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

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

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

4 Real GDP PL SRAS AD 2 YRYRYRYR YFYFYFYF [Incr G; Decr T][ But we get negative Xn] P L1 AD 1 PL 2 G ADY/Empl./PL; G LFM I.R. T DIDIDIDICAD Y/Emp/PL; TLFM IRIRIRIR Start from a Balanced Budget G & T = $2 Trillion $2 tr. I cant get a job. N ow, this is better. G T G T E1E1E1E1 E2E2E2E2 LRAS D1D1D1D1 D2D2D2D2S Loanable Funds Market r =6 % r =8 % Real In. Rate F1F1F1F1 F2F2F2F2 $2 tr. $2.2 tr. $2.2 $2.2 $1.8 $1.8

5 Y R DMDMDMDM Investment Demand Nominal Interest Rate Money Market QID1 MS 1 AS AD 1 PL 1 8% 8% 6% 4% 0 MS 2 AD 2 PL 2 If there is a RECESSION MS will be increased. QID2 DIDIDIDI Y* Buy B onds MS I.R.QID AD Y / E mp/ PL Real GDP Buy E1E1E1E1 E2 6% Fed PL I want a job as a Rockette

6 $2 T tril. Real GDP PL SRAS AD 2 YIYIYIYI YFYFYFYF [Decr G; Incr T ] [Again, we get negative Xn] P L1 AD 1 PL 2 G ADY/Empl./PL; G LFM I.R. T DIDIDIDICAD Y/Emp/PL; TLFM IRIRIRIR Start from a Balanced Budget G & T = $2 Trillion $2 tril. G T G T [like we have money trees] E1E1E1E1 E2E2E2E2 LRAS Loanable Funds Market r =3 % r =6 % D1D1D1D1 D2D2D2D2 F1F1F1F1 F2F2F2F2 S $2.2 T tril. $1.8 tril.. $ 1.8 $2.2 $2.2 Real In. Rate

7 If there is INFLATION, MS will be decreased. Y I Y/E mpl. /PL DIDIDIDI AD 1 PL DmDmDmDm Investment Demand Nominal Interest Rate 10 % 8% 6% 0 Money Market QID 2 AS AD 2 PL 2 MS 1 PL 1 MS 2 Sell QID 1 Y*Y*Y*Y* Its cheaper to burn money than wood. SellBonds MSI.R. QID AD like money treesmoney trees E1E1E1E1 E2E2E2E2 Fed

8 0 Real GDP AD 1 AD 2 AS 1 AS 2 PL 2 PL 3 Y* 1 Y2Y2 Y3Y3Y3Y3 Can sustain a much greater increase in AD if the AS curve is also shifting to the right, due to increasing productivity also shifting to the right, due to increasing productivity. Economys Speed Limit at F ull E mployment is 4 %, instead of 2.5 %. In the early 90s, at FE, 2.5% was the speed limit. AS shifted slowly due to low productivity. So, at FE, the goldilocks economy has expanded. PL 1 4% Real GDP under 4% 17 increases Goldilocks Economy [not too fast or slow] Increasing productivity of the late 90s allowed more growth at FE GDP.

9 – Americas Main Stabilization ToolInflation NominalInterestRate

10 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 Recession NominalInterestRate

11 ASSETS Securities [90%]Securities [90%] Loans to Commercial BanksLoans to Commercial Banks LIABILITIES Reserves of Commercial BanksReserves of Commercial Banks Treasury DepositsTreasury Deposits Federal Reserve Notes [90%]Federal Reserve Notes [90%]

12 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 K ingdom Bank of England Mexico Banco de Mexico (Mex Bank) Sweden Sveriges Ribsbank [Nobel Pr.] U.S. F ederal R eserve S ystem [ Fed ] Assets [own] Liabilities [owe] Assets [own] Liabilities [owe] Securities*758,551 Reserves of commercial banks $14,923 Treasury deposits 4,463 Treasury deposits 4,463 L oans to C ommercial B anks 19,250 Federal Reserve Notes *754,567 [when these notes are in circulation, they [when these notes are in circulation, they constitute claims against assets of the Fed] constitute claims against assets of the Fed] All other assets 59,967 All other liabilities & net worth 63,615 Total$837,768 Total $837,768

13 $ % The Fed controls the banks ability to create new money to ensure the economy doesnt get too much money, nor too little. Overfed Fed just right $75.00 Money Prices Underfed And – so it is with money. Not too much, not too little.

