Sec 05 Quiz Econ

Which of the following is an open market operation?

A central bank purchasing bonds

Which of the following is NOT a function of money? HINT: Money serves multiple functions in an economy. Money is first and foremost a medium of exchange. Because it eliminates the need for barter, it makes commerce much more convenient and efficient. It is also a unit of account in that it serves as the unit people use to describe how much of something they want. Finally, it is supposed to hold value over time. A dollar bill should be worth the same amount tomorrow that it is today.

A source of intrinsic value

Expansionary monetary policy can affect the economy through which of the following chains of events?

Buying bonds increases the money supply, which lowers the interest rate.

To move the economy closer to full employment, the FED decides the federal funds rate must be increased. The appropriate open market operation (OKO) is to ______, which ______ the money supply, ______ aggregate demand and fights ______. HINT: If the central bank has decided that moving to full employment requires an increase in the federal funds rate, it must sell bonds to decrease the money supply. The resulting increase in interest rates decreases AD and puts downward pressure on the price level.

E OMO - sell bonds MONEY SUPPLY - decreases AD - decrease TO FIGHT - inflation

Which of the following is true of the quantity demanded of money?

It falls when interest rates rise, because the opportunity cost of holding money increases

In order to carry out expansionary Open Market Operations, the Fed must first __________.

Purchase treasury bills from banks.

Which of the following does the Federal Reserve directly change during open market operations?

The money supply.

A decrease in business spending on plant and equipment with an increase in the real interest rate could be caused by: HINT: When the government borrows funds, there is a reduction in funds available for the private sector, causing an increase in the interest rate and reduced private borrowing. This process is called "crowding out."

an increase in borrowing by the federal government.

In the short run, when the Fed increases the quantity of money:

bond prices rise and the interest rate falls.

Liabilities, by definition, mean what is owed, not owned. Which of the following would be included as a liability on a bank's balance sheet?

demand deposits

If foreigners decide to invest more financial assets in the US economy we would expect to see the real interest rate in the US:

fall and investment rise.

If the supply of money in the money market shifts to the left:

interest rates will rise and capital investment will fall

Under a fractional reserve banking system, banks are required to:

keep part of their deposits as reserves

If the inflation rate rises unexpectedly, who will be more disappointed: a borrower or a lender? HINT: A lender will be more disappointed because the loan will be repaid with money that has lost more value than expected due to the inflation. Borrowers do mind some inflation during the course of a loan since they get to repay with money that is not a valuable as when the loan was made.

lender

If the real interest rate is currently above its equilibrium value, then there is a: HINT: If the real interest rate is currently above its equilibrium value, then the quantity of loanable funds supplied exceeds the quantity demanded. This is a surplus. Lenders will have to lower the interest rate in order to loan out all the funds they desire.

surplus of loanable funds, which will drive the real interest rate down.

The long run money supply curve is vertical no matter what the interest rate is because:

the Federal Reserve controls the supply of money.

Which function of money best defines $1.25 as the price of a 20-ounce bottle of pop? HINT: The price in this case measures the relative price (value) of the pop.

unit of account

Which of the following is the most likely long-run impact of government deficits? HINT: Deficit spending leads to higher interest rates and less spending on investment. Less investment spending means the rate of capital accumulation in an economy will slow down, which will lead to a slower rate of economic growth or even a decline in potential output.

A smaller stock of capital

One intended effect of contractionary Open Market Operations is to _____________.

Lower the inflation rate

Imagine an economy that previously banned foreign investors now opens its doors to foreign lenders. You would expect to see the real interest rate:

fall, and the quantity of loanable funds to increase

All of the following are components of the money supply in the United States EXCEPT: HINT: The U.S. currency is a "fiat currency", which means its value is not backed by a commodity. Thus, gold bullion (a commodity) is not a part of the money supply, even though it is WORTH money. Every other choice listed here is a more direct form of money, and is a component of the money supply.

gold bullion

Assume the Reserve Requirement is 15 percent and that a bank receives a demand deposit of $300. Which of the following will occur to the Required Reserve? HINT: The demand deposits increased by $300. The demand deposits are liabilities of the bank, and an increase in demand deposits leads to an increase in liabilities. The problem states that the reserve requirement is 15%. This is as a percent of the demand deposit. By multiplying $300 x 0.15, we find the Required Reserve. Since the bank's deposits increased, the required reserves must also increase.

increase by $45

A decrease in the Money supply will cause which of the following?

increase in nominal interest rates

Banks create money by:

lending excess reserves that get redeposited in other banks.

If the real interest rate is currently below its equilibrium value, then the quantity of loanable funds supplied is: HINT: If the real interest rate is currently below its equilibrium value, then there is a shortage of loanable funds. Lenders will realize they can raise the interest and still loan out all their funds. So the real interest rate will rise toward its equilibrium value.

less than the quantity of loanable funds demanded, and the real interest rate will rise

A decrease in the supply of loanable funds will: HINT: An inward shift of the supply of loanable funds for a given demand function will raise the interest rate and reduce total funds transacted.

raise the real interest rate and decrease investment spending.

