Home of the 7 Board of Governors Ben Bernanke

Home of the 7 Board of Governors Ben Bernanke
Monetary Policy The “Fed” Fed Chairman Home of the 7 Board of Governors Ben Bernanke

Monetary Policy [Objectives]
1. Know the cause-effect of both expansionary [easy] and contractionary [tight] monetary policy. 2. Three tools of monetary policy. A. Discount Rate B. Reserve Requirement C. Buying and Selling of Government Securities 3. Know the strengths of monetary policy. [Is monetary policy as effective against depression as it is against inflation?] 4. Know the “Taylor Rule” for the monetary policy. 5. Quiz over “Money Creation.”

Expansionary Fiscal Policy
Loanable Funds Market [Incr G; Decr T][But we get negative Xn] D2 S D1 SRAS r=8% PL Real In. Rate Start from a Balanced Budget G & T = $2 Trillion r=6% AD2 LRAS AD1 F1 F2 “Now, this is better.” $2.2 tr. “I can’t get a job.” PL2 $2 tr. $2 tr. PL1 E2 G T E1 YR YF Real GDP $2.2 $2.2 G G I.R. AD Y/Empl./PL; LFM $1.8 $1.8 T Y/Emp/PL; DI C AD T LFM IR

Expansionary [Easy] Money Policy
DM DI MS1 MS2 Investment Demand 8% 6% 4% 8 4 Nominal Interest Rate 6% Buy If there is a RECESSION MS will be increased. Money Market QID1 QID2 AS AD1 AD2 PL I want a job as a Rockette PL2 E2 PL1 E1 YR Y* Real GDP Fed Buy Bonds MS I.R. QID AD Y/Emp/PL

Contractionary Fiscal Policy
Loanable Funds Market [Decr G; Incr T ] [Again, we get negative Xn] D1 D2 S PL r=6% SRAS r=3% Real In. Rate Start from a Balanced Budget G & T = $2 Trillion AD2 LRAS F2 F1 PL1 $2.2 T tril. E1 $2 tril. $2 T tril. $1.8 tril.. PL2 G T E2 AD1 YF YI Real GDP [like we have “money trees”] $1.8 $1.8 G G I.R. AD Y/Empl./PL; LFM $2.2 $2.2 T Y/Emp/PL; DI C AD T LFM IR

Contractionary [Tight] Money Policy
Dm MS2 MS1 DI “It’s cheaper to burn money than wood.” Investment Demand 10 8 6 10% 8% 6% Nominal Interest Rate Sell If there is INFLATION, MS will be decreased. Money Market QID2 QID1 AS like “money trees” AD2 AD1 PL PL1 E1 PL2 E2 YI Y* Fed Sell Bonds MS I.R. QID AD Y/Empl./PL

Economy’s Speed Limit at Full Employment is 4%, instead of 2.5%.
Can sustain a much greater increase in AD if the AS curve is also shifting to the right, due to increasing productivity. AD2 In the early 90’s, at FE, 2.5% was the speed limit. AS shifted slowly due to low productivity. AD1 AS1 AS2 PL2 PL3 PL1 So, at FE, the “goldilocks economy” has expanded. Increasing productivity of the late 90’s allowed more growth at FE GDP. Real GDP under 4% Y*1 Y2 Y3 Real GDP 17 increases 4% “Goldilocks Economy” [not too fast or slow]

– America’s Main Stabilization Tool
Monetary Policy Nominal Interest Rate Inflation

– America’s Main Stabilization Tool
Monetary Policy Nominal Interest Rate Recession Monetary Policy Tools 1. Discount Rate – when banks borrow from the Fed [“symbolic”] 2. Reserve Ratio – currently 10%; the most powerful tool 3. Buying [recession] & selling [inflation] of bonds

BALANCE SHEET OF FED BANKS
ASSETS Securities [90%] Loans to Commercial Banks LIABILITIES Reserves of Commercial Banks Treasury Deposits Federal Reserve Notes [90%]

Consolidated Balance Sheet of the Federal Reserve Banks[millions]
Assets [own] Liabilities [owe] Consolidated Balance Sheet of the Federal Reserve Banks[millions] Securities *758, Reserves of commercial banks $14,923 Treasury deposits ,463 Loans to Commercial Banks , Federal Reserve Notes *754,567 [when these notes are in circulation, they constitute claims against assets of the Fed] All other assets , All other liabilities & net worth ,615 Total $837, Total $837,768 Australia Reserve Bank of Australia [RBA] Canada Bank of Canada Euro Zone Central Bank of Europe[CBE] Japan The Bank of Japan [“BOJ”] Russia Central Bank of Russia United Kingdom Bank of England Mexico Banco de Mexico (Mex Bank) Sweden Sveriges Ribsbank [Nobel Pr.] U.S Federal Reserve System [“Fed”]

+30% Underfed Overfed 1983 1980 And – so it is with money.
The Fed controls the banks’ ability to create new money to ensure the economy doesn’t get too much money, nor too little. Underfed Fed just right Overfed 1980 1983 And – so it is with money. Not too much, not too little. +30% $75.00 $97.50 Money Prices

3 Tools of Monetary Policy
1. Discount Rate – banks borrow from the Fed (symbolic) 2. Required Reserve - % of DD which cannot be loaned. 3. Buy/Sell Bonds – government debt - 3 mo., 6 mo., & 1 year; purchase price: $10,000 - 2 yr., 3 yr., 5 yr.,($5,000), & 10 yr., ($10,000) - 30 years with purchase of $1,000 Federal Funds Target Rate – overnight lending rate between banks to correct a temporary imbalance in reserves. Recession Lower Buy Inflation Raise Sell AS AD AS LRAS AD AD AD Prime Rate-loan rate to the best (prime) customers. Y*YI YR Y* Real GDP .6% 17 increases 4%

