AP Econ #26-30

Monetary Policy Tools

1. open market operations 2. discount policy 3. reserve requirements

Increase money supply...

Buy bonds, lower/decrease reserve ratio (more loands and bigger money multiplier), lower discount rate (cheaper to borrow from Fed, banks can loan more)

Open Market Opperations

Buy/sell US govt bonds

Lower inflation helps...

Creditor

Lenders are...

Creditors (banks); anticipate inflation

Market of Loanable Funds graph

D=investment, S=saving, X-axis= quantity of loanable funds, Y-axis= real interest rate

Borrowers are...

Debtors

Higher inflation helps...

Debtors

Stop/slow inflation

Decrease money supply

PV=

FV/(1+i)^n

monetary policy

Government policy that attempts to manage the economy by controlling the money supply and thus interest rates.

Batteling a recession

Increase money supply

confusion and inconvenience

Inflation changes the yardstick we use to measure transactions. Complicates long-range planning and the comparison of dollar amounts over time

Discount Rate

Interest rate on loands Fed make to banks

Price level and value of money are

Inversely related

Demand=

Investors (businesses)

M2

M1 + saving deposits, small time deposits, money market mutual funds

When Feds sell bonds...

MS decreases, bank reserves decreases, need to borrow increases, Feds fund rate increases

When Feds buy bonds...

MS increases, bank reserves increases, need to borrow decreases, Feds fund rate decreases

Money market graph...

MS= vertical, MD= DWS, X-axis= quantity of money, Y-axis= nominal interest rate

Equation for velocity

MV=PY

FV=

PV(1+i)^n

MS increases, what happens to other variables

R decreases, C increases, Investment increases, NX increases, P increases, U-rate decreases, Output or GPA increases

MS decreases, what happens to other variables

R increases, C decreases, Investment decreases, NX decreases, P decreases, U-rate increases, Output or GDP decreases

Equation that relates real, nom and inflation

Real= Nominal - Inflation

Supply=

Savers (households)

Inflation discourages

Savings

Decrease money supply

Sell bonds, increase reserve ratio (banks keeo more, smaller money multiplier), increase discount rate (costs more to borrow from Fed, less willing to loan)

Money > Barter because

Specialization, increased productivity and standard of living

Public savings

T-G

National savings

Y-C-G

Private savings

Y-T-C

Most economists believe that monetary neutrality provides

a. a good description of the long run, but not the short run.

The money supply increases when the Fed a. buys bonds. The increase will be larger the smaller the reserve ratio is. b. sells bonds. The increase will be larger the larger the reserve ratio is. c. buys bonds. The increase will be larger the larger the reserve ratio is. d. sells bonds. The increase will be larger the smaller the reserve ratio is.

a. buys bonds. The increase will be larger the smaller the reserve ratio is.

Demand deposits are a type of a. checking account. b. time deposit. c. savings deposit. d. money market mutual fund.

a. checking account.

The money supply increases when the Fed a. lowers the discount rate. The increase will be larger the smaller the reserve ratio is.. b. raises the discount rate. The increase will be larger the larger the reserve ratio is. c. raises the discount rate. The increase will be larger the smaller the reserve ratio is. d. lowers the discount rate. The increase will be larger the larger the reserve ratio is.

a. lowers the discount rate. The increase will be larger the smaller the reserve ratio is..

If the central bank in some country lowered the reserve ratio, the money multiplier a. would increase. b. would not change. c. would decrease. d. could do any of the above.

a. would increase.

store of value

an item that people can use to transfer purchasing power from the present to the future

medium of exchange

anything that is used to determine value during the exchange of goods and services (purchase g & s)

Suppose the banking system currently has $300 billion in reserves, that the reserve requirement is 10%, and that $3 billion of the reserves are excess reserves that will not be lent out. What is the value of deposits? a. $2,673 billion b. $2,970 billion c. $2,700 billion d. $3,300 billion

b. $2,970 billion

Which of the following is correct? a. If the Fed sells bonds in the open market, then the money supply curve shifts right. A change in the price level does not shift the money supply curve. b. If the Fed purchases bonds in the open market, then the money supply curve shifts right. A change in the price level does not shift the money supply curve. c. If the Fed sells bonds, then the money supply curve shifts right. A decrease in the price level shifts the money supply curve right. d. If the Fed purchases bonds, then the money supply curve shifts right. An increase in the price level shifts the money supply curve right.

b. If the Fed purchases bonds in the open market, then the money supply curve shifts right. A change in the price level does not shift the money supply curve.

Which of the following is accurate? a. Monetary policy is neutral in both the short run and the long run. b. Though monetary policy is neutral in the long run, it may have effects on real variables in the short run. c. Monetary policy has profound effects on real variables in the long run, but is neutral in the short run. d. Monetary policy has profound effects on real variables in both the short run and the long run.

b. Though monetary policy is neutral in the long run, it may have effects on real variables in the short run.

When the Fed decreases the discount rate, banks will a. borrow more from the Fed and lend less to the public. The money supply decreases. b. borrow more from the Fed and lend more to the public. The money supply increases. c. borrow less from the Fed and lend more to the public. The money supply increases. d. borrow less from the Fed and lend less to the public. The money supply decreases.

b. borrow more from the Fed and lend more to the public. The money supply increases.

