Monetary Policy

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which of the following does the FED carefully monitor?

bank reserves

Which of the following statements is correct?

The prime rate involves longer, more risky loans than the federal funds rate.

Which of the following statements best describes what occurs when monetary authorities sell government securities?

The size of commercial banks' excess reserves decreases, the money supply decreases, and the interest rates rise, thereby causing a decrease in investment spending and real GDP.

in the real world, the actual money multiplier tends to be smaller than 1/rr because

banks do not loan out all of their excess reserves and people hold some loaned money as cash

if one bank doesn't have enough reserves, they

borrow from another bank

raising the discount rate, banks will

borrow less and make fewer loans, causing the money supply to decrease (contract)

if the Fed's lower the interest rate, the banks will

borrow more reserves and make additional loans, increasing the money supply (expansion)

the federal funds rate is determined by the supply and demand for

borrowed reserves

banks can expand reserves, and make more loans by

borrowing from the FED and attracting deposits and encouraging saving

Assume that the MPC is 0.9 and the reserve requirement is 0.2. If the Federal Reserve needs to increase aggregate demand by $100 billion at each price level to move the economy back to full employment and the current interest rate is 6%, then the Federal Reserve should _________ bonds on the open market equal to ________.

buy, $2 billion

how do banks hope to make a profit?

by charging interest on loans

how does monetary policy affect the economy?

by either encouraging or discouraging investment in new capital

An expansionary monetary policy _____.

can reduce the length of a recession

The major purpose of the Federal Reserve buying government securities in open market operations is to _____.

allow banks to increase their lending

federal funds market

allows banks that fall short of the reserve requirement to borrow funds from banks with excess reserves

The Federal Reserve System regulates the money supply primarily by _____.

altering the reserves of commercial banks, largely through sales and purchases of government bonds

expansionary monetary policy

an increase in the money supply designed to stimulate economic activity

how can banks expand reserves and make more loans?

attracting deposits and encouraging saving; borrowing from the Federal Reserves

An expansionary monetary policy may be less effective than a restrictive monetary policy because ______.

commercial banks may not be able to find good loan customers

lending bank earns extra income (interest rate), which the borrowing bank

complies with reserve requirements

one of the key interest rates in the economy is called the

federal funds rate

fewer reserves =

fewer loans

When there is a liquidity trap, the money demand curve is _____.

flat

If the Fed were to decrease the discount rate, banks will borrow

more reserves, causing an increase in lending and the money supply

increase =

multiply

Because of policy lags in monetary policy, the Fed _____.

must try to anticipate changes in the economy before they happen

there's a ________ relationship between interest rate and the quantity of investment demanded

negative

the Fed directly sets

neither the federal funds rate not the prime rate

buying bonds creates

new money and additional reserves, which expands the money supply, causing interest rates to fall

The commercial banking system borrows from the Federal Reserve Banks. As a result, the checkable deposits _____.

of commercial banks are unchanged, but their reserves increase

The purchase and sale of government securities by the Fed is called _____.

open market operations

the Federal Reserve often uses

open market operations

To adjust the targeted federal funds rate, the Federal Reserve will need to make:

open market sales, decreasing reserves in the banking system

selling bonds takes money

out of the economy and reduces reerves, which contracts the money supply, causing interest rates to rise

the ______ rate is generally equal to the federal funds rate plus 3%

prime

as the interest rate falls

quantity demanded will rise from uppercase I1 to uppercase I2

at a higher interest rate, some investment projects are no longer profitable, so the

quantity of I demanded falls from I1 to I3

The purpose of a contractionary monetary policy is to ______.

raise interest rates and restrict the availability of bank credit

The discount rate is the interest _____.

rate at which the Federal Reserve Banks lend to commercial banks

Y =

real GDP

A newspaper headline reads: "Fed Raises Discount Rate for Third Time This Year." This headline indicates that the Federal Reserve is most likely trying to _____.

