Chap 9

Suppose the equilibrium real federal funds rate is 2 percent, the target rate of inflation is 2 percent, the current inflation rate is 4 percent, and real GDP is 2 percent above potential real GDP. If the weights for the inflation gap and the output gap are both 1/2, then according to the Taylor rule the federal funds target rate equals

8 percent.

Monetary policy refers to the actions the

Federal Reserve takes to manage the money supply and interest rates to pursue its macroeconomic policy objectives.

Expansionary monetary policy refers to the ________ to increase real GDP.

Federal Reserve's increasing the money supply and decreasing interest rates

Which of the following statements about inflation targeting is true?

Inflation targeting would make it easier for households and firms to form accurate expectations of future inflation, improving their planning and the efficiency of the economy.

Which of the following explains why mortgages weren't considered securities prior to 1970?

Prior to 1970, mortgages were rarely resold in the secondary market.

The Federal Reserve responded to the 2008 financial crisis in several ways. Which of the following is not one of the ways the Fed responded?

The Fed lowered the required reserve ratio on demand deposit accounts in order to increase the amount of bank reserves.

In 2008, the Treasury and Federal Reserve took action to save large financial firms such as Bear Stearns and AIG from failing. Which of the following is one reason why these measures were taken?

The bankruptcy of a large financial firm would force the firm to sell its holdings of securities, which could cause other firms that hold these securities to also fail.

In October 2008, Congress passed the ________, under which the Treasury provided funds to banks in exchange for stock.

Troubled Asset Relief Program (TARP)

The situation in which short-term interest rates are pushed to zero, leaving the central bank unable to lower them further is known as

a liquidity trap.

When the Fed buys a security from a financial firm and the financial firm agrees to buy back the security the next day, the transaction is known as

a repurchase agreement.

When the Fed sells a security to a financial firm and the Fed agrees to buy back the security the next day, the transaction is known as

a reverse repurchase agreement.

In the figure above, when the money supply shifts from MS1 to MS2, at the interest rate of 3 percent households and firms will

buy Treasury bills.

If the Federal Reserve targets the interest rate and the money demand curve shifts to the left, then the Fed

can maintain the interest rate target, but at a lower quantity of the money supply.

If the Federal Reserve targets the money supply, and the money demand curve shifts to the left, then the Fed

can maintain the money supply target, but at a lower interest rate.

Using the money demand and money supply model, an open market purchase of Treasury securities by the Federal Reserve would cause the equilibrium interest rate to

decrease

An increase in the interest rate

increases the opportunity cost of holding money.

By the 2000s, an important change in the mortgage market had occurred when ________ became significant participants in the secondary market for mortgages.

investment banks

With the federal funds rate near zero and the economy still struggling, in response to already low interest rates doing little to stimulate the economy, the Fed began buying 10-year Treasury notes and certain mortgage-backed securities to keep interest rates low. This policy is known as

quantitative easing.

Under the monetary growth rule proposed by the monetarists, the money supply would grow each year at a constant rate equal to the long-run rate of growth of

real GDP.

The ability of the Federal Reserve to use monetary policy to affect economic variables such as real GDP ultimately depends upon its ability to affect

real interest rates.

During the turmoil in the market for subprime mortgages in 2007 and 2008, the Fed increased the volume of discount loans. The goal of the Fed was to

reassure financial markets and promote financial stability.

The Fed can attempt to increase the federal funds rate by

selling Treasury bills, which decreases bank reserves.

The interest rate the Fed pays banks on their reserve holdings

sets a floor for the federal funds rate.

Which of the following describes what the Fed would do to pursue an expansionary monetary policy?

use open market operations to buy Treasury bills

Using the Taylor rule, if the current inflation rate exceeds the target inflation rate and real GDP exceeds potential GDP, then the federal funds target rate ________ the sum of the current inflation rate plus the real equilibrium federal funds rate.

will be greater than

In the figure above, the movement from point A to point B in the money market would be caused by

an open market sale of Treasury securities by the Federal Reserve.