If the Fed raises the money supply, then 1/P

b. falls, so the value of money falls.

When a country saves a larger portion of its GDP, it will have a. more capital and lower productivity. b. more capital and higher productivity. c. less capital and higher productivity. d. less capital and lower productivity.

b. more capital and higher productivity.

The money supply decreases if the Fed a. sells Treasury bonds. The larger the reserve requirement, the larger the decrease will be. b. sells Treasury bonds. The smaller the reserve requirement, the larger the decrease will be. c. buys Treasury bonds. The larger the reserve requirement, the larger the decrease will be. d. buys Treasury bonds. The smaller the reserve requirement, the larger the decrease will be.

b. sells Treasury bonds. The smaller the reserve requirement, the larger the decrease will be.

Liquidity refers to a. the suitability of an asset to serve as a store of value. b. the ease with which an asset is converted to the medium of exchange. c. a measurement of the intrinsic value of commodity money. d. how many time a dollar circulates in a given year.

b. the ease with which an asset is converted to the medium of exchange.

Suppose that the Federal Reserve increases bank reserves and banks lend out some of these reserves, but at some point banks still have $5 million more they wish to lend out. If the required reserve ratio is 10%, how much more money can banks create if they lend out the remaining amount? a. $55 million b. $40 million c. $50 million. d. $45 million

c. $50 million.

Which of the following best illustrates the medium of exchange function of money? a. You keep some money hidden in your shoe. b. You keep track of the value of your assets in terms of currency. c. You pay for your double latte using currency. d. None of the above is correct.

c. You pay for your double latte using currency.

As the reserve ratio increases, the money multiplier a. increases. b. does not change. c. decreases. d. could do any of the above

c. decreases.

When the Fed conducts open market purchases, bank reserves a. increase and banks must decrease lending. b. decrease and banks can increase lending. c. increase and banks can increase lending. d. decrease and banks must decrease lending.

c. increase and banks can increase lending.

In the money market, long-run equilibrium is obtained when the quantity demanded and quantity supplied of money are equal due to adjustments in the a. real interest rates. b. money supply. c. nominal interest rates. d. the value of money.

c. nominal interest rates.

According to the principle of monetary neutrality, a decrease in the money supply will not change a. nominal GDP. b. the price level. c. unemployment. d. All of the above are correct.

c. unemployment.

Bonds are

certificate of indebtedness (IOU), government(low risk, low return), corporate(high risk, less than stocks)

Money supply =

currency + demand deposits

Two main assests that are money in the USA

currency, demand deposit

M1

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

Money a. is more efficient than barter. b. makes trades easier. c. allows greater specialization. d. All of the above are correct.

d. All of the above are correct.

Which type of currency has intrinsic value? a. neither commodity money nor fiat money b. both commodity money and fiat money c. fiat money d. commodity money

d. commodity money

Most economists believe the principle of monetary neutrality is a. mostly relevant to the short run. b. relevant to both the short and long run. c. irrelevant to both the short and long run. d. mostly relevant to the long run.

d. mostly relevant to the long run.

Which of the following lists two things that both decrease the money supply? a. raise the discount rate, make open market purchases b. lower the discount rate, make open market purchases c. lower the discount rate, make open market sales d. raise the discount rate, make open market sales

d. raise the discount rate, make open market sales

If the quantity of loanable funds supplied exceeds the quantity of loanable funds demanded, a. there is a shortage and the interest rate is below the equilibrium level.. b. there is a shortage and the interest rate is above the equilibrium level. c. there is a surplus and the interest rate is below the equilibrium level. d. there is a surplus and the interest rate is above the equilibrium level.

d. there is a surplus and the interest rate is above the equilibrium level.

People who hold bonds are..

debt finance

People who hold stocks are..

equity finance

Increase in budget deficit causes...

fall in investment

misallocation of resources

firms do not change prices at once

High return means..

higher risk

tax distortions

inflation makes nominal income grow faster than real income

Run on banks

low on $, run to bank, withdraw money, currency increases, demand deposits decreases

If people decide to demand less money, then

lower value of money and higher price level

Three functions of money

medium of exchange, unit of account, store of value

Fractional Reserve banking system creates...

money NOT wealth

Money supply

money multiplier x bank reserves

What happens when Feds sell bonds...

money supply decreases, bank reserves decreases, need to borrow increases, Fed funds rate increases

What happens when Feds buy bonds...

money supply increases, bank reserves increase, need to borrow less, Fed funds rate decreases

Money is what in LR

neutral in LR because real variables are unaffected by inflation (classic dichotomy)

Stocks are

partial ownership in a company (high risk), you are a partial owner

CDs are

pledge to leave money in bank for X amount of years (low risk, low return)

Buying bonds or stocks is savings or investment?

savings

money multiplier

the amount of money the banking system generates with each dollar of reserves

menu costs

the costs to firms of changing prices

Federal funds rate

the interest rate at which banks make overnight loans to one another

reserve requirement

the percentage of deposits that banking institutions must hold in reserve

shoelether costs

the resources wasted when inflation encourages people to reduce their money holdings

unit of account (standard of value)

yardstick people use to post prices and record debts