Macro Midterm 3
Real Exchange Rate Formula using PPP
(Nominal Exchange Rate x Domestic Price)/Foreign Price
Money Multiplier
1/reserve ratio
Federal Reserve System
12 Regional Banks that work to control the money supply using open market operations to ensure a healthy economy
In the nation of Wiknam, the money supply is $80,000 and reserves are $18,000. Assuming that people hold only deposits and no currency, and that banks hold no excess reserves, then the reserve requirement is
22.5 percent 18000/80000 x 100
If the real exchange rate for coal is 1.5, the price of coal in the United States is $50 per ton, and the price of coal in Britain is 20 British pounds per ton, what is the nominal exchange rate?
3/5 or 0.6 pounds per dollar (20/50) x 1.5 (Foreign Price/ Domestic Price) x real exchange rate
If velocity = 4, the quantity of money = 20,000, and the price level = 2.5, then the real value of output is
32,000 (Quantity of Money x Velocity)/Price Level (20000 x 4)/ 2.5
If the real interest rate is 6 percent and the price level is falling at a rate of 2 percent, what is the nominal interest rate?
4 percent Price level is Falling so it is deflation Nominal Int. rate - inflation rate = Real Int. rate x -(-2) =6 x + 2=6 x=6-2
Suppose the banking system currently has $400 billion in reserves, the reserve requirement is 8 percent, and excess reserves amount to $5 billion. What is the level of deposits?
4937.5 Billion Total Reserve - Excess Reserve = Required Reserve 400-5=395 Required Reserve/ Reserve Requirement 395/0.08=4937.5
Suppose a Banks Assets are as follows: Reserves: $1200 Loans: 8000 Short-Term Securities: 800 Now Suppose the Banks Liabilities are as follows: Deposits: $9000 Debt: 800 Capital (Owners' Equity): 200 The Banks Leverage Ratio would be:
50 Ratio of Assets to Banks Capital 10000/200 = 50
Suppose the relevant money-supply curve is the one labeled MS 1 where Value of money = 0.5 and Money Supplied = $10,000 ; also suppose the economy's real GDP is 30,000 for the year. If the market for money is in equilibrium, then the velocity of money is approximately
6.0 30000/0.5 = 60000/10000 = 6.0 (GDP x Value of money)/Quantity of money 10000V=30000 x 0.5
Board of Governors
7 members appointed by the President of the US, confirmed by the senate and serve 14 years. Create and implement monetary policy, decides on amount of money to loan member banks and to set the rate of interest on loans, over sees bank mergers and acquisitions of American banks and any international member banks. Reports to congress.
In an open economy, gross domestic product equals $2,450 billion, consumption expenditure equals $1,390 billion, government expenditure equals $325 billion, investment equals $510 billion, and net capital outflow equals $225 billion. What is national saving?
735 Billion National Saving (S) = GDP (Y) - Consumption (C) - Government Expenditure (G) 2450-1390-325=735
The nominal exchange rate is about 2 Aruban florin per dollar. If a basket of goods in the United States costs $40, how many florins must a basket of goods in Aruba cost for purchasing-power parity to hold?
80 florin
Which of the following is an example of U.S. foreign direct investment?
A US company opens an auto parts factory in Canada
What are 2 ways to increase the money supply?
A decrease in the discount rate and a decrease in the interest rate on reserves Buy Bonds
The Law of one Price
A good should sell for the same price everywhere around the world, when converted to the same currency (Also referred to as Purchasing Power Parity PPP)
When people take advantage of differences in prices for the same good by buying it where it is cheap and selling it where it is expensive, this is known as...
Arbitrage
Demand Deposits
Balances in bank accounts, highly liquid
How can the Fed INCREASE the money supply?
Buy Government Bonds, Decrease interest rate on reserves (More Loans), Decreasing Discount Rate (Encourage Borrowing from the Fed)
Which of the following functions as both a store of value and a medium of exchange?
CASH but not Stocks
Suppose the market for money, drawn with the value of money on the vertical axis and the quantity of money on the horizontal axis , is in equilibrium. If the money supply increases, then at the old value of money there is an
EXCESS supply of money that will result in an INCREASE in spending
You hold currency from a foreign country. If that country has a higher rate of inflation than the United States, then over time the foreign currency will buy
Fewer goods in that country and buy fewer dollars
The claim that increases in the growth rate of the money supply increase nominal interest rates but not real interest rates is known as the...
Fisher Effect
What is not true about the relationship between national saving, investment, and net capital outflow?
For a given amount of saving, a decrease in net capital outflow must decrease domestic investment
The purchase of U.S. government bonds by Egyptians is an example of
Foreign Portfolio Investment (FPI) by Egyptians
GATT
Global Agreement on Tariffs and Trade Used to monitor world trade Not Powerful
When Microsoft establishes a distribution center in France, US net capital outflow...
Increases, because Microsoft makes a Foreign Direct Investment (FDI) in France
Inflation Fallacy
Inflation robs people of purchasing power False Nominal Wages increase with Inflation
Intrinsic Value Definition
Items that have value even if they aren't used as money
John and Jane decide to go on a vacation. As a result, they withdraw $2,500 from their savings account to purchase $2,500 worth of traveler's checks. As a result of these changes,
M1 Increases by $2500 and M2 stays the same
M2
M1 plus savings accounts, certificates of deposit, and other liquid assets
What are the 3 Functions of Money
Medium of Exchange Store of Value Unit of Account
Medium of Exchange
Money given to buy good/service
S-I=
NCO Net Capital Outflow
Which of the following helps to explain why the "inflation fallacy" is a fallacy?
