Econ test 3
Monetary policy tools
1. open market operations 2. discount policy 3. reserve requirements
Which of these statements about the federal debt is correct?
At some point, the government may have to raise taxes or cut spending to pay interest on the debt.
For purposes of monetary policy, the Federal Reserve has targeted the interest rate known as the
federal funds rate
The largest and fastest growing category of federal expenditures is __________.
transfer payments
Assume that banks are always fully loaned and people hold no cash. Given a required reserve ratio of 10%, an infusion of $100 billion in reserves will result in a maximum of:
$1000 billion in deposits
Suppose that the reserve ratio is 25% and that banks loan out all their excess reserves. If a person deposits $100 cash in a bank, checking account balances will increase by a maximum of:
$400
means of monetary substitute
(Acceptability, Standardized Quality, Durability, Valuable, Divisibility)
Goals of Monetary Policy
1. price stability 2. high employment 3. stability of financial markets and institutions 4. economic growth
If the spending multiplier is 1.5 and a $200 billion spending increase is implemented, what is the change in GDP holding everything else constant, (the price level stays constant)
300$ billion increase in GDP
MP as AS static
AS increases as our resources and technology increase AS remains constant
Which of these fiscal policy actions will increase real GDP in the short run?
An increase in government expenditures
Which of these will shift the money demand curve to the right?
An increase in real GDP
Which of these statements best describes the scenario shown in these graphs?
An open market purchase leads to an increase in the money supply which causes interest rates to fall and investment spending to rise.
federal reserve
Central bank of US Created in 1913 after federal reserve act Created to stop bank panics
M1
Currency + Checking Account balances + Traveler's Checks (what we spend)
Quantity theory of money
Each dollar in the Money Supply on average will get spent V times to purchase NGDP (refers to inflation over long run) Growth rate of M + Growth rate of V = Growth rate of P + Growth rate of Y The growth rate of P is the inflation rate. And the Quantity Theory of Money assumes V is constant.
Money demand and money supply
Holding the MD constant, if the MS increases, the Interest Rate drops and vice versa. Where MS and MD intersect is equilibrium in the money market = equil. Interest Rate
contractionary monetary policy
If the economy is "doing too well" from a production standpoint, meaning our short run AS/AD equilibrium is above potential GDP, there will be inflationary effects Decrease the money supply as a response increase Interest Rates and Decrease AD which will lower inflation. GDP will fall and Unemployment will increase
Which of these would be a fiscal policy the government might want to use if the economy is operating at too high a level of output?
Increasing income tax rates
Which of these are the largest sources of federal government revenues?
Individual income taxes and social security withholdings
How changing the interest rate affects C, I, NX
Interest rates are negatively correlated with Consumption, Investment, and Net Export expenditures. When interest rates go up, C, I, and NX decrease and vice versa. anytime C, I, G, and/or NX change for any reason other than the Price Level, AD will shift accordingly.
Quantity Theory of Money Equation
M x V = P x Y M is the Money Supply, V is the Velocity of Money, P is the Price Level, and Y is Real GDP. P*Y is Nominal GDP.
The sum of all currency in the hands of the public plus demand deposits and other checkable deposits plus traveler's checks is the official definition of:
M1
M2
M1 + Savings Account balances + Small Time Deposits + Money Market Mutual Fund Shares (money we build up and save)
functions of money
Medium of exchange, Unit of account, Store of value, Standard of deferred payment
Open market operations
Open Market Operations are decided by the Federal Open Market Committee (FOMC). The FOMC is a 12-member committee consisting of the Fed's 7 Board of Governors, the president of the Fed Reserve Bank of New York, and 4 of the 11 other Fed banks' presidents.
goals of Fiscal Policy
Price Stability High Employment Economic Growth (GDP)
When we say that money serves as a unit of account, we mean that:
Prices are quoted in terms of money.
required reserves
Required reserves / excess reserves = reserves that banks hold, calculate as a % of total checking account deposits (set by federal reserve as required reserve ratio)
total reserves
Reserves = Required Reserves + Excess Reserves
Money Demand: money market
The Demand for Money (Money Demand, MD) is a downward sloping curve that is inversely related to the Interest Rate. The Money Demand curve will increase (shift to the right) if there is an increase in R-GDP or the Price Level and vice versa.
