Money and Banking Final

Liquidity Preference Theory

3 motives behind the demand for money

$400

A consol bond paying $20 annually when the interest rate is 5% has a price of

Taylor Rule

A monetary rule that would stipulate exactly how much the Federal Reserve System should change real interest rates in response to divergences of real GDP from potential GDP and divergences of actual rates of inflation from a target rate of inflation.

liquidity trap

A situation in a severe recession in which the central bank's injection of additional reserves into the banking system has little or no additional positive impact on lending, borrowing, investment, or aggregate demand.(when people don't put their savings in bonds because bond prices would go down as interest rates rise which means less profit)

short-term interest rates are expected to rise in the future

A steeply upward sloping yield curve indicates that

decreases; decreases; left

A tax increase​ ________ disposable​ income, ________ consumption​ expenditure, and shifts the IS curve to the​ ________, everything else held constant.

​increase; decrease

According to aggregate demand and supply​ analysis, the rising oil prices coupled with the global financial crisis in 2007−2008 caused the unemployment rate to​ ________ and the level of real aggregate output to​ ________.

expected return, risk of other assets, liquidity of other assets, and wealth

According to the portfolio theories of money​ demand, what are the four factors that determine money​ demand?

the inflation rate is the growth rate of the money supply minus the growth rate of aggregate output.

According to the quantity theory of​ money, in the long​ run:

quantity of money lead to proportional changes in the price level.

According to the quantity​ theory, changes in​ the

an increase; reduce

All else the same, if a bank's liabilities are more sensitive to interest rate fluctuations than are its assets, then ____ in interest rates will ___ bank profits.

Federal Open Market Committee

Although reserve requirements and the discount rate are not actually set by the ___

take too much risk

Although the FDIC was created to prevent bank failures, its existence encourages banks to

zero lower bound

An expansionary monetary policy tool where a central bank lowers short-term interest rates to zero, if needed, to stimulate the economy. A central bank that is forced to enact this policy must also pursue other, often unconventional, methods of stimulus to resuscitate the economy. Causes a liquidity trap

rise; IS; right

An increase in government spending causes the equilibrium level of aggregate output to​ ________ at any given interest rate and shifts the​ ________ curve to the​ ________, everything else held constant.

quantitative easing

An unconventional monetary policy in which a central bank purchases government securities or other securities from the market in order to lower interest rates and increase the money supply. Try's to encourage banks to lend more but banks may hoard their new found money. Decreases yields and increases inflation/prices.

forward guidance

An unconventional policy in which the central bank communicates to the market about future policy prospects such as keeping interest rates low.

5%

Assuming the same coupon rate and maturity length, when the interest rate on a Treasury Inflation Indexed Security is 3 percent, and the yield on a nonindexed Treasury bond is 8 percent, the expected rate of inflation is

increases, reduces

Bank capital has both benefits and costs for the bank owners. Higher bank capital ___ the likelihood of bankruptcy, but higher bank capital ___ the return on equity for a given return on assets.

liability; asset

Banks may borrow from or lend to another bank in the federal funds market. A loan of excess reserves from one bank to another bank is recorded as a(n) _____ for the borrowing bank and a(n) ____ for the lending bank

contagion effect

Because of asymmetric information, the failure of one bank can lead to runs on other banks. This is the

a decline in real interest​ rates, an increase in planned investment​ spending, and an increase in aggregate output demanded

By analyzing aggregate quantity demanded through its component​ parts, we can conclude​ that, everything else held​ constant, a decline in the inflation rate causes

an asset

Collateral is ____ the lender receives if the borrower does not pay back the loan

currency, smaller

Decisions by depositors to increase their holdings of ___, or of banks to hold excess reserves will result in a ___ expansion of deposits than the simple model predicts.

​increases; demand

Everything else held​ constant, an autonomous monetary policy easing​ ________ aggregate​ ________.

aggregate demand to decrease.

Everything else held​ constant, an autonomous tightening of monetary policy will cause

​right; increase

Everything else held​ constant, an increase in autonomous consumer spending will cause the IS curve to shift to the​ ________ and aggregate demand will​ ________.

right; increase

Everything else held​ constant, an increase in autonomous planned investment spending will cause the IS curve to shift to the​ ________ and aggregate demand will​ ________.

aggregate demand to increase

Everything else held​ constant, an increase in government spending will cause​ ________.

increases; demand

Everything else held​ constant, an increase in government spending​ ________ aggregate​ ________.

