ECON 102 - 2020

Banks borrow from the Fed at the

discount rate

Which of the following is a bank liability?

Deposits

Which of the following will not cause US imports from China to increase?

Increase in US Prices

Dodd-Frank includes "living will" regulations to help reduce taxpayer burden in the event of another financial crisis. Explain what "living wills" are in financial markets. Explain why "living wills" might cause banks to engage in less risky behavior and might also reduce the cost of a bailout should there be financial crisis anyway.

"living wills" outline how different types of stock and bondholders will be affected in the case that many loans go into default. This makes stock and bondholders aware of the costs to them if the bank behaves in a risky way and so they will pressure banks to be more careful in their lending (or can competition will lead them to require a higher rate of return for risky behavior). if there is a financial crisis, the government has contracted to limited support/rescue of stock and bondholders, and mostly rescue of just depositors.

If the interest rate is 12 percent, the present value of $200 paid 1 year from now equals . If the $200 is received in 2 years, the present value is .

$178.57; $159.44

Suppose that banks keep 15% of all their deposits as reserves and that there is an initial cash deposit of $534. Approximately how much do we expect total checking account deposits to increase?

$3,560

Suppose Ariana deposits $75,000 in her bank. If the reserve ratio is 20 percent, this will lead to a maximum increase of ___________ in checking account balances throughout all banks.

$375,000

In the long run

The economy operates at full employment

What time period and economic policies and consequences does "Smoot-Hawley" refer to?

½ point: Protectionist policies started in the US during the Great Depression ½ point: That led to a global trade war that worsened the Great Depression

What is Quantitative Easing? How does it differ from conventional Open Market Operations in terms of its impact on the economy?

½ point: QE: The Fed's purchase of long-term private debt (or can say corporate debt or can say MBS's) rather than (or in addition to) using traditional Open Market purchases of government securities ½ point: QE affects long-term rather than short term interest rates (don't need to say because these are purchases of long-term bonds, as that is implied if they got the first point for credit

The United States' monetary policy targets while China's monetary policy targets .

The federal funds rate; the exchange rate

Describe one circumstance under which President-elect Trump's fiscal plan would not cause crowding out of either Investment or Net Exports.

The only way is if either the tax cuts (L* or K* up) or infrastructure spending (K* up) cause potential GDP to increase more than Government spending increases, so either argument would be fine. Deduct ¼ point if they don't indicate in their answer that potential GDP would have to increase a lot in order to avoid crowding out. Some answers may focus on "if interest rates don't change" or something like that. Give ½ point for that answer, as it shows economic reasoning even if it is not technically sufficient (if G goes up C, I, and NX must fall unless Yp changes—that is just accounting)

Many analysts credited the change in Forward Guidance to the Fed's reaction to President Elect Trump's tax and spending plans. Explain why the President-elect Trump's fiscal policy plans (no details about his proposals are needed) might cause the FOMC to want to further increase the target federal funds rate.

(1/2 point) Trump's proposals will increase AD, which will cause both prices and wages to rise and L to rises. (1/2 point) The Fed's will want to slow AD growth in order to maintain price stability.

As the Federal Reserve ___________bonds, interest rates fall and the price of bonds_________

Buys; rises

What is a "liquidity trap" and what policy did the US Federal Reserve use during the Great Recession to help avoid falling into a Liquidity Trap? Explain the economic logic, making sure to define any terms you use.

1 point: Expansionary monetary policy can drive lending rates very close to zero, which leaves little room for further policy action. This is known as a liquidity trap 1 point: If banks earn a positive interest rate for not making a loan (keeping in reserve) then they will always charge a lending rate above zero, which leaves room for more policy

Why might expansionary open market operations be ineffective in stimulating investment spending? (i.e. Why may it be like "pushing on a string"?). Explain briefly, making sure to explain how an effective policy would work so we know what you are comparing things to.

1 point: Expansionary open market operations increase the deposits held at banks, but the policy only "works" if banks increase lending. 1 point: Banks may refuse to increase lending if they think the economy is too risky, if interest rates are already so low as to give them no incentive to make more loans (liquidity trap), or if they need to increase their reserves to meet regulatory requirements. Any one of those reasons would be acceptable answers.

Why will President-elect Trump's fiscal plan likely lead to dollar appreciation? Make sure to teach us the steps that lead to dollar appreciation, assuming we haven't been paying attention in class.