reduce inflationary pressures in the economy

higher interest rate __________ the quantity of investment demanded

reduces

The Federal Reserve can increase aggregate demand by _____.

reducing the discount rate

rr =

reserve requirements

shift in AD causes price levels to ______OR______

rise OR fall

a "bank run" occurs when depositors

rush, in mass, to withdraw their funds from a bank

When the Federal Reserve seeks to raise the targeted federal funds rate, it _____.

sells government securities to decrease the excess reserves available for overnight loans

when rr increases, the money multipler is

smaller

difference =

spread

open market operations

the Federal Reserve buys or sells government debt in the open market to influence the money supply and interest rates

Changes in interest rates, all else held constant, cause a shift in _____.

the aggregate demand curve, but not the investment demand curve

Monetary policy is determined by ______.

the central bank (the Fed)

When a commercial bank borrows from a Federal Reserve Bank, _____.

the commercial bank's lending ability is increased

If the Fed wants to maintain current interest rates, it would be buying government bonds in the open market when _____.

the demand for money increases

spread

the difference between the interest rate a bank earns on a loan and the interest rate it pays

The interest rate that the Fed charges on loans made directly to banks is called _____.

the discount rate

what three aspects are all related?

the dollar value of reserves held by banks, the reserve requirement, and the money supply are all related

Assume that there is a 25% reserve requirement and that the Federal Reserve buys $4 billion worth of government securities. This action has the potential to increase the money supply by a maximum of ______.

$16 billion

If demand for overnight funds in the graph should increase by $50 billion at each and every point on the demand curve, but the Federal Reserve wants to keep the target rate at 5.0%, what will be the new equilibrium quantity of reserves?

$200 billion

three parts of OMO

1. Federal Reserve 2. Banks 3. People

if the fed decides to sell debt to households paying with checkable deposits, it will lead to ______ reserves in the banking system and ______ money in circulation

1. fewer 2. less

what are the two factors that determines in households or firms invest or not?

1. interest rate 2. expected rate of return

if the fed wants to increase money supply, make an ____________. to find total money supply use the ________

1. open market purchase 2. change in Ms

money multiplier =

1/rr

If the reserve requirement is 10% and the Fed increases reserves by $20 billion, what is the total increase in the money supply? (rr = 10% and multiplier = 10)

200

Which of the following represents the chain of causation for expansionary policy?

An increase in the money supply reduces the interest rate, which increases investment, which increases real GDP.

Which of the following best describes the cause-and-effect chain of an expansionary monetary policy?

An increase in the money supply will lower the interest rate, increase investment spending, and increase aggregate demand and GDP.

Which of the following is an example of an economic investment?

Building a new bank office

Which of the following Fed actions increases the excess reserves of commercial banks?

Lower the reserve requirement

Which of the following is a monetary policy intended to rein in inflation?

Decreasing the money supply to shift the aggregate demand curve leftward

gross investment =

I

The purchase and sale of government securities by the Fed is called _____.

OMOs

. Suppose the Federal Reserve wants to increase the money supply. What should it do to accomplish this goal? (rr=15%)

The Fed could make an open market purchase of $30 billion, resulting in a total increase in the money supply of $ 200 billion.

suppose the Fed wants to decrease the money supply. What should it do to accomplish this goal?

The Fed could make an open market sale of $40 billion, resulting in a total decrease in the money supply of $267 Correct billion.

the Federal Reserve decides to sell $250 million in government debt to households paying with checkable deposits. The current reserve requirement is 10%.

The Fed decision will lead to fewer reserves in the banking system and less money in circulation; The money supply will decrease by a maximum of $2,500 million.

The Federal Reserve decides to buy $550 million in government debt. The current reserve requirement is 25%.

The Fed decision will lead to more reserves in the banking system and more money in circulation; The money supply will increase by a maximum of $2,200 million.

which of the following statements is true?

The Federal Reserve does not set the federal funds rate, but it influences it through the use of its open-market operations.