“Easy Money” During Recessions
“Students, should the Fed buy or sell bonds to jumpstart this economy?” “Easy Money” During Recessions MS1 MS2 DI Investment Demand 10 8 6 10 8 6 Nominal Interest Rate Buy DM If there is RECESSION MS will be increased. Money Market QID1 QID2 AD1 [C+Ig+G+Xn] AD2 LRAS AS “Easy Money” – (Buy/Sell) bonds, which (increase/decrease) MS, which (increase/decrease) interest rates, which (appreciate/depreciate) the dollar, which (increase/decrease) C, Ig, & Xn, which (increase/decrease) AD & therefore, PL, GDP, & emp. Jobs are tough to get. Price level P2 E2 P1 E1 YR Real GDP Y*

“Tight Money” To Fight Inflation
“Now, should I buy or sell?” “Tight Money” To Fight Inflation DI MS1 Dm MS2 10 8 6 10 8 6 Investment Demand Nominal Interest Rate Sell If there is INFLATION, MS will be decreased. Money Market QID1 QID2 AS LRAS AD2 “Tight Money” – (Buy/Sell) bonds, which (incr/decr) the MS, which (incr/decr) in. rates, which (apprec/deprec) the dollar, which (incr/decr) C, Ig, & Xn, which (incr/decr) AD, PL,& GDP. “I’ll get rid of some money.” P1 E1 P2 E2 AD1 YI Y*

Hypothetical Ideal Economy
MS2 Dm DI AD2 AS 6% 6% I=$60 PL2 Y* 120 $60 QID RDO Money Market Investment Demand Ideal Economy MS is at 120 billion, putting the Interest rates at 6%, and Investment is at $60 billion.

Recessionary Gap Recessionary Gap DI Y* RDO AD2 AD1 AS Dm QID 9% PL2
MS1 MS2 AD2 AD1 AS 9% 9% I=$50] I=$60 6% 6% PL2 PL1 Dm YR $100 $120 $50 $60 Y* RDO QID Money Market Investment Demand Recessionary Gap Increase MS from $100 to $120, which lowers the I.R. from 9% to 6%, which increases QID from $50 to $60, which increases AD from AD1 to AD2.

Decrease MS from $140 to $120, which increases the I.R. from 3% to 6%.
Inflationary Gap AD3 DI MS2 Dm MS3 AD2 I=$70 AS 3% 3% I=$60 6% 6% PL3 PL2 Y* YI $120 $140 $60 $70 QID RDO Money Market Investment Demand Inflationary Gap Decrease MS from $140 to $120, which increases the I.R. from 3% to 6%. which decreases QID from $70 to $60, which decreases AD from AD3 to AD2.

…to assist the economy in achieving a full employment, non-inflationary level of output

1. Discount Rate – when banks borrow from the Fed. [Symbolic] 2. Reserve Ratio – how much of demand deposits that have to be kept in reserve and can’t be loaned out. [Currently 10%] 3. Buying [recession gap] and selling [inflation gap] of securities.

1. Open Market Operations [at first this was used just to increase bank earnings] - “nuts & bolts” of Monetary Policy [main tool] - $60-$70 billion every day

2. Reserve Requirement - most powerful (seldom used)
- affects money creation by changing ER and the multiplier - an increase of ½ of 1% would increase bank reserves by over $5 billion - RR was 20% from 2. Reserve Requirement Sledgehammer of Monetary Policy Banks that fail to maintain at least the RR [10%] on average over a two-week period face severe penalties. RR - Atomic Bomb of Monetary Policy

Atomic Bomb of Monetary Policy
Reserve Requirement Example Suppose the banking system has $500 billion in DD. The RR is 12% & TR are $60 billion, which is 12% of the $500 billion DD. So, there are no ER. Now, the Fed lowers the RR to 10%. Now banks are required to keep only $50 billion in RR. So, $10 billion more ER is available to loan out. $10 billion X 10 = $100 billion in new DD. So, 20% increase MS [DD] from $500 to $600 billion.

“Easy Money” – increase the money supply
Reserve Requirement at 10% - Easy Money [In 1980, the RR was set at 12%; stayed there until 1992; went to 10%] Monetary Expansion [10% RR] [1/.10=10] “Easy Money” $10,000 [$9,000+$1,000] AS $729 AD2 AD1 PL $810 YR Y* $900 [$900x10] $1,000 $1,000 Initial deposit “Easy Money” “Easy Money” – increase the money supply

“Tight Money” - decrease the money supply
RR at 20% - Tight Money Monetary Expansion (20% RR) [1/.20=MD of 5] “Tight Money” $5,000 [$4,000+$1,000] AD1 AS $512 AD2 $640 PL $800 Y* YI $1,000 Initial deposit “Tight Money” - decrease the money supply

3. Discount Rate Hurricane EarthQuake
- emergency Fed loans to banks - symbolic (raises Prime Rate) - Discount Rate was 1% from and the prime rate was 1.5% 3. Discount Rate FL borrowed $99 million In 1991 Hurricane EarthQuake The Fed tends to change the D.R. in lockstep with the fed funds target rate.

Uppercut

After the recession, the unemployment rate still increased.
"Easy Money" At Work After the recession, the unemployment rate still increased. During this period, , the Fed did 4 things: 1. Decreased discount rate from 10% to 3%; 2. Decreased the RR from 12% to 10%; 3. Decreased the Fed Funds Rate 24 times, and 4. Bought bonds

Fed Funds Rate 1996-2008 2.00% “Tight” Money “Easy” Money April, 2008
08’

Did it work? Relative Importance of Monetary Policy
A. WWII-1979 – Fed targeted the interest rate not the growth of MS. B – Fed targeted the growth of the MS not the in. rate. C Present - Fed targets the interest rate, not the MS. 1. Discount Rate – not a primary tool of monetary policy. It does have an “announcement effect.” 2. Reserve Requirement (10%)-has changed one time in 2 decades (12% to 10% in 1992). It would affect bank profits so is seldom used. 3. Open-market operations – evolved as the most effective tool of monetary policy because of flexibility. Securities can be bought or sold in large amounts & their impact on reserves is very prompt. Did it work?