Suppose the government deficit increases dramatically. We would expect to see the real interest rate: HINT: Government budget deficits are funded by issuing bonds. The bonds are a way for government to borrow. This government borrowing is represented by an increase in the demand for loanable funds. This increase in the demand for loanable funds increases the real interest rate. At a higher real interest rate the quantity of private investment demanded decreases.

rise and business spending on new plant and equipment fall.

Using the information in the table, calculate the demand deposits possible if this bank complies with a reserve ratio of 20% and maintains no excess reserves. HINT: If the reserve ratio is 20%, then 1/5 of the deposits must be held as required reserves. $25,000 is 1/5 of $_______. $25,000/$_______ = 1/5, which equals 20%.

$125,000

Assume that the Federal Reserve buys $5 million in government bonds on the open market. As a result of the open market purchase, calculate the maximum increase in the money supply in the banking system (assume banks hold no excess reserves, and there are no currency drains). For this question, the reserve requirement is 20%. HINT: With the purchase of the $5 million bond on the open market, demand deposits are increased by $5 million. Of this $5 million, 20% must be put into required reserves and the remainder becomes a part of excess reserves and is loaned out. Each additional loan and subsequent demand deposit increases the money supply. Demand deposits increase by $25 million - $5 million x 5 (the money multiplier if the reserve requirement is 20%) = $25 million. This question does not ask how much money was created through loans. If that had been the question, the answer would be $20 million. That $20 million plus the $5 million from the bond purchase equal $25 million, the change in the money supply.

$25 million

Assume that the Federal Reserve buys $5 million in government bonds on the open market. As a result of the open market purchase, calculate the maximum increase in the money supply in the banking system (assume banks hold no excess reserves, and there are no currency drains). For this question, the reserve requirement is 20%. HINT: With the purchase of the $5 million bond on the open market, demand deposits are increased by $5 million. Of this $5 million, 20% must be put into required reserves and the remainder becomes a part of excess reserves and is loaned out. Each additional loan and subsequent demand deposit increases the money supply. Demand deposits increase by $25 million-$5 million x 5 (the money multiplier if the reserve requirement is 20%) = $25 million. This question does not ask how much money was created through loans. If that had been the question, the answer would be $20 million. That $20 million plus the $5 million from the bond purchase equal $25 million, the change in the money supply.

$25 million

If a deposit of $500 in circulating currency is deposited into Bank A, with a 10 percent reserve requirement, what is the maximum change in the money supply possible throughout the banking system? HINT: In this question, the aim is to recognize what happens to the amount of money created throughout the entire banking system, not just from one bank. In this question, with a reserve requirement of 10% (1/rr, which would be 1/.1 or 1/1/10), the maximum money multiplier is 10, so $500 (the original demand deposit) times 10 equals $5,000. Demand deposits have increased by $5,000, but circulating currency has decreased by $500, so the maximum change in the money supply is $4,500. Another way to determine the amount of money created is to use the following formula: excess reserves (of the original deposit) times the money multiplier. Since the reserve requirement is 10 percent, the multiplier is 10 (1/rr, which would be 1/.1 or 1/1/10). Of the original demand deposit, $50 must be kept in required reserves, leaving $450 in excess to be loaned out, therefore, $450 x 10 = ____

$4,500

Assume the Federal Reserve buys $10,000 in government bonds from a bank as a part of an open market operation. If the reserve ratio is 0.2, the maximum change in loans throughout the banking system will be: HINT: The question asks about the maximum change in loans, not the maximum change in the money supply. After the original increase in excess reserves of $10,000, each subsequent demand deposit will require that a portion of the reserves be placed in the bank vault/on reserve at the regional Fed as required reserves. The maximum change in the money supply and in demand deposits is $50,000. On the asset side of the balance sheet there will be $10,000 in reserves that support the $50,000 in demand deposits and $40,000 in loans.

$40,000

Assume the Federal Reserve buys $10,000 of government bonds from a bank as a part of open market operations. If the reserve ratio is 0.2, the maximum change in loans throughout the banking system will be: HINT: The question asks about the maximum change in loans, not the maximum change in the money supply. After the original increase in excess reserves of $10,000, each subsequent demand deposit will require that a portion of the reserves be placed in the bank vault/on reserve at the regional Fed as required reserves. The maximum change in the money supply and in demand deposits is $50,000. On the asset side of the balance sheet there will be $10,000 in reserves that support the $50,000.

$40,000

If the Required Reserve is 20%, then what is the maximum increase in the money supply if a person deposits $100 into a checking account at a member bank of the Federal Reserve that had no excess reserves before the deposit? HINT: To do this problem, you must perform two steps. Calculate the value of the multiplier, then use that answer and multiply it by the excess reserves the bank has on hand. The formula used to calculate the money multiplier is one divided by the Reserve Ratio (RR). 1/RR Convert the 20% to a decimal and put it into the formula. One divided by 0.2 equals 5. So, for every one dollar of excess reserves the bank has, the maximum increase to the money supply will be five times that. Remember to subtract the required reserve before calculating this answer.

