ECON Chapter 17 Study Guide

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

A and C

The figure to the right illustrates the economy using the Dynamic Aggregate Demand and Aggregate Supply Model. If actual real GDP in 2006 occurs at point B and potential GDP occurs at LRAS06​, 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? Actual real GDP _______. Potential real GDP _______. Price level _______. Unemployment _______.

A contractionary Decreases; does not change; decreases; increases

Which of the following is not one of the monetary policy goals of the Federal Reserve ("the Fed")?

A high foreign exchange rate of the U.S. dollar relative to other currencies.

What is a banking​ panic? Which of the following best explains how the Federal Reserve acts to help prevent banking​ panics?

A situation in which many banks experience runs at the same time. The Fed acts as a lender of last​ resort, making loans to banks so that they can pay off depositors.

In the figure to the right, when the money supply increased from MS1 to MS2, the equilibrium interest rate fell from 4% to 3%. Why?

All of the above

The hypothetical information in the following table shows what the situation will be in 2021 if the Fed does not use monetary policy. If the Fed wants to keep real GDP at its potential level in​ 2021, it should use _______ policy. Use the diagram to the right to illustrate the effects of this monetary policy action consistent with the data for the year 2021 in the table above.

An expansionary Picture 2

Consider the figures below and determine which is the best description of what causes the shift from AD1 to AD2.

Both A and B

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?

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

If the Federal Open Market Committee​ (FOMC) decides to increase the money​ supply, it orders the trading desk at the Federal Reserve Bank of New York to If the FOMC orders the trading desk to sell Treasury​ securities,

Buy U.S. Treasury securities. The money supply curve will shift to the​ left, and the equilibrium interest rate will rise.

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

What is inflation​ targeting?

Committing the central bank to achieve an announced level of inflation.

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

Decreases

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

Decreases

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 AD2 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? Actual real​ GDP: ______ Potential real GDP: _______ Price level: _______ Unemployment: _______

Expansionary monetary policy Increases; does not change; increases; decreases

To affect economic variables such as real GDP or the price​ level, the monetary policy target the Federal Reserve has generally focused on is the

Federal funds rate.

The interest rate that banks charge each other for overnight loans is called the Which of the following statements is​ correct?

Federal funds rate. All of the above are true.

In​ 2017, one article in the Wall Street Journal had the​ headline: "Federal Reserve Expected to Deliver Rate​ Increase." What rate was the headline likely referring​ to? Who is able to borrow and lend at that​ rate? Why does the​ Fed's actions to increase or decrease the rate you identified above attract so much​ attention?

Federal funds rate. Banks are able to borrow and lend from each other at that rate. This rate ultimately has a substantial effect on many other interest rates.

An article in the New York Times in 1993 stated the following about Fed Chairman Alan​ Greenspan's decision to no longer announce targets for the​ money: ​"Since the late​ 1970's, the Federal Reserve has made many of its most important decisions by setting a specific target for growth in the money supply ... and often adjusted interest rates to meet​ them." If the Fed would no longer have a specific target for the money​ supply, it would be targeting the The Fed gave up targeting the money supply because

Federal funds rate. The relationship between monetary aggregates and other economic variables was becoming unreliable.

Since​ 1950, the annual inflation rate in the U.S.

Has typically been​ positive, but it has also varied​ substantially, peaking around​ 1980, and becoming negative for several months in early 2009 due to the effects of the Great Recession.

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 MD1 to MD2 ​(Point A to Point ​C)​?

Increase in real GDP or increase in the price level

Which of the following is a monetary policy target used by the​ Fed? The Fed uses policy targets of interest rate​ and/or money supply because

Interest rate. It can affect the interest rate and the money supply directly and these in turn can affect​ unemployment, GDP​ growth, and the price level.

How do investment banks differ from commercial​ banks?

Investment banks do not take deposits AND Investment banks generally do not lend to households

The federal funds rate

Is the rate that banks charge each other for short-term loans of excess reserves

What do economists mean by the demand for​ money? What is the advantage of holding​ money? What is the disadvantage of holding​ money?