Effectiveness of Monetary Policy
Strengths of Monetary Policy 1. Speed and flexibility –can quickly be altered (compared to fiscal policy). This can occur on a daily basis and influence interest rates and the MS. 2. Isolation from political pressures – because of the 14 year terms. They can enact unpopular policies which might be best for our economy’s health.

Monetarist View of Transmission Mechanism v. Keynesian View
DI(K) MS2 Investment Demand MS1 AD2(M) AS 10 8% 6% 10% 8% 6% AD1 AD2 DI(M) Dm(K) PL2 PL2 PL1 Dm(M) (K) YR Y* YI Money Market QID1 QID2 QID2 Dm is more inelastic [I.R. more sensitive] DI is more elastic [or more responsive] Mainly, we end up just getting inflation. AS Keynesian view is that DI is rather steep so monetary policy is not that strong. Fiscal policy is “top banana.” AD2 AD1 Also, the Keynesians don’t think the lower interest rate is as important as “profit expectations.”

Cyclical asymmetry Strengths of Monetary Policy
Speed and flexibility Isolation from political pressure Successes in the 1980s & 1990s Shortcomings and problems Monetary Policy better I may not drink water but I’ll eat spiked brownies. I’d like one of those 1% mortgages, but I don’t have a job. Cyclical asymmetry [better at fighting inflation than fighting depressions] Fiscal Policy better

Shortcomings and Problems of Monetary Policy
But – I will also eat spiked muffins. Cyclical Asymmetry (lack of balance) – “Tight money during inflations is more effective than easy money policy during a depressions.” a. An easy money policy during depression does not guarantee that people will take out loans if they don’t have jobs. [“You can lead a horse to water, but you can’t make him drink.”] b. The cyclical asymmetry has not created a major difficulty for monetary policy except during times of depression. c. Velocity of money may increase during inflation when the fed is trying to decrease the MS & decrease during recession when the Fed is trying to increase MS. d. The lower interest rates during recession & depreciation of the dollar may cause foreign investors to pull their money out of the U.S. and reduce the MS. e. Banks may hold their ER or the public may hold too much currency. f. Dm curve may be more flat so that interest rate will not drop as much, or the DI curve may be more vertical so that investment will not increase as much.

Taylor Rule The Fed does not adhere to a strict inflationary target or monetary policy rule. It targets the Federal funds rate at the level it thinks is appropriate for the economic conditions. They appear to roughly follow a rule first established by economist John Taylor of Stanford. The Taylor Rule assumes a 2% target rate of inflation and has three parts. 1. If real GDP rises by 1% above potential GDP, the Fed should raise the Federal funds rate by ½ a percentage point. 2. If inflation rises by 1% above its target of 2%, then the Fed should raise the Federal funds rate by ½ a percentage point. 3. When real GDP is equal to potential GDP and inflation is equal to its target rate of 2%, the Federal funds rate should remain at about 4%, which would imply a real interest rate of 2%. These rules are reversible for situations in which the real GDP falls below potential GDP and the rate of inflation falls below 2%. The Fed is free to diverge from the Taylor Rule, like after 9/11.

Fiscal Policy Monetary Policy Recession Inflation
Increase G Decrease G Decrease T Increase T Monetary Policy Recession Inflation Lower D. Rate Raise D. Rate Lower R. Rate Raise R. Ratio Buy Bonds Sell Bonds “Easy Money” “Tight Money”

Tools of Monetary Policy
Discount Rate The Reserve Ratio Open Market Operations “Easy Money” Fed Easy Money Policy Lower Discount Rate Lower Reserve Ratio Buy Bonds

Tools of Monetary Policy
Discount Rate The Reserve Ratio Open Market Operations “Got to decrease the MS.” Fed Tight Money Policy Raise Discount Rate Raise Reserve Ratio Sell Bonds

NS 48-58 (MS = DD + Currency of Public)
48. The 3 tools of monetary policy are open market operations, changes in RR, & (changes in T/changes in G/ changes in discount rate). 49. The main tool of the Fed in regulating the MS is (open-market operations/DR/RR). 50. When the Fed[ ] sells securities to the PUBLIC[ ], DD (don’t change/incr/decr) & banking system RR, ER & TR (incr/decr). 51. When the Fed[ ] buys securities from commercial banks[ ], DD (don’t change/increase/decrease) & ER and TR (increase/decrease). 52. When the commercial banking system[ ] borrows from the Fed, DD (don’t change/increase/decrease) but ER & TR (incr/decr). 53. When commercial banks[ ] sell government bonds to the Fed[ ], DD (don’t change/incr/decr) but their ER & TR (do not change/incr/decr). 54. When the PUBLIC[ ] buys securities from the Fed[ ], DD (don’t change/incr/decr) and RR, ER, & TR of banks (don’t change/incr/decr). 55. When a commercial bank gets a loan from the Fed, their lending ability (incr/decr). 56. Assume that the RR is 25% & the Thunder Bank borrows $100,000 from the Fed., commercial bank ERs are increased $________. PMC in the banking system are increased by $_______. TMS can be as much as $________. 57. The (margin requirement/discount rate) specifies the size of the down payment on stock purchases. 58. If the Fed were to increase the RR [10% to 20%] we would expect (higher/lower) interest rates, a (reduced/expanded) GDP and (appreciation/depreciation) of the dollar. [less “C”, “Ig”, & “Xn”] 100,000 400,000 400,000

