ECO 202, Chapter 14: Part C & Quantity of Money Theory

discount rate

interest rate the Fed charges on loans (called discount loans) to banks

the fed provided dis

investment banks

lender of last resort

function when banks face liquidity problems

the government budget constraint sheds light on why governments....

increase the money supply at a rate that leads to continual inflation

a decrease in the interest rate the Fed pays on bank reserves....

increases bank lending and the money supply

fed purchase of treasury securities...

increases bank reserves

What is the Federal Reserve responsible for?

-acting as a lender of last resort -managing the US money supply -managing money supply is part of monetary policy

the federal reserve has four tools of monetary policy...

-open market operations -discount policy -reserve requirements -interest of reserves

government budget constraint

G + TR= T + Change in Bonds + Change in Money Supply, where G denotes government purchases of goods and services, TR transfer payments, and T for taxes

quantity equation (equation of exchange)

M x V = P x Y -M is money supply -V is velocity of money -P is price level -Y is real GDP (P x Y is nominal GDP)

what does potential GDP depend on?

Quantity of labor, capital stock, and technology.

open market operations

The Fed, historically, conducts monetary policy primarily through?

interest of revenues

Today, the Fed heavily relies on the?

interest on revenues

What does the Fed pay banks?

increases; loans

When the Fed decreases the interest rate it pays on bank reserves, it ____________ the incentive of banks to make ________ rather than hold reserves.i

reserve requirements

a decrease by a central bank in the required reserve ratio converts required reserves into excess reserves allowing banks to make more loans

2 ways to finance a budget deficit

a government can finance this by either issuing bonds or by printing money

monetary policy

actions the Fed takes to manage the money supply and interest rates to pursue macroeconomic policy objectives

velocity of money

average number of times each dollar of the money supply is used to purchase goods and services included in GDP V= P x Y/ M

open market operations

buying and selling of treasury securities by the Federal Reserve in order to control the money supply

fed sale of treasury securities...

decreases bank reserves

the quantity of money...

does NOT affect potential GDP

to use the quantity of money theory to explain and to predict inflation in the long run, it is important to know that,...

real GDP, Y, equals potential GDP in the long-run

when a bank receives a loan from the Fed,..

the banks reserves increase by the amount of the loan

treasury securities

the bonds sold by the U.S. government to pay for the national debt

-taxes -issuing bonds -printing money

the gov budget constraint shows they have three ways to pay for gov spending...

issuing bonds and printing money

the gov budget constraint shows they have two ways to finance a budget deficit..

as banks increase the loans they make...

the money supply increases

how increases in the quantity of money creates inflation

what does the quantity theory of money explain and predict?