What policy tool of the Federal Reserve relies on bank borrowing to be effective?

The discount rate

delta Ms =

[1/rr] x change in reserves

Which of the following will increase the total amount of reserves banks are holding?

a bank borrows reserves from the Fed; a bank attracts new customers depositing funds into their checkable deposits

bond

a financial instrument that obligates a borrower to repay money, with interest, to a lender

contractionary monetary policy

a reduction in the money supply to slow down economic activity

liquidity trap

a situation where increasing the money supply does not lower interest rates, due to a flattening of the money demand curve

Financial markets pay close attention to changes in the federal funds rate because these changes _____.

affect other interest rates in the economy

excess reserves are lent,

creating new checkable deposits and additional excess reserves, which are then used to create additional loans, further increasing the money supply through the money multiplier

Suppose that, for every 1 percentage point decline of the discount rate, commercial banks collectively borrow an additional $2 billion from Federal Reserve Banks. Also assume that the reserve requirement is 20%. If the Fed increases the discount rate from 4.0% to 4.25%, bank reserves will _____.

decline by $0.5 billion and the money supply will decline by $2.5 billion

if consumers _____ the amount of spending, AD shifts to the left

decrease

In the graphs, the numbers in parentheses near the AD1, AD2, and AD3 labels indicate the level of investment spending associated with each curve, respectively. All numbers are in billions of dollars. The interest rate and the level of investment spending in the economy are at point D on the investment demand curve. To achieve the long-run goal of a noninflationary full-employment output of Qf in the economy, the Fed should try to _____.

decrease aggregate demand by increasing the interest rate from 4% to 6%

Assume that the reserve requirement is 25%. If the Federal Reserve sells $120 million in government securities to the general public, the money supply will immediately _____.

decrease by $120 million with this transaction, and the decrease in money supply could eventually reach a maximum of $480 million

fewer reserves and fewer loans =

decrease in money supply

In order to increase interest rates, the Federal Reserve will need to

decrease the money supply

Assume the economy is operating at less than full employment. An expansionary monetary policy will cause interest rates to ________, which will _____ ______ investment spending.

decrease; increase

raising the rr ________ the money multiplier and ________ the money supply

decreases

An increase in the reserve requirement _____.

decreases the money supply by decreasing excess reserves and decreasing the monetary multiplier

overall change in money supply =

delta Ms

how many loans a bank can make

depends on the value of the reserves on hand that are not needed to satisfy the Fed's rr

banks can expand reserves, and make more loans, by attracting

deposits

required reserves =

deposits x rr

The interest rate at which the Federal Reserve Banks lend to commercial banks is called the _____.

discount rate

decrease =

divide

the demand curve for federal funds is...

downward-sloping, because higher interest rates discourage commercial banks from borrowing federal funds, but lower rates encourage borrowing

A newspaper headline reads: "Fed Cuts Federal Funds Rate for Fifth Time This Year." This headline indicates that the Federal Reserve is most likely trying to _____.

ease monetary policy

The time between when a policy is enacted and when it affects the economy is the _____lag.

effectiveness

if a bank wants to increase its lending, it has to increase

excess reserves

When investment demand shifts to the left, _____.

expansionary monetary policy will shift aggregate demand to the right by less than before.

the actions taken by a country's central bank to expand the money supply and lower interest rates is called

expansionary monetary policy; easy money

reduction in AD causes the price level and real GDP to _____

fall

what will cause consumption to fall?

falling wealth, repayments of loans, higher taxes

In order to reach the new money market equilibrium, the Federal Reserve will need to target a:

higher federal funds rate

interest rates =

i

Suppose the Fed reduces the interest rate from 6% to 4%. As a result of this decrease in the interest rate, using column (2) investment will _____.

increase by $20 billion

higher investment spending causes AD to ________

increase, shifting from AD1 to AD2 (expansionary monetary policy)

When the reserve requirement is decreased, the excess reserves of member banks are _____.

