Macroeconomics Module 12

Macroland's central bank wants a 3% target for inflation in its economy. Currently, inflation is 1%. Since the central bank follows the Taylor rule when doing monetary policy, by how much must the nominal interest rate increase?

2.5

If Macroland's monetary base (B) is $150 billion, M1 is $450 billion, M2 is $900 billion, and the reserve requirement rate (RR) is 10%, what is the M1 money multiplier when people hold currency outside the bank?

3

When banks are holding excess reserves, __________.

actual reserves exceed required reserves, and they are not maximizing loans and profit potential

In the classical tradition, an increase in the money supply creates excess money balances. As these balances are spent, __________.

aggregate demand shifts to the right, increasing equilibrium prices and output

If the Fed is committed to a money supply target and interest rates increase because of a housing boom, the Fed would need to __________.

allow interest rates to increase, even though investment spending could suffer as a result

It is important for the Fed to pay attention to interest rates, because letting interest rates rise too high will likely __________.

discourage investment and cause a recession

In the classical view, monetary policy works directly to change the economy because when the Federal Reserve buys bonds in the open market, the money supply __________.

expands and spending increases

The Central Bank must choose between targeting the money supply and targeting the interest rate, since increasing the money supply causes the interest rate to __________.

fall

Between August of 1929 and March of 1933, the U.S. money supply __________.

fell by 25%, and there were widespread bank failures

If the Fed follows a money supply target, interest rates will ___________.

fluctuate with the ups and downs of the business cycle, causing more volatile investment spending

For monetary policy, the outside lag may be long because __________.

it takes time for banks to increase or decrease their lending or for individuals to adjust their spending.

In the Keynesian view, an increase in the money supply causes aggregate demand to shift to the right. That means that if there is an increase in bank reserves, this leads to __________.

lower interest rates, which causes investment spending to increase

Effective monetary policy increases bank reserves, which results in __________.

more lending and more investment spending

The Keynesian economists believe monetary policy has an indirect effect. They believe an expansionary monetary policy stimulates the economy by __________.

providing excess reserves to banks

In 1993, Federal Reserve Board of Governors Chair Alan Greenspan announced that the policy of the Fed would emphasize __________.

real (inflation-adjusted) interest rates as a policy target

In discussions of monetary policy, the inside lag is the __________.

recognition and implementation lags combined

According to the Keynesian view of the monetary process, higher investment spending causes output and national income to __________.

rise and employment rise

When the Fed bought government bonds during World War II to help finance the war effort, the money supply __________.

rose, creating inflationary pressures

The implementation lag is __________.

shorter for monetary policy

Monetary policy is less effective in a global economy because if policymakers expand the money supply and cause spending to increase, __________.

some of the increased spending is used to purchase foreign-produced goods and services

In 1987, Federal Reserve Chair Paul Volcker was succeeded by whom?

Alan Greenspan

What are the outside influences that limit the effectiveness of monetary policy?

Globalization

If the Fed reduces interest rates using expansionary monetary policy, aggregate demand will shift to the __________ and, in the long run, the price level will ___________. When people expect inflation, interest rates are likely to __________, and this change __________ the reduction in the interest rate brought about by expansionary monetary policy.

If the Fed reduces interest rates using expansionary monetary policy, aggregate demand will shift to the right and, in the long run, the price level will increase. When people expect inflation, interest rates are likely to increase, and this change offsets the reduction in the interest rate brought about by expansionary monetary policy.

If the Fed tries to control interest rates, it must adjust the money supply to whatever level is needed to maintain the desired rates. If interest rates rise above the desired level, the Fed must __________ bonds and __________ bank reserves to bring interest rates back down. If interest rates fall below the desired level, the Fed must __________ bonds and __________ bank reserves to bring interest rates back up.

If the Fed tries to control interest rates, it must adjust the money supply to whatever level is needed to maintain the desired rates. If interest rates rise above the desired level, the Fed must buy bonds and increase bank reserves to bring interest rates back down. If interest rates fall below the desired level, the Fed must sell bonds and decrease bank reserves to bring interest rates back up.

In a global economy, when the U.S. central bank pursues contractionary monetary policy, domestic interest rates __________, attracting funds from abroad and causing the international value of the dollar to __________. This change in the value of the dollar causes U.S. exports to __________and imports into the United States to __________, ceteris paribus.

In a global economy, when the U.S. central bank pursues contractionary monetary policy, domestic interest rates increase, attracting funds from abroad and causing the international value of the dollar to increase. This change in the value of the dollar causes U.S. exports to decrease and imports into the United States to increase, ceteris paribus.