59. When the RR is increased [10% to 50%], the ER of member banks
are (increased/decreased) and the monetary multiplier is (incr/decr). 60. Assume the RR is 25% & the Fed [ ]buys $4 M of bonds from the public[ ]. The MS is increased by ($3/$4/) million and the PMC is increased by ($16/$12) mil. Potential TMS is ($3/$4/$12/$16) mil. 61. When the Fed lends to commercial banks [ ], this is called the (Fed Funds Rate/discount rate) and when commercial banks make loans to one another, this is the (Fed Funds Rate/ Discount Rate). 62. The Keynesian cause-effect chain of an easy money policy would be to (buy/sell) bonds; which would (increase/decrease) the MS, which would (lower/raise) interest rates & (incr/decr) Ig, “C”, Xn, & Y. 63. If the Fed were to buy government securities in the open market, we would anticipate (lower/higher) interest rates, an (expanded/contracted) GDP, and (appreciation/depreciation) of the dollar. 64. If the Fed were reducing demand-pull inflation, the proper policies would be (lower/raise) the discount rate, (lower/raise) the RR and ((buy/sell) government bonds. 65. Monetary policy is thought to be more effective in (controlling inflation/ fighting depressions) and fiscal is more effective (controlling inflation/ fighting depressions). 66.The “net export effect” of an “easy” money policy (strengthens/ weakens) that policy, while the “net export effect” of “expansionary” fiscal policy (strengthens/weakens) that policy. [impact of interest rates] NS 57-66

NS 67-70 DI YI AD3 AD2 AD1 AS Dm RDO
MS1 MS2 MS3 AD2 I=$70 AD1 AS 9% 6% 3% 9% 6% 3% I=$50] I=$60 PL3 PL2 PL1 Dm YR Y* YI $ $50 $60 $70 QID RDO Money Market Investment Demand 67. If AD is AD3, what must the Fed do to get to AD2(FE GDP [Y*])? (increase/decrease) the MS from ($120/$140) to ($100/$120). 68. If the MS is MS1, & the goal of the Fed is FE GDP[Y*], they should (increase/decrease) the MS from ($100/$120) to ($120/$140). 69. Which of the following would shift the MS curve from MS3 to MS2? (buying/selling) bonds. 70. If the MS is MS2 and the goal of the Fed is FE GDP of Y*, they should (increase/decrease/don’t change) the Ms.

NS 71-72 71. An easy money policy will (apprec/deprec) the dollar & (incr/decr) U.S. Xn. A tight money policy will (apprec/deprec) the dollar & (incr/decr) U.S. Xn. 72. If the economy were in a severe recession, proper monetary policy would call for (lowering/raising) the discount rate, (lowering/raising) the RR, & (buying/selling) bonds. Proper fiscal policy would be to (incr/decr) “G” & (incr/decr) “T”, both of which would result in a bugetary (deficit/surplus).

Money, Banking, & Fed Test Review 1-8
1. If your bank [ ]borrows $50,000 from the Fed, does this automatically increase the MS? _____ Does this loan increase the amount in RR?_____ ER? ____ With 10% RR, PMC is __________. TMS is __________. 2. If the RR is 50% & the Fed buys $100 mil. of securities from the public, then: MS is increased by ________. PMC is _________. TMS is ________. 3. What will cause the Dt(& total demand) for money curve to shift right? (increase/decrease) in nominal (money) Y? 4. When the Fed buys bonds from banks [or gives them a loan], DD are (incr/decr/ unchanged) but their ER & TR both (incr/decr/unchanged). 5. If the Fed buys $10 million of securities from the public, with a RR of 40%, MS is increased by ________ & PMC is _________. TMS is ________. 6. If the Fed decreased the RR from 20% to 10%, we would expect (higher/lower) interest rates, (appreciation/depreciation) of the dollar, and an (increase/decrease) in GDP. 7. DD of $100,000 and RR of 25% in a commercial banking system with TR of $40,000. PMC in the banking system is ($240,000/$60,000). 8. If you are estimating your expenses for the prom at $3,000, money is functioning as (unit of account/medium of exchange/store of value). No No Yes $500,000 $500,000 $100 mil. $200 mil. $100 mil. $10 mil. $15 mil. $25 mil.

“Easy Money” During Recessions
“Students, should the Fed buy or sell bonds to jumpstart this economy?” “Easy Money” During Recessions MS1 MS2 DI Investment Demand 10 8 6 10 8 6 Nominal Interest Rate Buy DM If there is RECESSION MS will be increased. Money Market QID1 QID2 AD1 [C+Ig+G+Xn] AD2 LRAS AS 9.“Easy Money” – (Buy/Sell) bonds, which (increase/decrease) MS, which (increase/decrease) interest rates, which (appreciate/depreciate) the dollar, which (increase/decrease) C, Ig, & Xn, which (increase/decrease) AD & therefore, PL, GDP, & emp. Jobs are tough to get. Price level P2 E2 P1 E1 YR Real GDP Y*

“Tight Money” To Fight Inflation
“Now, should I buy or sell?” “Tight Money” To Fight Inflation DI MS1 Dm MS2 10 8 6 10 8 6 Investment Demand Nominal Interest Rate Sell If there is INFLATION, MS will be decreased. Money Market QID1 QID2 AS LRAS AD2 10. “Tight Money” – (Buy/Sell) bonds, which (incr/decr) the MS, which (incr/decr) in. rates, which (apprec/deprec) the dollar, which (incr/decr) C, Ig, & Xn, which (incr/decr) AD, PL,& GDP. “I’ll get rid of some money.” P1 E1 P2 E2 AD1 YI Y*