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

15 Y R Real GDP DMDMDMDM I nvestment Demand Nominal Interest Rate Money Market Q I D1 MS 1 AS P1P1 MS 2 P2P2 Price level Buy If there is RECESSION MS will be increased. Q I D2 DIDIDIDI Y* Easy Money – (Buy/Sell) bonds, which (increase/decrease) MS, which (increase/decrease) interest rates, which (appreciate/depreciate) the dollar, which (increase/decrease) C, I g, & Xn, which (increase/decrease ) AD & therefore, PL, GDP, & emp. E1E1E1E1 E2E2E2E2 AD 2 Jobs are tough to get. LRAS Students, should the Fed buy or sell bonds to jumpstart this economy? AD 1 [ C+Ig+G+Xn] [ C+Ig+G+Xn]

16 InvestmentDemand DIDIDIDI AD 1 Y I DmDmDmDm Nominal Interest Rate Money Market QID 2 AS P2P2P2P2 MS 1 P1P1P1P1 MS 2 If there is INFLATION, MS will be decreased. Sell QID 1 Y*Y*Y*Y* 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. E1E1E1E1 E2E2E2E2 AD 2 Now, should I buy or sell? Ill get rid of some money. LRAS

17 Y * Investment Demand 6 % 0 Money Market $60 ASASASAS 6 % 0 MS 2 AD 2 PL 2 DIDIDIDI DmDmDmDm QIDQIDQIDQID I =$60 RDO Ideal Economy 1.MS is at 120 billion, putting the 2.Interest rates at 6%, and 3.Investment is at $60 billion.

18 Y R Investment Demand 9 % 0 Money Market $50 ASAS AD 1 PL 1 9 % 0 MS 2 AD 2 PL 2 DIDI DmDmDmDm MS 1 $100 $100 QID I =$50] I =$60 RDO Recessionary Gap $100$1209%6%, Increase MS from $100 to $120, which lowers the I.R. from 9% to 6%, $50$60AD 1 AD 2 which increases QID from $50 to $60, which increases AD from AD 1 to AD 2. 6%6%6%6% 6%6%6%6% $120 $60 Y*Y*Y*Y*

19 Y * Y * Investment Demand 3 % 0 Money Market $60 $60 AS 3 % 0 MS 2 AD 2 PL 2 $70 YIYIYIYI AD 3 DIDI DmDmDmDm PL 3 MS 3 $140 QIDQIDQIDQID I =$60 I =$70 RDO Inflationary Gap $140$1203%6%. D ecrease MS from $140 to $120, which increases the I.R. from 3% to 6%. $70$60AD3AD2 which decreases QID from $70 to $60, which decreases AD from AD3 to AD2. 6%6%6%6% 6%6%6%6% $120

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

21 Discount Rate 1. Discount Rate – when banks borrow from the Fed. [Symbolic] Reserve Ratio 2. Reserve Ratio – how much of demand deposits that have to be kept in reserve and cant be loaned out. [Currently 10%] Buyingrecession gapselling inflation gapsecurities 3. Buying [recession gap] and selling [inflation gap] of securities.

22 1. 1. Open Market Operations [at first this was used just to increase bank earnings] [at first this was used just to increase bank earnings] - nuts & bolts - nuts & bolts of M onetary P olicy [main tool] $60-$70 billion - $60-$70 billion every day

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

24 Reserve Requirement Example Reserve Requirement Example $500 billion in DD Suppose the banking system has $500 billion in DD. RR is 12% $60 billion12% The RR is 12% & TR are $60 billion, which is 12% of $500 billionDDno ER the $500 billion DD. So, there are no ER. Fed lowers the RR to 10% Now, the Fed lowers the RR to 10%. Now banks are required to keep only $50 billion $10 billion required to keep only $50 billion in RR. So, $10 billion more ER more ER is available to loan out. $10 billion X 10 = $100 billion in new DD $10 billion X 10 = $100 billion in new DD. 20% increase MS [DD]$500 to $600 So, 20% increase MS [DD] from $500 to $600 billion. Atomic Bomb of Monetary Policy