$400

First National Bank has a simplified balance sheet: Use the table to calculate the maximum possible change in loans for this bank if the reserve ratio is 10%. HINT: This is tricky. On the balance sheet, the reserve of $20,000 includes required and excess reserves. Demand deposits are $150,000 and 10% of $150,000 equals $15,000. THINK!

$5,000 (On the above balance sheet, the reserves include both required and excess reserves. Since demand deposits are $150,000, 10% of $150,000 equals $15,000. Therefore, there will be $5,000 in excess reserves for this bank ($20,000 - $15,000).

Suppose the reserve requirement is 20%. If Paul deposits $200 he earned mowing lawns, what is the maximum increase in the money supply? HINT: You need the money multiplier formula, which is MM = 1/rr. In this case MM = 1/0.2 or 5. 5 times $200 = $1000. So the answer is $1000 right? That is how much the money supply increased after taking into account the MM, right? No, because the $200 already existed.

$800

The FED has set the reserve ratio at 10% for banks in the nation. Suppose Eli deposits $1000 into his checking account. If the bank keeps only the required reserves, initial excess reserves from this deposit are equal to _____ and the money supply of will eventually grow by _____. HINT: Because of the original deposit, the bank must keep $100 in required reserves (10% of $1000), leaving $900 in excess reserves. With a reserve ratio of 10%, the money multiplier is equal to 10 so the $900 of excess reserves will eventually grow to $9000 through multiple loans and expansion of deposits.

$900; $10,000

If, upon receiving a checking deposit of $600, a bank's excess reserves increased by $510, the required reserve ratio must be: HINT: This means the RR is $90. ($90/$600) x 100 = __

15%

If the central bank has set the reserve ratio at 5%, the money multiplier is equal to: HINT: The money multiplier (M) is equal to 1/rr, where rr is the reserve ratio. If the reserve ratio is 5%, M=1/0.05 = 20.

20

Assume the required ratio is 25%: Suppose that the central bank purchases $5,000 worth of bonds from Macro Bank. What will be the change in the dollar value of excess reserves and demand deposits immediately after the purchase? HINT: Since the central bank purchased the bond from the bank, it will only be exchanging one asset, a bond, for another asset, excess reserves. The question states "immediately after the purchase," so there will be no change made to the demand deposits. Once loans are made from the excess reserves, then demand deposits will increase, and the money supply will increase.

Excess reserves +$5,000, Demand deposits +$0

Which of the following is an example of using money as a store of value? HINT: Buying a dress or an automobile, ordering products online, and paying rent are all examples of money being used as a method of payment. However, keeping $200 on hand for an emergency is an example of storing money today to cover a potential need in the future. In this case, money is serving as a store of value.

Keeping $200 on hand for an emergency

Which of the following measures of economic activity would always be consistent with a prolonged recession?

an unemployment rate of 9%

If an individual deposits $10,000 in their savings account and the bank uses those funds to buy a U.S. Treasury security, then the: HINT: Financial intermediation is shuttling funds from savers to borrowers. In this case the individual is the saver, the U.S. Treasury is the borrower, and the bank is the one shuttling the funds between the two.

bank is acting as a financial intermediary

The Federal Reserve can increase the money supply by: HINT: If the Fed is buying government bonds from a bank, the bank converts one asset (the bond) into another asset (excess reserves). By increasing excess reserves, banks are able to increase loans and demand deposits, and subsequently, the money supply.

buying government bonds on the open market

The Federal Reserve can increase the money supply by: HINT: If the Fed is buying government bonds from a bank, the bank converts one asset (the bond) into another asset (excess reserves). By increasing excess reserves, banks are able to increase loans and demand deposits, and subsequently, the money supply.

buying government bonds on the open market.

An increase in the supply of loanable funds will: HINT: An increase in the supply of loanable funds is reflected in a shift to the right of the supply curve. The new equilibrium will occur at a lower real interest rate and a higher equilibrium quantity of loanable funds.

decrease the equilibrium real interest rate and increase the equilibrium amount of funds loaned out.

If the real interest rate rises, then the quantity of loanable funds demanded will: HINT: When the real interest rate rises neither the supply nor the demand for loanable funds shifts. Instead, there is upward movement along each curve. On the demand curve this upward movement results in a decrease in the quantity of loanable funds demanded. On the supply curve this upward movement results in an increase in the quantity of loanable funds supplied.

fall, and the quantity of loanable funds supplied will rise.

Suppose there is a decrease in foreign portfolio investment in an economy. One would expect the supply of loanable funds to_________ and gross private domestic investment to_________ HINT: A decrease in foreign portfolio investment will decrease the supply of loanable funds. This will increase the real interest rate. At a higher real interest rate, the quantity of gross private domestic investment demanded decreases.

fall; fall

If the demand for loanable funds decreases, then the equilibrium real interest rate: HINT: If you draw the graph then you will see a leftward shift in the demand curve will decrease price (real interest rate) and decrease supply (all funds).

falls, and the equilibrium quantity of funds decreases

If the demand for loanable funds decreases, then the equilibrium real interest rate: HINT: A leftward shift in the demand curve will decrease price (real interest rate) and decrease supply (all funds).

falls, and the equilibrium quantity of funds decreases.