MS = Currency + DD of PUBLIC
RR is 20% Assets DD (Liabilities) TR[RR+ER]=$20 mil. $100 million How much can this bank loan out? $______ 2. If Pam Anderson puts $1,000 in this bank(DD), Pam can write a check for as much as ________; ER will increase by $_______. 3. Possible Money Creation in the system could be $_______. 4. Potential Total Money Supply could be as much as $________. MS = Currency + DD of PUBLIC $1,000 800 4,000 5,000

TR 11-14 MS = Currency + DD of PUBLIC
RR is 20% Assets DD(Liabilities) TR[RR+ER] = $20 mil. $100 million 11. How much can Pam’s bank loan out? $______ 12. If Pam Anderson’s Bank borrows $1,000 from the Fed ER will increase by $_______. 13. Possible Money Creation in the system could be $_______. 14. Potential Total Money Supply could be as much as $________. TR MS = Currency + DD of PUBLIC 1,000 Pam Anderson’s Bank Fed 5,000 5,000

MS = Currency + DD of Public
RR is 25% Assets DD (Liabilities) TR[RR+ER]=$25 mil. $100 million How much can this bank loan out? $______ 2. If Pam Anderson puts $4,000 in this bank(DD), Pam can write a check for as much as _______; ER will increase by $_______. . 3. Possible Money Creation in the system could be $________. 4. Potential Total Money Supply could be as much as $________. MS = Currency + DD of Public $4,000 3,000 12,000 16,000

RR is 40% Assets DD (Liabilities)
TR[RR+ER]=$40 mil. $100 million 1. How much can this bank loan out? $______ 2. If Cameron Diaz puts $10,000 in this bank(DD), Pam can write a check [DD] for as much as $__________; ER can increase by $_________. 3. Possible Money Creation in the system could be $________. 4. Potential Total Money Supply could be as much as $_________. Extra Practice MS = Currency + DD of PUBLIC 10,000 6,000 15,000 25,000

Extra Practice MS = Currency + DD of Public
RR is 50% Assets DD (Liabilities) TR[RR+ER] = $50 mil. $100 million 11. How much can Cameron’s bank loan out? $______ 12. If Cameron Diaz’s Bank borrows $5,000 from the Fed ER will increase by $_______. 13. Possible Money Creation in the system could be $________. 14. Potential Total Money Supply could be as much as $________. Extra Practice MS = Currency + DD of Public 5,000 Cameron Diaz’s Bank Fed 10,000 10,000

Test Review 15-19 DI YI AD3 AD2 AD1 AS Dm RDO
MS1 MS2 MS3 AD2 I=$70 AD1 AS 9% 6% 3% 9% 6% 3% I=$50] I=$60 PL3 PL2 PL1 Dm YR Y* YI $ $50 $60 $70 QID RDO Money Market Investment Demand 15. If the goal is F.E., & the interest rate is 9%, a(an) (recess/ inflat) gap exists, the Fed should (incr/decr) the in. rate. 16. If the interest rate is 3%, a(an) (recess/inflat) gap exists, the Fed should (increase/decrease) the interest rate. 17. If the interest rate is 6%, the Fed should (incr/decr/do nothing) to the interest rate. 18. To reduce inflation, the Fed should (lower, lower, buy/raise, raise, sell) 19. To get out of a recession, the Fed should (lower, lower, buy/raise, raise, sell)

Thanks for letting this family own me and not Michael Vick.
The End

Review of Money Creation, The Fed, & Monetary Policy

Money Creation

$1,000 DD by Ashley [MS=Currency+DD of Public]
$600 to Michael Jackson for dance lessons New Deposits [New Reserves] DD New Required Reserves RR=40% DD Created By New Loans [equal to new ER] Bank $1,000.00 A $400.00 600.00 Prom date with Britney 600.00 B 600.00 $240.00 360.00 C 360.00 $144.00 216.00 Practice cigarette cessation lessons with Bruce Willis D 216.00 $86.40 129.60 PMC = ER[$800 x M[5] PMC = $1,500.00 Prom date with Napoleon Dynamite Katy’s DD PMC = TMS $1, $ = $ MS grows by multiple of 2.5

Money Supply = DD + Currency of the Public
“PMC” “PMC” “TMS” ER Loans Crea. In “Potential” $100[10% RR] [1st Bank] [1st Bank] System Total MS Banks/Public DD [$100] $ $ $ $1,000 Fed /Public/Banks DD[$100] $ $ $ $1,000 [*Fed buys bonds from public who put the money in their DD] Banks/Fed Fed Loan[$100] $ $100 $1, $1,000 [or sells bonds to Fed] “PMC” “PMC” “TMS” ER Loans Crea. In “Potential” $100 [20% RR] [1st Bank] [1st Bank] System Total MS Banks/Public DD [$100] $ $ $ $500 Fed/Public/Banks DD [$100] $ $ $ $500 [*Fed buys bonds from public who put the money in their DD] Banks/Fed Fed Loan[$100] $ $ $ $500 Short Run Long Run

Additional Practice on Money Creation
1. If the RR is 40% and the Fed buys $100 M of bonds from the public[Kate], then the MS is increased by _____. ER are increased by ______. PMC is _______. TMS would be ______. 2. RR is 50% and the Bolding Bank borrows $100 M from the Fed. As a result, RR are increased by ______. ER is increased by _______. PMC and TMS is increased by ________. 3. Recsnik Bank has DD of $400,000 and the RR is 25%. If RR and ER are equal, then TR are _______. 4. The Green Bank has ER of $60,000 & DD is $200,000. If the RR is 20%, TR are _________. 5. RR is 20% & the Fed buys $50 million of bonds from the public[Jenn]. The MS is increased by ____. ER are increased by _______. PMC is _______. TMS would be _________. $100 M $60 M $150 M $250 M $100 M $200 M $200,000 $100,000 $50 M $40 M $200 M $250 M Banks Public Fed