25 $10,000[$9,000+$1,000] [In 1980, the RR was set at 12 % ; stayed there until 1992; went to 10 % ] E asy M oney E asy M oney AS AD 1 AD 2 Y R Y * PL PL $1,000Initialdeposit $900[$900x10]$1,000 $810 $729 Monetary Expansion [10% RR] [1/.10=10] Easy Money Easy Money – increase the money supply Easy Money – increase the money supply

26 $5,000[$4,000+$1,000] Tight Money - decrease the money supply Tight Money - decrease the money supply Monetary Expansion (20% RR) [1/.20=M D of 5] Tight Money $1,000Initialdeposit $800 $640 $512 PL PL Y * Y I Y * Y I AD 2 AD 1 AS

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

28 Uppercut

29 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 After the recession, the unemployment rate still increased.

30 08 EasyMoney TightMoney EasyMoney 2.00% April, 2008

31 Relative Importance of Monetary Policy Relative Importance of Monetary Policy WWII Fed targeted theinterest rate A. WWII – Fed targeted the interest rate not the growth of MS Fed targeted thegrowth of the MS B – Fed targeted the growth of the MS not the in. rate Present Fed targetstheinterest rate C Present - Fed targets the interest rate, not the MS. Discount Ratenot a primary tool 1. Discount Rate – not a primary tool of monetary policy. announcement effect. It does have an announcement effect. Reserve Requirement10 changed one time in 2 decades 2. Reserve Requirement (10%)- has changed one time in 2 decades seldom used (12% to 10% in 1992). It would affect bank profits so is seldom used. Open-market operations 3. Open-market operations – evolved as the most effective tool of flexibility monetary policy because of flexibility. Securities can be bought or sold in large amounts & their impact on reserves is very prompt. Did it work?

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

33 Keynesians the Also, the Keynesians dont think the lower interest rate is as important as profit expectations. Y * Y R Y * D m(K) Investment Demand 10 % 8 % 6 % 0 Money Market QID 1 QID 2 Monetarist View of Transmission Mechanism v. Keynesian View ASAS AD 1 PL % 6 % 0 MS 2 AD 2 PL 2 YIYIYIYI D m is more inelastic I.R. moresensitive [I.R. more sensitive] QID 2 D I is more elastic or moreresponsive [or more responsive] AD 2(M) D I(K) D I(M) D m(M ) (K) PL 2 Mainly, we end up just getting inflation. MS 1 K eynesian view steep K eynesian view is that D I is rather steep so monetary F iscal policy top banana. policy is not that strong. F iscal policy is top banana. AS AD 1 AD 2

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

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

36 targets the Federal funds rate follow a rule first John Taylor of StanfordThe 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. Taylor Rule assumes a 2% target rate three partsThe Taylor Rule assumes a 2% target rate of inflation and has three parts. GDP rises by 1% above potential GDP ½ a percentage point 1. If real GDP rises by 1% above potential GDP, the Fed should raise the Federal funds rate by ½ a percentage point. inflation rises by 1% above its target of 2% 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. real GDP is equal to potential GDPinflation is equal to its target rate of 2%remain at about 4% real interest rate of 2% 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%. reversible for situations in which the real GDP falls below potential GDPrate of inflation falls below 2%These rules are reversible for situations in which the real GDP falls below potential GDP and the rate of inflation falls below 2%. Fed is free to diverge from the Taylor Ruleafter 9/11The Fed is free to diverge from the Taylor Rule, like after 9/11.