1 point: It increases government borrowing (or can say increases AD, which increases prices and the transactions demand for money, which puts upward pressure on interest rates) , which puts upward pressure on interest rates 1 point: When US interest rates rise relative to the rest of the world, our assets become relatively attractive to foreigners, who need dollars to get our assets 1 point: Demand for dollars increases and the dollar appreciates.

If the reserve ratio is 0.1, the money multiplier (also known as "deposit multiplier") is equal to

10

Bank deposits $70,000 Loans $25,000 Required Reserves $15,000 Excess Reserves $10,000 Given the information from the table above, what is the reserve ratio for this bank?

35.7% (Reserves/Bank Deposits)

What is a problem that arises when exchanges can only be made through a system of barter (a system where goods or services are directly exchanged for other goods or services without using a medium of exchange)?

A double coincidence of wants is necessary to make transactions.

Why, as part of its ongoing expansionary monetary policy following the Great Recession, is the European Central bank setting a negative interest rate on reserves held at the European Central Bank?

A negative interest rate penalizes savings and encourages spending ;more spending means more Aggregate Demand

In an aggregate supply and aggregate demand diagram, the long-run aggregate supply curve is represented by

A vertical line at the full employment level of output

When the Federal Reserve sells bonds on the open market, it leads to

An appreciation of the dollar

In an aggregate supply and aggregate demand diagram, the short-run aggregate supply curve is represented by

An upward-sloping but relatively flat line relating prices and output

The European Union is using new and creative monetary policy tools to fight deflation in the EU "Euro" zone. Deflation may

Be the result of falling wages Be the result of falling AD Be the result of lower oil prices

If GDP is _________ potential output, the economy is in a _______ and prices and wages will tend to decrease

Below; recession

The European Union is using new and creative monetary policy tools to fight deflation in the EU "Euro" zone. Deflation can be particularly harmful to

Borrowers

If banks hold excess reserves, Keynesians expect

Both M2 and GDP to fall

Quantitative Easing occurs when the Fed

Buys mortgage-backed securities

As the Federal Reserve ________ bonds, interest rates fall and the price of bonds ________.

Buys; rises

In the short run when prices don't have enough time to change, the Federal Reserve

Can influence the level of interest rates in the economy

After the financial crisis of 2008, the Fed

Changed the composition of its assets to include mortgage-backed securities, Changed the composition of its assets to include long-term government debt, Changed the composition of its assets to include more short-term government debt

Which of the following affects Investment spending in the long run?

Changes in the government budget deficit

Which of the following factors does NOT shift the demand curve for money?

Changes in the interest rate

According to the data we saw in class, what is the largest component of M1?

Currency

Based on the model of the money market, when real income decreases, the equilibrium interest rate is expected to do which of the following?

Decrease

In the long run, a decrease in government spending will,

Decrease both the real interest rate and the value of the domestic currency

When the supply of money increases, the purchasing power of each dollar and exports are expected to .

Decreases; increase

Which of the following is considered a liability for a bank?

Deposits

Which of the following is an example of "moral hazard"?

Those who have health insurance are more likely to engage in activities that could harm their health than if they were not insured.

Why, as part of its expansionary monetary policy during the Great Recession, did the US Federal Reserve start to pay interest on reserves held at Federal Reserve Banks?

Expansionary monetary policy can drive lending rates very close to zero, which leaves little room for further policy action. ½ point: If banks earn a positive interest rate for not making a loan (keeping in reserve) then they will always charge a lending rate above zero, which leaves room for more policy

When considering the long-term income-distributional effects of expansionary fiscal and monetary policies,

Expansionary monetary policy tends to hurt and expansionary fiscal policy tends to help the elderly, who are living on a combination of savings and fixed retirement incomes

Why might expansionary open market operations be ineffective in stimulating investment spending? (Why may it be like "pushing on a string"?). Explain briefly, making sure to explain how an effective policy would work so we know what you are comparing things to.

Expansionary open market operations increase the deposits held at banks, but the policy only "works" if banks increase lending. ½ point: Banks may refuse to increase lending if they think the economy is too risky, if interest rates are already so low as to give them no incentive to make more loans (liquidity trap), or if they need to increase their reserves to meet regulatory requirements.

Raising the discount rate (rate charged for a loan from the Fed) is likely to cause the money multiplier (also called the deposit multiplier) to

Fall

As the Federal Reserve sells bonds, the stock market ____ and expected stock returns for holding stocks ____.

