Ap Economics Unit 5
What causes movement along the curve versus a shift in a Phillips curve ?
A change in any component of AD causes movement while a shift is caused by change in inflation or expected inflation
three Problems with controlling money supply/money multiplier?
1. assure that banks loan out all excess reserves 2. all loans are redeposited 3. no control of how much households deposit
Two problems in controlling the money supply?
1. cannot influence how much households deposit 2. cannot influence amount of money banks decide to lend
What is the money multiplier?
1/required reserve ratio, multiply by excess reserves to determine money creation
what decade had the longest economic growth?
1990s
What happens if money demand is above/below equilibrium?
Above- people want to get rid of money through bonds to lower interest rate Below- people want to obtain more money causes interest rates to rise
Who was the first Secretary of Treasury?
Alexander Hamilton
What are assets and liabilties and what is included under each in a t-account?
Assets are objects of value- reserves and loans Liabilities are what you owe- deposits
Why is money supply fixed/vertical?
Because it is set by the Fed.
The Fed consists of four groups specifically?
Board of govrnors, regional banks, FOMC, member banks
How is a bill made?
Bureau of engraving and printing then to Federal Reserve Regional banks then to commercial banks and then to customers
Classical dichotomy and money neutrality are?
Classical dichotomy is the separation of nominal and real variables Money neutrality states that changes in money supply do not affect real variables in the long run
What was the first currency printed and why?
Continentals were America's first currency in order to finance the American Revolution
How to calculate reserve ratios for banks?
Divide total deposits by the reserve ratio and that is your reserve amount, subtract that from the deposit amount and that is your loan amount. when using money multiplier, multiply that with excess reserves to find deposit expansion
Explain what happens to federal funds rate with expansionary and contractionary monetary policy?
Expansionary causes it to lower because more reserves while contractionary causes it to raise because less reserves
When and why did we go off the gold standard?
FDR took it aay in the 1930s because gold is not a reliable supply.
Explain contractionary monetary policy in short run?
If Fed contracts money supply, interest rates rise which causes AD to decrease because there will be less investment which decreases RGDP. This lowers price level.
Explain expansionary monetary policy in short run?
If Fed increases money supply, interest rates fall and this causes AD to increase because more people invest at lower interest rates which increases RGDP. This pushes up price level.
Explain expansionary monetary policy in long run?
If the Fed increases money supply, the interest rates fall and AD then RGDP increases as well as price level, but this cannot be maintained in long run so SRAS decreases left returning the economy to natural rate of output, but leaving the price high.
When did the Fed begin using open market operations? What are they?
In the 1920s, and open market operations helps control money supply by the Fed buying and selling government securities. They buy them to increase money supply, and they sell them to decrease money supply.
Explain the effect on nominal and real interest rates with increased money supply in the short run versus the long run.
Increasing money supply causes nominal interest rates to fall in the short run and because inflation is unexpected, real interest rates fall too. But in the long run, real interest rates adjust to price level while nominal increase to adjust to inflation.
What is the relationship between interest rate and money demand?
Inverse. If interest rates are high, opportunity cost of holding money is high so money demanded is less. if interest rates are low, opportunity cost of holding money is low so more money is demanded. (Opportunity cost and interest rate have direct relationship)
What did the national banking act of 1863 do?
It effectively created a currency for America because of growing demand for deposits.
What is the relationship between demand for money and interest rate
It is inverse. Lower interest rate, higher demand for money (for investment). Higher interest rate, lower demand for money.
When was the Federal Reserve created and why?
It was created December 23, 1913 after a bank failure in 1907.
What is the theory of liquidity?
Keynsian theory that interest rates adjust to bring money supply/demand to balance
when should expansionary (loose) policy and contractionary (tight) policy be used?
Loose policy should be used in recessions to stimulate growth and increase employment by putting more money into the supply while tight policy should be used to slow down growth and reduce inflation.
What is the equation of exchange? what are the variables?
MV=PQ, where m is money supply, v is velocity, p is price level, q is real gdp and PQ is nominal GDP
Real vs nominal interest rates?
