Ch 11 Macroeconomics

If the Fed wants to increase interest rates, it should _____ government treasuries (e.g. government bonds, bills or notes), which will ____ the money supply. buy; decrease buy; increase sell; increase sell; decrease

sell; decrease When the FED sells government treasuries, they are effectively giving a slip of paper to a bank with an "I-owe-you" on it, and the bank will give the FED money. When the FED takes this money from the bank, the bank has less to lend out, which will drive up interest rates.

The discount rate is _____ and the federal funds rate is _____. determined by market forces but manipulated by the FED; determined by market forces but manipulated by the FED set by the FED, set by the FED set by the FED, determined by market forces but manipulated by the FED determined by market forces but manipulated by the FED; set by the FED

set by the FED, determined by market forces but manipulated by the FED The discount rate is the rate banks can borrow from the FED, and this rate is just set directly by the FED. The federal funds rate is the rate banks borrow from each other, and though the FED manipulates this rate, it is effectively determined by the supply and demand of funds available for this borrowing.

The United States is divided into __________ Federal Reserve districts, each with a district bank.

twelve There are 12 Federal Reserve districts, each with a bank. Any paper bill issued by the Federal Reserve will have the corresponding number and letter to where that bank came from, up to a maximum of "12" or "L" (since L is the 12th letter in the alphabet).

the equation of exchange?

"M * V = P * Q" where M = Money, V = velocity, P = Price level (inflation), and Q = Quantity of goods produced (rGDP). Basically, P* Q = nominal GDP (price level * rGDP), and M* V = nominal GDP as well (more intuitively, M, or the number of dollars, multiplied by "V" or the average number of times a dollar changes hands, should equal the total nominal dollar amount of final goods produced in a nation. For example, if $1000 were in an economy, and the V = 3.5, that means each dollar has "transacted" 3.5 times on average, so $3500 of transactions took place in that year.

If the required reserve ratio is 10% and new money is deposited in Bank of America of $10,000, what is the maximum amount of money that can be created in the money supply (including the $10,000 new money)? $19,000 $10,000 $100,000 $9,000 more than $1,000,000

$100,000 We can use the formula: final change in money supply = (initial change in money supply) * (simple money multiplier) where the multiplier = (1/rr) = (1/0.10) = 10. final change in money supply = $10,000 * 10 final change in money supply = $100,000

Using the equation of exchange, assume velocity is stable and the %change in rGDP (Q) is 3%. If the Fed wants to target an inflation rate of 2%, by what percentage should the Fed change the money supply?

5

Using the equation of exchange, assume velocity is stable and the %change in rGDP (Q) is 3%. If the change in the money supply is 9%, what is the inflation rate for the year?

6

The Federal Reserve has 6 goals. Use the dropdown menus to answer the questions below about each goal: Full employment: The Fed targets an unemployment level of approximately _________ to achieve this goal. Price stability: The Fed targets an inflation rate of approximately _________ to achieve this goal. Economic growth: The Fed considers growth rate policy of _______ to achieve this goal. Interest Rate stability: The Fed's policy for interest rates is ___________ . Currency Stability: The Fed's main goal is a __________ U.S. Dollar. Financial System Stability: The Fed _________ oversight over the financial/banking system

Answer 1:5% Answer 2:2% Answer 3:positive growth rates that are sustainable and consistent Answer 4:consistent, but adaptive to macroeconomic needs Answer 5:consistent Answer 6:has

Word Bank Matching (each word is used only once): Federal Reserve; The Quantity Theory of Money; Money; Velocity; Price Level; rGDP; Federal Open Market Committee (FOMC); Expansionary Monetary Policy; Contractionary Monetary Policy; Federal Funds Rate; Discount Rate; Interest On Reserve Rate (IOR Rate) The equation M x V = P x Q is used in understanding money and inflation in the theory: ___________ . The "M" above stands for ___________ , which represents the aggregate amount of money in the economy (represented by M1 and/or M2) The "V" above stands for ___________ , which is defined as the average number of times a dollar changes hands each year (e.g. if "V = 2.2," this means that "a dollar changed hands on average 2.2 times this year). The "P" above stands for ___________ , which is measuring inflation. The "Q"(sometimes "Y") above stands for ___________ , which measures the actual quantity of goods & services produced in a nation in a year. The ___________ is generally responsible for overseeing the financial system & controlling the money supply, and a specific committee called the ___________ is responsible for decisions regarding monetary policy. If banks want to borrow money from each other, they borrow at the ___________ . If banks want to borrow from the Federal Reserve directly, they borrow at the ___________ . If banks have reserves, the Federal Reserve will pay a rate called the Interest On Reserve Rate (IOR Rate) . The purchase of government treasuries (e.g. bonds) is part of ___________ while the sale of government securities (e.g. bonds) is part of ___________

