EXAM 3

The idea that a change in the money supply would affect prices but not real GDP is associated with the

Classical monetary transmission mechanism

What is inflation targeting?

Committing the central bank to achieve an announced level of inflation

How many members are there is the Fed's board of governors?

The Fed's Board of Governors consists of seven members serving one 14-year term who are appointed by the president and confirmed by the Senate

What is open market operations?

The buying and selling on the open market of U.S. government securities, such as Treasury bills and bonds, to adjust reserves in the banking system.

What is marginal propensity to consume?

The change in consumption associated with a given change in income

What is marginal propensity to save?

The change in saving associated with a given change in income

What is commodity money?

consists of objects and materials (such as gold, silver, and trinkets) that have value in and of itself.

Suppose the marginal propensity to consume is equal to 0.9 and spending increases by $50 billion. Assume no taxes and no trade, by how much real GDP change?

$500 billion increase

What is the spending multiplier formula?

1/(1-MPC)=1/MPS

What is the money multiplier formula?

1/reserve requirement

What is the spending multiplier?

Any initial change in spending leads to a chain reaction of more spending which causes a greater change in demand

If the marginal propensity to save is 0.25, the multiplier is

4

What is a medium of exchange?

A function of money in which goods and services are sold for money, then the money is used to purchase other goods and services.

What is leakage?

A leakage is money that leaves the money creation process of deposits and loans due to an action taken by a bank, an individual, a business, or a foreign entity.

What is money illusion?

A misperception of wealth caused by a focus on increases in nominal income but not increases in prices.

What is monetary hawks?

A policymaker who advocates for monetary policies that emphasize keeping inflation low as its top priority.

What is Monetary Doves?

A policymaker who advocates for monetary policies that emphasize low unemployment and high growth as its top priorities.

What is cost-push inflation?

A rise in the general price level resulting from an increase in the cost of production

What is the federal open market committee (FOMC)?

A twelve-member committee that is composed of members of the Board of Governors of the Fed and selected presidents of the regional Federal Reserve Banks. It oversees open market operations (the buying and selling of government securities), the main tool of monetary policy.

What happens when the U.S. aggregate price level rises?

American goods become more expensive in the global marketplace.The result is that foreigners purchase fewer American products, and our exports decline.

If Americans generally are holding smaller amounts of cash, who then is holding all of these dollars?

Due to the relative stability of the U.S. dollar, many countries hold U.S. dollars in reserves in order to provide support to their own currencies.

In times of economic downturn the fed will engage in __ monetary policy by__ bonds

Expansionary; buying

What is contractionary monetary policy?

Fed actions designed to decrease the money supply and raise interest rates to shrink income and employment, usually to fight inflation.

What is expansion monetary policy?

Fed actions designed to increase the money supply and lower interest rates to stimulate the economy (expand income and employment).

What is the Taylor Rule equation?

Federal Funds Target Rate=Target Inflation+Current Inflation Rate+½(Inflation Gap)+½(Output Gap)

What is one way of managing economic fluctuations?

Fiscal policy uses the tools of taxation, government transfer payments, and government spending

What is the wealth effect?

Households usually hold some of their wealth in financial assets such as savings accounts, bonds, and cash, and a rising aggregate price level means that the purchasing power of this monetary wealth declines, reducing output demanded.

What is liquidity?

How quickly, easily, and reliably an asset can be converted into cash.

When was the federal reserve act passed?

In 1913 by congress led to the establishment of regional banks governed by a central authority

The value of the Indian rupee_______ in response to the federal reserve announcement

Increase; drop

What is monetary rule?

Keeps the growth of money stocks such as M1 on a steady path, following the equation of exchange (or quantity theory) to set a long-run path for the economy that keeps inflation in check.

In the classical monetary transmission mechanism any change in __ will bring about__

M a direct proportionate change in P

What is M2?

M1 + savings deposits, small-denomination time deposits, Money market deposit accounts and shares in retail money market mutual funds.

What is a reserve?

Money banks keep on hand (vault cash)

What is the equation of exchange?

M×V=P×Q

What is a bank run?

People all demand to withdraw all of their money from the bank at the same time

What is the Federal Deposit Insurance Corporation (FDIC)?

Protects bank deposits (up to $250k) from bank failure. When a bank gets into financial trouble, the FDIC typically arranges for another (healthy) bank to take over the failing bank.

