When Congress established the Federal Reserve in 1913, its main responsibility was to
To make discount loans to banks suffering from large withdrawals by depositors.
Congress broadened the Fed's responsibility since
the 1930's as a result of the Great Depression
What are the monetary policy goals of the Fed?
Maintain stability of financial markets and institutions, price stability, and high employment
What is a banking panic?
When banks experience runs at the same time
Explain how the Federal Reserve helps to prevent bank panics
The Fed acts as a lender of last resort, making loans to banks so that they can pay off their depositors.
Why is price stability one of the Fed's monetary policies?
Promotes economic growth
If inflation is low, Feds have flexibility to help with recessions
Rising prices erode the value of money as a medium of exchange and store value.
Problems of high inflation?
1. Creates difficulties for the Fed to conduct monetary policy
2.Reduces the real value of money
3. Reduces economic growth
True or False
Stable prices make it easier to plan for the future, so expectations can remain stable, which means it is less costly to make loans
How are asset prices different from the 4 goals in the chapter?
Asset prices deal with specific type of wealth that carries risk associated with individual firms
A monetary policy target used by the Feds?
The Fed uses policy targets of interest rate and/or money supply because
It can affect the interest rate and the money supply directly and these in turn can affect unemployment, GDP growth, and the price level
When the Fed Reserve conducts an open market purchase of Treasury securities, the money supply..
increases as banks, now holding excess reserves, lower their lending (interest) rate to convert these reserves into new loans
The federal funds rate is
The interest rate that banks charge each other for overnight loans
The federal funds rate is very important for
The Fed's monetary policy. Uses the rate as a monetary policy target bc it can control the rate through open market operations, and other interest rates usually follow the movement of the fed funds rate
If the Fed purchases 120 million worth of Treasury bills from the public, the money supply will
To decrease the federal funds rate, the Fed must
increase the money supply
To pour money into the banking system and to increase the money supply, the Fed
buys bonds on the open market, which increases bank reserves
An increase in interest rates affects aggregate demand by
shifting the aggregate demand curve to the left, reducing real GDP and lowering the price level
As the interest rate increases, consumption, investment, and net exports
decreases because these are interest-sensitive spending components and aggregate demand decreases as shown by the shift of the aggregate demand curve to the left
If the Fed believes the economy is about to fall into recession, it should
use expansionary monetary policy to lower the interest rate and shift AD to the right
If the Fed believes that the interest rate is about to increase, it should
use contractionary monetary policy to increase the interest rate and shift AD to the left
Capital spending, is spending on , and a reduction in capital spending will decrease .
pant and equipment/investment
By keeping the money in the bank you are referring to in the reserves in banks.
The real problem was the banks were not the reserves.
The reason for this may have been a lack of
What is the term for a falling price level?
When central banks raise target rates, it should slow the economy down, which would the rate of growth of prices.
Deflation impacts price stability
Signs of inflation might signal a turn in the business cycle, requiring .
a change in policy
Removing the punch bowl refers to engaging in policy.
"Just as the party gets going refers to where GDP is greater than potential GDP which will ressult in
contractionary/an increase in the inflation rate
The money supply affects real GDP directly
Expansionary fiscal policy is likely to stimulate aggregate , which can cause .
Budget deficits can cause inflation if
a central bank purchases the govt bonds that were used to finance the budget deficit, it will mean and increase in the money supply, which causes inflation.
A monetary Rule is
A plan for increasing the money supply at a constant rate regardless of prevailing economic condition
The Fed has used the federal funds rate as its monetary policy target and not the money supply for 20 years bc
they cannot target both at the same time. They had to choose between targeting an interest rate and targeting the money supply
Why might a move to inflation targeting temp. increase the unemployment rate?
Lower inflation targets can lead to a reduction in aggregate demand, which could reduce output in the short run
The german hyperinflation of the early 1920's was caused by
the German govt raising funds for expenditures by selling bonds to the central bank
They money demand curve has a
negative slop because an increase in the interest rate decreases the quantity of money demanded
Using the money demand supply model, an open market purchase of Treasury securities by the Federal Reserve would cause the equilibrium interest rate to
An increase in real GDP can shift
money demand to the right and increase the equilibrium interest rate
When the Fed Reserve decreases the money supply, at the previous equilibrium interest rate households and firms will now want to
sell Treasury bills
Changes in the federal funds rate usually result in
changes in both short and long term interest rates, with more of an affect on short term rates.
The ability of the federal reserve to use monetary policy to affect economic variable such as real GDP depends upon its ability to affect
real interest rates
response to already low interest rates. The Fed began buying 10-yr Treasury notes and certain mortgage securities to keep interest rates low.