False

Financing a persistent deficit by bond purchases will lead to a sustained inflation. True or false

True

Financing a persistent deficit by money creation will lead to a sustained inflation. True or false

When the real interest rate is very low​, the cost of funds is very low and the return on many of the​ firm's planned investments will exceed it. As the real interest rate​ rises, the return on fewer and fewer planned investments will exceed the cost of funds.​ Thus, planned investment spending falls as the real interest rate rises.

How and why do changes in the real interest rate affect planned investment​ spending?

try to eliminate the high unemployment by attempting to shift the aggregate demand curve to the right.

If aggregate output is below the natural rate​ level, activists of policies would recommend that the government

adverse selection

If bad credit risks are the ones who most actively seek loans then financial intermediaries face the problem of

falls, increases

If people expect nominal interest rates to be higher in the future, the expected return to bonds ___, and the demand for money ____.

4%

If the growth rate of the money supply is 10​%, velocity is​ constant, and real GDP grows at 6​% per year on​ average, then the inflation rate will be

6

If the money supply is​ $500 and nominal income is​ $3,000, the velocity of money is

no; no

In a liquidity​ trap, monetary policy has​ _____ effect on aggregate spending because a change in the money supply has​ _____ effect on interest rates.

decline, decreases

In the market for reserves, if the federal funds rate is between the discount rate and the interest rate paid on excess reserves, a ____ in the reserve requirement __ the demand for reserves, lowering the federal funds interest rate, everything else held constant.

rise, increases

In the market for reserves, if the federal funds rate is between the discount rate and the interest rate paid on excess reserves, a ____ in the reserve requirement ___ the demand for reserves, raising the federal funds interest rate, everything else held constant

The demand for money will increase because Keynes believed that people would require more money for more transactions.

In​ Keynes's analysis of the transactions demand for​ money, what will happen to money demand if​ people's incomes​ increase?

increase; decrease

Macroprudential supervision policies try to prevent a leverage cycle by changing capital requirements so that they ___ during an expansion and ___ during a downturn.

collateral

Property that is pledged to the lender in the event that a borrower cannot make his or her debt payment is called

currency; savings bonds; house

Ranking assets from most liquid to least liquid, the correct order is

Volker Rule

Regulation that aims to protect bank customers by preventing banks from making bad speculative investments.

Dodd-Frank Law

Regulation that increases transparency and prevents banks from taking on so much risk.

Basel 3

Regulation that provides a framework for capital and liquidity requirements to limit exposures and manage credit risk. It does this by requiring different levels of reserves for different forms of bank deposits and other borrowings. Additionally, it makes banks strengthen bank capital, increase liquidity, and decrease bank leverage.

decrease; increase

Risk premiums on corporate bonds tend to ___ during business cycle expansions and ___ during recessions, everything else held constant.

mortgage-backed securities and long-term Treasuries

The Fed's open market operations normally involve only the purchase of government securities, particularly those that are short-term. However, during the crisis, the Fed started new programs to purchase

quasi-public; private commercial banks in the district where the Reserve Bank is located

The Federal Reserve Banks are __ institutions since they are owned by the ___

increase; temporarily

The Federal Reserve will engage in a repurchase agreement when it wants to ___ reserves ___ in the banking system.

interest​ rates; investment​ spending; net exports

The IS curve slopes downward because higher​ ______________ lead to lower​ ___________ and​ ___________.

more; rise

The Taylor Principle states that central banks raise nominal rates by​ ________ than any rise in expected inflation so that real interest rates​ ________ when there is a rise in inflation.

credit spread

The ____, the difference between the interest rate on Baa corporate bonds and U.S. Treasury bonds. rose sharply during the Great Depression.

​real; lowering

The aggregate demand curve is downward sloping because a higher inflation rate leads the central bank to raise​ ________ interest​ rates, thereby​ ________ the level of equilibrium aggregate​ output., everything else held constant.

the monetary policy authorities to raise real interest rates

The aggregate demand curve slopes downward because a rise in inflation​ leads:

arbitrage

___ occurs when market participants observe returns on a security that are larger than what is justified by the characteristics of that security and take action to quickly eliminate the unexploited profit opportunity

velocity

The average number of times that a dollar is spent in buying the total amount of final goods and services produced during a given time period is known as

expansionary; a higher inflation rate; contractionary

The political business cycle refers to the phenomenon that just before elections, politicians enact ___ policies. After the elections, the bad effects of these policies (for example, ____) have to be counteracted with ____ policies.

2%

The quantity theory of inflation indicates that if the aggregate output is growing at​ 3% per year and the growth rate of money is​ 5%, then inflation is

Securitization

____ is a process of bundling together smaller loans (like mortgages) into standard debt securities

8%

if the nominal interest rate is 2%, and the expected inflation rate is -10%, the real interest rate is

the central bank raises real interest rates when inflation rises.