If the supply of loanable funds increases, then the equilibrium real interest rate: HINT: An increase in supply is a rightward shift of the supply curve, which lowers price (real interest rate) and increases quantity (all funds).

falls, and the equilibrium quantity of funds increases.

When large New York banks make overnight loans to each other, they charge the: HINT: Banks are required to hold a certain percentage of their deposits in "reserve." They loan out the "excess reserve". Sometimes, a bank does not have enough reserves and, in order to comply with the regulations of the Federal Reserve, they must borrow money temporarily. In order to achieve the appropriate level of reserves, banks borrow overnight from other banks and the interest rate they pay on these loans is the federal funds rate. The prime rate is the interest rate banks charge to their best customers. The discount rate is the interest rate banks pay when they borrow directly from the Federal Reserve (this method is a last resort).

federal funds rate

The money-creating ability of the banking system will be less than the maximum amount indicated by the money multiplier when:

households hold a larger portion of their money as currency.

If the federal deficit increases, then the equilibrium real interest rate will: HINT: An increase in the federal deficit shifts the demand for loanable funds to the right or the supply of loanable funds to the left. This results in a higher equilibrium real interest rate which discourages investment spending. Investment requires borrowing funds and the higher real interest rate makes some investment projects unprofitable or too risky to undertake.

increase and investment spending will fall.

An increase in the tax rate on interest earned on savings accounts will: HINT: An increase in the tax rate on interest earnings will discourage them. This is reflected in a shift to the left of the supply of loanable funds. The new equilibrium will at a higher real interest rate and a lower equilibrium quantity of loanable funds.

increase the equilibrium real interest rate and decrease the equilibrium quantity of loanable funds.

When the Federal Reserve buys bonds, which of the following happens to interest rates and bond prices? HINT: When the Fed buys bonds, this increases demand for existing bonds in the bond market. By increasing demand for bonds, the price of these bonds is pushed up. With a higher price of bonds the interest yield as a portion of the price of the bonds is now lower.

interest rates decrease; bond prices increase

If a bank customer deposits $1,000 of circulating currency into her demand deposit, what will be the immediate effect on M1? HINT: M1 is the total of circulating currency and demand deposits. Since the circulating currency was deposited into a demand deposit, circulating currency decreased by $1,000, and demand deposits increased by $1,000.

no change

The money-creating ability of the banking system will be less than the maximum amount indicated by the money multiplier when: HINT: Money creation is dependent on excess reserves that are used to make loans. Loans lead to increased demand deposits, thus increasing the money supply. For example, if you borrow $10,000 to pay for remodeling your basement, it is necessary that all $10,000 be spent and the receiver(s) of the money deposit the money into their bank's demand deposits. If some of the money borrowed ends up being saved under the mattress, it means that the amount of money created will be less than the maximum possible.

people hold a portion of their money in the form of currency.

If there is an increase in capital investment, which of the following changes to the price level and unemployment will occur in the short run?

price level increases, unemployment decreases

Assume the economy is operating at full employment. If the economy enters a sudden economic expansion, the quantity of money available in the economy will: HINT: This is a trick question. Many students assume when GDP increases (as it would during an economic expansion), the quantity of money available in the economy automatically increases. While more money is demanded in an expanding economy, the supply of money is effectively controlled by the Fed. Because they control the money supply, it is not dependent on interest rates, and therefore is illustrated with a vertical line in the money market model.

stay the same

Assume the bank holds $1000 in excess reserves. Which of the following is true? Hint: Both sides must be equal. It is not a coincidence that assets = liabilities. People have deposited $10,000. The bank has lent out $5,000. The bank kept $3,000 in reserve and bought $2000 worth of treasury bonds. The question gives you the information you need. "The bank holds $1000 in excess reserves." By law the bank has to hold in the bank, a certain amount of reserves, called the " reserve requirement", to satisfy the needs of depositors to withdraw money. This practice prevents bank runs and keeps the bank solvent. This bank is extra careful because it is keeping an extra $1000 in what we call "excess reserve". This means the reserve requirement must be $2,000. The Fed can adjust this reserve requirement up or down in order to shift the money supply and combat inflation or recession.

the reserve requirement is 20%

How do we correctly describe the relationship between bond prices and interest rates? HINT: A bond is a loan with an interest rate and a fixed interest payment. Bonds are sold all the time, and when they are sold, the interest rate is usually at the current market rate, which changes over time. Many economic decisions involve tradeoffs, and bond investors face this because they are constantly comparing the value of new bonds with the value of old bonds previously issued. For example, you might buy a newly issued bond paying 7% today (the "prevailing interest rate") while next year a new bond is issued at 8%. When the prevailing interest rate changes, the price of old bonds already owned goes up or down since a bond's payment is fixed. The price of an old 7% bond would decrease if the market interest rate rose to 8% because the 7% fixed payment is less attractive than that of an 8% bond. In order to create an equilibrium, the free market adjusts the price of bonds based on changes in the interest rates.

The price of a bond varies inversely with market interest rates.