increased and the multiple by which the commercial banking system can lend is increased

reducing the rr ________ the money multiplier and _________ the money supply

increases

banks pay their expenses and hope to make a profit by charging

interest on loans

discount rate

interest rate at which banks can borrow reserves from the Federal Reserve

the discount rate is the

interest rate at which banks can borrow reserves from the Federal Reserve

a decrease in the money supply will cause the

interest rate to rise and the quantity of investment demanded to fall

monetary policy affects

interest rates paid on savings; interest rates charged on loans; and the price of goods, services, and resources

as interest rates rise,

investment spending falls

as interest rates fall,

investment spending rises

what does monetary policy's affect on interest rates affect

investment, economic growth, employment, inflation

A contractionary monetary policy _____.

is used when the inflation rate is high

If the Federal Reserve System buys government securities from commercial banks and the public, then _____.

it will be easier to obtain loans at commercial banks

If businesses are pessimistic, they are _____.

less likely to borrow and invest

Expansionary monetary policy should initially change gross investment by _____.

less than necessary to reach full employment

In an effort to stabilize the banking sector and keep banks lending, from October 2008 to September 2009, the Fed _____.

lowered the federal funds target rate

the Fed can increase or decrease the money supply by

lowering or raising the reserve requirement

In the graphs, the numbers in parentheses near the AD1, AD2, and AD3 labels indicate the level of investment spending associated with each curve, respectively. All numbers are in billions of dollars. The interest rate and the level of investment spending in the economy are at point C on the investment demand curve. To achieve the long-run goal of a noninflationary, full-employment output of Qf in the economy, the Fed should try to _____.

make no change in the interest rate

Lowering the discount rate has the effect of _____.

making it less expensive for commercial banks to borrow from central banks

rr is a

minimum

overall reduction in supply =

money multiplier

MS =

money supply

If the Fed were to decrease the discount rate, banks will borrow

more reserves, causing a increase in lending and the money supply

organizational safeguards put in place to prevent one government agency from creating money for another government office to spend include

the establishment of the federal reserve as independent from the federal government; the requirement that the federal reserve buy bonds from the institutions and people that have already bought bonds

the two factors that affect whether or not a firm chooses to invest in new equipment, machinery, or facilities are

the interest rate and the expected rate of return

federal funds rate

the interest rate at which banks make overnight loans to one another; the interest rates they pay; one of the key interest rates in the economy; helps determine the interest rates charged on other loans (like home and auto)

reduction in the money supply causes

the interest rate o rise from i1 to i3

the discount rate =

the interest rate set by the Fed's when banks borrow $

prime rate

the interest rate that banks charge their best customers; the lowest commercially available interest rate

when banks borrow from the Fed's

the interest rate they pay is set by the Fed

increase in supply of money will cause

the interest rate to fall from lowercase i1 to lowercase i2

the larger the rr,

the larger the money multiplier

the higher the reserve requirement,

the less money that can be loaned out and the less money that is created in the economy

Assuming that the Federal Reserve Banks sell $40 million in government securities to commercial banks and the reserve requirement is 20%, then the effect will be to reduce _____.

the money supply by potentially $200 million

the bigger the deposit =

the more loans the bank can make

the more loans a bank makes,

the more revenue it can generate

investment demand

the negative relationship between the quantity of new physical capital demanded by firms and the prevailing interest rate

Reserves borrowed at the federal funds rate are usually repaid _____.

the next day

money multiplier =

the overall change in the MS/the initial change in reserves

how can the Federal Reserve use monetary policy?

to influence interest rates and shape outcomes in the economy; trying to smooth out the business cycle and respond to inflation and unemployment; influence real GDP

frequently changing the rr would be

very disruptive to the banking sector and credit merkets

how does the Fed operate OMOs?

via the Domestic Trading Desk of Federal Reserve Bank of New York

excess reserves =

what the Fed's do not need to satisfy their rr

bank panic

when several banks experience bank runs simultaneously


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