Econ 101 McGraw-Hill Chapter 12 Monetary Policy
Federal Open Market Committee (FOMC)
A committee of the Federal Reserve System that is responsible for monetary policy decisions, specifically for open market operations for the Federal Reserve System. The FOMC consists of the Federal Reserve Board, the president of the New York Fed, and 4 of the other 11 regional bank presidents.
Bond
A financial agreement that obligates a borrower (such as an individual, firm, or government) to repay the amount borrowed (principal) and interest on a specific date in the future.
Suppose the current federal funds rate is 4%, and Fed wants to decrease the rate to 2%. How will the Fed decrease the Federal Funds rate?
Buying bonds in the open market. Reason: To decrease the federal funds rate, the Fed will conduct open market operations by buying bonds. This will increase the supply of reserves available, which will decrease the supply of federal funds and decrease the federal funds rate.
change in money supply excess reserves
Change in Ms= (-1/rr) x change in ER
According to the video, what happens to interest rates and investment when the Federal Reserve increases the money supply?
Interest rates decrease and investment increases.
What happened to the reserve requirement in the video example?
It rose from 10% to 20%.
Suppose the Federal Reserve is planning to conduct expansionary monetary policy during a recession. Which of the following is a tool they may consider using?
Reducing the interest rate paid on excess reserves
How does selling bonds in the open market change the federal funds rate?
Selling bonds decreases the supply of reserves, causing the federal funds rate to increase. Reason: By selling bonds, the Fed encourages banks to use their reserves to buy bonds. This causes a decrease in the supply of reserves and an increase in the federal funds rate.
Which of the following would cause the Fed to implement contractionary monetary policy?
The AD curve shifts to the right.
Asset Demand
The demand for money to be saved for future use.
expenditures multiplier
The effect that a $1 change in expenditure has on real GDP; calculated as the ratio of the total change in real GDP due to a change in initial expenditure.
discount rate
The interest rate at which banks can borrow money directly from the Federal Reserve.
investment demand
The negative relationship between the quantity of new physical capital demanded by firms and the prevailing interest rate.
Face Value
The nominal, or dollar, value of a security, generally printed on the face (front) of the security. For bonds, it is the amount paid to the bondholder when the bond is repaid in full.
Money Supply
The relationship between the interest rate and the quantity of money supplied in an economy; usually a given value. In the United States the money supply is equal to M2.
The actions taken by a country's central bank to contract the money supply and raise interest rates is called _____ monetary policy
contractionary
A(n) _____ in aggregate demand will cause the price level to fall and unemployment to rise in the short run.
decrease
To increase gross investment, the interest rate must:
decrease
When banks borrow from the Fed, the interest rate they pay is set by the Fed, and it's called the _____ rate.
discount
reserves are equal to total reserves minus required reserves.
excess
____ monetary policy is sometimes referred to as "easy money."
expansionary
Use the following diagram to answer the next question. Assume the economy is initially at the full employment level of real GDP. If there is a decrease in gross investment, the Fed should
increase the money supply.
When aggregate demand rises, to avoid_____ and return to the long-run equilibrium, we must decrease aggregate demand.
inflation
Monetary policy affects aggregate demand by changing the quantity of ____ demanded in the economy.
investment
The interest rate:
is the price of money.
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.
The reserve requirement is the _____ percentage of deposits that banks must keep on hand as reserves.
minimum
____ policy affects interest rates charged on loans and paid on savings, thereby influencing the price of goods, services, and resources.
monetary
A market in which the demand for and supply of money determine an interest rate or opportunity cost of holding money balances is called a(n) ____ market
money
The purpose of a contractionary monetary policy is to
raise interest rates and restrict the availability of bank credit.
When the reserve requirement is increased, the excess reserves of member banks are
reduced and the multiple by which the commercial banking system can lend is reduced.
_____ reserves are equal to deposits times the reserve requirement.
required
money multiplier
the amount of money the banking system generates with each dollar of reserves
Which graph was not shown in this video?
the bond market
The Fed implemented expansionary monetary policy several months ago, but the economy remains stagnant. This is an example of:
the implementation lag.
Which of the following will increase commercial bank reserves?
the purchase of government bonds in the open market by the Federal Reserve Banks
Suppose the Federal Reserve wants to decrease the money supply by $400 billion. If the reserve requirement (rr) is 0.2, calculate the change in reserves that the Federal Reserve must make.
-80 billion
How many reserves did Martin need to meet the reserve requirement in the video?
100,000
Bond Market
A financial market in which participants can buy and sell new bonds (primary market) or trade bonds already in circulation (secondary market).
money market
A market in which the demand for and supply of money determine an interest rate, or opportunity cost of holding money balances.
liquidity trap
A situation in which increasing the money supply does not lower interest rates, due to a flattening of the money demand curve.
According to the video, what happens when the money supply is decreased?
AD decreases and real GDP decreases.
change in money supply
Money Multiplier x Change in Bank Reserves
Which of the following is a monetary policy tool used by the Federal Reserve? Collecting personal income taxes Government spending Paying interest on excess reserves
Paying interest on excess reserves
Which of the following statements is true? 1 The Federal Reserve sets the federal funds rate. 2 The Federal Reserve sets the target for the federal funds rate, and then uses the reserve requirement to push banks toward that target. 3 The Federal Reserve does not set the federal funds rate, but it influences it through the use of its open-market operations.