Nominal incomes tend to rise at the same time that the price level is rising, leaving real income unchanged
Because most loans are written in ________ terms, an unexpected increase in inflation hurts ________.
Nominal; Creditors
tax-induced distortions
Pay more taxes because you're in a higher tax bracket because inflation raises income
Classical Theory of Inflation
Prices rise when the government prints too much money
To explain the long run determinants of the price level and the inflation rate, most economists today rely on the
Quantity theory of money MV=PY Every Change in M has an equal change in P
Difference between Reserve Requirement and Required Reserve
Reserve Requirement: Regulation on the minimum amounts of reserves that banks must hold against deposits (Percentage of Deposits) Required Reserve: The amount the bank holds based on the Reserve Requirement (Amount of Money)
How can the Fed DECREASE the money supply
Sell Bonds, Increase interest rate on reserves (Less Loans), Increase Discount Rate ( Discourage Borrowing From Fed)
Friedman Rule
Small amount of inflation is Ideal
Who makes up the Federal Reserve open market committee?
The 7 members of the Board of Governors + 5/12 Regional Bank Presidents The Committee aims to create maximum employment and stable prices
If nominal GDP is $400, real GDP is $200, and the money supply is $100, then what is the price level and velocity?
The Price Level is 2, and the Velocity is 4 400= P x 200 100 x V = 2 x 200
Menu Costs of Inflation
The cost of changing prices because of inflation
When the Money supply curve shifts to the right
The equilibrium value of money decreases
Bank Capital is...
The resources that owners have put into the bank
Store of Value
Transfer purchasing power from present to future
When Nominal Exchange Rate<Actual Exchange Rate
US dollar depreciates against currency
Which of the following is correct about US Exports and Imports since 1950
US exports and US Imports each have increased significantly (About Triple)
Which of the following is not included in either M1 or M2?
US treasury bills Treasury bills are M4
Unit of Account
Used to value goods/services, record debts, and make calculations
If Wardell's Nominal Income is $15.00 in 2020 and a Coke costs $5.00 in 2020 then what is Wardell's Real Income? If Wardell's Income Rose to $20.00 in 2022 and the price of a Coke rose to $6.65 in 2022 what happened to Wardell's Real Income? What theory is this proving?
Wardell's Real Income is 3 Cokes His Real Income Stayed the Same in 2022 This Proves the Inflation Fallacy
When inflation causes relative-price variability consumer decisions,
are distorted and the ability of markets to efficiently allocate factors of production is impaired
Changes in nominal variables are determined mostly by the quantity of money and the monetary system according to
both the classical dichotomy and the quantity theory of money
M1
currency, demand deposits, traveler's checks, and other checkable deposits
When the price level falls, the number of dollars needed to buy a representative basket of goods
decreases, so the value of money rises
In the last part of the 1800s
deflation made it harder for farmers to pay off their debt.
How to find nominal exchange rate with PPP
e=P*/P e=nominal exchange rate P*=Price of good in foreign market P=Price of good domestically
If the exchange rate is expressed as euros/dollar, the dollar is said to depreciate against the euro if the exchange rate
falls. Other things the same, it will cost fewer euros to buy US goods
A bank has an 8 percent reserve requirement, $10,000 in deposits, and has loaned out all it can, given the reserve requirement.
it has $800 in reserves and $9200 in loans. Reserve Requirement x Deposits 0.08 x 10000 = 800
When the market for money is drawn with the value of money on the y-axis and the quantity of money on the x-axis the price level increases if money demands shifts...
left and decreases if money supply shifts left
Fiat Money
money that has no intrinsic value (US Dollar post 1971)
Commodity Money
money that takes the form of a commodity with intrinsic value Ex: Cocoa Beans, Alcohol, Copper, Gold, Salt, Silver, Tea, Tobacco
A depreciation of the U.S. real exchange rate induces U.S. consumers to buy
more domestic goods and fewer foreign goods
Suppose that real interest rates in the U.S. rise relative to real interest rates in other countries. This increase would make foreigners
more willing to purchase US bonds, so US net capital outflow would fall
According to the assumptions of the quantity theory of money, if the money supply increases by 5 percent, then
nominal GDP would rise by 5 percent; real GDP would be unchanged.
If purchasing-power parity holds, then the value of the ____ Exchange Rate is ________
real exchange rate is equal to 1
Nominal Interest Rate Formula
real interest rate + inflation rate
A country's trade balance will fall if either
savings falls or investment rises
If saving is greater than domestic investment, then there is a trade
surplus and Y > C + I + G
The inflation Tax refers to
the revenue a government creates by printing money
In the long run, money demand and money supply determine
the value of money but not the real interest rate
Nominal Variables
variables measured in monetary units
Real Variables
variables measured in physical units/assets
The shoeleather cost of inflation refers to the
waste of resources used to maintain lower money holdings This Causes people to hold less cash on hand and visit the bank more often
Gold Standard
when a monetary unit's value is backed by gold the monetary unit can be converted to an amount of gold