion. (80 / 4 = 20) b. 20 billion. (10 / 4 = 2.5; 80 x 0.1 = 8; 8 x 2.5 = 20) c. 5.0 billion. (20 / 10 = 2; 10 / 4 = 2.5; 2 x 2.5 = 5)
Suppose that each 0.1 percentage-point decrease in the equilibrium interest rate induces a $10 billion increase in real planned investment spending by businesses. In addition, the investment multiplier is equal to 4, and the money multiplier is equal to 4. Furthermore, every $30 billion increase in the money supply brings about a 0.1-percentage-point reduction in the equilibrium interest rate. Use this information to answer the following questions under the assumption that all other things are equal. a. Calculate by how much must real planned investment increase if the Federal Reserve desires to bring about a $80 billion increase in equilibrium real GDP $___billion. b. Calculate by how much must the money supply change for the Fed to induce the change in real planned investment that is needed for a $80 billion increase in equilibrium real GDP $___billion. c. Calculate the dollar amount of open market operations that the Fed must undertake to bring about the money supply change needed for a $80 billion increase in equilibrium real GDP $___billion.
a. 20 billion. (80 / 4 = 20) b. 60 billion. (30 / 4 = 7.5; 80 x 0.1 = 8; 8 x 7.5 = 60) c. 15 billion. (20 / 10 = 2; 30 / 4 = 7.5; 2 x 7.5 = 15)
Suppose that each 0.1 percentage-point decrease in the equilibrium interest rate induces a $5 billion increase in real planned investment spending by businesses. In addition, the investment multiplier is equal to 5, and the money multiplier is equal to 5. Furthermore, every $30 billion increase in the money supply brings about a 0.1-percentage-point reduction in the equilibrium interest rate. Use this information to answer the following questions under the assumption that all other things are equal. a. Calculate by how much must real planned investment increase if the Federal Reserve desires to bring about a $120 billion increase in equilibrium real GDP $__billion. b. Calculate by how much must the money supply change for the Fed to induce the change in real planned investment that is needed for a $120 billion increase in equilibrium real GDP $___billion. c. Calculate the dollar amount of open market operations that the Fed must undertake to bring about the money supply change needed for a $120 billion increase in equilibrium real GDP $___billion.
a. 24 billion. (120 / 5 =24) b. 144.0 billion. (30 / 5 = 6; 120 x 0.1 = 12; 12 x 6 = 72; 72 x 2 = 144) c. 28.8 billion. (24 / 5 = 4.8; 4.8 x 6 = 28.8)
Suppose that each 0.1 percentage point decrease in the equilibrium interest rate induces a $10 billion increase in real planned investment spending by businesses. In addition, the autonomous spending multiplier is 2 and the money multiplier is equal to 3. Furthermore, every $20 billion increase in the money supply brings about a 0.1 percentage point reduction in the equilibrium interest rate. a. How much must real planned investment increase if the Fed desires to bring about a $100 billion increase in real GDP? $___ billion. (Round your answer to a whole number.) b. What dollar amount of open market operations must the Fed undertake to bring about the money supply change necessary to bring about a $100 billion increase in real GDP? $___ billion. (Round your answer to a whole number.)
a. 50 (100/2) b. 33 (50 x 2 = 100; 100/3 = 33.33 rounded to 33).
Let's denote the price of no maturing bonds ( called a consol) as Pb. the equation that indicates this price is Pb= I/R, where I is the annual net income the bond generates and r is the nominal market interest rate. a. Suppose that a bond promises the holder $500 per year forever. The nominal market interest rate is 4 present. Calculate the bond's current price:____________ b. If the market interest rate increases, the price of the bond will fall as P and r are inversely related, where P b = I/R thus, Pb =________________
a. 500/0.04 = $ 12500 b. 500/0.08 = 6250
Let's denote the price of a nonmaturing bond (called a consol) as Pb. The equation that indicates this price is Pb = I(over) r, where I is the annual net income the bond generates and r is the nominal market interest rate. a. Suppose that a bond promises the holder $500 per year forever. The nominal market interest rate is 4 percent. Calculate the bond's current price: $___. (Round your answer to the nearest whole dollar.) b. Calculate the bond's price, if the market interest rate increases to 8 percent: $___. (Round your answer to the nearest whole dollar.)
a. 500/0.04 = $12500 b. 500/0.08 = $6250
If there is an inflation gap in the short run, the federal reserve can eliminate the gap in the short run by undertaking a policy action that reduces aggregate demand. But, if federal reserve chooses not to close the gap in the short run, the economy will eventually get back to full employment in the long run. Because when there is an inflationary gap in the short run, then in the long run a new EW will arise as input prices and expectations adjust upwar, causing the aggregate supply to shift upward and to the left and pushing EQ real GDP back to its long-run potential value. a. A monetary policy action that could eliminate an inflationary gap in the short run is ____________ b. If Fed implements the short run monetary policy option instead of simply waiting for the long-run adjustments to take place, then it _______
a. An open market sale of government securities. b. Benefits the society as the inflationary pressures are removed quickly.
