Macro Midterm 3

Real Exchange Rate Formula using PPP

(Nominal Exchange Rate x Domestic Price)/Foreign Price

Money Multiplier

1/reserve ratio

Federal Reserve System

12 Regional Banks that work to control the money supply using open market operations to ensure a healthy economy

In the nation of Wiknam, the money supply is $80,000 and reserves are $18,000. Assuming that people hold only deposits and no currency, and that banks hold no excess reserves, then the reserve requirement is

22.5 percent 18000/80000 x 100

If the real exchange rate for coal is 1.5, the price of coal in the United States is $50 per ton, and the price of coal in Britain is 20 British pounds per ton, what is the nominal exchange rate?

3/5 or 0.6 pounds per dollar (20/50) x 1.5 (Foreign Price/ Domestic Price) x real exchange rate

If velocity = 4, the quantity of money = 20,000, and the price level = 2.5, then the real value of output is

32,000 (Quantity of Money x Velocity)/Price Level (20000 x 4)/ 2.5

If the real interest rate is 6 percent and the price level is falling at a rate of 2 percent, what is the nominal interest rate?

4 percent Price level is Falling so it is deflation Nominal Int. rate - inflation rate = Real Int. rate x -(-2) =6 x + 2=6 x=6-2

Suppose the banking system currently has $400 billion in reserves, the reserve requirement is 8 percent, and excess reserves amount to $5 billion. What is the level of deposits?

4937.5 Billion Total Reserve - Excess Reserve = Required Reserve 400-5=395 Required Reserve/ Reserve Requirement 395/0.08=4937.5

Suppose a Banks Assets are as follows: Reserves: $1200 Loans: 8000 Short-Term Securities: 800 Now Suppose the Banks Liabilities are as follows: Deposits: $9000 Debt: 800 Capital (Owners' Equity): 200 The Banks Leverage Ratio would be:

50 Ratio of Assets to Banks Capital 10000/200 = 50

Suppose the relevant money-supply curve is the one labeled MS 1 where Value of money = 0.5 and Money Supplied = $10,000 ; also suppose the economy's real GDP is 30,000 for the year. If the market for money is in equilibrium, then the velocity of money is approximately

6.0 30000/0.5 = 60000/10000 = 6.0 (GDP x Value of money)/Quantity of money 10000V=30000 x 0.5

Board of Governors

7 members appointed by the President of the US, confirmed by the senate and serve 14 years. Create and implement monetary policy, decides on amount of money to loan member banks and to set the rate of interest on loans, over sees bank mergers and acquisitions of American banks and any international member banks. Reports to congress.

In an open economy, gross domestic product equals $2,450 billion, consumption expenditure equals $1,390 billion, government expenditure equals $325 billion, investment equals $510 billion, and net capital outflow equals $225 billion. What is national saving?

735 Billion National Saving (S) = GDP (Y) - Consumption (C) - Government Expenditure (G) 2450-1390-325=735

The nominal exchange rate is about 2 Aruban florin per dollar. If a basket of goods in the United States costs $40, how many florins must a basket of goods in Aruba cost for purchasing-power parity to hold?

80 florin

Which of the following is an example of U.S. foreign direct investment?

A US company opens an auto parts factory in Canada

What are 2 ways to increase the money supply?

A decrease in the discount rate and a decrease in the interest rate on reserves Buy Bonds

The Law of one Price

A good should sell for the same price everywhere around the world, when converted to the same currency (Also referred to as Purchasing Power Parity PPP)

When people take advantage of differences in prices for the same good by buying it where it is cheap and selling it where it is expensive, this is known as...

Arbitrage

Demand Deposits

Balances in bank accounts, highly liquid

How can the Fed INCREASE the money supply?

Buy Government Bonds, Decrease interest rate on reserves (More Loans), Decreasing Discount Rate (Encourage Borrowing from the Fed)

Which of the following functions as both a store of value and a medium of exchange?

CASH but not Stocks

Suppose the market for money, drawn with the value of money on the vertical axis and the quantity of money on the horizontal axis , is in equilibrium. If the money supply increases, then at the old value of money there is an

EXCESS supply of money that will result in an INCREASE in spending

You hold currency from a foreign country. If that country has a higher rate of inflation than the United States, then over time the foreign currency will buy

Fewer goods in that country and buy fewer dollars

The claim that increases in the growth rate of the money supply increase nominal interest rates but not real interest rates is known as the...

Fisher Effect

What is not true about the relationship between national saving, investment, and net capital outflow?

For a given amount of saving, a decrease in net capital outflow must decrease domestic investment

The purchase of U.S. government bonds by Egyptians is an example of

Foreign Portfolio Investment (FPI) by Egyptians

GATT

Global Agreement on Tariffs and Trade Used to monitor world trade Not Powerful

When Microsoft establishes a distribution center in France, US net capital outflow...

Increases, because Microsoft makes a Foreign Direct Investment (FDI) in France

Inflation Fallacy

Inflation robs people of purchasing power False Nominal Wages increase with Inflation

Intrinsic Value Definition

Items that have value even if they aren't used as money

John and Jane decide to go on a vacation. As a result, they withdraw $2,500 from their savings account to purchase $2,500 worth of traveler's checks. As a result of these changes,

M1 Increases by $2500 and M2 stays the same

M2

M1 plus savings accounts, certificates of deposit, and other liquid assets

What are the 3 Functions of Money

Medium of Exchange Store of Value Unit of Account

Medium of Exchange

Money given to buy good/service

S-I=

NCO Net Capital Outflow

Which of the following helps to explain why the "inflation fallacy" is a fallacy?