It is the amount of money—currency and checking account deposits—that individuals hold. Money can be used to buy​ goods, services, or financial assets. ​Money, in the form of currency or checking account​ deposits, earns either no interest or a very low rate of interest.

Which of the following is NOT a monetary policy 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 AD2 to AD2, 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 AD2 to AD2, policy and reach equilibrium​ (point C) in the second​ period?

Open market purchase of government securities.

The​ Fed's two new policy tools are The Fed now needs to rely on these two new policy tools to change the federal funds rate because

Paying interest on bank reserve holdings and paying interest on repurchase and reverse repurchase agreements. Banks were not loaning out excess reserves.

The graph shows equilibrium in the money market. The equilibrium interest rate is determined at point E where the money demand and money supply curves intersect. Suppose the Fed wants to lower the equilibrium interest rate.

Picture 1

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

​"Fannie Mae" and​ "Freddie Mac"

When interest rates on Treasury bills and other financial assets are​ low, the opportunity cost of holding money is​ _________, so the quantity of money demanded will be​ _________.

​Low; high

In​ mid-2017, an article in the Wall Street Journal noted​ that: ​"The Federal​ Reserve's interest-rate increases​ aren't having the desired effect of cooling off Wall​ Street's hot streak...where stocks have rallied to records this​ year..." Is cooling off rapid increases in stock prices part of the​ Fed's dual​ mandate? Are such increases a concern for the​ Fed? Briefly explain.

​No, this is not part of the​ Fed's dual mandate of price stability and high employment. ​Yes, rapidly rising stock prices could be a concern for the Fed because it has a goal of stable financial markets.

Suppose that when the Fed decreases the money​ supply, households and firms initially hold less money than they want​ to, relative to other financial assets. As a​ result, households and firms will​ _________ Treasury bills and other financial​ assets, thereby​ _________ their​ prices, and​ _________ their interest rates.

​Sell; decreasing; increasing

When the Fed conducts monetary​ policy, the most relevant interest rate is the

​Short-term nominal interest rate.

According to the Taylor rule​, what is the federal funds target rate under the following​ conditions? follows ≻Equilibrium real federal funds rate equals 22​% follows ≻Target rate of inflation equals 22​% follows ≻Current inflation rate equals 11​% follows ≻Real GDP is 11​% below potential real GDP The federal funds target rate equals _______​%.

2.0

If real GDP​ increases, If the price level​ decreases,

The money demand curve shifts to the right. The money demand curve shifts to the left.

Which of these variables are the main monetary policy targets of the​ Fed?

The money supply and the interest rate

One of the goals of the Federal Reserve is price stability. For the Fed to achieve this​ goal,

The rate of inflation should be low, such as 1% to 3%, and should be fairly consistent.

How can investment banks be subject to liquidity​ problems? Investment banks can be subject to liquidity problems because

They often borrow short​ term, sometimes as short as​ overnight, and invest the funds in​ longer-term investments.

In response to problems in financial markets and a slowing​ economy, the Federal Open Market Committee​ (FOMC) began lowering its target for the federal funds rate from 5.25 percent in September 2007. Over the next​ year, the FOMC cut its federal funds rate target in a series of steps. Writing in the New York Times​, economist Steven Levitt​ observed, ​"The Fed has been pouring more money into the banking system by cutting the target federal funds rate to 0 to 0.25 percent in December​ 2008." What is the relationship between the federal funds rate falling and the money supply​ increasing? How does lowering the target for the federal funds rate​ "pour money" into the banking​ system?

To decrease the federal funds​ rate, the Fed must increase the money supply. To increase the money​ supply, the Fed buys bonds on the open​ market, which increases bank reserves.

When Congress established the Federal Reserve in​ 1913, its main responsibility was Congress broadened the​ Fed's responsibility since

To make discount loans to banks suffering from large withdrawals by depositors. The 1930s as a result of the Great Depression.