Monetary policy could be pro cyclical if the Federal Reserve
is late recognizing that a recession has begun and conducts expansionary monetary policy
Most of the pressure for a monetary growth rule has disappeared because since 1980
the relationship bet movements in the money supply and movements in real GDP and the price level have become much weaker
Using the taylor rule, if the current inflation rate exceeds the target inflation rate and real GDP exceeds potential GDP, then the federal funds target rate the sum of the current inflation rate plus the real equil. federal funds rate
will be greater than
A financial asset can be considered a security if
it can be sold in a secondary market
To reassure investors, Congress sponsored Fannie mar and Freddie Mac to stand bet. investors and banks that grant mortgages. Freddie Mae and Mac
sell bonds to investors and use the funds to purchase mortgages from banks
The larger the fraction of an investment financed by borrowing
he greater the potential return and potential loss on that investment
The failure of Purchasing Power Parity to hold well between the US and the British pound in the mid 1970's was said by the commentary
Monetary shocks were far from dominant (oil prices) and the inflation diff. bet the 2 countries was not that large
Fiscal policy refers to changes in
Federal taxes and purchases that are intended to achieve macroeconomic policy objectives
The increase in the amt govt collects in taxes when the economy expands and the decrease in the amt of the govt collects in taxes when the economy goes into a recession is an example of
Before the great depression the govt spending took place at and after it took place at the .
state and local levels/federal level
The largest source of federal govt revenue in 2008 was
ind. income taxes
Since the Social Security system began in 1935, the number of workers per retiree hasc
Expansionary fiscal policy involves
increasing got purchases or decreasing taxes
Which would induce Congress to conduct contractionary fiscal policy? A significat increase in
The tax multiplier is smaller in absolute value than govt purchases multiplier bc some portion of the decrease in taxes
will be saved by individuals and not spent, and some portion will be spent on imported goods
Real GDP is 12.6 and potential is GDP. To move the economy back to potential, the govt should
decrease by .2
The Federal Reserve plays a larger role than Congress and the president in stabilizing the economy bc
the Federal Reserve can more quickly change monetary policy than the president can change fiscal policy
The impact of crowding out may be the least
during a deep recession
The cyclically adjusted budget deficit or surplus measures what the deficit or surplus would be if the economy were
at potential GDP
The federal govt debt equals
the total value of US treasury bonds outstanding
Tax rates, marginal tax rates affect the incentive to work, save, and invest, and therefore, aggregate supply.
Commentary- the size of the multiplier effect is likely to vary with
context and time period involved
Commentary: country member of Eurozone and has difficulties in borrowing in the past years is
The natural rate of unemployment
The unemployment rate that exists when the economy is at potential GDP
An increase in inflation will decrease unemployment if the inflation is by both workers and firms.
An increase in the expected inflation rate will
Shift the short-run Phillips curve to the right
Increase in natural rate of unemployment
An increase in the number of younger, less skilled workers in the economy
What impact does monetary policy have on the long-run phillips curve?
monetary has no impact on the long run
When did inflation remain above 5 percent each year?
When inflation is very low, how do workers and firms adjust their expectations of inflation?
They tend to ignore inflation
If inflation is greater than expected inflation, what is the relationship bet the actual real wage and the expected real wage?
The actual real wage will be lower than the expected real wage
If workers and firms have rational expectations, including knowledge of the policy being used by the federal reserve
expansionary monetary policy is ineffective
The major criticism of real business cycle model is
neg. technology shocks are uncommon and cant explain all business cycle fluctuations.
A fall price level is called and a fall in the rate of inflation is called .
Data from the 2007-2009 recession indicates the current trade-off bet unemployment and inflation is such that
it is much stronger now than it was during in the mid 1990s.
Commentary: The Chinese have amassed very large amounts of official US dollar assets as foreign exchange as reserves in part bc
They were concerned about the experiences of southeast Asian economies in 1997 disrupted economies.
An American citizen purchasing a new Toyota made in Japan would be in Japan's account. c
Increase in the US current account would result from
an increase in the balance of trade
When the US sends money to other countries to help tsunami survivors, it is recorded in the account.
An increase in capital outflows from the US will
decrease the balance on the financial account
If the balance of the current account in the US is -500 then the balance on the financial account is
How does an increase in a country's exchange rate affect its balance of trade?
An increase in the exchange rate raises imports, reduces exports, and reduces the balances of trade
Currency traders expect the value of the dollar to fall. What effect will this have?
Demand for dollars will decrease and supply will increase
If the exchange rate changes from 2 =1GBP to 2.01=1GBP then
the dollar has depreciated
An expansionary monetary policy in the US should
decrease the foreign currency price of US exports
Since 2002, the US dollar has to other currencies
higher inflation rate in the US affect real exchange rate bet. countries
the real exchange rate will rise
If foreign investment is negative, then
domestic investment must be greater than national saving
What impact might increase in the budget deficit have on interest rates and exchange rates?
Commentary: concept of identity for ind.
may be needed for a fuller understanding and is made harder to explore bc of the limited roles of govt
Commentary: U-shaped cost curve suggests
issues of optimal size, smaller and larger size
When the value of a currency is determined by supply and demand, the exchange rate is defined as
If used gold like 1849,
raise money supply but no impact on price level
Factors that are not imp in determining exchange rate fluctuations in the long run?
speculating in currency markets
Countries that use the euro face problems such as
unable to conduct monetary policy
If inflation in Russia is greater than the US than
the value of the dollar will rise in the long run
An increase in the demand for American goods from other countries will increase
the value of the dollar in the long run
Pegging a country's exchange rate can be advantageous if
investors believe the dollar to be more stable than the domestic currency
Which 2 countries account for foreign purchases of US stocks and bonds
China and UK
If interest rates in the US rise, the value of the dollar will as the foreign investors their holdings of US investments
In order to support an undervalued euro, the European Central Bank must dollars. This will cause the rate of inflation in the EU to .
The bretton woods system had problems like
dollars held by foreign central banks exceeded gold reserves held by the US.
Commentary: An ideal for fixed exchange rates bet countries would seem to require
uniform inflation rates across countries
During recession, the only reluctance was from
western european countries that had stronger social safety nets