In the Keynesian model, when the Fed engages in open market operations, buying bonds and thereby increasing the cash that banks have on hand, this causes bank reserves to increase, so interest rates will __________, causing investment spending to __________. This change in investment spending leads to a __________ shift of aggregate demand, which causes output and employment to __________.

In the Keynesian model, when the Fed engages in open market operations, buying bonds and thereby increasing the cash that banks have on hand, this causes bank reserves to increase, so interest rates will fall, causing investment spending to rise. This change in investment spending leads to a rightward shift of aggregate demand, which causes output and employment to rise.

In the Keynesian view, money demand ___________ highly sensitive to interest rates. When money demand is highly sensitive to interest rates, the money demand curve is __________ than when money demand is insensitive to interest rates. A given expansion of the money supply will bring about a __________ decline in interest rates, causing monetary policy to be __________ effective.

In the Keynesian view, money demand is highly sensitive to interest rates. When money demand is highly sensitive to interest rates, the money demand curve is flatter than when money demand is insensitive to interest rates. A given expansion of the money supply will bring about a smaller decline in interest rates, causing monetary policy to be less effective.

If the Federal Reserve is buying bonds in the open market, what is its objective for the economy?

Increasing GDP

Macroland's government did not think the country was in a recession for 4 months and then took another 4 months considering what to do before deciding on an expansionary monetary policy. What type of problem with monetary policy is shown here?

Inside lag

Why would a central bank use the Taylor rule?

It creates less volatility in the inflation rate and more certainty, which help banks and businesses plan for the future.

The classical economists believe expansionary monetary policy provides households with more money than they wish to hold. They might spend the excess until their holdings have returned to the desired levels of holding. How does this stimulate the economy?

It increases consumption in aggregate demand, which increases equilibrium output.

Keynesians argue that monetary policy works better by focusing on the __________. Monetarists place more emphasis on the effects of changes in the __________ on spending.

Keynesians argue that monetary policy works better by focusing on the interest rates. Monetarists place more emphasis on the effects of changes in the the money supply on spending.

The equation for the money multiplier when people hold currency outside of banks is __________.

M1/B or M2/B, when B is the monetary base

Macroland's economy is in a recession. The government has bought treasury bonds to increase the bank reserves of cash. The government hopes banks will lower the interest rate so that people and businesses will invest more to stimulate the economy. The recession has caused many businesses to fail and many homeowners to default on their mortgages. This has made the banks very nervous. Thus, they will choose to __________ money, which will __________.

Macroland's economy is in a recession. The government has bought treasury bonds to increase the bank reserves of cash. The government hopes banks will lower the interest rate so that people and businesses will invest more to stimulate the economy. The recession has caused many businesses to fail and many homeowners to default on their mortgages. This has made the banks very nervous. Thus, they will choose to not lend money, which will counteract the government's goal.

Setting a target for the money supply means that the Federal Reserve is attempting to _________ the money supply.

Setting a target for the money supply means that the Federal Reserve is attempting to maintain a specified level of the money supply.

According to the monetarist view, the Fed should use monetary policy to stabilize money growth and keep the economy on a stable growth path.

TRUE

Banks not lending money to businesses and consumers is a possible problem with the implementation of monetary policy.

TRUE

Globalization lowers the effectiveness of monetary policy because when the interest rate is lowered in Macroland, investors will lend money in other countries with higher interest rates.

TRUE

In 2014, the target range for the federal funds rate was between 0 and 0.25%.

TRUE

It is estimated that it takes about 18 to 24 months for the full effect of monetary policy to be felt due to inside and outside lags.

TRUE

Monetary policy is affected by the same kinds of lags as fiscal policy: recognition, implementation, and impact.

TRUE

The 1951 Accord was an agreement between the Federal Reserve and the U.S. Treasury.

TRUE

The Fed cannot pursue both an interest rate target and a money supply target at the same time.

TRUE

The Fed did not cause the Depression, but perhaps a more aggressive expansionary monetary policy would have made it shorter and milder.

TRUE

The Keynesian belief that banks are more likely to hold larger amounts of excess reserves during a recession was supported when excess reserves rose from $1.5 billion in September 2008 to above $900 billion in January 2009.

TRUE

The average length of business cycles from 1945 to 1982 were short in duration (11 months). This meant that the Federal Reserve could spend more time on the inside lag.

TRUE

The benefit of inflation targeting is to reduce uncertainty and reassure the public regarding how the Fed intends to respond when inflation threatens to escalate.