Falls; rises

The current US currency system is

Fiat money

When GDP is below potential output, prices fall because

Firms can easily find new workers and can offer lower wages, which decreases the cost of production

The short-run aggregate supply curve is relatively flat because

In the short run, prices do not change very much but it is relatively easy to hire or fire workers that produce output

Based on the model of the money market, if world events make the stock market suddenly look risky, the equilibrium interest rate should

Increase

What is one balance-sheet regulation under Dodd-Frank? Explain how that bank balance sheet regulation might help prevent another financial crisis.

Increase in owner's equity is most likely answer or can also say can't speculate with owner's equity. Bad loans first come out of owner's equity before hitting deposits, so more of the shock is contained and doesn't spread to depositors.

If the Fed wanted to decrease inflation, it could

Increase the reserve requirement or conduct an open market sale

The goal of Quantitative Easing was to ______________ the prices of government bonds and mortgage securities and _____________ the interest rates on both bonds and mortgages

Increase; decrease

All other things being equal, increases in GDP should be correlated with

Increases in bond yields

As the price level increases, the demand for money ____________ and the exchange rate _______

Increases; increases

The purpose of having the members of the Board of Governors of the Federal Reserve serve fourteen-year terms is to

Insulate the governors' policy decisions from the influence of presidential elections and politics

Investment banks bought lots of MBS's (mortgage-backed securities) prior to the Great Recession because:

Interest rates were low and housing prices were high, presenting an arbitrage opportunity.

Which of the following is NOT a function of the Federal Reserve?

Issue new treasury bonds

What is the name of the chair of the Federal Reserve? What other Fed officials (don't need their names, just their job title) sit on the FOMC?

Jerome Powell 1/2 point: New York Fed 1 point: rotating membership 5 regional Federal Reserve Banks

Which of the following is not a function of the Federal Reserve?

Lender of last resort to the federal government

The demand for money that arises so that individuals or firms can make purchases on quick notice is called the

Liquidity demand for money.

Which of the following is a bank asset?

Loans made to customers

Inside lags are

Longer for fiscal policy than for monetary policy

Because liquid assets can get away with offering rates of return, people generally only hold liquid assets if they plan to them.

Lower; spend

If consumers were to shift funds from checking accounts to savings accounts, which of the following is true?

M2 is unchanged and M1 decreases

Which of the following is part of the dual mandate given to the Federal Reserve?

Maintain stable prices

The transaction demand for money comes mostly from the fact that

Money is a medium of exchange

The appreciation of the dollar will make US goods __________________ to foreigners and make imports ______________for US residents

More expensive; cheaper

Should the government just break up all the big banks or should they use the regulatory process set up in Dodd-Frank? Why?

Most common answers will likely be something along the lines of "we don't want to break up the big banks because that will make them less competitive" or "break them up because it's not credible that we won't rescue them later on if they are too big to fail and we just can't afford it"

Describe one of the criticisms we heard in class about the Fed's use of Quantitative Easing.

Most likely either that it is an interference in the private market or can say that it is hard to reverse because it is hard to find buyers for low-grade MBS's and many won't get paid back automatically as they are high-risk, or can say that they should have bought something with a higher return

If a household buys a bond from another household on the secondary bond market, Keynesians expect

Neither M2 nor GDP to be affected

The United States Federal Reserve's most commonly used monetary policy tool is

Open Market operations

Wages and prices throughout an economy are lower when what occurs?

Output falls short of potential output

The Wednesday, December 14, FOMC announcement included a change in their Forward Guidance, suggesting more rate increases than had been expected by the financial markets. Why does the Fed use Forward Guidance? Give one reason from class.

QE is less transparent than open market operations so Forward Guidance lets markets know what they are doing with QE They are afraid that real wages will get out of equilibrium, or in other words that coordination failures, will be worse, if the Fed surprises markets with rate changes that affect prices in unexpected ways.

What would be a way for the Federal Reserve to slow down the economy when it is growing too quickly or is inflationary?

Raise interest rates on reserves

Suppose the United States' currency came under attack by speculators who expected the value of the dollar to fall. To prevent the value of its currency from falling, the central bank would need to

Raise interest rates. The policy would cause net exports to fall

To increase the money supply using reserve requirements, what would the Fed typically do?

Reduce the reserve requirement for banks

Higher U.S. interest rates cause the value of the dollar to

Rise, making U.S. goods relatively more expensive on world markets

Suppose that the central bank engages in open market sales, this will cause interest rates to , and will cause net exports to .

Rise; fall

A wage-price spiral occurs when

Rising wages cause higher prices, which in turn cause higher wages

US Excess Reserves

Rose during the Great Recession, reducing lending to firms and decreasing both AS and AD

An open market ___________by the Fed increases interest rates and causes an _________ of the currency price.