Hard Money Quizzes Coming Up

Commercial Bank Fed Public
Quiz 4 RR+ER=TR; TR-RR=ER; TR-ER=RR; MxER=PMC; PMC[Public]+1st DD=TMS; PMC[Fed]= TMS RR are 10% & there are no ER in the Hicks Bank. Trey deposits (DD) $ there. This one bank can increase its loans by a maximum of $______. 2. RR are 20%; the Wells Bank borrows $80,000 from the Fed. This bank can increase its loans by a maximum of $______. 3. RR are 25%; the Fed buys $8,000 of bonds from the Public[Anne M]. PMC in the banking system could be as much as $_________. 4. The Secker Dead-Dog Bank has DD of $10 million; RR are 20%; RR & ER are equal. TR are $_____________. 5. The Morell Bank, with no ER, borrows $20 M from the Fed. With a RR of 50%, PMC in the banking system could be $____. 6. RR are 40%; the Fed buys $100 M of bonds from the Public[Steve.]. Potential Money Creation in the banking system could be $____. 7. RR are 50%; the Cusimano Bank borrows $40 M from the Fed; this single bank’s ER are increased by $_______________. 8. RR are 50%; Fed buys $50 billion of bonds from the Public[Conner]. Potential Total Money Supply (TMS) could be as much as $____. 9. The RR is 40%. The Fed buys $20 M of bonds from the Rigal Bank. Potential Money Creation in the banking system is $______. 10. No ER in Gangel Bank & RR is 25%. Amy deposits $200. PMC is $___ 180.00 80,000 24,000 4 million 40 M 150 M 40 million 100 B 30 Million 600

Commercial Bank Fed Public
Quiz 5 RR+ER=TR; TR-RR=ER; TR-ER=RR; MxER=PMC; PMC[Public]+1st DD=TMS; PMC[Fed]= TMS RR are 50% & there are no ER in a Bank. Katy deposits (DD) $10.00 there. This one bank can increase its loans by ?____. 2. RR are 50%; the Kilroy Bank borrows $1 mil. from the Fed. This bank can increase its loans by a maximum of $_______. 3. RR are 40%; the Fed buys $100,000 of securities from the Public. Potential Total Money Supply could be as much as $______. 4. The Sedillo Bank has DD of $400,000 and RR is 25%. RR & ER are equal. Total Reserves are $_______________. 5. The Baker Bank, with no ER, borrows $200,000 from the Fed. With RR of 40%, this one bank can increase its loans by $_________. 6. RR are 50%; the Fed buys $60,000 of securities from the Public. Potential Money Creation in the banking system is $_______________. 7. RR are 10%; the Blasssingille Bank borrows $150 million from the Fed. This single bank’s ER are increased by $__________. 8. RR are 25%; Fed buys $200 M of securities from the Public. Potential Total Money Supply could be $_______________. 9. RR are 25% & the Fed buys $40 M of bonds from the Lawrence Bank. PMC and TMS are both $___________. 10. RR are 20% & no ER in the Montes Bank. Steph deposits $ there. PMC in the banking system is $__________. 5.00 1 million 250,000 200,000 200,000 60,000 150 million 800 million 160 million 500.00

Commercial Banks Fed Public
Quiz 6 RR+ER=TR; TR-RR=ER; TR-ER=RR; MxER=PMC; PMC[Public]+1st DD=TMS; PMC[Fed]= TMS RR are 40% & there are no ER in a Bank. Bo deposits (DD) $ there. This one bank can increase its loans by $____. 2. RR are 10%; the Eubanks Bank borrows $9 mil. from the Fed. This bank can increase its loans by a maximum of $_______. 3. RR is 50%; the Fed buys $10,000 of securities from the Public. Potential Total Money Supply could be as much as $______. 4. The Hovitz Bank has DD of $100,000 and RR is 40%. RR & ER are equal. Total Reserves are $________________. 5. The Richa Bank, with no ER, borrows $500,000 from the Fed. With RR of 20%, this one bank can increase its loans by $_____. 6. RR are 50%; the Fed buys $500,000 of securities from the Public. Potential Money Creation in the banking system is $______. 7. RR are 10%; the McGahran Bank borrows $5 million from the Fed. This single bank’s ER are increased by $____________. 8. RR are 10%; Fed buys $10 M of securities from the Public. Potential Total Money Supply is $_____________. 9. RR are 25% & the Fed buys $8 M of bonds from the Suchta Bank. Potential Money Creation in the banking system is $________. 10. RR are 20% & no ER in the Norwood Bank. Steph deposits $ there. Potential Total Money Supply is $_________. 60.00 9 million 20,000 80,000 500,000 500,000 5 million 100 million 32 million 500.00

Commercial Banks Fed Public
Quiz 7 RR+ER=TR; TR-RR=ER; TR-ER=RR; MxER=PMC; PMC[Public]+1st DD=TMS; PMC[Fed]= TMS RR are 25% & there are no ER in a Bank. Sami deposits (DD) $ there. This one bank can increase its loans by $_____. 2. RR are 10%; the McHenry Bank borrows $20 mil. from the Fed. This bank can increase its loans by a maximum of $_______. 3. RR is 40%; the Fed buys $10,000 of securities from the Public. Potential Total Money Supply could be as much as $______. 4. The Manning Bank has DD of $200,000 and RR is 40%. RR & ER are equal. Total Reserves are $________________. 5. The Flores Bank, with no ER, borrows $750,000 from the Fed. With RR of 20%, this one bank can increase its loans by $_____. 6. RR are 50%; the Fed buys $600,000 of securities from the Public. Potential Money Creation in the banking system is $______. 7. RR are 10%; the Lao Bank borrows $35 million from the Fed. This single bank’s ER are increased by $____________. 8. RR are 10%; Fed buys $50 M of securities from the Public. Potential Total Money Supply is $_____________. 9. RR are 25% & the Fed buys $40 M of bonds from the Burgess Bank. Potential Money Creation in the banking system is $________. 10. RR are 20% & no ER in the Bernet Bank. Katy deposits $ there. Potential Total Money Supply is $_________. 300.00 20 million 25,000 160,000 750,000 600,000 35 million 500 million 160 million 2,500.00

