Money and Banking Exam 3

If M= the money supply, Y = real output, P = the price level, and V = Velocity, what equals the velocity of money?

(PxY)/M

Suppose the real interest rate falls in the absence of other economic changes. What would you expect to happen to A. consumption, B. investment, and C. net exports in the economy

A. Consumption will rise as borrowing to purchase consumer durables becomes less costly B. Investment will rise as more projects will be profitable at the lower interest rate C. Net exports will rise as a fall in foreign investor demand for US assets will lead to a depreciation of the dollar, making US exports more competitive

Economy A and Economy B are similar in every way except that in Economy A, 25% of aggregate expenditure is sensitive to changes in the real interest rate and in Economy B, 50% of aggregate expenditure is sensitive to changes in the real interest rate. A. Which economy will have a steeper aggregate expenditure curve? B. How would the dynamic aggregate demand curves differ given that the monetary policy reaction curve is the same in both countries?

A. Economy A B. Economy A will have a steeper dynamic aggregate demand curve. Economy B will have a flatter dynamic aggregate demand curve.

State whether each of the following will result in movement along or a shift in the monetary policy reaction curve and in which direction the effect will be. A. Policymakers increase the real interest rate in response to a rise in current inflation B. Policymakers increase their inflation target C. The long-run real interest rate falls

A. movement along he monetary reaction curve; up along B. Shift in the monetary policy reaction curve; Shift right C. Shift in the monetary policy reaction curve; shift right

Suppose that expected inflation rises by 2 percent at the same time that the yields on money and on nonmoney assets both rise by 2 percent. A. What will happen to the demand for money? B. What if expected inflation rose by 3 percent? C. What if the yield on nonmoney assets rose instead by 4 percent?

A. the expected real yields on money and on nonmoney assets are unchanged and the demand for money will not be affected B. The expected real yields on money and nonmoney assets both fall by 1 percent and the demand for money will not be affected C. the return to alternative investments relative to the return on money rises, regardless of the level of inflation. This reduces the portfolio demand for money

Why is inflation higher than money growth in high-inflation countries and lower than money growth in low-inflation countries

At very high levels of inflation, the velocity of money rises dramatically as people rush to spend their currency before it loses value; this causes inflation to be higher than money growth. Inflation is lower than money growth in low-inflation countries because part of the growth of money is offset by economic growth

Which of the following factors would increase the portfolio demand for money? A. a new website allows you to liquidate your stock holdings quickly and cheaply B. you expect future interest rates to rise C. a financial crisis is looming

Both options B and C would increase the portfolio demand for money. If future interest rates are expected to rise, bond prices will fall, making money relatively more attractive. The prospect of a financial crisis will increase the relative riskiness of alternative assets, thus increasing the portfolio demand for money

Which of the following factors would increase the transactions demand for money? A. Lower nominal interest rates B. Rumors that a computer virus had invaded the ATM network C. A fall in nominal income

Both options a and b would increase the transactions demand for money. Lower nominal interest rates would reduce the opportunity cost of holding money, while a computer virus in the ATM network would lead to worries about the system closing down

The Fed can do which of the following in the economy?

Change both interest rates and the supply of money

The conventional policy tools available to the Fed include...

Discount rate Target Federal Funds Rate Range Reserve Requirement

Inflation targeting does all of the following, except which one

Does: increase policymakers' credibility increase policymakers' accountability communicate policymakers' objectives clearly and openly Doesn't: hinder economic growth

If velocity were predictable but not constant, would a monetary policy that fixed the growth rate of money work?

If velocity is not constant, then fixing the growth rate of money will result in either rising or falling inflation. However, if velocity is predictable, policy makers could increase money growth at the same time that velocity is decreasing in order to stabilize inflation

Use the following formula for the Taylor rule to determine the change in the target federal funds rate for every one percent increase in the rate of inflation. This will

Increase the target federal funds rate by 1.5% and increase the real federal funds rate by .5 %

Which one of the following is not a part of aggregate expenditure?

Is: consumption, government purchases, net exports Not: nominal interest rate

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It is impossible to have high, sustained inflation without monetary accommodation

Which one of the following statements is most correct?

It is impossible to have high, sustained inflation without monetary accommodation

If we let Md reflect money demand, in equilibrium in the money market, we can write the equation for money demand as

Md = (1/V)PY

Equilibrium in the money market would be expressed by which one of the following?

Ms=Md

Consider a country where the level of excess reserves fluctuates widely and unpredictably. Would such a country be a good candidate for a money growth rule to guide monetary policy?