An increase in investment will cause which of the following in the long run.

a rightward shift of LRAS

As a unit of account, money is used to: HINT: If someone quotes a price of $100, everyone understands the value this represents. On the other hand, four pounds of lobster may have the same value, but quoting prices in lobster is not useful because most consumers cannot relate to the value it represents.

state prices of all goods and services

Assume Sally receives $500 in circulating currency as a graduation gift. She deposits the $500 into her bank as a demand deposit. Based on this deposit, how much did the money supply immediately change, and what is the maximum possible change in the money supply if the reserve requirement is 20%? HINT: Sally deposited $500 in currency which is already a part of the money supply. If the reserve ratio is 20%, then $100 will be placed either in the bank's vault or on deposit at the central bank. The remaining $400 is considered excess reserves, and the $400 will be available for loans. To determine the maximum change in the money supply, the multiplier must be determined—1/rr = 1/0.20, or 5. 5 x $500 = $2,500, but $500 was already in the money supply.

$0 immediate change, $2,000 maximum possible change

Assume Sally receives $500 in currency as a graduation gift. She deposits the $500 into her bank as a demand deposit. Based on this deposit, how much did the money supply immediately change, and what is the maximum possible change in the money supply if the reserve requirement is 20%? HINT: Sally deposited $500 in currency which is already a part of the money supply. If the reserve ratio is 20%, then $100 will be placed either in the bank's vault or on deposit at the central bank. The remaining $400 is considered excess reserves, and the $400 will be available for loans. To determine the maximum change in the money supply, the multiplier must be determined—1/rr = 1/0.20, or 5. 5 x $500 = $2,500, but since $500 was already in the money supply, then the amount of change will be $2,000.

$0 immediate change, $2,000 maximum possible change

Suppose the central bank purchases $10,000 in government bonds from the Macro Bank. Calculate the maximum amount that the money supply can change as a result of the $10,000 purchase. Assume that this bank is complying with the reserves required by the central bank. HINT: The answer requires a two-step process, determining the required reserve ratio to be able to determine the money multiplier and calculating the change in the money supply. First, if the demand deposits are $250,000 and the required reserves are $25,000, then the reserve ratio must be 10% (25,000/250,000 = 1/10, or 0.1, or 10%). The formula for the maximum money multiplier is 1/(reserve ratio), therefore, 1/0.1 = 10. Next, since the central bank purchased a $10,000 bond, the bank now has $10,000 as excess reserves, and the bank can begin the process of creating money by using the excess reserves to increase loans and demand deposits. The maximum change in the money supply is calculated as the money multiplier x excess reserves.

$100,000

If the interest rate is 10% and you expect to receive income of $1100 one year from now, the present value of that income is: HINT: The relationship between money today (present value PV) and money in the future (future value FV) depends upon the interest rate (r) is: FV = PV(1+r). Since you know that $1100 is received in the future and the interest rate is r = 0.10, you can solve for present value of $1000. Alternatively, if you put $1000 in the bank today (PV), and earned 10% interest over the year, it would grow to $1100 in a year (FV).

$1000

Using the information in the table, calculate the demand deposits possible if this bank complies with a reserve ratio of 20% and maintains no excess reserves. HINT: If the reserve ratio is 20%, then 1/5 or 20% of deposits must be held as required reserves.

$125,000

The central bank has set the reserve ratio at 5%. If Theodore deposits $500 into his checking account, initial excess reserves will be _____. HINT: Because the reserve ratio is 5%, banks must keep 5% of checking deposits in reserve and the remainder is excess reserves that can be held or lent to borrowers. Since 5% of the $500 deposit is $25, there are $500 - $25 = $475 in excess reserves.

$475

What is the maximum loan the bank can make without violating Federal Reserve policy if the Reserve Requirement Rate is 20% no matter the size of the bank or its deposits? HINT: The Bank has to keep a certain amount on hand as required reserve. Given its cash reserves which include money on deposit with the FED and vault cash, it has $100 million in cash available. The required reserve rate of 20% of checkable deposits must be held on hand. Checkable Deposits are $150 million so $30 million must be kept and $70 million may be lent out ($100 million available - $30 million required reserve = $70 million excess). A typical mistake is to think that savings deposits must also be part of the required reserve amount, but that is not true so you would not select $66 million.

$70 million

If a commercial bank has no excess reserves and the reserve requirement is 20%, what is the value of new loans this single bank can issue if a new customer deposits $1,000? HINT: When an individual makes a deposit at a bank, that bank can only lend out the excess reserves from that deposit. The $1,000 deposit has a $200 reserve requirement (20% of $1,000), so $1,000 - 200 provides excess reserves of $800. The multiple expansion only takes place among all the banks within an economy over time assuming all excess reserves are loaned out and there are no currency drains.

$800

If a bank has $500 in checking deposits and the bank is required to reserve $50, what is the reserve ratio? How much does the bank have in excess reserves? HINT: The reserve ratio = Required reserves/checking deposits = .1 = 10%. Excess reserves = (Checkingdeposits - Required reserves) = ($500 - $50) = $450.