TRUE

The Fed has the most direct control over __________.

the monetary base

In recent years, the link between the money supply and GDP has __________.

weakened, leading the Fed to focus more on interest rate targets

Why do Keynesian economists think monetary policy is less effective in stimulating the economy than fiscal policy?

Banks do not always lend out excess reserves, and people and businesses do not always want to borrow during a recession.

In the Keynesian view, several things could go wrong in translating changes in the money supply into changes in output. Which of the following is not one of these things?

Consumers may not respond to lower taxes.

When the Federal Reserve targets a certain level for interest rates, which interest rate are they targeting?

Discount rateXXXX

According to the classical economists, savings is the primary factor in affecting the economy when the money supply changes.

FALSE

According to the quantity theory, when the central bank increases the money supply, individuals and private banks find that they are holding smaller money balances than they want.

FALSE

An interest rate target requires the Fed to decrease the monetary base when the actual interest rate is higher than the target rate.

FALSE

If interest rates are low, the opportunity cost of holding money instead of interest-bearing assets is higher.

FALSE

If the Federal Reserve decides to pursue expansionary monetary policy, the Federal Reserve would decrease the money supply.

FALSE

In the Keynesian view, financial markets are linked to aggregate supply and aggregate demand primarily through changes in planned investment. Additionally, planned investment is the most stable component of aggregate demand.

FALSE

Macroland's central bank will pursue an interest rate target and a money supply target at the same time.

FALSE

Monetarists think monetary policy is not very effective, while Keynesian economists think it is very effective.

FALSE

Regardless of whether monetary policy works the way Keynesians believe or the way monetarists believe, it is more effective in an open economy than in a closed economy.

FALSE

Since 1982, the Fed has been committed to a money supply target and has allowed the money supply to grow at a fixed rate each year.

FALSE

The monetary base is equal to deposits made by the public in their bank accounts.

FALSE

The Federal Reserve System was established as the U.S. central bank in __________. One of the first challenges for the Fed was to help the treasury finance __________.

The Federal Reserve System was established as the U.S. central bank in 1913. One of the first challenges for the Fed was to help the treasury finance World War I.

The main disadvantage of following a money supply target is that the Fed is then unable to target __________. The main disadvantage of following an interest rate target is that it might become necessary to take steps to prevent an increase in the interest rate, even when an increase in the interest rate is the correct policy to cure ___________.

The main disadvantage of following a money supply target is that the Fed is then unable to target interest rates. The main disadvantage of following an interest rate target is that it might become necessary to take steps to prevent an increase in the interest rate, even when an increase in the interest rate is the correct policy to cure inflation.

To explain how people react when money balances increase, classical theory puts a strong emphasis on __________. The Keynesian model puts an equally strong emphasis on __________.

To explain how people react when money balances increase, classical theory puts a strong emphasis on spending. The Keynesian model puts an equally strong emphasis on lending.

When the Fed buys bonds from banks, bank reserves __________. When the Fed buys bonds directly from the public rather than from banks, the switch from bonds to money __________ the money supply. If the public deposits payments from the Fed in checkable deposits, bank reserves will __________.

When the Fed buys bonds from banks, bank reserves increase. When the Fed buys bonds directly from the public rather than from banks, the switch from bonds to money increases the money supply. If the public deposits payments from the Fed in checkable deposits, bank reserves will increase.

The recognition lag is __________.

about the same for monetary and fiscal policy

Targeting the interest rate as the primary tool for monetary policy is effective if businesses __________ responsive to changes in the interest rate.

are notXXX

The federal funds rate is the interest rate __________.

banks charge each other on reserve loans

According to the Keynesian model, contractionary monetary policy is more likely to be more effective than expansionary monetary policy because __________.

banks have no choice but to reduce loans when reserves fall, but they can maintain positive excess reserves

If the Fed attempts to maintain a target interest rate and a recession causes interest rates to fall, the Fed would need to pursue __________.

contractionary monetary policy to raise interest rates, but this would likely worsen the recession

The monetary base consists of __________.

currency in the hands of the public plus reserves held by banks

Banks are more likely to hold a larger amount of excess reserves when the economy is __________.

in recession and the risk of borrowers defaulting is higher

The Taylor rule stipulates that for each 1% increase in inflation, the Fed should __________.

increase the nominal interest rate by more than 1%

Net exports __________ when the value of the dollar rises due to a contractionary monetary policy, ceteris paribus.

increaseXXXX

Lags for monetary policy are divided into two groups. They are __________.

inside and outside