Which of the following is true about the Federal Reserve and its ability to prevent recessions? The Federal Reserve

cannot realistically fine tune the economy, but seeks to keep recessions shorter and milder than they would otherwise be.

An increase in interest rates

decreases investment spending on machinery, equipment, and factories, consumption spending on durable goods, and net exports.

The supporters of a monetary growth rule believe that active monetary policy

destabilizes the economy, increasing the number of recessions and their severity.

When the price of a financial asset ________ its interest rate will ________.

falls; rise

The Fed uses a "core" price index, one that excludes food and energy prices to measure inflation. It does so because

food and energy prices have wide swings that are not related to the causes of general inflation.

Following the financial crisis of 2007-2009, banks had a glut of excess reserves. Because of this extraordinary amount of excess reserves being held by banks, the Fed's draining some of them through open market sales of Treasury securities would

have no effect on interest rates.

Suppose that the Federal Reserve Open Market Committee adheres to the ideas expressed by ________. If the economy moves into a recession, the Fed would recommend that the federal funds target rate decrease as long as the inflation rate did not rise above the publicly announced goal for inflation.

inflation targeting

Buying a house during a recession may be a good idea if your job is secure because the Federal Reserve often

lowers interest rates during recessions.

An increase in real GDP can shift

money demand to the right and increase the equilibrium interest rate.

When the Federal Reserve increases the money supply, at the previous equilibrium interest rate households and firms will now have

more money than they want to hold.

When the Federal Reserve System was established in 1913, its main policy goal was

preventing bank panics.

The Federal Reserve System's four monetary policy goals are

price stability, high employment, economic growth, and stability of financial markets and institutions.

Although the Federal Reserve had traditionally made discount loans only to commercial banks, in response to the financial crisis in 2008 the Fed made ________ eligible for discount loans as well.

primary dealers

If the Federal Reserve raises or lowers interest rates too late, it could result in a ________ policy that destabilizes the economy.

procyclical

If the Fed raises the interest rate, this will ________ inflation and ________ real GDP in the short run.

reduce; lower

To reassure investors who were unwilling to buy mortgages in the secondary market, the U.S. Congress used two government sponsored enterprises, Fannie Mae and Freddie Mac, to stand between investors and banks that grant mortgages. Fannie Mae and Freddie Mac

sell bonds to investors and use the funds to purchase mortgages from banks.

The money market model is concerned with ________ and the loanable funds market model is concerned with ________.

short-term nominal interest rates; long-term real interest rates

By the height of the housing bubble in 2005 and early 2006, lenders had greatly loosened the standards for obtaining a mortgage loan, with many mortgages being granted to ________ borrowers with flawed credit histories and ________ borrowers who did not document their incomes.

sub-prime; "Alt-A"

The Federal Reserve does not target both the money supply and an interest rate because

the Fed cannot achieve a target for both the money supply and an interest rate at the same time.

The money supply curve is vertical if

the Fed is able to completely determine the money supply.

Suppose that the economy is producing below potential GDP and the Fed implements the correct change in monetary policy, but not until after the economy has passed the trough of the recession. Then

the Fed's expansionary policy may result in too large of an increase in GDP.

Monetarists think that the Fed should use ________ as a target when conducting monetary policy.

the money supply

A monetary growth rule means that

the money supply should grow at a constant rate.

Most of the pressure for a monetary growth rule has disappeared because since 1980

the relationship between movements in the money supply and movements in real GDP and the price level have become much weaker.

While many analysts defended the actions taken by the Fed and the Treasury to respond to the financial crisis in 2008, others were critical of these actions. The critics were concerned that by not allowing large firms to fail

there is an increased likelihood that other firms will engage in risky behavior in the future with the expectation that they will also not be allowed to fail.

When housing prices fell as they did beginning in 2006 following the housing market bubble, most banks and other lenders ________ the requirement for borrowers, making it ________ for potential home buyers to obtain mortgages.

tightened; harder