Answer 1:The Quantity Theory of Money Answer 2:Money Answer 3:Velocity Answer 4:Price Level Answer 5:rGDP Answer 6:Federal Reserve Answer 7:Federal Open Market Committee (FOMC) Answer 8:Federal Funds Rate Answer 9:Discount Rate Answer 10:Interest On Reserve Rate (IOR Rate) Answer 11:Expansionary Monetary Policy Answer 12:Contractionary Monetary Policy

Use the dropdown menus below to answer the following question: If the Fed wanted to decrease the money supply, it could: ["keep constant", "decrease", "increase"] the reserve requirements sell government securities like bonds ["increase", "keep constant", "decrease"] the discount rate

Answer 1:increase Answer 2:sell Answer 3:increase

Open Market Operations: If the Fed wants to reduce the money supply, fill in the drop down menus below to describe the process: The Fed["buys", "sells"] a bond from/to a bank Bank ["increases", "reduces"] loans The supply curve of money ["shifts right", "shifts left"] The equilibrium interest rates ["increase", "decrease"] The AD curve shifts ___________

Answer 1:sells Answer 2:reduces Answer 3:shifts left Answer 4:increase Answer 5:shifts left

In the liquidity trap, the demand curve for investment is horizontal

False

Nonactivists argue against the use of discretionary monetary policy and rules-based monetary policy.

False

The money supply curve is usually horizontal.

False

True or False: The Federal Reserve Chairperson has the power to set the discount rate by her or himself.

False

%change M + %change V = %change P + %change Q

If "velocity is stable" then that means %change V = 0% (i.e. velocity hasn't changed...note that "stable velocity" is a key assumption of the monetarists, which is why we emphasize this language to mean %change V = 0%) Why is this equation important? It shows the key determinants of inflation, and the importance of matching money supply growth with rGDP growth to maintain price level in an economy over the long run (assuming velocity is stable).

Expansionary monetary policy

If the economy is in a recessionary gap (you can think about the great recession), the Fed will begin expansionary monetary policy. The steps are as follows: The Fed will buy bonds from banks (Fed gives cash to banks for a bond). Banks have more cash now to lend out, which puts downward pressure on the interest rate. The lower interest rate attracts businesses and households to take more loans to start new projects or expand existing capacity. The increase in spending leads to an increase in output, helping correct the recessionary gap. Expansionary monetary policy is used during recessionary gaps in the economy. It is when the Fed tries to lower interest rates to increase the AD in the economy, thus "stimulating" borrowing and spending and rGDP in the short run. Historically, the Fed conducts expansionary monetary policy by buying bonds which increases the money supply and drives down interest rates (specifically the federal funds rate) in the economy.

Contractionary monetary policy

If the economy is in an expansionary gap (some economists believe we are heading for an expansionary gap right now), the Fed will begin contractionary monetary policy. The steps are as follows: The Fed will sell bonds from banks (Fed gives bond notes to banks and collects cash from banks). Banks have less cash now to lend out, which puts upward pressure on the interest rate. The higher interest rate make it more costly for businesses and households to take loans. The decrease in spending leads to a decrease in output, helping correct the expansionary gap. Contractionary monetary policy is used during inflationary gaps in the economy. It is when the Fed tries to raise interest rates to decrease the AD in the economy, thus reducing borrowing and spending and rGDP in the short run. This is often done in efforts to control rising inflation.Historically, the Fed conducts contractionary monetary policy by selling bonds which decreases the money supply and drives down interest rates (specifically the federal funds rate) in the economy.