Sale; appreciation

An open market by the Fed increases interest rates and output.

Sale; decreases

To decrease the money supply, the Fed should

Sell bonds, pay interest on reserves, and/or raise the discount rate

Show 3 graphs side-by-side: The market for goods (AD-AS), the money-market, and the graph showing equilibrium determination of Investment spending. Assume we are in a long-run equilibrium. Using all three graphs, show both the short-run and long-run effects of an increase in the money supply on goods, money, and investment markets. Explain any shifts in curves as well as any movements along curves in your graphs. Explain the impact on GDP, prices, wages, real interest rates, and investment spending in both the short and long run.

Short run (1/2 point for each of the following, 2.5 points for short run): MS up, r down (don't need to explain why) Move along I, I up Shift AD as I up Move along AS (don't shift it in short run) because wages are sticky Costs and prices rise as GDP rises because of diminishing returns Long run (1/2 point for each of the following, 3.5 points for long run) Workers demand higher wages Costs rise at any level of output, so AS shifts up Prices rise, so Md shifts up because people need more cash to buy goods/services Interest rates rise to their original level I falls to original level Move along AD as I falls from the price change (or they can mention move along AD in the short run section) Return to LRAS (GDP*) at higher prices and wages, but original r and I

The Friday, May 6, report on the US employment situation was not as strong as had been expected. That report, coupled with recent weak estimates for first-quarter 2016 GDP growth, caused both the stock market and the value of the dollar to fall. Using the language and theory from class, provide a possible explanation for the stock market reaction. Next provide an explanation for the currency market reaction.

Stock markets affected by expectations of future firm value, which could now be lower (don't need to say therefore prices fall as it is implied in the question) ½ point: Returns in asset (can say stock) markets expected to be lower therefore less demand for US assets by foreigners leading to less demand for the dollar (don't need to say therefore price falls as it is implied in the question)

As inflation rates increase, money becomes less useful as a

Store of value

Classical economics is often associated with Say's law, which states

Supply creates its own demand

Which of the following are factors that affect GDP in the long run?

Supply of Labor, Stock of Capital, Technological Progress

The voting members of the Federal Open Market Committee is made up of

The Board of Governors, the president of the New York Fed, and a rotating set of regional federal reserve bank presidents

Will the Fed's rate increases reverse or increase the impact of President Trump's policies on US net exports? Why?

The Fed policy raises rates even more, causing further dollar appreciation and making US exports seem even more expensive to foreigners, further reducing NX.

A severe winter storm warning is most likely affect

The Liquidity demand for money

The opportunity cost of holding money is

The return that could have been earned from holding wealth in other assets

The Federal Reserve might engage in open market sales of bonds if

There is rapid inflation

During the housing boom, overeager lenders made loans to very risky borrowers (those with no income and/or no wealth or with very bad credit ratings)

This is economically sensible if the loans are well-diversified, posing little chance of causing a decline in housing prices.

One of the essential functions that a bank performs is

Transferring money from savers to lenders

Most of the cost of bailing out the banking system during the great depression is and will likely be financed by taxes on labor rather than by taxes on the banking sector itself. Using the language and theory from class, briefly explain why it might be more effective to tax labor than capital (taxing banking, financial transactions, or earnings in capital markets).

Unlike labor, many capital transactions can move across borders to low-tax areas, so if a country raises taxes firms and capitalists will shift across borders to low-tax areas. Labor can't do this as easily. (Don't have to use words like "elasticities" but of course that language would be awesome—elasticities in labor supply are lower than in savings). Another approach might be to argue that even without tax-shifting across borders, elasticities are high for savings—small changes in return have a big impact on the willingness to forgo current consumption. That is certainly a logical argument. A third approach consistent with language and theory from class would be to argue that taxing capital affects real wages and therefore income taxes, so it is less efficient than taxing labor that doesn't feedback into capital returns. A fourth approach that is worth only ½ point because it is not based on the language and theory from class is that capitalists have more power in a political-economy sense and so they block taxes on capital.

Suppose the economy is in both a recession and a liquidity trap. Policymakers can address both issues if they

Use government borrowing to stimulate Aggregate Demand

In terms of determining the money supply, the primary difference between debit cards and credit cards is that

Using a debit card is like writing a check, while using a credit card is like taking out a loan

If the economy is below full-employment output, the short-run aggregate supply curve

Will shift down and to the right

The rate of interest charged to commercial banks by the Fed for loans is called the

discount rate