10 percent, $450 in excess reserves

Assume the bank holds $1000 in excess reserves. What is the money multiplier? Hint: The rr is 20%. 1/rr = MM

5

The required reserve ratio is 20% and the Federal Reserve buys $1 million in securities. If there are no leakages and banks do not hold excess reserves, then which of the following is the maximum change in the money supply? HINT: There are two parts worth noting in this question. First, given the RR as 0.2, this means that the money multiplier is 5, based on the formula 1/rr. Next, it states that the Fed buys bonds. In so doing, it increases the money supply. Since the question states that there are no leakages and banks do not hold excess reserves, all the money will be available for loans and redeposits. Therefore, the $1 million times 5 leads to a $5 million increase in the money supply.

A increase of $5 million

If market interest rates fall, what will likely occur? HINT: A bond is a loan with an interest rate and a fixed interest payment. Because the interest payments on a bond are fixed, and the prevailing market interest rates change over time, the price of existing bonds go up and down based on changes in the interest rate. When interest rates rise, bond prices go down. When interest rates fall, bond prices rise. There is an inverse relationship between bond prices and interest rates.

Bond prices will rise.

Which of the following is a likely result of expansionary monetary policy in a recession? HINT: Expansionary monetary policies decrease the interest rate, causing AD to increase, which increases GDP at equilibrium and increases employment.

Increases aggregate demand, which increases real GDP and increases employment.

Which of the following measures of the money supply is largest? HINT: The Federal Reserve publishes weekly and monthly data on two money supply measures M1 and M2. The money supply measures reflect the different degrees of liquidity that different types of money have. The narrowest measure, M1, is restricted to the most liquid forms of money; it consists of currency in the hands of the public and checks. M2 includes M1, plus savings accounts and mutual funds.

M2

Which of the following measures of the money supply is largest? HINT: The Federal Reserve publishes weekly and monthly data on two money supply measures M1 and M2. The money supply measures reflect the different degrees of liquidity—or spendabilty—that different types of money have. The narrowest measure, M1, is restricted to the most liquid forms of money; it consists of currency in the hands of the public; travelers checks; demand deposits (checkable deposits), and other deposits against which checks can be written. M2 includes M1, plus savings accounts, time deposits of under $100,000, and balances in retail money market mutual funds.

M2

The economy only needs $100 Billion in stimulus but Congress provided $200 billion. So the FED will want to counteract Congress to keep the economy from overheating. Both the Reserve Requirement option and the Open Market sale of securities are workable options in slowing the economy. But the FED almost never changes the reserve requirement the most likely move will be solving the problem through Open Market Operations since that is the most used tool of the FED.

Reduce its T-Bill holdings by selling on the open market

Which of the following represents an exercise of tight money policy by the Fed? HINT: Tight money policy refers to money being harder to get. In other words, people will pay more for the use of money. By selling bonds the Fed is taking money out of the market. In order to entice people to buy their government bonds the Fed must offer higher interest rates. The FED does not control tax policy, that is Fiscal in nature and so taxes cannot be considered for this question. Buying bonds and lowering discount rates makes money easier to get and therefore are not good choices. A tight money policy decreases the money supply (shifts it left) and the resulting change is higher interest rates. The rate being targeted is the Federal Funds rate which is the rate banks charge each other for short-term loans.

Selling Bonds on Open Market.

An economy has a budget deficit, and you want to show the impact of the deficit on the real interest rate. What model would you use, and what would be the impact on the interest rate? HINT: When a government engages in deficit spending, it either provides less savings (which means the supply of loanable funds decreases) or it borrows money (which means the demand for loanable funds increases). In either case, the impact will be an increase in real interest rates.

The loanable funds market; real interest rate increases

If the money supply increases, what happens in the money market (assuming money demand is downward sloping)? HINT: If the demand for money is downward sloping, the nominal interest rate falls because the money supply curve has shifted rightward.

The nominal interest rates falls.

Which of the following statements correctly describes the relationship between bond prices and interest rates? HINT: A bond is a loan with an interest rate and a fixed interest payment. Because the interest payments on a bond are fixed, and the prevailing market interest rates change over time, the price of existing bonds go up and down based on changes in the interest rate. When interest rates rise, bond prices go down. When interest rates fall, bond prices rise.

The price of a bond varies inversely with market interest rates.

When the loanable funds market is in equilibrium: HINT: The supply of money in the economy is different from the amount of loanable funds. The real interest rate is a number like 5 percent, so it does not equal the supply nor the demand for loanable funds which are dollar amounts. There is a balance when the loanable funds market is in equilibrium, but is between the forces of shortage and surplus, and has nothing to do with the money supply.

The quantity of loanable funds supplied equals the quantity of loanable funds demanded

During a period of rising nominal interest rates, what will be the effect on bond prices? HINT: This is tricky. Think about it. If I see that banks are offering a higher and higher interest rate am I more or less likely to put my money in a bank rather than by bonds. If the demand for bonds decreases what happens to the price of bonds?

