ECON 2301- CH 28
The figure shows the demand for money curve. Draw the supply of money curve if the quantity of money is $5.9 trillion. Label it MS. Draw a point at the equilibrium quantity of money and nominal interest rate. The equilibrium nominal interest rate is ____ percent a year.
(DRAW A LINE GOING DOWN AND DRAW A POINT AT (5.9, 6)) 6
The supply of money is the relationship between the quantity of money supplied and the _____.
nominal interest rate
What is the demand for money? When the nominal interest rate rises, does the opportunity cost of holding money increase or decrease? Does the quantity of money demanded increase or decrease? The demand for money is the relationship between the quantity of money demanded and the _______ when all other influences on the amount of money that people wish to hold remain the same. When the nominal interest rate rises, the opportunity cost of holding money _______ and the quantity of money demanded _______.
nominal interest rate rises; decreases
The Fed conducts an open market purchase of securities. What are the effects of this action on the nominal interest rate in the short run and the value of money in the long run? In the short run, the nominal interest rate _______. In the long run, the value of money _______.
falls; falls
The Fed's $2.2 trillion fire hose The Fed threw a lot of money at the financial crisis in 2008 to unfreeze credit markets and encourage economic activity. As part of its effort to keep the interest rate low, the Fed purchased government bonds worth $300 billion between March and September 2009. By October, the Fed held $770 billion in government securities, nearly double its pre-crisis total. Before the crisis, the Fed held mainly government securities, which it used to control the quantity of money in the economy. Now government securities make up just 35% of the Fed's balance sheet. If the Fed purchased the government securities on the open market, explain why the purchase of $300 billion of government securities would influence the interest rate. If the Fed purchases the government securities on the open market, the quantity of money _______ because _______.
increases; bank reserves increase The nominal interest rate falls
Does an increase in real GDP change the demand for money? Do changes in financial technology change the demand for money? An increase in real GDP _______ the demand for money and changes in financial technology _______.
increases; can increase the demand for money or decrease the demand for money
The figure shows the demand for money curve. Draw the supply of money curve if the quantity of money is $2.9 trillion. Label it MS. Draw a point at the equilibrium quantity of money and nominal interest rate. The equilibrium nominal interest rate is ___ percent a year.
(DRAW A LINE GOING DOWN AND DRAW A POINT AT 2.9) 9
Suppose that banks launch an aggressive marketing campaign to get everyone to use debit cards for every conceivable transaction. They offer prizes to new debit card holders and introduce a charge on using a credit card. How would the demand for money and the nominal interest rate change? The demand for money _______ and the nominal interest rate _______.
increases; rises
The graph shows the money market. If the quantity of money is $6.0 trillion and real GDP increases, how will the interest rate change? Explain the process that changes the interest rate. The equilibrium interest rate before real GDP increases is ___ percent a year. After real GDP increases, at an interest rate of 4 percent a year, people want to hold _______ money so they _______ bonds. The price of a bond _______ and the interest rate _______.
(DRAW MD1 LINE ABOVE MD LINE AND DRAW POINT) 4 more; sell falls; rises
Sally has a credit card balance of $500. The credit card company charges a nominal interest rate of 18 percent a year on unpaid balances. The inflation rate is 6 percent a year. Calculate the real interest rate that Sally pays the credit card company. The real interest rate that Sally pays the credit card company is ____ percent a year.
12 (real interest rate= nominal interest rate - inflation rate) 18 - 6= 12
In 2004, the Canadian economy was close to full employment. Real GDP was $1,035 billion. The nominal interest rate was 3.0 percent a year, the inflation rate was 3.0 percent a year, the price level was 1.30, and the velocity of circulation was 7.00. What was the quantity of money in Canada? In 2004, the quantity of money in Canada is $ ______ billion.
192.2 (Velocity of Circulation= Nominal GDP(P x Y) / Quantity of Money) (1.30 x 1035) / 7= 192.2
The quantity of money is $5 trillion, real GDP is $9 trillion, the price level is 1.2, the real interest rate is 4 percent a year, and the nominal interest rate is 8 percent a year. Calculate the velocity of circulation, the value of M × V, and nominal GDP. The velocity of circulation is ____ The value of M × V is $______ trillion The value of nominal GDP is $ ______ trillion.
2.16 10.8 10.8 (SOLVED IN NOTEBOOK)
If the quantity of money grows at 9 percent a year, the velocity of circulation is constant, and potential GDP grows at 6 percent a year, what is the inflation rate in the long run? The inflation rate in the long run is ___ percent a year.
3 (Inflation rate= money growth + velocity growth rate - real (potential) GDP ) 9 + 0 -6 = 3
The velocity of circulation is growing at 6 percent a year, the real interest rate is 1 percent a year, the nominal interest rate is 6 percent a year, and the growth rate of real GDP is 1 percent a year. Calculate the inflation rate, the growth rate of money, and the growth rate of nominal GDP. The inflation rate is ___ percent a year. The growth rate of money is ___ percent a year. The growth rate of nominal GDP is ___ percent a year.
5 0 6(SOLVED IN NOTEBOOK)
The graph shows the demand for money curve. Draw the supply of money curve if the equilibrium interest rate is 5 percent a year. Label it MS. Draw a point at the equilibrium quantity of money and nominal interest rate. If the price level falls, the _______.
DRAW MS LINE VETICALLY & DRAW POINT AT 5,5 demand for money decreases and the nominal interest rate falls
The graph shows the money market. If the quantity of money is $6.0 trillion and the Fed decreases it to $5.9 trillion, how will the price of a bond change? Why? The equilibrium interest rate before the Fed decreases the quantity of money is __ percent a year. After the decrease in the quantity of money, at an interest rate of 4 percent a year, people want to hold _______ money so they _______ bonds. The price of a bond _______ and the interest rate _______.
