last quiz ECO
Near money includes:
some of M2 but none of M1
Long Run:
Changes in the money supply show up directly as increases in the price level because both velocity and output are considered fixed in the equation of exchange (M × V = P × Q). Because classical economists focused on the long run, they saw no use for monetary policy.
liquidity
How quickly, easily, and reliably an asset can be converted into cash.
_____ occurs when a central bank sets a target inflation rate and adjusts monetary policy to keep inflation within that range.
Inflation targeting
José is putting money for college in a savings account. The bank makes the money available to business borrowers. In essence:
José is supplying loanable funds for business investment.
Contractionary Monetary Policy
Less money → higher interest rates → lower C, I, G, and (X − M) = decrease in aggregate demand and output
unit of account
Money provides a yardstick for measuring and comparing the values of a wide variety of goods and services. It eliminates the problem of double coincidence of wants associated with barter.
fiat money
Money without intrinsic value but nonetheless accepted as money because the government has decreed it to be money.
excess reserves
Reserves held by banks above the legally required amount.
open market operations
The buying and selling of U.S. government securities, such as Treasury bills and bonds, to adjust reserves in the banking
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.
Federal Reserve System
The central bank of the United States.
inflation targeting
The central bank sets a target on the inflation rate (usually around 2% per year) and adjusts monetary policy to keep inflation near that target.
barter
The direct exchange of goods and services for other goods and services.
Information lag:
The time it takes for economic data to become available.
If the Fed reduces the money supply:
bond prices fall.
If the economy is in a recession, the Federal Reserve would most likely pursue _____, which causes interest rates to _____.
expansionary monetary policy; fall
True/False Stocks and bonds are the most liquid assets.
false
Open market operations involve the purchase and sale of:
government securities.
Liquidity refers to:
how quickly, easily, and reliably an asset can be converted into a medium of exchange.
quantity theory of money
is a product of the classical school of thought, which concludes that the economy will tend toward equilibrium at full employment in the long run.
The main tool of monetary policy is:
open market operations.
Monetary policy is LEAST effective in maintaining low inflation and high GDP when:
there has been a supply shock.
Incentives to Save
Governments and companies offer various incentives to individuals to save, such as retirement contribution plans and other tax incentives. Adjusting such incentives will change the level of savings accordingly.
federal funds rate
The interest rate financial institutions charge each other for overnight loans used as reserves.
vesting period
The minimum number of years a worker must be employed before the company's contribution to a retirement account becomes permanent.
M1
The narrowest definition of money that measures highly liquid instruments including currency (banknotes and coins), demand deposits (checks), and other accounts that have check-writing or debit capabilities
Quantitative easing refers to the process whereby the Federal Reserve:
buys securities to stimulate the economy.
If the reserve requirement is 2.5% and a bank initially receives $30,000 in deposits from the Fed, then the maximum amount of money that the banking system can create is:
$1.2 million
If a person borrows $3,000 at 8% interest and never makes any payments, how much will the loan balance be after 10 years?
6,476.77
Suppose a one-year bond with a face value of $200 is sold for $188. What is the bond's yield?
6.4%
money
Anything that is accepted in exchange for goods and services or for the payment of debt.
The _____ is the central bank of the United States.
Federal Reserve System
Which is NOT one of the three basic functions of money?
a means to collect taxes
Monetary policy is LEAST effective in reversing:
an adverse supply shock.
A bank has excess reserves of $4,000 and demand deposits of $40,000; the reserve requirement is 20%. If the reserve requirement is increased to 25%, the maximum amount of new loans this bank can make is:
$2,000.
If a person borrows $2,000 at 5% interest and never makes any payments, how much will the loan balance be after five years?
$2,552.56
A bank has excess reserves of $5,000 and demand deposits of $40,000; the reserve requirement is 20%. If the reserve requirement is increased to 25%, the maximum amount of new loans this bank can make is:
$3,000.
money multiplier formula
1/Reserve Requirement If the reserve requirement is 25%, the money multiplier = 1/0.25 = 4.
Using the equation of exchange, if the money supply is $4 trillion, the price level is 2, and the level of output (real GDP) is $6 trillion, then the velocity of money is:
3
If the reserve requirement is 25%, then the potential money multiplier is _____ and the actual money multiplier is _____.
4; less than 4
M2
A broader definition of money that includes "near monies" that are not as liquid as cash, including deposits in savings accounts, money market accounts, and money market mutual fund accounts.
financial system
A complex set of institutions, including banks, bond markets, and stock markets, that allocate scarce resources (financial capital) from savers to borrowers.
money multiplier
A formula that measures the potential or maximum amount the money supply can increase (or decrease) when a dollar of new deposits enters (exits) the system and is defined as 1 divided by the reserve requirement.