The Federal Reserve does not set the federal funds rate, but it influences it through the use of its open-market operations.
contractionary monetary policy
The actions taken by a country's central bank to contract the money supply and raise interest rates with the objective of decreasing real GDP and controlling inflation. Sometimes referred to as tight money. Definition in context: After data revealed that prices and wages were rising sharply for the last six months, the Fed decided to use
Expansionary monetary policy
The actions taken by a country's central bank to expand the money supply and lower interest rates, with the objective of increasing real GDP and reducing unemployment. Sometimes referred to as easy money. Causes interest rates to fall and shifts the aggregate demand to the right.
monetary policy
The actions taken by a country's central bank to influence the supply of money and credit in the economy.
excess reserves
The amount of reserves that a bank can lend out to earn interest; equal to total reserves minus required reserves.
required reserves
The amount of reserves that a bank must keep on hand to meet regulatory requirements; equal to deposits times the reserve requirement.
How is a change in the money supply calculated when there is a change in excess reserves?
The change in the money supply equals a negative money multiplier (−1/rr) multiplied by the change in excess reserves.
Transaction Demand
The demand for money to be used in daily transactions.
spread
The difference between the interest rate a bank earns on a loan and the interest rate it pays.
gross investment (I)
The dollar value of all new capital purchased (as investment) and the expansion of inventories in an economy during a given time period. Gross investment is classified into three categories: business fixed investment, residential investment, and inventory investment. Sometimes referred to simply as investment.
Yield
The effective interest rate earned on a bond or another asset; equal to the net profit earned divided by the amount invested.
Which of the following does the Federal Reserve Board set a target for?
The federal funds rate Reason: The Federal Reserve Board targets the federal funds rate to encourage or discourage economy activity.
reserve requirement (rr)
The fraction of checkable deposits that banks must keep on hand as reserves, either as currency or on deposit with the Federal Reserve.
cyclical asymmetry
The idea that the aggregate demand for goods and services is more responsive to contractionary monetary policy than to expansionary monetary policy. As a result, monetary policy may be more effective when used to control inflation than to reduce unemployment.
Coupon Rate
The interest rate stated on a bond, as a percentage of the bond's face value.
federal funds rate
The interest rate that banks pay when borrowing reserves from other banks.
interest rate on reserves
The interest rate that the Federal Reserve pays when banks hold reserves at the Fed.
prime rate
The lowest commercially available interest rate.
federal funds market
The market for borrowing and lending reserves between banks.
interest rate
The payment made to agents that lend or save money, expressed as an annual percentage of the monetary amount lent or saved. Sometimes called nominal interest rate or price of money.
open market operations
The purchase or sale of government securities by a central bank; a key tool of monetary policy used to influence the money supply and interest rates.
Demand for Bonds
The relationship between the interest rate and the quantity of bonds demanded in an economy, all else held constant.
Suuply of Bonds
The relationship between the interest rate and the quantity of bonds supplied in an economy, all else held constant.
Money Demand
The relationship between the interest rate and the quantity of money demanded, all else held constant; the sum of the transaction demand and asset demand for money.
implementation lag
The time between when a policy is enacted and when it has its full effect on the economy.
recognition lag
The time between when an event affects an economy and when we recognize that effect in the data collected.
The actions taken by a country's central bank to contract the money supply and raise interest rates is called:
contractionary monetary policy. tight money.
If the Board of Governors of the Federal Reserve System increases the reserve requirement, this change will
decrease the excess reserves of member banks and thus decrease the money supply.
____ reserves the amount the bank can lend out to earn interest equal _____ reserves minus _____ reserves.
excess, total, required
The Federal Reserve Board set a target for the __ to influence interest rates and to either encourage or discourage additional economic activity.
federal funds rate
The interest rate that banks pay in the formal market for overnight loans of federal reserves is called the:
federal funds rate.
The interest rate that helps determine the interest rates charged on other loans is called the:
federal funds rate.
A reserve requirement specifies the ____ of checkable deposits that a bank must keep on hand.
fraction
The impact of monetary policy on investment spending may be weakened
if the investment demand curve shifts to the right during inflation and to the left during recession.
The time between when a policy is enacted and when it has its full effect on the economy is called the __ lag. The time between when an event affects an economy and the time when we recognize that effect in the data collected is called the __ lag.
implementation; recognition
The money multiplier is the amount by which a $1 change:
in reserves will change the money supply.
A(n) ____ in aggregate demand will cause the price level to rise and unemployment to fall in the short run.
increase
Suppose that the demand for money increases as people anticipate upcoming economic problems. To offset this increase in money demand, the Fed should ______ the money supply, which would put ______ pressure on nominal interest rates.
increase; downward
The ____ rate is the payment made to agents that lend or save money expressed as an annual percentage of the monetary amount lent or saved.
interest
Governments use ____ policy to keep prices stable and encourage economic growth.
monetary or fiscal
The ____ multiplier is the amount by which a $1 change in reserves will change the money supply.
money
When output is above the full employment level of real GDP, the Federal Reserve banks should
raise the discount rate.
When aggregate demand falls, to avoid a(n)_____ and return to the long-run equilibrium, we must increase aggregate demand
recession
The fraction of checkable deposits that banks must keep on hand as reserves, either as currency or on deposit with the Federal Reserve, is called the
reserve requirement
The money multiplier is the amount by which a $1 change in ____ will change the money supply.
reserves
When a commercial bank borrows from a Federal Reserve Bank,
the commercial bank's lending ability is increased.
If an economy experiences a change in excess reserves, the change in money supply will also depend on
the money multiplier.
Assuming that the Federal Reserve Banks sell $40 million in government securities to commercial banks and the reserve requirement is 20 percent, then the effect will be to reduce
the money supply by potentially $200 million.
The money multiplier equals: the initial change in reserves/the overall change in the money supply. the overall change in the money supply/the initial change in reserves. the initial change in reserves/reserve requirement.
the overall change in the money supply/the initial change in reserves.
The Federal Reserve changes the amount of money in circulation by:
using open market operations to buy and sell government debt (U.S. Treasury bonds).