They decrease

Under which circumstance is crowding out most likely to be a concern? HINT: This is a hard one. I missed it twice. An economy that has a high unemployment rate is in recession. When an economy is experiencing a severe recession, crowding out is the least likely to occur. During severe downturns, there is less private investment. Less investment spending means there is less competition for funds if the government borrows to finance deficit spending. When an economy is operating near full employment there is likely to be more private investment and interest sensitive consumption. Any borrowing by a government would have more competition for savings and therefore a higher potential for crowding out.

When an economy is operating near full employment

The required reserve ratio is 20% and the Federal Reserve buys $1 million in securities. If there are no leakages and banks do not hold excess reserves, then which of the following is the maximum change in the money supply? HINT: There are two parts worth noting in this question. First, given the reserve ratio as 0.2, this means that the money multiplier is 5, based on the formula 1/rr. Next, it states that the Federal Reserve buys bonds. In so doing, it increases the money supply. Since the question states that there are no leakages and banks do not hold excess reserves, all the money will be available for loans and redeposits.

a increase of $5 million

If the real interest rate is above the equilibrium value, then there will be: HINT: If the real interest rate is above the equilibrium level, then the quantity of loanable funds supplied will be greater than the quantity of loanable funds demanded. This is a surplus, or excess supply. Like any commodity, a surplus will drive the price of the item down. Here the price of the loan is the real interest rate and it is driven down by the surplus of loanable funds.

an excess supply of loanable funds that pushes the real interest rate down

If the real interest rate is above the equilibrium value, then there will be: HINT: If the real interest rate is above the equilibrium level, then the quantity of loanable funds supplied will be greater than the quantity of loanable funds demanded. This is a surplus, or excess supply. Like any commodity, a surplus will drive the price of the item down. Here the price of the loan is the real interest rate and it is driven down by the surplus of loanable funds.

an excess supply of loanable funds that pushes the real interest rate down.

A rise in the real rate of interest could be caused by: HINT: Using a loanable funds graph, an increase in demand tends to raise the interest rate and increase the use of funds. A decrease in the supply of funds tends to raise the interest rate and decrease the use of funds. Thus the simultaneous increase in demand and decrease in supply will unambiguously increase the interest rate but have an indeterminant effect on the quantity of funds transacted.

an increase in the demand for loanable funds or a decrease in the supply of loanable funds.

People's attitudes about the trade-off between risk and return affect how much of their wealth people hold as money. Heightened fear will lead to: HINT: The greater the fear of loss, the less people will want to hold investments that could suffer a loss, an increase in the demand for riskier assets such as bonds.

an increase in the demand for money.

Which of the following is a way that the Fed can increase the money supply? HINT: The Fed has no control of tax rates, which are an example of fiscal policy. All of the other choices are tools of contractionary monetary policy.

buying treasury securities from commercial banks

With a constant money supply, if the demand for money decreases, the equilibrium interest rate will change in which of the following ways? HINT: In the money market model, a shift in money demand moves the equilibrium interest rate up or down. A leftward shift of the downward-sloping money demand curve illustrates a decrease in the demand for money, leading to a lower interest rate. Since the money supply is controlled by the Federal Reserve, it does not change when money demand changes. Therefore, in this question, the quantity of money will not change.

decrease

Imagine the required reserve ratio is 10% and the Fed sells $2 million in bonds to banks. What will happen to the money supply? HINT: Obviously if the Fed is selling bonds they are taking money out of the economy, probably to fight inflation, so the money supply is decreasing. You have to calculate the money multiplier. MM = 1/rr. You know rr = 10%, which gives us: 1/0.1, which means the multiplier is 10. $2 million times 10 = _________

decrease by $20 million

If total income increases, then the real interest rate will: HINT: As income increases, both consumption spending and savings increase. An increase in savings increases the supply of loanable funds. The increase in the supply of loanable funds decreases the real interest rate. At a lower real interest rate, the quantity of investment demanded increases.

fall and business spending on new plant and equipment will rise.

Imagine an economy that previously banned foreign investors now opens its doors to these lenders. You would expect to see the equilibrium real interest rate: HINT: The inflow of foreign funds will increase the supply of loanable funds.

fall, and the equilibrium quantity of funds increase.

If the real interest rate rises, then the quantity of loanable funds demanded will: HINT: When the real interest rate rises neither the supply nor the demand for loanable funds shifts. Instead, there is upward movement along each curve. On the demand curve this upward movement results in a decrease in the quantity of loanable funds demanded. On the supply curve this upward movement results in an increase in the quantity of loanable funds supplied.

fall, and the quantity of loanable funds supplied will rise

If the supply of loanable funds increases, then the equilibrium real interest rate: HINT: If you draw the graph you would see that an increase in supply is a rightward shift of the supply curve, which lowers price (real interest rate) and increases quantity (all funds).

falls, and the equilibrium quantity of funds increases

As the price level decreases, the value of money: HINT: Changes in the price level will influence the demand for money because money is required to conduct transactions. When prices go up or down, individuals and firms are able to buy more or less goods with the same amount of money. If the price level decreases, that means prices for goods and services are lower, so it takes less money to buy these goods and services.

increases, so people want to hold less of it.

If the supply of money in the money market shifts to the left:

interest rates will rise and capital investment will fall.