What is tightening monetary policy?

Raising interest rates → decreases consumption and investment → decreases aggregate demand.

Because of the wealth effect, a rising aggregate price level ____ the purchasing power of wealth and therefore _____ output demanded.

Reduces, Reduces

What Loosening monetary policy?

Reducing interest rates → increases consumption and investment → increases aggregate demand.

What is excess reserves?

Reserves (Cash) held by banks above the legal required amount.

What is demand-pull inflation?

Results when aggregate demand expands so much that equilibrium output exceeds full employment output and the price level rises.

What is store of value?

The function that enables people to save the money they earn today and use it to buy the goods and services they want tomorrow.

What is the federal funds rate?

The interest rate financial institutions charge each other for overnight loans used as reserves.

What is the discount rate?

The interest rate the Federal Reserve charges commercial banks and other depository institutions to borrow reserves from a regional Federal Reserve Bank.

What is aggregate demand?

The output of goods and services (real GDP) demanded at different price levels.

What is reserve ratio?

The percentage of a bank's total deposits that are held in reserves.

What is aggregate supply?

The real GDP that firms will produce at varying price levels. The aggregate supply curve is positively sloped in the short run but vertical in the long run.

Why would a bank choose not to loan out the maximum amount of money allowed?

The recession caused many loan defaults and foreclosures as workers were laid off or faced wage cuts. The bank absorb these losses through the profits they earn from charging interest to those who pay back their loans.

What is the reserve requirement?

The rule that every bank must have a certain amount of cash and negotiable securities on hand at all times

What is a barter?

Trading/exchanging of goods and services without the use of money

When the housing bubble collapsed in 2007, ___ rose significantly, and the fed ___ interest rates.

Unemployment; Lowered

What is long-run aggregate supply (LRAS) curve?

Vertical line that represents the full employment capacity of the economy and depends on the amount of resources available for production and the available technology.

What is Cryptocurrency?

Virtual currency stored electronically and under no government authority

What is the leakage-adjusted money multiplier?

[1/(Reserve Requirement+Excess Reserves+Cash Holdings)]

What is the formula for unit of account?

[N(N-1)]/2

What is a unit of account?

a means for comparing the values of goods and services

Why Is the Interest Rate So Important to the Economy?

a reduction in interest rates promotes greater consumption and investment, which leads to an increase in aggregate demand, shifting the aggregate demand curve to the right.

What is a short-run aggregate supply (SRAS) curve?

aggregate supply increases as the price level rises (and vice versa) and is represented by an upward-sloping curve

What is liquidity trap?

an increase in the money supply does not result in a decrease in interest rates; there is no change in investment and consequently no change in income or output.

What is money?

anything that is accepted in exchange for goods and services or for the payment of debt

What is fractional reserve banking?

banks keep some money on hand and lend out the rest

How do banks avoid the risk of becoming insolvent?

banks often hold excess reserves during tough economic times to ensure that they have the ability to absorb a higher rate of default.

What is M1?

currency + checkable deposits

What is the reserve ratio formula?

dividing total reserves by total deposits.

What is fiat money?

inconvertible paper money made legal tender by a government decree.

a decrease in the real interest rate will cause export to __ and import to __

increase; decrease

European Central Bank (ECB)

institution that sets and implements EU monetary policy

What happens when interest rates rise?

investment will fall and the aggregate demand curve will shift to the left, and vice versa.

What is another way of managing economic fluctuations?

monetary policy, which deals with how the money supply is controlled to target interest rates in an economy.

Why was the fed as lender of last resort?

stepping in to loan money to banks that are facing emergency cash shortages or other financial difficulties.

What is the federal reserve system?

the central bank of the United States

What is reserve requirement?

the government requires that banks maintain a minimum level of reserves

What is macroeconomic equilibrium?

the intersection of the short-run aggregate supply and aggregate demand curves

Which statement correctly describes the sequence that explains how a contractionary monetary policy impacts an economy?

the policy raises interest rates; higher interest rates reduce spending; lower spending reduces AG demand, which impact output and price level

How many regional federal reserve districts exist?

twelve regional Federal Reserve Banks in major cities around the nation

Why does aggregate demand slope downward?

wealth effect, interest rate effect, exchange rate effect

Insolvent

when it's liabilities exceed its assets. This means that the bank owes more than what is owed to it, increasing the likelihood of bankruptcy.