37 Fiscal Policy Fiscal Policy RecessionInflation Increase GDecrease G Decrease TIncrease T Monetary Policy Monetary Policy Recession Inflation Lower D. Rate Raise D. Rate Lower R. Rate Raise R. R atio Buy Bonds Sell Bonds Easy Money Tight M oney Easy Money Tight M oney

38 Discount Rate The Reserve Ratio Open Market Operations Easy Money Policy Lower Discount Rate Lower Reserve Ratio Buy Bonds Easy Money Fed

39 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

40 3 tools of monetary policy 48. The 3 tools of monetary policy are open market operations, changes in RR, & (changes in T/changes in G/ changes in discount rate). main tool of the Fed 49. T he main tool of the Fed in regulating the MS is (open-market operations/DR/RR). Fe d PUBLICDD 50. When the Fe d [ ] sells securities to the PUBLIC [ ], DD (dont change/incr/decr) & banking system RR, ER & TR (incr/decr). Fed commercial banks 51. When the Fed [ ] buys securities from commercial banks[ ], DD (dont change/increase/decrease) & ER and TR (increase/decrease). commercial bankingsystem Fed 52. W hen the commercial banking system[ ] borrows from the Fed, DD (dont change/increase/decrease) but ER & TR (incr/decr). commercial banks Fed 53. When commercial banks [ ] sell government bonds to the Fed [ ], DD (dont change/incr/decr) but their ER & TR (do not change/incr/decr). PUBLIC Fed 54. When the PUBLIC [ ] buys securities from the Fed [ ], DD (dont change/incr/decr) and RR, ER, & TR of banks (dont change/incr/decr). commercial bank Fed 55. When a commercial bank gets a loan from the Fed, their lending ability (incr/decr). Thunder Bank 56. Assume that the RR is 25% & the Thunder Bank borrows $100,000 from the Fed 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 down payment on stock purchases size of the down payment on stock purchases. Fed were to increase the RR [10% to 20%] 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] NS ( MS = DD + Currency of Public ) 100, ,000400,000

41 RR is increased [10 % to 50 % ] 59. When the RR is increased [10 % to 50 % ], the ER of member banks are (increased/decreased) and the monetary multiplier is (incr/decr). Fed 60. Assume the RR is 25% & the Fed [ ]buys $4 M of bonds from the public [ ] public [ ]. The MS is increased by ($3/$4/) m illion and the PMC is increased by ($16/$12) mil. P otential TMS is ($3/$4/$12/$16) mil. Fed commercial banks [ ] 61. When the Fed lends to commercial banks [ ], this is called the commercial banks (Fed Funds Rate/discount rate) and when commercial banks make loans to one another, this is the (Fed Funds Rate/ Discount Rate). cause-effect chain of aneasy money policy 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) I g, C, Xn, & Y. Fed were to buy government securitiesin the open market 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. Fed were reducing demand-pull inflation 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. Monetary policy is thought to be more effective 65. Monetary policy is thought to be more effective in (controlling inflation/ fiscal is more effective fighting depressions) and fiscal is more effective (controlling inflation/ fighting depressions). net export effecteasy money policy 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

42 Y R Y * Investment Demand 9 % 6% 3 % 0 Money Market $50$60 $50 $60 ASAS AD 1 PL 1 9 % 6 % 3 % 0 MS 2 AD 2 PL 2 $70 YIYIYIYI AD 3 DIDI DmDmDmDm PL 3 MS 1 MS 3 $ $ QIDQIDQIDQID I =$50] I =$60 I =$70 RDO 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). (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). (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. (buying/selling) bonds. 70. If the MS is MS2 and the goal of the Fed is FE GDP of Y*, they should (increase/decrease/dont change) the Ms. (increase/decrease/dont change) the Ms. NS 67-70

43 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. 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) 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 bonds. Proper fiscal policy would be to (incr/decr) G & (incr/decr) T, both of which would result in a bugetary (deficit/surplus). which would result in a bugetary (deficit/surplus). NS 71-72

44 bank Fed 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 __________. Fed public 2. If the RR is 50% & the Fed buys $100 mil. of securities from the public, MS then: MS is increased by ________. PMC is _________. TMS is ________. Dt(& total demand) for money curve to shift right 3. What will cause the Dt(& total demand) for money curve to shift right? (increase/decrease) in nominal (money) Y? Fedbuys bonds from banks 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). Fed public 5. If the Fed buys $10 million of securities from the public, with a RR of MS 40%, MS is increased by ________ & PMC is _________. TMS is ________. Fed RR from 20% to 10% 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. commercial banking system 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). estimating your expensesfor the prom at $3, 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). Money, Banking, & Fed Test Review 1-8 No No Yes $500,000 $500,000 $100 mil. $200 mil. $10 mil. $15 mil. $25 mil.