No. To be effective at controlling inflation, a money growth rule requires a stable link between the monetary base and monetary aggregates, such as M1 and M2. This would not be the case here, since the volatile reserve-deposit ratio would cause fluctuations in the money multiplier

Under what circumstances might the SRAS be vertical?

Perfectly flexible prices

The short-run aggregate supply curve is upward sloping due to which of the following factors?

Price stickiness

If the equation of exchange is MV=PY, the Y represents

Real GDP

In the short run, the point on the aggregate demand curve where an economy will end up in equilibrium depends on the the

Short-run aggregate supply curve

The components of the formula for the Taylor rule include each of the following

Target Federal Funds Rate Current Inflation Rate Inflation Gap

Considering the market for excess reserves, how can the Fed control independently both the price and quantity of aggregate bank reserves in the post-2008 environment?

The Fed can control the price in the market for reserves by changing the interest rate it pays on reserves. When the Fed raises this rate, banks would be willing to pay a higher rate to borrow from nonbank participants in the federal funds market in order to deposit these funds at the IOER at the Fed. This process does not change the supply of aggregate reserves. It is reflected in an upward shift in the flat portion of the demand curve for reserves.

Explain how the Federal reserve would implement a rise in the target range for the federal funds rate.

The Federal Reserve would increase the interest rate on excess reserves (IOER), an interest rate that it controls directly. This raises the minimum rate at which banks would be willing to lend to other institutions because they can earn the IOER rate risk-free by depositing these funds with the Fed.

Suppose the economy is in short-run equilibrium at a level of output that exceeds potential output. How would the economy self-adjust to return to long-run equilibrium?

The expansionary output gap exerts upward pressure on costs, shifting the short-run aggregate supply curve to the left until the economy reaches the long-run equilibrium point where aggregate demand, short-run aggregate supply, and long-run aggregate supply all intersect. At this point, the economy has returned to the potential level of output.

Which of the following are cited by economists as determinants of potential output growth?

The growth rate of the labor force The growth rate of the capital stock The rate of technological change

Explain why we observed a fall in the velocity of M2 during the financial crisis of 2007-2009.

The increase in uncertainty during the financial crisis drove investors to hold a larger portion of their assets in the form of money. This change in money holding relative to the level of economic activity means that each dollar will be used fewer times, lowering velocity.

Given the expected relationship between the real interest rate and investment, how would you explain a scenario where investment continued to fall despite low or even negative real interest rates?

The relationship between the real interest rate and investment is usually expected to be negative. Changes in the level of investment, however, depend both on the level of real interest rates and changes in expectations about future business conditions. If firms are pessimistic about the economic outlook, investment may remain weak despite low or negative real interest rates.

If we look at the equation for money demand that summarizes Irving Fisher's quantity theory of money, what is true?

There isn't an explicit role for the interest rate in the equation

How does its action influence the market federal funds rate?

This change in the IOER rate raises the rate at which banks would be willing to borrow in the money markets from nonbank participants that cannot earn interest on deposits at the Fed. This therefore puts upward pressure on the market federal funds rate to bring it into the new higher target range

Which one of the following would not be included in aggregate expenditures?

Would: your purchase of a new car, your purchase of new textbooks for the semester, the value of blue jeans produced in the US and exported to Japan Wouldn't: the value of 100 shares of Microsoft you purchased

While GDP was once a key cyclical indicator, its usefulness has declined substantially for all of the following reasons except which one?

Yes: Requires seasonal adjustment Constant revisions for decades lack of timeliness No: Contains too much information

The central bank of a country facing economic and financial market difficulties asks for your advice. The bank cut its policy interest rate to the effective lower bound, but it was not low enough to stabilize the economy. Drawing on the actions taken by the Federal Reserve during the financial crisis of 2007-2009, what might you advise this central bank to do?