If the inflation rate rises unexpectedly, who will be more disappointed? HINT: The loan will be repaid with money that has lost more value than expected due to the inflation. Borrowers do not mind some inflation during the course of a loan since they get to repay with money that is not a valuable as when the loan was made. Usually, lenders try to predict what the inflation rate is going to be and take that number into account when charging an interest rate for the loan. If they underestimate the inflation rate the lender losses money and the borrower benefits.

lender

If the real interest rate is currently below its equilibrium value, then the quantity of loanable funds supplied is: HINT: If the real interest rate is currently below its equilibrium value, then there is a shortage of loanable funds. Lenders will realize they can raise the interest and still loan out all their funds. So the real interest rate will rise toward its equilibrium value.

less than the quantity of loanable funds demanded, and the real interest rate will rise.

The money demand curve illustrates the relationship between the interest rate and: HINT: Economists use the demand curve for money to illustrate the inverse relationship between the quantity of money demanded and the interest rate. It depicts how much money is demanded at each interest rate.

the quantity of money demanded.

Financial intermediaries perform the vital task of: HINT: In most economies, the central bank—and not financial intermediaries—controls the money supply and ensures its safety (i.e., fights counterfeiting). The amount of borrowing in an economy depends on many things, not only the behavior of financial intermediaries. Loanable funds are money.

moving funds from savers to investors

Suppose the economy is in a recessionary gap. If the central bank is charged with stabilizing the economy, an appropriate monetary policy would be to: HINT: Because the economy is in a recessionary gap, the central bank should use monetary policy to reduce interest rates and boost aggregate demand in the economy. The open market purchase of government securities will push down interest rates by increasing the money supply in the money market. Lower taxes and increased government spending are expansionary fiscal policies, not monetary policies.

purchase government securities in an open market operation

A decrease in the supply of loanable funds will: HINT: When the supply of loanable funds decreases, by definition the quantity of savings supplied at every real interest rate decreases. This decrease in the supply of loanable funds is represented on the model by shifting the supply of loanable funds curve to the left. When this supply curve shifts to the left along an unchanging demand for loanable funds curve, the real interest rate increases and the equilibrium quantity of loanable funds decreases. The investment demanded by firms is a downward sloping curve. This is because at higher real interest rates, there are less capital investment projects that are profitable and at lower real interest rates there are more capital investment projects that are profitable. Therefore, at this new higher real interest rate the quantity of investment demanded by firms will decrease.

raise the real interest rate and decrease investment spending.

Suppose Congress borrowed money because of a shortfall in tax revenue. You would expect to see the equilibrium real interest rate: HINT: The increase in government borrowing increases the demand for all loanable funds, public and private. The graph below, which has all funds (both public and private) on the horizontal axis, shows that this will raise the equilibrium real interest rate and increase the equilibrium quantity of loanable funds. Some analysts approach an increase in government borrowing in a different manner, claiming the supply of loanable funds to the private sector will decrease. This approach is fine as long as you realize that the horizontal axis has changed to "quantity of private loanable funds." When the government borrows more, the supply of funds to private borrowers is reduced. Note that in both cases the interest rate increases and the aggregate quantity of funds (both public and private) increases.

rise, and the equilibrium quantity of funds to increase

Suppose our federal government needed to borrow more money because of a shortfall in tax revenues. You would expect to see the equilibrium real interest rate: HINT: The increase in government borrowing increases the demand for all loanable funds, public and private. The graph below, which has all funds (both public and private) on the horizontal axis, shows that this will raise the equilibrium real interest rate and increase the equilibrium quantity of loanable funds. Some analysts approach an increase in government borrowing in a different manner, claiming the supply of loanable funds to the private sector will decrease. This approach is fine as long as you realize that the horizontal axis has changed to "quantity of private loanable funds." When the government borrows more, the supply of funds to private borrowers is reduced. Note that in both cases the interest rate increases and the aggregate quantity of funds (both public and private) increases.

rise, and the equilibrium quantity of funds to increase.

If the real interest rate is currently above its equilibrium value, then there is a: HINT: If the real interest rate is currently above its equilibrium value, then the quantity of loanable funds supplied exceeds the quantity demanded. This is a surplus. Lenders will have to lower the interest rate in order to loan out all the funds they desire.

surplus of loanable funds, which will drive the real interest rate down

The opportunity cost of holding money refers to: HINT: Opportunity cost refers to a foregone opportunity. In this case, it is the opportunity to earn interest on an interest-bearing asset such as a bond. When you hold money, you are giving up the opportunity to earn interest on something else you could hold instead.

the interest that could have been earned if the money balances had been changed into an interest-bearing asset.

The speculative demand for money: HINT: The speculative demand for money refers to situations in which people hold money in order to find an opportune time to purchase other assets that will earn them a return. In others words, to speculate on these investments. It is also called "the asset demand for money." They could either hold money or hold these investments instead. The higher the interest rate on these other assets (such as bonds), the less money people choose to hold. Therefore, the speculative demand for money varies inversely (negatively) with the interest rate.

varies inversely with the interest rate