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.
money illusion
A misperception of wealth caused by a focus on increases in nominal income but not increases in prices.
leakages
A reduction in the amount of money that is used for lending that reduces the money multiplier. It is caused by banks choosing to hold excess reserves and from individuals, businesses, and foreigners choosing to hold more cash.
pensions
A retirement program into which an employer pays a monthly amount to retired employees until they die.
Taylor rule
A rule for the federal funds target that suggests the target is equal to 2% + Current Inflation Rate + 1/2(Inflation Gap) + 1/2(Output Gap).
solvency crisis
A situation when a bank's liabilities exceed its assets.
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.
Price of Bond
Annual Interest Payment ÷ Yield (%). Example: If a bond pays $100 per year, and the yield is 6%, the price of the bond is $100 ÷ 0.06 = $1,667.
Income or Asset Prices
As incomes rise, people generally save a larger proportion of their income, all else equal. Asset prices, however, tend to work the other way. As home prices and stock values increase, people feel wealthier (without necessarily having more income) and will spend more and save less. The opposite effects occur when incomes fall or asset prices fall.
Demand Shocks
Demand shocks to the economy can come from reductions in consumer demand, investment, government spending, or exports, or from an increase in imports. For example, the economy faced a demand shock in 2008 when households, fearing unemployment after the housing bubble burst, increased saving and reduced spending.
fractional reserve banking system
Describes a banking system in which a portion of bank deposits are held as vault cash or in an account with the regional Federal Reserve Bank, while the rest of the deposits are loaned out to generate the money creation process.
True/False Because of the compounding effect, a large loan balance becomes smaller.
False
tight money or restrictive monetary policy
Fed actions designed to decrease excess reserves and the money supply to shrink income and employment, usually to fight inflation. See alsocontractionary monetary policy.
contractionary monetary policy
Fed actions designed to decrease the money supply and raise interest rates to shrink income and employment, usually to fight inflation.
easy money, quantitative easing, or accommodative monetary policy
Fed actions designed to increase excess reserves and the money supply to stimulate the economy (increase income and employment). See alsoexpansionary monetary policy.
expansionary monetary policy
Fed actions designed to increase the money supply and lower interest rates to stimulate the economy (expand income and employment).
financial intermediaries
Financial firms (banks, mutual funds, insurance companies, etc.) that acquire funds from savers and then lend these funds to borrowers (consumers, firms, and governments)
monetary rule
Keeps the growth of money stocks such as M1 or M2 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.
Short Run:
Keynes believed that when the economy is well below full employment, monetary policy is ineffective because investment is more influenced by business expectations about the economy than interest rates.`
Expansionary Monetary Policy:
More money → lower interest rates → higher C, I, G, and (X − M) = increase in aggregate demand and output
What is the likely chain of events if asset prices rise?
People feel wealthier, so their spending rises and their saving falls, causing interest rates to rise.
teaser rates
Promotional low interest rates offered by lenders for a short period of time to attract new customers and to encourage spending.
return on investment
The earnings, such as interest or capital gains, that a saver receives for making funds available to others. It is calculated as earnings divided by the amount invested.
compounding effect
The effect of interest added to existing debt or savings leading to substantial growth in debt or savings over the long run
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.
Tradeoff Between Risk and Return:
The greater the risk involved, the higher the average annual return on investment.
equation of exchange
The heart of classical monetary theory uses the equation M × V = P × Q,where M is the supply of money, Vis the velocity of money (the average number of times per year a dollar is spent on goods and services, or the number of times it turns over in a year), P is the price level, and Q is the economy's real output level.
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.
discount rate
The interest rate the Federal Reserve charges commercial banks and other depository institutions to borrow reserves from a regional Federal Reserve Bank.
tradeoff between risk and return
The pattern of higher risk assets offering higher average annual returns on investment than lower risk assets.
reserve ratio
The percentage of a bank's total deposits that are held in reserves, either as cash in the vault or as deposits at the regional Federal Reserve Bank.
reserve requirement
The required ratio of funds that commercial banks and other depository institutions must hold in reserve against deposits.
Reserve requirements
The required ratio of funds that commercial banks and other depository institutions must hold in reserve against deposits.`
Government Deficits
The supply of loanable funds includes both private and public saving. When a government runs a budget surplus, additional loanable funds are provided to the market, increasing the supply of loanable funds.
Recognition lag:
The time before a trend in the data is certain enough to warrant a change in policy.
Implementation lag:
The time it takes for banks and financial markets to react to the policy change.
Decision lag:
The time it takes for the Federal Reserve Board to meet and make policy decisions.
True/ False Because of the compounding effect, a $7,500 loan at 12% interest can grow to $23,293.86 after 10 years.
True
True/ False During the 2007-2009 financial crisis, both the Federal Reserve and the European Central Bank bought bad debt in order to stabilize banks.
True
True/False If Jordan deposits $1,200 cash into his checking account, his bank's assets rise by $1,200 and its liabilities rise by $1,200.
True
True/False If a large number of borrowers default on their loans, the bank risks a solvency crisis.