Suppose that, initially, the U.S. economy is an aggregate demand-aggregate supply EQ at point A alone the aggregate demand curve AD in the diagram. Now, however, appreciated relative to foreign currencies. This appreciation happens to have no measurable effect on either the short-run or the long-run aggregate supply curve in the united states. it does, however influence U.S aggregate demand. a. As a result of the dollar appreciation, U.S. net export expenditures will ___. b. The aggregate demand curve that could represent the aggregate demand effect of the U.S. dollar's appreciation is ___. c. Federal Reserve may take a certain policy action to prevent the dollar's appreciation from affecting equilibrium real GDP in the short run. Which one of the following is not a likely policy action that the Fed will take? A. Decreasing the discount rate. B. Decreasing reserve ratios. C. Increasing government spending. D. Buying government securities in the open market.
a. Decrease. b. AD2 will decrease; decrease c. C. Increasing government spending.
Suppose that the market rate of interest is 5 percent and at this interest rate you have decided to hold half your financial wealth as bonds and half as holdings of non interest bearing money. You notice that the market interest rate is starting to rise, however you become convinced that it will ultimately rise to 10. a. As the interest rate rises, the value o your bond holdings will b. If you wish to prevent the value of your financial wealth from declining in the future, you will.
a. decline. b. hold less bonds and more money.
When the rate of interest in the economy falls, there will be
an increase in the market price of existing bonds
If the Fed sells bonds through its open market operation, then there is
an increase in the supply of bonds and a fall in the price of existing bonds
During 2008, the Fed acted to keep the nominal federal funds rate very close to zero because the fed
extended loans to select institutions at very low nominal rates of interest through its credit policy programs.
Since the Fed began implementing credit policy alongside traditional monetary policy in 2008, it has
failed to achieve a consistently counter-recessionary monetary policy in conjunction with its credit policy.
the indirect effect of an increase in the money supply is to
increase aggregate demand as interest rates fall and investment spending increases.
The direct effect of an increase in the money supply is to
increase the AD as people spend their excess money balances.
Traditional Keynesian analysis suggests that decreases in the money supply shift the aggregate demand curve by decreasing
investment. changes in interest rate impact investment spending only according to this model.
Traditional Keynesian analysis suggests that increases in the money supply shift the aggregate demand curve through increasing
investment. changes in interest rates impact investment spending according to the Keynesian theory.
Keynesians believe that monetary policy applied during recessions
is ineffective since changes in the money supply have little impact on the interest rate. The Keynesians argue that the investment function is relative inelastic to changes in the interest rate.
Suppose that the central bank under took an expansionary monetary policy. draw the new expenditure line. b. Expansionary monetary policy will
lower interest rates.
In an open economy, the net export effect
may offset an expansionary fiscal policy but enhance an expansionary monetary policy
The money demand function implies that money demand is
negatively related to interest rates.
In order to induce private banks to maintain substantial reserve deposits with the federal reserve banks, since 2008 the FED has
paid banks an interest rate that is higher than the federal funds rate on their reserves.
Keynesians argue that expansionary monetary policy during recessions will cause.
people to accumulate money.
The precautionary demand for holding money arises because
people want to be able to make unexpected purchases or to meet emergencies.
The Feds credit policy since 2008 has
provided banks more liquidity given private banks more time to recover from financial crisis led to an expansion of asymmetric information problems by reducing banks incentives to screen and monitor borrowers.
Suppose that the central bank undertook a contractionary monetary policy. c. Contractionary monetary policy will _____ interest rates.
raise interest rates.
According to the Keynesian theory, an decrease in the money supply increases the interest rate and decreases investment spending. The result of this is that
real GDP decreases by a larger amount than the change in investment.
According to the Keynesian theory, an increase in the money supply decreases the interest rate and increases investment spending. The result of this is that
real GDP increases by a larger amount than the change in investment.
an expansionary monetary policy results in lower interest rates, which in turn
reduces the international price of the dollar and increases net exports.
Expansion of the money supply during a recession, according to the Keynesians, will
result in virtually no change in investment and aggregate demand. they argue that the investment function is relative inelastic to changes in the interest rate.
The economy is currently experiencing a recessionary gap. The government is contemplating the use of expansionary monetary policy. Answer the following questions by applying Keynesian theory to this situation. The Keynesians feel that changes in the money supply lead to _____ changes in the interest rate. This is because Keynesians believe that if monetary authorities increase the money supply during a recession, individuals A. make no significant change to their investment spending. B. significantly decrease their investment spending. C. increase the rate in which they borrow. D. significantly increase their investment spending.
small A. make no significant change to their investment spending.
The Keynesians feel that changes in the money supply lead to
small changes in the interest rate.
Contractionary monetary policy by the fed can be hampered by
the ability of US citzens and businesses to obtain dollars from foreign sources
The federal reserves credit policy refers to
the feds direct lending to financial and non financial firms
The opportunity cost of holding money refers to
the interest that could have been earned if the money balances had been transferred to an interest bearing asset.