You should advise the central bank to use unconventional monetary policy tools such as quantitative easing, where aggregate reserves are provided beyond the level needed to lower the policy rate to zero, or credit easing, a policy in which the central bank alters the composition of its balance sheet. The central bank could also inform markets of its commitment to keep interest rates low (forward guidance)

Inflation can be thought of as

a decrease in the price of money

Modern monetary policymakers work to reduce the volatility created by fluctuations in _____ by adjusting _____

aggregate demand and aggregate supply; Target interest rate

Modern monetary policymakers work to reduce the volatility created by fluctuations in _____ by adjusting _____.

aggregate demand and aggregate supply; target interest rate

The Taylor Rule is

an approximation that seeks to explain how the FOMC sets their target

A rate of inflation that exceeds the growth rate of money for a country could be explained by

an increasing velocity of money

The quantity theory of money along with the assumption of constant velocity can explain

at a given level of money growth, the higher the level of real growth the lower the level of inflation will be

Raising interest rates following the use of unconventional policy tools depends on

both the size and composition of the central bank's balance sheet and the toolbox available to the central bank

If the nominal interest rate decreases, the

cost of holding money decreases

History shows that

countries with high rates of money growth have high rates of inflation

The key to the success of forward guidance as a monetary policy tool is

credibility

the key to the success of forward guidance as a monetary tool is

credibility

The economy is in both a short and long run equilibrium if

current inflation equals expected inflation and current output equals potential output

If the economy is in long-run equilibrium, then

current inflation should equal expected inflation

All other factors equal, as nominal interest rates increase, checking account balances should

decrease

In the long run, if we ignore changes in velocity, inflation will

equal money growth less the growth in potential output

The Taylor rule allows the real long term interest rate to

fluctuate with the natural rate of interest

Consumption can be sensitive to changes in the real interest rate because

higher interest rates can increase the cost of durable goods like automobiles

The fact that there is a market for federal funds enables banks to

hold a lower level of excess reserves than they otherwise would

As a person's wealth increases, we would expect the demand for money to

increase, but at a rate less than dollar for dollar

The velocity of money

increases if each unit of money is used more frequently

For central bankers to alter the real interest rate by changing the nominal interest rate,

inflation expectations should be quite stable

The primary monetary policy tool most used by central banks to day is

interest rates

A major contributing factor to the instability of money demand over the past 25 years is the

introduction of financial instruments that pay higher returns than money but can be used as a means of payment

Discount lending by the Fed

is usually small except in times of crisis

While GDP was once a key cyclical indicator, its usefulness has declined substantially because

lack of timeliness requires seasonal adjustment constant revisions for decades

Discount lending is part of the Fed's function of

lender of last resort

If the level of current output suddenly falls below the potential level of output, central bankers would typically

lower the interest rate

If the level of current output suddenly falls below the potential level of output, central bankers would typically

lower the real interest rate

To say that the relationship between velocity of money and the opportunity cost of holding money is not stable is the same as saying

money demand is not stable

Over the long run if central banks want to avoid high rates of inflation, they need to be concerned with the

money growth rate

In studying the average annual inflation and money growth in 160 countries over the three decades that began in 1980, it is startling to see that researchers found many countries that had experienced rates of inflation that averaged

more than 200% per year

If the market federal funds rate were below the target rate, the response from the fed would likely be to

raise the IOER rate

In the long run, with % change in velocity = 0, we can conclude that the inflation rate equals the

rate of money growth minus growth in potential output

The only solution available to a country experiencing extremely high rates of inflation is to

reduce money growth

One of the ways inflation reduces aggregate demand is by

reducing real balances

What would be the impact on the monetary policy reaction curve if the Fed were to raise the target inflation rate?

short-run aggregate supply

Forward guidance includes

statements today about policy targets in the future

With the policy rate at the effective lower bound, how might a central bank counter unwanted deflation?

targeted asset purchases Quantitative easing Forward guidance

Potential output of the country when viewed over long periods of time

tends to rise

Potential output of the country when viewed over long periods of time

tends to rise over time

A characteristic of long-run equilibrium is that the economy is producing its potential output, which is

the level of output the economy produces when its resources are used at normal rates

In the short run, the point on the aggregate demand curve where an economy will end up in equilibrium depends on

the short-run aggregate supply curve

One way the Fed can inject reserves into the banking system is to increase

the size of the Fed's balance sheet through purchasing securities

To use market growth as a short-term monetary policy instrument, a central bank must believe that

there is a stable link between the monetary base and the rate of inflation

To use money growth as a short-term monetary policy instrument, a central bank must believe that

there is a stable link between the monetary base and the rate of inflation

Explain how a recessionary output gap would emerge in an economy where the long-run aggregate supply curve is persistently shifting to the right

this occurs when actual output grows more slowly than potential output

A good monetary policy instrument is

tightly linked to monetary policy objectives

Federal funds loans are

unsecured loans

Using the equation of exchange, if real output and the money supply stay the same and price level increases

velocity of money increases

Key assumptions behind the quantity theory of money include that the

velocity of money is constant