Fed buying bonds incr MS, which decr the I.R.
Monetary Policy Questions from the 2005 Macro MC Exam (60%) 44. When the U.S. government engages in deficit spending, that spending is primarily financed by a. increasing the required reserves ration b. borrowing from the World Bank c. issuing new bonds d. appreciating the value of the dollar e. depreciating the value of the dollar (75%) 45. When the Fed buys government securities on the open market, which of the following will decrease in the short run? a. Interest rates b. Taxes c. Investment d. The amount of money loaned by banks e. The money supply (57%) 46. When a central bank sells securities in the open market, which of the following set of events is most likely to follow? a. An increase in the MS, a decrease in interest rates, and an increase in AD b. an increase in the MS, an increase in interest rates, and a decrease in AD c. An increase in interest rates, an increase in the government budget deficit, and a movement toward trade surplus d. A decrease in the MS, an increase in interest rates, and a decrease in AD e. A decrease in the MS, a decrease in interest rates, and a decrease in AD Fed buying bonds incr MS, which decr the I.R.

Decr the MS to combat inflation would incr the I.R.
(41%) 47. The federal funds rate is the interest rate that a. the Fed charges the federal government on its loans b. banks charge one another for short-term loans c. banks charge their best customers d. equalizes the yield on government bonds and corporate bonds e. is equal to the inflation rate (46%) 48. Assume that the government implements a deficit-reduction policy that results in changes in aggregate income and output. Then the Fed engages in monetary policy actions that reverse the changes in income and output caused by fiscal policy action. Which of the following sets of changes in taxes, government spending, the RR, and the discount rate is most consistent with these policies? Government Required Taxes Spending Reserve Ratio Discount Rate a. Increase Increase Decrease Increase b. Increase Decrease Decrease No change c. Increase Decrease Increase Decrease d. Decrease Increase No change Increase e. Decrease Decrease Decrease Increase (53) 49. If the Fed institutes a policy to reduce inflation, which of the following is most likely to increase? a. Tax rates b. Investment c. Government spending d. Interest rates e. GDP The G would increase T and decr G to reduce the deficit which would reduce AD. To reverse this & incr AD, the Fed would decr the RR & NC the DR to lower the I.R. [decreasing the Discount Rate would have been better but is not a choice here] Decr the MS to combat inflation would incr the I.R.

Monetary Questions From 2000 AP Exam
Money and the Fed 1. (61%) In the Keynesian model, an expansionary monetary policy will lead to a. lower real interest rates and more investment b. lower real interest rates and lower prices c. higher real interest rates and lower prices d. higher real interest rates and higher real income e. higher nominal interest rates and more investment 2. (58%) Which of the following will most likely occur in an economy if more money is demanded than is supplied? a. the amount of investment spending will increase. d. interest rates will decrease b. the demand curve for money will shift to the left e. interest rates will increase. c. the demand curve for money will shift to the right. 3. (64%) When consumers hold money rather than bonds because they expect the interest rate to increase in the future, they are holding money for what purposes? a. transactions c. speculation (asset) b. unforeseen expenditures d. illiquidity When interest rates are too low, people will hold more asset (speculation) money. They don’t want to tie their money into interest rate bearing assets (like CDs & bonds) getting low returns. They will hold the speculative money until interest rates go back up. Money Creation 4. (80%) If on receiving a checking deposit of $300 a bank’s ER increased by $255, the RR must be: a. 5% b. 15% c. 25% d. 35% e. 45%

maximum amount indicated by the money multiplier when
5. (62%) The money-creating ability of the banking system will be less than the maximum amount indicated by the money multiplier when a. interest rates are high b. the velocity of money is rising c. people hold a portion of their money in the form of currency d. the unemployment rate is low 6. (71%) RR is 20%. If a bank initially has no ER and $10,000 cash is deposited in the bank, the maximum amount by which this bank may increase its loans is a. $2, b. $8, c. $10, d. $20, e. $50,000 7. (86%) RR is 15% and that bank receives a new DD of $200. Which of the following will most likely occur in the bank’s balance sheet? Liabilities(DD) Required Reserves a. increase by $200 increase by $170 b. increase by $200 increase by $30 c. increase by $200 no change d. decrease by $200 decrease by $30 e. decrease by $200 decrease by $170 The Fed and Monetary Policy 8. (89%) The Federal Reserve can increase the money supply by a. selling gold reserves to the banks b. selling foreign currency holdings c. buying government bonds on the open market d. borrowing reserves from foreign governments

following short-run effects on real interest rates and real output?
9. (73%) An increase in the money supply is most likely to have which of the following short-run effects on real interest rates and real output? Real Interest Rates Real Output a. decrease decrease b. decrease increase c. increase decrease d. increase no change e. no change increase 10. (81%) Under which of the following conditions would a restrictive (contractionary) monetary policy be most appropriate? a. high inflation d. low interest rates b. high unemployment e. a budget deficit c. full employment with stable prices 11. (82%) The Fed can change the U.S. money supply by changing the a. number of banks in operation d. prime rate b. velocity of money e. discount rate c. price level 12. (*30%) If the money stock decreases but nominal GDP remains constant, which of the following has occurred? a. income velocity of money has increased. d. price level has decreased. b. income velocity of money has decreased. e. real output has decreased. c. price level has increased.