45 Y R Real GDP DMDMDMDM I nvestment Demand Nominal Interest Rate Money Market Q I D1 MS 1 AS P1P1 MS 2 P2P2 Price level Buy If there is RECESSION MS will be increased. Q I D2 DIDIDIDI Y* 9.Easy Money – (Buy/Sell) bonds, which (increase/decrease) MS, which (increase/decrease) interest rates, which (appreciate/depreciate) the dollar, which (increase/decrease) C, I g, & Xn, which (increase/decrease ) AD & therefore, PL, GDP, & emp. E1E1E1E1 E2E2E2E2 AD 2 Jobs are tough to get. LRAS Students, should the Fed buy or sell bonds to jumpstart this economy? AD 1 [ C+Ig+G+Xn] [ C+Ig+G+Xn]

46 InvestmentDemand DIDIDIDI AD 1 Y I DmDmDmDm Nominal Interest Rate Money Market QID 2 AS P2P2P2P2 MS 1 P1P1P1P1 MS 2 If there is INFLATION, MS will be decreased. Sell QID 1 Y*Y*Y*Y* 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. E1E1E1E1 E2E2E2E2 AD 2 Now, should I buy or sell? Ill get rid of some money. LRAS

47 RR is 20% Assets DD (Liabilities) TR[RR+ER]=$20 mil. $100 million TR[RR+ER]=$20 mil. $100 million 1.How much can this bank loan out? $______ Pam Anderson$1, If Pam Anderson puts $1,000 in this bank DD 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 $________.0 $1,000 4,000 5,000 MS = Currency + DD of PUBLIC 800

48 RR is 20% Assets DD (Liabilities) TR[RR+ER] = $20 mil. $100 million TR[RR+ER] = $20 mil. $100 million 11. How much can loan out? $______ 11. How much can Pams bank loan out? $______ Fed 12. If Pam Andersons 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 $________.0 1,000 5,000 5,000 5,000 TR MS = Currenc y + DD of PUBLIC Pam Andersons Bank Fed

49 RR is 25% Assets DD (Liabilities) TR[RR+ER]=$25 mil. $100 million TR[RR+ER]=$25 mil. $100 million 1.How much can this loan out? $______ 1.How much can this bank loan out? $______ Pam Anderson $4, If Pam Anderson puts $4,000 in this DD 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 $________. 0 $4,000 12,000 16,000 MS = Currency + DD of Public 3,000

50 RR is 40% Assets DD (Liabilities) TR[RR+ER]=$40 mil. $100 million TR[RR+ER]=$40 mil. $100 million 1. How much can this bank loan out? $______ Cameron Diaz $10,000 DD 2. If Cameron Diaz puts $10,000 in this bank ( DD ), 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 $_________.0 10,000 15,000 25,000 Extra Practice MS = Currency + DD of PUBLIC 6,000

51 RR is 50% Assets DD (Liabilities) TR[RR+ER] = $50 mil. $100 million TR[RR+ER] = $50 mil. $100 million 11. How much can loan out? $______ 11. How much can Camerons bank loan out? $______ Fed 12. If Cameron Diazs 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 0 5,000 10,000 10,000 Cameron Diazs Bank Fed

52 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. 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. the Fed should (increase/decrease) the interest rate. 17. I f the interest rate is 6% the Fed shoul d (incr/decr/do nothing) 17. I f the interest rate is 6%, the Fed shoul d (incr/decr/do nothing) to the interest rate. 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) Y R Y * Investment Demand 9 % 6% 3 % 0 Money Market $50$60 $50 $60 ASAS AD 1 PL 1 9 % 6 % 3 % 0 MS 2 AD 2 PL 2 $70 YIYIYIYI AD 3 DIDIDIDI DmDmDmDm PL 3 MS 1 MS 3 $ $ QIDQIDQIDQID I =$50] I =$60 I =$70 RDO