DRAW MS1 LINE VERTICALLY AT 5.9 POINT AND DRAW POINT 4 more; sell falls; rises
If the quantity of money is $6.0 trillion and the Fed increases it to $6.1 trillion, how will the price of a bond change? The equilibrium interest rate before the Fed increases the quantity of money is ___ percent a year. After the increase in the quantity of money, at an interest rate of 4 percent a year, people want to hold _______ so they _______ bonds. The price of a bond _______ and the interest rate _______.
DRAW MS1 LINE VERTICALLY AT 6.1, 2 AND DRAW POINT. 4 less money than the quantity supplied; buy rises; falls
What is the effect of an income tax on interest income?
The income tax on interest income drives a wedge between the before-tax interest rate paid by borrowers and the after-tax interest rate received by lenders.
What is the effect of inflation?
The increased uncertainty of inflation misallocates resources.
In 2001, the Canadian economy was at full employment. Real GDP was $960 billion. The nominal interest rate was 5.0 percent a year, the inflation rate was 1.0 percent a year, the price level was 1.20, and the velocity of circulation was 9.00. Calculate the real interest rate. If the real interest rate remains unchanged when the inflation rate increases to 3 percent a year and then remains constant, how does the nominal interest rate change in the long run? If the real interest rate remains unchanged when the inflation rate increases to 3 percent a year, the nominal interest rate __________ ___ percent a year.
The real interest rate in 2001 is 4 percent. (5.0 - 1.0 = 4) increases to 7 (4 + 3 = 7)
The Fed's $2.2 trillion fire hose The Fed threw a lot of money at the financial crisis in 2008 to unfreeze credit markets and encourage economic activity. As part of its effort to keep the interest rate low, the Fed purchased government bonds worth $300 billion between March and September 2009. By October, the Fed held $770 billion in government securities, nearly double its pre-crisis total. Before the crisis, the Fed held mainly government securities, which it used to control the quantity of money in the economy. Now government securities make up just 35% of the Fed's balance sheet. If government securities make up just 35 percent of the Fed's assets, calculate the Fed's total assets. What effect did the Fed's purchase of $300 billion of government bonds have on the Fed's total liabilities? The Fed's purchase of $300 billion of government bonds_____________
Total assets= 2200 (770/ 35%) increased; 300
Holding money provides a benefit _______.
because it is a means of payment
If the Fed makes a decision to cut the quantity of money, explain the short-run effects on the quantity of money demanded and the nominal interest rate. In the short run, the quantity of money demanded _______ and the nominal interest rate _______.
decreases; rises
The opportunity cost of holding money _______.
equals the nominal interest rate on bonds
The quantity of money demanded is the amount of money that households and firms choose to _____.
hold
What is the effect of the spread of ATMs and the increased use of debit cards on the money market? The spread of ATMs and the increased use of debit cards _______ money. Everything else remaining the same, the nominal interest rate _______.
increase the demand for; rises
What determines the equilibrium real interest rate? What is the relationship between the real interest rate and the inflation rate in the long run? The _______ determines the equilibrium real interest rate. The real interest is _______ the inflation rate in the long run.
loanable funds market; independent of
The demand for money is the relationship between the quantity of money demanded and the _____, when all other influences on the amount of money that people wish to _____ remain the same.
nominal interest rate; hold
What is the quantity theory of money? Define the velocity of circulation and explain how it is measured. The quantity theory of money is the proposition that when _______, an increase in the quantity of money brings _______ percentage increase in the price level. The velocity of circulation is the average number of times in a year that each dollar of money gets used to buy _______. The formula used to measure the velocity of circulation, V, is _______, where P is the price level, Y is real GDP, and M is the quantity of money.
real GDP equals potential GDP; an equal final goods and services; V = (P x Y) / M
The Fed's $2.2 trillion fire hose The Fed threw a lot of money at the financial crisis in 2008 to unfreeze credit markets and encourage economic activity. As part of its effort to keep the interest rate low, the Fed purchased government bonds worth $300 billion between March and September 2009. By October, the Fed held $770 billion in government securities, nearly double its pre-crisis total. Before the crisis, the Fed held mainly government securities, which it used to control the quantity of money in the economy. Now government securities make up just 35% of the Fed's balance sheet. When the Fed purchases $300 billion of government securities, the price of government securities _______ because the price of a bond and its interest rate _______.
rises; moves in opposite directions (consider a bond that has a price of $1,000 and pays interest of $100 a year. The interest rate is 10 percent. If the interest rate falls to 8 percent a year and the bond continues to pay interest of $100 a year, then the price of the bond rises to $1,250.)
What to do with $50,000 now A good strategy: Put about two-thirds of the money into bonds of developed nations and the rest into riskier emerging- market bonds. The opportunity cost of holding money is _______. When lots of people followed this advice and put their money into bonds, the demand for money _______ and the interest rate on bonds _______.
the interest rate forgone on an alternative asset decreases; falls
Cash is more popular than bonds Money in the bank earns almost nothing. Even so, in the second half of 2015 an additional $208 billion was added to bank deposits and money market funds and billions of dollars were moved from bonds. What is the opportunity cost of holding money? If people move out of bonds and into money, how will the demand for money and the interest rate change? The opportunity cost of holding money is _______. When people move out of bonds and into money, the demand for money _______ and the interest rate on bonds _______.
the interest rate forgone on an alternative asset increases; rises
The velocity of circulation is the _____ number of times in a _____ that each dollar of money gets used to buy final goods and services.
average; year
The equation of exchange is an equation that states that the quantity of _____ multiplied by the velocity of circulation equals the _____ multiplied by _____.
money; price level; real GDP