True
True/False The central banks of monetary unions face the risk that the poor financial condition of some of their members may cause the collapse of their currency.
True
True/False if a large number of borrowers default on their loans, the bank risks a solvency crisis.
True
liquidity trap
When interest rates are so low, people hold on to money rather than invest in bonds due to their expectations of a declining economy or an unforeseen event such as war.
The demand for loanable funds is downward sloping because:
as interest rates fall, businesses find more projects to be profitable and thus want to borrow more.
Supply Shocks
can hit the economy for many reasons, including changes in resource costs such as a drought causing a rise in food prices, changes in inflationary expectations, or changes in technology.
Interest charges accrue on top of existing debt and saving leads to substantial growth savings over the long run. This is known as the:
compounding effect.
To counteract a positive demand shock, the Federal Reserve uses _____ monetary policy, which _____.
contractionary; reduces both output and the price level
If the real interest rate were below the equilibrium real interest rate in the loanable funds market, an excess _____ for loanable funds would occur and the real interest rate would _____.
demand; rise
If Abigail withdraws $300 cash from her checking account, her bank's assets then:
fall by $300 and liabilities fall by $300.
Suppose a news article reports, "Dismal jobs report suggests the Federal Reserve will lower interest rates." If the Fed does lower interest rates, the dollar will _____ against foreign currencies, and U.S. goods will become _____ for foreigners.
fall; cheaper
When the interest rate falls, the value of the U.S. dollar in foreign exchange markets tends to _____ and net exports tend to _____.
fall; increase
Suppose that while households are deciding to increase savings, the demand by firms for investment funds falls. In the market for loanable funds, the real interest rate will _____ and the quantity of loanable funds will _____.
fall; rise, fall, or stay the same
Assume initially that market interest rates are 7% and the bondholder is receiving a $70 coupon payment per year on a bond with a face value of $1,000. If market interest rates rise to 8%, the bond price:
falls to $875.
Institutions that acquire funds from savers and then lend those funds to borrowers are called:
financial intermediaries.Federal Reserve banks.
Which of these is NOT a way financial institutions reduce risk?
guaranteeing a high rate of return for all lenders
A lower reserve requirement:
increases the ability of banks to make loans.
When the Fed buys bonds, its demand _____ the price of bonds, _____ nominal interest rates.
increases; decreasing
The housing bubble of 2004-2006 caused _____ pressures, leading the Federal Reserve to _____ interest rates.
inflationary; raise
Assume that the reserve requirement is 20% and the Federal Open Market Committee buys a $10,000 bond. The impact on the banking system is a(n):
injection of $10,000 in new reserves.
The Fed announced in September 2013 that it would postpone winding down its monetary stimulus until the economic recovery was stronger. When the Fed does finally begin to reduce bond purchases:
interest rates will rise.
money multiplier
is the maximum amount the money supply can increase (or decrease) when a dollar of new deposits enters (or exits) the system.
Which of these was NOT a factor leading to the 2007-2009 financial crisis?
lack of faith in the ability of the U.S. Treasury to pay on government bonds
The financial panic and credit freeze in late 2008 pointed to the Fed's important role as a:
lender of last resort.
When the interest rate falls, American bonds become _____ attractive to foreign investors, often leading to a(n) _____ in the value of the U.S. dollar in foreign exchange markets.
less; decrease
Generally, economists believe that monetary policy should focus on price stability in the _____ run and output or income in the _____ run.
long; short
Some analysts blame the last economic crisis on Federal Reserve policy. They argue that:
low interest rates encouraged excessive mortgage borrowing, leading to the housing bubble.
According to the Taylor rule, the lower the inflation rate, other things equal, the:
lower the federal funds target rate.
The dramatic collapse in the price of technology stocks in 2001-2003, coupled with a short recession in 2001, caused the Federal Reserve to _____ interest rates to stimulate _____.
lower; employment
In the equation of exchange, the term P × Q is the same as:
nominal GDP.
The Federal Open Market Committee is responsible for:
overseeing the buying and selling of government securities in the open market.
Tight monetary policy refers to the Federal Reserve:
raising interest rates, usually to fight inflation.
A policy of transparency in the Federal Reserve:
requires the Fed to explain why it acted or chose not to act in a specific situation.
If the Fed is buying bonds, then it wants bond prices to _____ and the federal funds rate to _____.
rise; fall
A reduction in the interest rate causes consumption and investment to _____, which shifts the aggregate demand curve _____.
rise; rightward
When the Fed wants to decrease the money supply, it will:
sell bonds.
Suppose the government implements a policy reducing the rewards earned by savers. In this case, the _____ loanable funds shifts _____.
supply of; left
leakage-adjusted money multiplier
takes into account the excess reserves and cash holdings that reduce the loans made and therefore reduces the actual money multiplier.
The discount rate is the interest rate:
the Fed charges depository institutions to borrow reserves from a regional Federal Reserve bank.