"money is neutral" in the long run?

Monetary neutrality basically means that an influx of money (or reduction of money) in the economy would cause a temporary change in real production behavior, but that change will not be sustained in the long run. Changing money changes real production in the short run, but only changes price level in the long run.

Throughout the process of monetary policy, Keynesians are worried about ____________ because they believe that changing the money supply impacts ______________ in the process. Monetarists believe changes in the money supply directly impact _______________ , so they are not worried about the same things Keynesians are worried about with monetary policy.

Partial correct Answer 1:changes in AD Answer 2:Aggregate Demand Answer 3:Aggregate Demand

1The Keynesian transmission mechanism could be blocked by either interest-insensitive investment or by the liquidity

True

One argument in favor of activist monetary policy is that the economy does not always equilibrate quickly enough at Natural Real GDP

True

People should buy bonds when they think that interest rates are as high as they will go.

True

The price of old (or existing) bonds and interest rates have an inverse relationship.

True

When an economist states that the monetarist transmission mechanism is "direct" it means that a change in the money supply creates a direct impact on the goods and services market.

True

When an economist states that the monetarist transmission mechanism is "direct" it means that a change in the money supply creates a direct impact on the goods and services market.

True From the monetarist perspective, changes in the money supply directly impact the economy (goods and services markets) whereas the Keynesian perspective believe changes in the money supply are indirect, changing the interest rate which changes investment spending.

Lowering the required reserve ratio raises the simple money multiplier.

True The simple money multiplier is defined as (1 /rr) where "rr = required reserve ratio." If the rr = 10% or 0.10, then the simple money multiplier is (1/0.10) = 10. If the rr is lowered to 5% or 0.05, then the simple money multiplier is (1/0.05) = 20.

Identify all the responsibilities/powers of the federal reserve below. Mark all that apply. provide banking services to the general public control the money supply issue bank notes the lender of last resort decide how much the federal government gets to spend each year issuing social security payments

control the money supply issue bank notes the lender of last resort

A decrease in the money supply will shift the aggregate __________ curve to the __________. supply; left demand; right demand; left supply; right

demand; left Decreasing the money supply should raise interest rates (banks have less to loan) which decreases investment spending, decreasing AD.

. Which of the following is not a major responsibility of the Fed?

determining tax rates The Federal Reserve's goals include: controlling the money supply, serving as the federal government's banker, and acting as a lender of last resort. Determining most tax rates is up to Congress and the President.

Compared to the Keynesian transmission mechanism, the monetarist transmission mechanism is none of the answers is correct. indirect. inverse. direct.

direct. Monetarists believe in a more direct path from changes in the money supply to changes in AD, while Keynesians believe changes in the money supply impact investment spending which then changes AD.

Assume the reserve requirement is 20% and the Fed increased money supply by $25,000. Using the simple money multiplier, what is the theoretical maximum final change in the money supply?? If banks are hesitant to lend out, so they store excess reserves If the federal government increases transfer programs like social security If banks lend out with no excess reserves If borrowers use the money instead of just sitting/holding cash If people hold a lot of their savings in cash in their homes instead of putting it in the bank If tax rates are higher than at equilibrium

incorrect: If banks are hesitant to lend out, so they store excess reserves If banks lend out with no excess reserves

What happens to the interest rate if deflation occurs in the economy?

interest rate decreases (money demand curve shifts left)

What happens to the interest rate if the Federal Reserve decides to increase the money supply?

interest rate decreases (money supply curve shifts right)

What happens to the interest rate if the Federal Reserve decreases the money supply?

interest rate increases (money supply curve shifts left)

According to the Keynesian transmission mechanism, an increase in the money supply will __________ the interest rate, causing a __________ in investment, which then __________ Real GDP. lower; rise; raises raise; fall; lowers lower; fall; lowers raise; fall; raises raise; rise; lowers

lower; rise; raises The keynesian transmission mechanism is an indirect mechanism (using investment spending changes to change AD). An increase in the money supply increases the quantity of money able to be loaned, which decreases the interest rate and stimulates investment spending. Higher investment spending increases AD.