combinations of monetary and fiscal policy actions?
13. (54%) Policy-makers concerned about fostering long-run growth in an economy that is currently in a recession would most likely recommend which of the following combinations of monetary and fiscal policy actions? Monetary Policy Fiscal Policy a. sell bonds reduce taxes b. sell bonds raise taxes c. no change raise taxes d. buy bonds reduce spending e. buy bonds no change 14. (76%) Open market operations refer to which of the following activities? a. the buying and selling of stocks in the New York stock Market b. the loans made by the Fed to member commercial banks c. the buying and selling of government securities by the Federal Reserve d. the government’s purchases and sales of municipal bonds e. the government’s contribution to net exports 15. (58%) An open market sale of bonds by the Fed will most likely change the money supply, the interest rate, and the value of the U.S. dollar in which of the following ways? Money Supply Interest Rate Value of the Dollar a. increase decrease decrease b. increase decrease increase c. decrease decrease decrease d. decrease increase increase e. decrease increase decrease Buying bonds will increase MS & decrease the interest rate, increasing Ig. Reducing T would cause a deficit, resulting in G borrowing and higher interest rates. Raising T or reducing G would result in job losses, resulting in negative profit expectations, reducing Ig [LR growth].

1995 AP Exam 16. (82%) Commercial banks can create money by
a. transferring depositors’ accounts at the Fed for conversion to cash b. buying Treasury bills from the Federal Reserve c. sending vault cash to the Fed d. maintaining a 100% reserve requirement e. lending excess reserves to customers 17. (65%) If the RR is 20%, the existence of $100 worth of ER in the banking system can lead to a maximum expansion of the money supply equal to a. $ b. $ c. $ d. $ e. $750 18. (71%) If the Fed lowers the RR, which of the following would most likely occur? a. Imports will rise, decreasing the trade deficit. b. The rate of saving will increase. c. Unemployment and inflation will both increase. d. Businesses will purchase more factories and equipment. e. The budget deficit will increase. 19. (61%) If the public’s desire to hold money as currency increases, what will the impact be on the banking system? a. Banks would be more able to reduce unemployment. b. Banks would be more able to decrease AS. c. Banks would be less able to decrease AS. d. Banks would be more able to expand credit. e. Banks would be less able to expand credit 5x$100=$500 More MS means lower I.R. & more Ig Holding currency means less ER & higher I.R.

from a new customer. The bank now has excess reserves equal to
20. (86%) Which of the combinations is most likely to cure a severe recession? Open-Market Operations Taxes Gov. Spending a. Buy securities Increase Decrease b. Buy securities Decrease Increase c. Buy securities Decrease Decrease d. Sell securities Decrease Decrease e. Sell securities Increase Increase 21. (61%) The demand for money increases when national income increases because a. spending on goods and services increases d. the MS increases b. interest rates increase e. the budget deficit increases c. the public becomes more optimistic about the future 22. (76%) Suppose the RR is 20% and a single bank with no ER receives a $100 DD from a new customer. The bank now has excess reserves equal to a. $ b. $ c. $ d. $ e. $500 23. (45%) Which of the following is most likely to increase if the public decides to increase its holding of currency? a. the interest rate d. Employment b. The price level e. The reserve requirement c. Disposable personal income 24. (47%) During a mild recession, if policymakers want to reduce unemployment by increasing investment, which of the following policies would be most appropriate? a. Equal increases in government expenditure and taxes b. An increase in government expenditure only c. An increase in transfer payments d. An increase in the reserve requirement e. Purchase of government securities by the Fed Holding MS; banks have less; higher I.R.

likely result in a decrease in AD?
25. (73%) Which of the following monetary and fiscal policy combinations would most likely result in a decrease in AD? Discount Rate Open-Market Operations Gov. Spending a. Lower Buy bonds Increase b. Lower Buy bonds Decrease c. Raise Sell bonds Increase d. Raise Buy bonds Increase e. Raise Sell bonds Decrease 26. (35%) Under which of the following circumstances would increasing the MS be most effective in increasing real GDP? Interest Rates Employment Business Optimism a. High Full High b. High Less than full High c. Low Full High d. Low Full Low e. Low Less than full Low 27. (57%) According to both monetarists and Keynesians, which of the following happens when the Fed reduces the discount rate? a. The demand for money decreases and market interest rates decrease. b. The demand for money increases and market interest rates increase. c. The supply of money increases and market interest rates decrease. d. The supply of money increases and market interest rates increase. e. Both the demand for money and the MS increase and market interest rates increase. 28. (79%) All of the following are components of the MS in the U.S. EXCEPT a. paper money b. gold bullion c. checkable deposits d. coins e. demand deposits

fiscal policy changes, it should
29. (47%) If the Fed undertakes a policy to reduce interest rates, international capital flows (financial capital like CDs, bonds) will be affected in which of the following ways? a. Long-run capital outflows from the U.S. will decrease. b. Long-run capital inflows to the U.S. will increase. c. Short-run capital outflows from the U.S. will decrease. d. Short-run capital inflows to the U.S. will decrease. e. Short-run capital inflows to the U.S. will not change. 30. (73%) If the Fed wishes to use monetary policy to reinforce Congress’ fiscal policy changes, it should a. increase the MS when government spending is increased b. increase the MS when government spending is decreased c. decrease the Ms when government spending is increased d. increase interest rates when government spending is increased e. decrease interest rates when government spending is decreased Lower U.S. interest rates will result in fewer capital inflows This would keep the interest rate from going up.

Home of the 7 Board of Governors Ben Bernanke

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