How did the FOMC react to the recession of 2007-2009?
The FOMC reduced the target for the fed funds rate steadily in 2008.
Which of these facts is true about the creation of the Federal Reserve System (the Fed)?
The Fed was created in 1913.
Who is the chairperson of the Federal Open Market Committee (FOMC)?
The chairperson of the Board of Governors
Which of these statements is true about using fiscal policy to stabilize the economy?
The delay caused by the legislative process is typically longer for fiscal policy than for monetary policy.
Fed
They make discount loans to banks and charge them the discount rate Fed has 12 districts, 7 member panel of each (board of governors) for 14 year term by president
Why would the Fed intentionally use contractionary monetary policy to reduce real GDP?
To reduce real GDP in order to reduce inflation, which occurs if real GDP is above potential GDP.
expansionary fiscal policy
Underperforming, (fiscal policy), increasing G and/or decreasing T which will increase AD. Increasing AD will increase GDP and lower Unemployment. The Price level will also increase
Banks creating money
When banks make a loan (their largest assets), along with RR between the holdings of different banks
how tools change money supply: open market operations
When the Fed buys securities, they give banks more money to hold as reserves on their balance sheet. When the Fed sells securities, they take money from banks and reduce the money supply
Money Supply: money market
When the MS changes, it will impact the Interest Rate The fed affects MS but not MD or interest rates Interest Rate results from equilibrium between the MS and Money Demand in the money market. The Money Supply curve is vertical and equal to the current existing amount of money in circulation. (M1, total amount of money)
Monetarism is a school of economic thought that favors:
a monetary growth rule.
how tools change money supply: Discount policy:
a raised discount rate makes it more expensive for banks to borrow and thereby diminishes the money supply while retracting investment activity, A decrease in the discount rate makes it cheaper for commercial banks to borrow money
If the Federal Reserve wishes to decrease the money supply to slow the economy, it will conduct:
an open market sale
Liabilities
anything owed to another party
assets
anything owned that has value
The federal funds rate is the rate:
at which banks lend to each other.
When many depositors decide simultaneously to withdraw their money from a bank, there is __________.
bank run
If the federal government's expenditures are less than its revenues, then
budget surplus
To increase the money supply, the FOMC directs the trading desk located at the Federal Reserve Bank of New York to:
buy U.S. Treasury securities from the public.
If the Fed decreases the money supply and increases interest rates in order to reduce inflation, it is engaging in __________.
contractionary monetary policy
The decline in private expenditures that results from an increase in government purchases is known as:
crowding out.
In the dynamic model of AD- AS in the figure above, if the economy is at point A in year 1 and is expected to go to point B in year 2, the Federal Reserve would most likely
decrease interest rates
The nation of Hyperbole is in a recession, and the government decides to increase taxes and reduce government spending to reduce the growing deficit. This will ________ aggregate demand and will likely ________ real GDP and employment.
decrease: decrease
An increase in interest rates
decreases investment spending on machinery, equipment, and factories, consumption spending on durable goods, and net exports.
An increase in individual income taxes ________ disposable income, which ________ consumption spending.
decreases, decreases
When the tax rate increases, the size of the multiplier effect:
decreases.
Because of the __________ in forecasting the economy, many economists believe the Fed __________ take a very active role in trying to stabilize the economy.
difficulties, should not
Assuming there are no leakages out of the banking system, a money multiplier equal to 5 means that:
each additional dollar of reserves creates $5 of deposits.
The tax multiplier equals the change in:
equilibrium GDP divided by the change in taxes
The American Recovery and Reinvestment Act of 2009 is a clear example of:
expansionary fiscal policy.
Changes in the federal tax rate or changes in government spending designed to achieve some macroeconomic policy objective are known as:
fiscal policy.
Fiat money
has no other value other than its use as money (US dollars)
commodity money
have value outside of their use as money (beaver skins, salt tablets)
Which of the following is an objective for fiscal policy?
high rates of economic growth
Using the money demand and money supply model, an increase in money demand would cause the equilibrium interest rate to
increase
When the economy is in a recession, the government can:
increase government purchases or decrease taxes in order to increase aggregate demand.
