CH 34

Answer this Question on the basis of the following information: Bond price = $10,000; bond fixed annual interest payment = $1,000; bond annual rate of interest 5 10%. If the price of this bond increases by $2,000, the interest rate in effect will

decrease by 1.7 percentage points

When the Federal Reserve Banks decide to buy government bonds from banks and the public, the supply of reserves in the federal funds market

increases and the federal funds rate decreases

Suppose the demand for money falls. In order to maintain interest rates at their previous level, the Fed might:

sell government securities Feedback: A drop in the demand for money will put downward pressure on interest rates. In order to maintain rates, the Fed will need to reduce the supply of money. Fed sales of securities will remove reserves from the system and put upward pressure on interest rates to counteract the effects of the drop in demand.

The economy is experiencing high unemployment and a low rate of economic growth and the Fed decides to pursue an expansionary monetary policy. Which set of actions by the Fed would be most consistent with this

selling government securities and raising the discount rate

Assume that monetary policy increases interest rates and results in a decrease in investment spending of $5 billion. If the marginal propensity to consume is 0.80, then aggregate demand is most likely to

decrease by $25 billion

The total quantity of money demanded is

directly related to nominal GDP and inversely related to the rate of interest

The Taylor Rule suggests that:

for each 1 percent increase of real GDP above potential GDP, the Fed should raise the real Federal funds rate by ½ percentage point Feedback: The Taylor Rule is a rule of thumb that approximates the policy of the Fed. It suggests that the Fed raise the real Federal funds rate by ½ percentage point for each 1 percent increase of real GDP above potential GDP and for each 1 percent increase in inflation above its target rate.

Answer this Question on the basis of the following information: Bond price = $10,000; bond fixed annual interest payment = $1,000; bond annual rate of interest 5 10%. If the price of this bond decreases by $2,500, the interest rate in effect will

increase by 3.3 percentage points

Which is most likely to be affected by changes in the rate of interest?

investment spending

Assume the Fed creates excess reserves that get added to the banking system, but banks decide not to increase their lending because they are worried about loans being paid back because of the poor economic health of the economy. This situation would best describe a

liquidity trap

Commercial bank borrowing from the Federal Reserve

ncreases the excess reserves of commercial banks and their ability to offer credit

Which is the most important control used by the Federal Reserve to regulate the money supply?

open-market operations

If the intent of the Fed is to increase GDP, it should:

purchase government securities in the open market Feedback: Fed purchases of securities will add reserves to the banking system. As lending increases and the money supply expands, there will be downward pressure on interest rates, causing investment and GDP to expand.

There is an asset demand for money because money is

a store of value

The federal funds rate is the rate that

banks charge for overnight use of excess reserves held at the Federal Reserve banks

Assume that there is a 20% reserve ratio and that the Federal Reserve buys $100 million worth of government securities. If the securities are purchased from the public, this action has the potential to increase bank lending by a maximum of

$400 million, but by $500 million if the securities are purchased directly from commercial banks

If the dollars held for transactions purposes are, on the average, spent five times a year for final goods and services, then the quantity of money people will wish to hold for transactions is equal to

20% of the nominal GDP

Which one of the following points would be true?

A lower interest rate raises the opportunity cost of holding money.

Which of the following will cause the aggregate demand curve to shift to the left?

Fed sales of bonds to the public Feedback: Fed bond sales will drive down the price of bonds, raising interest rates. Higher interest rates will reduce desired investment spending and shift the aggregate demand curve to the left, reducing GDP.

The organization directly responsible for monetary policy in the United States is the

Federal Reserve

The largest single liability of the Federal Reserve Banks is

Federal Reserve Notes

In the chain of cause and effect between changes in the excess reserves of commercial banks and the resulting changes in output and employment in the economy,

a decrease in the money supply will increase the rate of interest

When the Federal Reserve uses open-market operations to reduce the federal funds rate several times over a year, it is pursuing

an expansionary monetary policy

A restrictive monetary policy would be most consistent with

an increase in the federal funds rate and a decrease in the money supply

Lowering the reserve ratio

changes required reserves to excess reserves

A decrease in the money supply will:

raise interest rates, reducing planned investment and GDP Feedback: A decrease in the money supply creates a shortage of funds in the market for money, putting upward pressure on interest rates. The higher interest rates imply that fewer investment projects will be profitable. Finally, lower planned investment reduces aggregate demand and GDP falls.

Suppose banks are just meeting their reserve requirement of 25% and the Fed sells $30 billion in government securities to commercial banks. The effect of this sale is to:

reduce the potential money supply by $120 billion Feedback: The $30 billion in sales will immediately reduce excess reserves by $30 billion. A 25% reserve ratio implies a monetary multiplier of 4, so that the potential money supply decreases by $120 billion.

The largest single asset in the Federal Reserve Banks' consolidated balance sheet is

securities

Two primary assets of the Federal Reserve Banks are:

securities and loans to commercial banks Feedback: The Fed owns substantial holdings of U.S. Treasury bills and bonds. In addition, the Fed makes short-term loans to commercial ban

An increase in the rate of interest would increase

the opportunity cost of holding money

The economy is experiencing inflation and the Federal Reserve decides to pursue a restrictive monetary policy. Which set of actions by the Fed would be most consistent with this policy?

selling government securities and raising the discount rate

The stock of money is determined by the Federal Reserve System and does not change when the interest rate changes; therefore, the

supply of money curve is vertical

If the current interest rate is below the equilibrium rate:

the interest rate will rise and the quantity of money demanded will decrease Feedback: If the interest rate is below its equilibrium value, the quantity of money demanded exceeds the money supply. The shortage of money will cause the interest rate to rise, causing households and businesses to reduce their desired money holdings. This brings the quantity of money demanded into equality with the money supply.

If the Fed buys bonds from the public through its open market operations:

the price of bonds will increase and the interest rate received by bond holders will decrease Feedback: Fed purchases increase the demand for bonds, driving up their price. The higher the price paid for the bond, the lower its effective yield, or interest.

Assuming that the Federal Reserve Banks sell $20 million in government securities to commercial banks and the reserve ratio is 20%, then the effect will be

to reduce the potential money supply by $100 million