The upward slope of the MP curve indicates that

creates tight labor and product markets that cause inflation to rise.

The​ short-run aggregate supply curve slopes upward because an increase in output relative to potential​ output:

Asymettric Information

Typically, borrowers have superior information relative to lenders about the potential returns and risks associated with an investment project. This difference in information is called

the growth rate of dividends decreases

Using the Gordon growth model, a stock's current price decreases when

the dividend growth rate increases

Using the Gordon growth model, a stock's current price increases when

The demand for money increases when wealth or the risk associated with other assets​ increases, and it decreases when expected return or liquidity of other assets increases or when the risk of inflation increases.

What changes in these can increase the demand for​ money?

An inflation gap is negative when the current inflation rate is less than the inflation target

What does it mean for the inflation gap to be​ negative?

be generally accepted as payment for goods and services or in the repayment of debt

Whatever a society uses as money, the distinguishing characteristic is that it must

​falls; less; rise

When interest rates fall in the United States​ (with the price level​ fixed), the value of the dollar​ ________, domestic goods become​ ________ expensive, and net exports​ ________.

​higher; depress

When output is below potential and the policy rate has hit the floor of​ zero, the resulting fall in inflation leads to​ ________ real interest​ rates, which​ ________ output​ further, which causes inflation to fall further.

increase, increase

When the Federal Reserve purchases a government bond from a primary dealer, reserves in the banking system ____ and the monetary base ___, everything else held constant.

decrease, decrease

When the Federal Reserve sells a government bond to a primary dealer, reserves in the banking system ___ and the monetary base ____, everything else held constant

true

When the coupon bond is priced at its face value, the yield to maturity equals the coupon rate. True or false.

long-term interest rates are above short-term interest rates

When yield curves are steeply upward sloping

direct

With ____ finance, borrowers obtain funds from lenders by selling them securities in the financial markets.

moral hazard

an example of the ___ problem would be if Brian borrowed money from Sean in order to purchase a used car and instead took a trip to Atlantic City using those funds

investment grade; junk bonds

bonds with relatively low risk of default are called ___ securities and have a rating of Baa (or BBB) and above; bonds with ratings below Baa (or BBB) have a higher default risk and are called ___

interest rates, income, payment tech., wealth, riskiness of other assets, inflation risk, and liquidity of other assets

factors that affect the demand for money:

total amount of capital in the economy, total of labor supplied in the economy, available tech. that puts labor and capital together to produce goods and services, not impacted by temporary changes

factors that shift the long-run aggregate supply curve:

expected inflation, a persistent output gap, and inflation shocks

factors that shift the short-run aggregate supply curve:

increase; right

higher government deficits ___ the supply of bonds and shift the supply curve to the ___, everything else held constant

long-term; short-term

prices and returns for ___ bonds are more volatile than those for ___ bonds, everything else held constant.

no change, decrease

suppose the economy is producing at the natural rate of output. A decrease in consumer and business confidence will cause ___ in real GDP in the long run and a ____ in inflation in the long run, everything else held constant.

the inflation rate and the level of aggregate output supplied

the aggregate supply curve shows the relationship between

falls

the demand of money ___, when interest rates rise.

yield to maturity

the interest rate that equates the present value of payments received from a debt instrument with its value today is the

the natural rate of output

the long-run aggregate supply curve is a vertical line passing through

deposits

the primary liabilities of a commercial bank are

default risk

the risk that interest payments will not be made, or that the face value of a bond is not repaid when a bond matures is

the data lag

the time it takes for policy makers to obtain data indicating what is happening in the economy.

precautionary motive

the want to hold money as a cushion against unexpected opportunities

transaction motive

the want to hold money for everyday transactions, as payment tech. advanced (credit cards), the demand for money would likely decline relative to income

speculative motive

the want to hold money for store of wealth

gdp/ money supply, (price x income= gdp)

velocity of money=

bond; stock

when I purchase a corporate ___, I am lending the corporation funds for a specific time. When I purchase a corporation's ___, I become an owner in the corporation.

the value of the house fell below the amount of the mortgage

when housing prices began to decline after their peak in 2006, many subprime borrowers found that their mortgages were "underwater". This meant that

slack, below, shift downward, decreases, increase.

when the unemployment rate is above the natural rate of unemployment, there is a ____ in the labor market and output is ____ potential. This causes the short-run aggregate supply curve to ____. Hence inflation ___ and output ___ over time, until the economy reaches a long-run equilibrium.