ECO 2013 Chapter 26 Homework

How do investment banks differ from commercial​ banks? ​

- investment banks do not take deposits - investment banks generally do not lend to households

According to the Taylor rule​, what is the federal funds target rate under the following​ conditions? ≻Equilibrium real federal funds rate equals 3​% ≻Target rate of inflation equals 3​% ≻Current inflation rate equals 2% ≻Real GDP is 2​% below potential real GDP

3.5% The Taylor Rule is: fft = π + ff*r + ½(π gap) + ½(Y gap) where fft = federal funds target π = inflation ff*r = the real equilibrium fed funds rate π gap = inflation gap (π - π target) Y gap = output gap (actual output [e.g. GDP] − output potential) so if you plug everything in you get: fft = 2+3+0.5(2-3)+0.5(-2)=5-0.5-1=3.5%

In the figure to the​ right, when the money supply increased from MS 1 to MS 2​, the equilibrium interest rate fell from​ 4% to​ 3%. Why?

All of the Above -Initially, firms hold more money than they want relative to other financial assets. -Increased demand for Treasury securities drives down their interest rate. -Increased demand for Treasury securities drives up their prices.

Consider the figures below and determine which is the best description of what causes the shift from AD 1 to AD 2

Both A and B Example A shows a contractionary monetary policy. The price level and real GDP both fall. Example B shows an expansionary monetary policy. The price level and real GDP both rise

Changes in interest rates affect aggregate demand. Which of the following is affected by changes in interest rates​ and, as a​ result, impacts aggregate​ demand? ​(Mark all that​ apply.)

Business investment projects Consumption of durable goods The value of the dollar

Why did the Fed help JP Morgan Chase buy Bear​ Stearns?

Commercial banks would be reluctant to lend to investment banks. Failure of Bear Stearns would lead to a larger investment bank failure. A and C only

What is inflation​ targeting?

Committing the central bank to achieve an announced level of inflation

The figure to the right illustrates a dynamic AD-AS model. Suppose the economy is in equilibrium in the first period at point A. In the second​ period, the economy reaches point B. We would expect the Fed to pursue what type of policy in order to move AD 2 to AD2(policy) and reach equilibrium​ (point C) in the second​ period? If the Federal Reserve​ Bank's policy is​ successful, what is the effect on the following macroeconomic​ indicators?

Expansionary monetary policy Actual real​ GDP: increases Potential real​ GDP: does not change Price​ level: increases ​Unemployment: decreases

Which of the following describes a liability on the Federal​ Reserve's balance​ sheet?

Federal Reserve notes

In the figure to the​ right, which of the following events is most likely to cause a shift in the money demand​ (MD) curve from MD 1MD1 to MD 2MD2 ​(Point A to Point ​C)​?

Increase in real GDP or increase in the price level

Which of the following is NOT a monetary policy LOADING... goal of the Federal Reserve bank​ (the Fed)?

Low prices

Consider the figure to the right. Can the Fed achieve a​ $900 billion money supply​ (MS) AND a​ 5% interest rate​ (point C)?

No. The Fed cannot target both the money supply and the interest rate simultaneously.

Suppose the economy is in equilibrium in the first period at point A. In the second​ period, the economy reaches point B. What policy would the Fed likely pursue in order to move AD 2AD2 to AD Subscript 2 comma policyAD2, policy and reach equilibrium​ (point C) in the second​ period? ​ (What policy will increase the price level and increase actual real​ GDP?)

Open market purchase of government securities

The figure to the right illustrates a dynamic AD-AS model. Suppose the economy is in equilibrium in the first period at point A. In the second​ period, the economy reaches point B. What policy would the Fed likely pursue in order to move AD 2 to AD2(policy) and reach equilibrium​ (point C) in the second​ period?

Open market purchase of government securities.

If the Federal Reserve is late to recognize a recession and implements an expansionary policy too​ late, the result could be an increase in inflation during the beginning of the next phase. Even though the goal had been to reduce the severity of the​ recession, the poor timing caused another​ problem: inflation. This is an example of what type of​ policy?

Procyclical policy

The Fed uses monetary policy to offset the effects of a recession​ (high unemployment and falling prices when actual real GDP falls short of potential​ GDP) and the effects of a rapid expansion​ (high prices and​ wages). Can the​ Fed, therefore, eliminate​ recessions?

The Fed can only soften the magnitude of​ recessions, not eliminate them.

Nobel laureate Milton Friedman and his followers belong to a school of thought known as monetarism. What do the monetarists argue the Fed should​ target?

The Fed should target the money​ supply, not the interest​ rate, and that it should adopt the monetary growth rule.

Which of the following accurately describes expansionary monetary​ policy?

The Federal Reserve causes an increase in the money supply.

Which of the following accurately describes a recent change in the Federal​ Reserve's balance​ sheet?

The Federal Reserve has more loans to financial markets and institutions on the assets side of its balance sheet.

Which of the following accurately describes contractionary monetary​ policy?

The Federal Reserve increases interest rates.

As the figure to the right​ indicates, the Fed can affect both the money supply and interest rates.​ However, in recent​ years, the Fed targets interest rates in monetary policy more often than it does the money supply. Which interest rate does the Fed​ target?

The federal funds rate

The figure to the right illustrates the economy using the Dynamic Aggregate Demand and Aggregate Supply Model LOADING... If actual real GDP in 2006 occurs at point B and potential GDP occurs at LRAS 06​, we would expect the Federal Reserve Bank to pursue ___________ monetary policy. If the​ Fed's policy is​ successful, what is the effect of the policy on the following macroeconomic​ indicators?

a contractionary Actual real GDP decreases Potential real GDP does not change Price level decreases Unemployment increases

Which of the following is not an example of monetary​ policy?

an increase in taxes

When the Federal Open Market Committee​ (FOMC) decides to increase the money​ supply, it ____ U.S. Treasury securities. If the FOMC wishes to decrease the money​ supply, it _____ U.S. Treasury securities.

buys, sells

In the figure to the​ right, the opportunity cost LOADING... of holding money ___________ when moving from Point A to Point B on the money demand curve.

decreases

What can we expect from the Federal Reserve Bank if it seeks to move the economy in the direction of​ long-run macroeconomic​ equilibrium? If the​ Fed's policy is​ successful, what is the effect on the following​ indicators?

he Fed will pursue a contractionary monetary policy. Actual real​ GDP: decreases Potential real​ GDP: does not change Price​ level: decreases ​Unemployment: increases

The prime rate

is the basis of the interest rate on many other types of loans

The federal funds rate

is the rate that banks charge each other for​ short-term loans of excess reserves.

When the Federal Reserve provides liquidity to banks by lending to​ them, it is acting as a

lender of last resort

The Federal Reserve may try to lower the federal funds rate to

make people more willing to borrow

The _________________ is considered the most relevant interest rate when conducting monetary policy.

short-term nominal interest rate

When we say that the Federal Reserve has lowered the interest​ rate, we mean that it has lowered its target for

the federal funds rate

The federal funds rate is the interest rate charged

when one bank lends money to another bank

What two institutions did Congress create in order to increase the availability of mortgages in a secondary​ market?

​"Fannie Mae" and​ "Freddie Mac"