An article on Reuters discussing a Reserve Bank of India​ (RBI) monetary policy meeting in early 2017 stated that the RBI​ "changed its stance to​ 'neutral' from​ 'accommodative,' saying it would monitor​ inflation." The article noted that​ "the decision to hold​ [the interest rate that is the​ RBI's equivalent of the federal funds rate​ constant] is a​ risk, as private forecasts are more pessimistic​ [about economic​ growth] than the​ RBI." Draw a dynamic aggregate demand and aggregate supply graph to show where the RBI expected real GDP to be relative to potential GDP in 2017 if it kept its target interest unchanged.​ Assume, for​ simplicity, that real GDP in India in 2016 equaled potential GDP. Assume the economy is initially in​ long-run equilibrium at Briefly explain what is happening in your graph. If the target interest rate and the​ RBI's expectations are​ correct, then real GDP _______ potential GDP. ​Now, using the​ graph, show where the private forecasters who are more pessimistic about growth see the economy in 2017. Briefly explain what is happening in your graph. If the private forecasters are​ correct, then real GDP _______ potential GDP.

Picture 3 Equals Picture 4 Is less than

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

Consider the variables that shift money demand and money supply. Match each of the following scenarios with one of the four graphs of money demand and money supply. a. More widespread use of mobile wallets b. Fed decreases the required reserve ratio c. Fed sells Treasury securities d. Real GDP increases Figure A illustrates Figure B illustrates Figure C illustrates Figure D illustrates

Real GDP increases. The Fed selling Treasury securities. More widespread use of mobile wallets. The Fed decreasing the required reserve ratio.

Which one of the following is not one of the monetary policy goals of the​ Fed? Why is the Fed sometimes said to have a​ "dual mandate"? The Fed is said to have​ a" dual​ mandate" because

Reduce income inequality. Maintaining price stability and high employment are the two most important goals of the Fed.

With a​ __________, the Fed buys a security from a financial​ firm, which promises to buy it back from the Fed the next day.

Repurchase agreement

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

Short-term nominal interest rate

A former Federal Reserve official argued that at the​ Fed, ​"the objectives of price stability and low​ long-term interest rates are essentially the same​ objective." This is true because

Stable prices make it easier to plan for the​ future, so expectations can be​ stable, which makes it less costly to make loans.

A column in the Wall Street Journal referred to policy actions aimed at​ "fulfilling both sides of the​ Fed's dual​ mandate." Which of the following gave the Fed a dual​ mandate? Does the​ Fed's dual mandate require it to attain a zero percent unemployment​ rate? Briefly explain. Does the​ Fed's dual mandate require it to attain a zero percent inflation​ rate? Briefly explain.

The Employment Act of 1946. ​No, because even when the economy is at full​ employment, there is still a natural rate of unemployment. ​No, because price stability is sufficient.

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 rapid expansion (high prices and wages). Can the Fed, therefore, eliminate recessions?

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

In the graph of the money market shown on the​ right, what could cause the money supply curve to shift from MS1 to MS2​? In the graph of the money market shown on the​ right, what could cause the money demand curve to shift from MD1 to MD2?

The Fed decreases the money supply by deciding to sell U.S. Treasury securities. Both​ (a) and​ (c).

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.

In response to the severity of the financial​ crisis, the Fed started to rapidly reduce the target range for the federal funds rate in September 2007​ and, from December 2008 to December​ 2015, held the target range between​ 0% and​ 0.25%. Which of the following statements is​ true?

The Fed successfully held the actual federal funds rate within that target range over the​ seven-year period by conducting open market operations to increase or decrease bank reserves quickly.

Consider the following​ table: 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? Actual real​ GDP: ______ Potential real GDP: _______ Price level: _______ Unemployment: _______

The Fed will pursue an expansionary monetary policy. Increases; does not change; increases; decreases

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 federal funds rate is ​Additionally, the federal funds rate is

The interest rate that banks charge each other for overnight loans. Very important for the​ Fed's monetary policy because the Fed uses the federal funds rate as a monetary policy target since it can control the rate through open market operations.