Money & Banking Chapter 5

) ________ in the money supply creates excess demand for ________, causing interest rates to ________, everything else held constant.

An increase; bonds; fall

Using the liquidity preference framework, what will happen to interest rates if the Fed increases the money supply?

The Fedʹs actions shift the money supply curve to the right. The new equilibrium interest rate will be lower than it was previously.

The opportunity cost of holding money is

The interest rate

When the growth rate of the money supply increases, interest rates end up being permanently lower if

The liquidity effect is larger than the other effects

In the market for money, an interest rate below equilibrium results in an excess ________ money and the interest rate will ________.

demand for; rise

When the price level falls, the ________ curve for nominal money ________, and interest rates ________, everything else held constant

demand; decreases; fall

When the price level falls, the ________ curve for nominal money ________, and interest rates ________, everything else held constant.

demand; decreases; fall

When the Fed ________ the money stock, the money supply curve shifts to the ________ and the interest rate ________, everything else held constant.

increases; right; falls

Interest rates increased continuously during the 1970s. The most likely explanation is

increasing expected rates of inflation

If there is an excess supply of money

individuals buy bonds, causing interest rates to fall.

If the liquidity effect is smaller than the other effects, and the adjustment to expected inflation is slow, then the

interest rate will initially fall but eventually climb above the initial level in response to an increase in money growth.

If the liquidity effect is smaller than the other effects, and the adjustment to expected inflation is immediate, then the

interest rate will rise immediately above the initial level when the money supply grows.

It is possible that when the money supply rises, interest rates may ________ if the ________ effect is more than offset by changes in income, the price level, and expected inflation.

rise; liquidity

When real income ________, the demand curve for money shifts to the ________ and the interest rate ________, everything else held constant.

rises; right; rises

When the price level ________, the demand curve for money shifts to the ________ and the interest rate ________, everything else held constant

rises; right; rises

When the interest rate is above the equilibrium interest rate, there is an excess ________ money and the interest rate will ________.

supply of; fall

If the Fed wants to permanently lower interest rates, then it should raise the rate of money growth if

the liquidity effect is larger than the other effects.

In his Liquidity Preference Framework, Keynes assumed that money has a zero rate of return; thus

when interest rates rise, the expected return on money falls relative to the expected return on bonds, causing the demand for money to fall.

In Keynesʹs liquidity preference framework, if there is excess demand for money, there is

excess supply of bonds

In Keynesʹs liquidity preference framework, individuals are assumed to hold their wealth in two forms:

money and bonds

In the Keynesian liquidity preference framework, an increase in the interest rate causes the demand curve for money to ________, everything else held constant.

stay where it is

________ in the money supply creates excess ________ money, causing interest rates to ________, everything else held constant.

A decrease; demand for; rise

Keynes assumed that money has ________ rate of return

a zero

In Keynesʹs liquidity preference framework,

an excess supply of bonds implies an excess demand for money

In the liquidity preference framework, a one-time increase in the money supply results in a price level effect. The maximum impact of the price level effect on interest rates occurs

at the moment the price level hits its peak (stops rising) because both the price level and expected inflation effects are at work.

A lower level of income causes the demand for money to ________ and the interest rate to ________, everything else held constant

decrease; decrease

A decline in the expected inflation rate causes the demand for money to ________ and the demand curve to shift to the ________, everything else held constant.

decrease; left

An increase in the interest rate

decreases the quantity of money demanded.

In Keynesʹs liquidity preference framework, as the expected return on bonds increases (holding everything else unchanged), the expected return on money ________, causing the demand for ________ to fall

falls; money

A business cycle expansion increases income, causing money demand to ________ and interest rates to ________, everything else held constant.

increase; increase

A rise in the price level causes the demand for money to ________ and the interest rate to ________, everything else held constant

increase; increase

In the Keynesian liquidity preference framework, a rise in the price level causes the demand for money to ________ and the demand curve to shift to the ________, everything else held constant.

increase; right

When the growth rate of the money supply is increased, interest rates will fall immediately if the liquidity effect is ________ than the other money supply effects and there is ________ adjustment of expected inflation.

larger; slow

When the Fed decreases the money stock, the money supply curve shifts to the ________ and the interest rate ________, everything else held constant.

left; rises

Milton Friedman called the response of lower interest rates resulting from an increase in the money supply the ________ effect.

liquidity

Of the four effects on interest rates from an increase in the money supply, the initial effect is, generally, the

liquidity effect.

The bond supply and demand framework is easier to use when analyzing the effects of changes in ________, while the liquidity preference framework provides a simpler analysis of the effects from changes in income, the price level, and the supply of ________.

) expected inflation; money

Using the liquidity preference framework, show what happens to interest rates during a business cycle recession.

During a business cycle recession, income will fall. This causes the money demand curve to shift to the left. The resulting equilibrium will be at a lower interest rate.

Of the four effects on interest rates from an increase in the money supply, the one that works in the opposite direction of the other three is the

Liquidity effect.

In the figure above, one factor not responsible for the decline in the demand for money is

an increase in income