Nominal incomes tend to rise at the same time that the price level is rising, leaving real income unchanged

Because most loans are written in ________ terms, an unexpected increase in inflation hurts ________.

Nominal; Creditors

tax-induced distortions

Pay more taxes because you're in a higher tax bracket because inflation raises income

Classical Theory of Inflation

Prices rise when the government prints too much money

To explain the long run determinants of the price level and the inflation rate, most economists today rely on the

Quantity theory of money MV=PY Every Change in M has an equal change in P

Difference between Reserve Requirement and Required Reserve

Reserve Requirement: Regulation on the minimum amounts of reserves that banks must hold against deposits (Percentage of Deposits) Required Reserve: The amount the bank holds based on the Reserve Requirement (Amount of Money)

How can the Fed DECREASE the money supply

Sell Bonds, Increase interest rate on reserves (Less Loans), Increase Discount Rate ( Discourage Borrowing From Fed)

Friedman Rule

Small amount of inflation is Ideal

Who makes up the Federal Reserve open market committee?

The 7 members of the Board of Governors + 5/12 Regional Bank Presidents The Committee aims to create maximum employment and stable prices

If nominal GDP is $400, real GDP is $200, and the money supply is $100, then what is the price level and velocity?

The Price Level is 2, and the Velocity is 4 400= P x 200 100 x V = 2 x 200

Menu Costs of Inflation

The cost of changing prices because of inflation

When the Money supply curve shifts to the right

The equilibrium value of money decreases

Bank Capital is...

The resources that owners have put into the bank

Store of Value

Transfer purchasing power from present to future

When Nominal Exchange Rate<Actual Exchange Rate

US dollar depreciates against currency

Which of the following is correct about US Exports and Imports since 1950

US exports and US Imports each have increased significantly (About Triple)

Which of the following is not included in either M1 or M2?

US treasury bills Treasury bills are M4

Unit of Account

Used to value goods/services, record debts, and make calculations

If Wardell's Nominal Income is $15.00 in 2020 and a Coke costs $5.00 in 2020 then what is Wardell's Real Income? If Wardell's Income Rose to $20.00 in 2022 and the price of a Coke rose to $6.65 in 2022 what happened to Wardell's Real Income? What theory is this proving?

Wardell's Real Income is 3 Cokes His Real Income Stayed the Same in 2022 This Proves the Inflation Fallacy

When inflation causes relative-price variability consumer decisions,

are distorted and the ability of markets to efficiently allocate factors of production is impaired

Changes in nominal variables are determined mostly by the quantity of money and the monetary system according to

both the classical dichotomy and the quantity theory of money

M1

currency, demand deposits, traveler's checks, and other checkable deposits

When the price level falls, the number of dollars needed to buy a representative basket of goods

decreases, so the value of money rises

In the last part of the 1800s

deflation made it harder for farmers to pay off their debt.

How to find nominal exchange rate with PPP

e=P*/P e=nominal exchange rate P*=Price of good in foreign market P=Price of good domestically

If the exchange rate is expressed as euros/dollar, the dollar is said to depreciate against the euro if the exchange rate

falls. Other things the same, it will cost fewer euros to buy US goods

A bank has an 8 percent reserve requirement, $10,000 in deposits, and has loaned out all it can, given the reserve requirement.

it has $800 in reserves and $9200 in loans. Reserve Requirement x Deposits 0.08 x 10000 = 800

When the market for money is drawn with the value of money on the y-axis and the quantity of money on the x-axis the price level increases if money demands shifts...

left and decreases if money supply shifts left

Fiat Money

money that has no intrinsic value (US Dollar post 1971)

Commodity Money

money that takes the form of a commodity with intrinsic value Ex: Cocoa Beans, Alcohol, Copper, Gold, Salt, Silver, Tea, Tobacco

A depreciation of the U.S. real exchange rate induces U.S. consumers to buy

more domestic goods and fewer foreign goods

Suppose that real interest rates in the U.S. rise relative to real interest rates in other countries. This increase would make foreigners

more willing to purchase US bonds, so US net capital outflow would fall

According to the assumptions of the quantity theory of money, if the money supply increases by 5 percent, then

nominal GDP would rise by 5 percent; real GDP would be unchanged.

If purchasing-power parity holds, then the value of the ____ Exchange Rate is ________

real exchange rate is equal to 1

Nominal Interest Rate Formula

real interest rate + inflation rate

A country's trade balance will fall if either

savings falls or investment rises

If saving is greater than domestic investment, then there is a trade

surplus and Y > C + I + G

The inflation Tax refers to

the revenue a government creates by printing money

In the long run, money demand and money supply determine

the value of money but not the real interest rate

Nominal Variables

variables measured in monetary units

Real Variables

variables measured in physical units/assets

The shoeleather cost of inflation refers to the

waste of resources used to maintain lower money holdings This Causes people to hold less cash on hand and visit the bank more often

Gold Standard

when a monetary unit's value is backed by gold the monetary unit can be converted to an amount of gold