Budget deficits automatically __________ during recessions and __________ during expansions.
increase, decrease
An increase in real GDP
increases the buying and selling of goods and increases the demand for money as a medium of exchange.
how tools change money supply: reserve requirements
increasing the (reserve requirement) ratios reduces the volume of deposits that can be supported by a given level of reserves and, in the absence of other actions, reduces the money stock and raises the cost of credit.
The federal funds rate
is determined by the supply of and demand for bank reserves
The cyclically adjusted budget deficit:
is measured as if the economy were at potential real GDP.
The tax multiplier
is negative
Real world deposit multiplier
less than the simple deposit multiplier. The simple deposit multiplier is a model with assumptions that keep it higher than the real-world multiplier.
On the balance sheet of a bank:
loans are the most important asset.
Suppose real gdp is $12.1 trillion and potential GDP is $12.6 trillion. to move the economy back to potential GDP congress should
lower taxes by an amount less than $500 billion
Contractionary fiscal policy to prevent real GDP from rising above potential real GDP would cause the inflation rate to be __ and real GDP to be ___
lower: lower
bank panic
many banks experience runs at the same time
Simple Deposit Multiplier
maximum amount checking account deposits can increase for every $1 change in bank reserves. 1/RR (Max) Change in checking account deposits = (Initial) Change in bank reserves * 1/RR
The actions the Federal Reserve takes to manage the money supply and interest rates in order to pursue economic objectives are called
monetary policy
bank reserves
monies that are deposited and held by a bank
It is ________ difficult to effectively time fiscal policy than monetary policy because ________.
more; fiscal policy takes longer to implement
bank run
occurs when many depositors try to withdraw their deposited funds at the same time
The Fed conducts monetary policy primarily through:
open market operations
If the Federal Reserve raises or lowers interest rates too late, it could result in a ________ policy that destabilizes the economy.
procyclical
The theory concerning the link between the money supply and the price level that assumes the velocity of money is constant is called the:
quantity theory of money.
Hyperinflation
rapid and unrestrained price increases in an economy, typically at rates exceeding 50% each month over time. Rapid, excessive, out of control general price increases can occur in times of war and economic turmoil in the underlying production economy, in conjunction with a central bank printing an excessive amount of money.
The ability of the Federal Reserve to use monetary policy to affect economic variables such as real GDP ultimately depends upon its ability to affect
real interest rates.
During recessions, government expenditures automatically
rises because of programs such as unemployment insurance and Medicaid
Consider the hypothetical information in the table above for potential real GDP, real GDP, and the price level in 2016 and in 2017 if the Federal Reserve does not use monetary policy. If the Fed wants to keep real GDP at its potential level in 2017, it should
sell Treasury securities.
We would expect the tax multiplier to be __________ in absolute value than the government purchases multiplier.
smaller
Long-term real rate of interest vs Short-term nominal rate of interest
the Fed sets a target for the Federal Funds Rate and influences the market by increasing or decreasing the MS and thus bank reserves (sets tone for interest rate)
expansionary monetary policy
the economy is underperforming (GDP is too low and/or decreasing and Unemployment is too high and/or rising) increasing the Money Supply which will lower interest rates which will increase AD; Increasing AD will increase GDP and lower Unemployment; The Price level will also increase
Federal Funds Rate
the interest rate that banks lend and borrow at in the Federal Funds Market.
If the price level increases, __________.
the money demand curve shifts to the right
If the FOMC orders the trading desk to sell Treasury securities:
the money supply curve will shift to the left and the equilibrium interest rates will rise.
When banks loan money
their reserves decrease but their RR does not change
When the interest rate decreases, __________.
there is movement down a stationary money demand curve
Which of the following describes what the Fed would do to pursue an expansionary monetary policy?
use open market operations to buy Treasury bills
MP demonstrated using AD/AS dynamic: start in a long-run equilibrium in the first period. In the second period AS (both LRAS and SRAS) and AD increase.
where the Macro Equilibrium (SRAS and AD intersection) will be in the 2nd period with no policy employed. If it's on the LRAS curve, no policy is needed. If it occurs below Potential GDP then Expansionary Monetary Policy should be employed if it occurs above Potential GDP then Contractionary Monetary Policy should be used.