Nominal- the states interest rate on bond,loan etc.. Real- adjusted for inflation Both are the same when there is no inflation
Which part of the Fed controls monetary policy?
The FOMC, Federal Open Markets Committee
Who determines money supply in the money market graph and how?
The Fed by using O.M.Os, reserve requirements and discount rates
Who owns the fed? Private or public?
The member banks own stocks so they own the fed and It is private
The interest rate represents
The opportunity cost of holding money
What makes up the Federal Reserve?
There is a seven-member board of directors and 12 regional reserve bank across the country.
Explain discount rate.
To increase money supply, the Fed lowers rates for banks to borrow from them, and they do not discourage it. To decrease the money supply, the Fed raises rates to borrow and discourages it.
Explain reserve requirements.
To increase money supply, the Fed lowers reserve requirements so banks will loan more. To decrease money supply, the Fed raises reserve requirements so the banks can loan less. This is most powerful, and is not used a lot because of it.
What are transaction, precautionary, and speculative demands?
Transaction- demand for money to make purchases Precautionary- demand for money for unexpected needs Speculative- demand for money for store of wealth
What is a double coincidence of want?
When two people have what they each want
If there is a high reserve ratio, and if there is a low reserve ratio
a high reserve ratio means less money supply, a low reserve ratio means more money supply
what consists of M2?
all of M1, also includes amounts in savings, MMDA, MMMF, small time deposits - store of value
What consists of M3?
all of M2 plus large time deposits, large business and financial insitutions - unit of account
What shifts money demand?
changes in interest rates
What is the effect of monetary policy on loanable funds?
contract ms- less money for saving so supply for loanable funds decrease, r raises expand money supply- more money for saving so supply for loanable funds increases, r lowers
what consists of M1?
currency, check-able deposits, travelers checks - medium of exchange
Two types of reserves?
excess (loans and vault cash) and required
Velocity of money?
how quickly is changes hands, is seen as constant over time
Explain what policy the Fed should implement to maintain constant interest rate when when demand for money increases vs decreases?
if it increases- expansionary If it decreases- contractionary
The U.S has so much currency per person because
it is held by criminals and in foreign countries
What is monetary policy and who controls it?
it is how the Federal reserve influences the money supply in the economy
What is the Federal Funds rate and why do banks borrow on those before the Fed?
it is the rate at which banks borrow from other banks overnight and it is lower than the Fed discount rate
The banking act of 1933 established the FDIC, what did it do?
it placed open market operations under control of the Fed and required banks to be observed by Fed
what did the monetary control act of 1980 do?
it required financial institutions to keep a reserve requirement.
What are the three functions of money?
medium of exchange- payment for goods and services unit of account- able to compare values of goods and services store of value- can be held for future/ purchasing power
What is commodity money?
money with intrinsic value, or has value even if not used as money, still has all three functions of money
What is fiat money?
no intrinsic value, used as money because government said so
What are the three main tools of monetary policy from most to least used?
open market operations, discount rate, and reserve requirements.
Formula for the fisher effect?
r= nominal - inflation
What are shoeleather cost and menu costs?
shoeleather costs are the resources wasted when inflation encourages people to reduce holdings and menu costs are the costs it takes to change prices
What is the quantity theory of money?
that amount of money determines the price level and that growth rate in that amount determines inflation rate
What is the fisher Effect?
the adjustment of nominal interest rate to inflation rate
What is the problem with bank runs?
the bank only keeps a required amount of money and loans the rest so it cannot give everyone all their monyy when they come to pull it out at the same time
What is currency?
the coins and bills in the hands of the public, most accepted medium of exchange
What is liquidity?
the ease that an asset is converted
If M grows faster than PQ?
there is inflation
What action did the Fed take after 9/11
they lowered interest rates and loaned billions to banks.
Reason why the fed would want constant interest rates?
to control investment to further control economic growth
What are the goals of the Fed using monetary policy?
to maintain economic output, employment, and prices at a desired level