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

54 Review of Money Creation, The Fed, & Monetary Policy

55

56 $1, MS = Currency + DD of Public $1,000 DD by Ashley [ MS = Currency + DD of Public ] MS MS grows by 2.5 multiple of Katys DD + PMC = TMS $ $ $ $86.40 $1, $ = $ $1, PMC = ER[$800 x M[5] PMC = New Deposits [New Reserves] DD New Required ReservesRR=40% DD Created By New Loans [equal to new ER] Bank A B C D $600 to Michael Jackson for dance lessons Prom date with Britney P ractice cigarette cessation lessons with Bruce Willis Prom date with Napoleon Dynamite

57 Money Supply = DD + Currency of the Public PMC PMCTMS ER Loans C rea. I n Potential $100[ 10 % RR] $100[ 10 % RR] [1 st Bank] [1 st Bank] System Total MS Banks / Public DD [$100] $90 $90 $900 $1,000 Fed / Public / B anks DD [$100] $90 $90 $900 $1,000 [* Fed buys bonds from public who put the money in their DD ] [* Fed buys bonds from public who put the money in their DD ] B anks / Fed Fed L oan [$ 100 ] $100 $100 $1,000 $1,000 [or sells bonds to Fed ] [or sells bonds to Fed ] PMC PMC TMS PMC PMC TMS ER Loans C rea. In Potential ER Loans C rea. In Potential $100 [ 20 % RR] [1 st Bank] [1 st Bank] System Total MS Banks / Public DD [$100] $80 $80 $400 $500 Fed / Public / B anks DD [$100] $80 $80 $400 $500 [* Fed buys bonds from public who put the money in their DD ] [* Fed buys bonds from public who put the money in their DD ] Banks / Fed Fed L oan [$100] $100 $100 $500 $500 [or sells bonds to Fed ] [or sells bonds to Fed ]

58 Fed 1. If the RR is 40% and the Fed buys $100 M of bonds from public [Kate] MS the public [Kate], then the MS is increased by _____. ER are increased by ______. PMC is _______. TMS would be ______. Bolding Bank 2. RR is 50% and the Bolding Bank borrows $100 M from the Fed Fed. As a result, RR are increased by ______. ER is increased by _______. PMC and TMS is increased by ________. RecsnikBank DD 3. Recsnik Bank has DD of $400,000 and the RR is 25%. If RR and ER are equal, then TR are _______. Green Bank 4. The Green Bank has ER of $60,000 & DD is $200,000. If the RR is 20%, TR are _________. Fed 5. RR is 20% & the Fed buys $50 million of bonds from the public [Jenn]. MS public [Jenn]. The MS is increased by ____. ER are increased by _______. PMC is _______. TMS would be _________. Additional Practice on Money Creation $100 M $60 M $150 M $250 M $100 M $200 M $200,000 $100,000 $50 M $40 M $200 M $250 M 0 Banks Public Fed

59 Hard Money Quizzes Coming Up

60 1.RR are 10% & there are no ER in the Hicks Bank. Trey deposits ( DD ) $ there. This one bank can increase deposits ( DD ) $ there. This one bank can increase its loans by a maximum of $______. 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 $______. 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 $_________. 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 $_____________. 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 $____. 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. ]. P otential M oney C reation in the banking system could be $____. P otential M oney C reation in the banking system could be $____. 7. RR are 50%; the Cusimano Bank borrows $40 M from the Fed; this single banks ER are increased by $_______________. this single banks ER are increased by $_______________. 8. RR are 50%; Fed buys $50 billion of bonds from the Public [Conner]. P otential T otal M oney Supply (TMS) could be as much as $____. P otential T otal M oney Supply (TMS) could be as much as $____. 9. The RR is 40%. T he Fed buys $20 M of bonds from the Rigal B ank. Potential Money Creation in the banking system is $______. Potential Money Creation in the banking system is $______. 10. No ER in Gangel B ank & RR is 25 %. Amy deposits $ 200. PMC is $___ Commercial Bank Fed Public Commercial Bank Fed Public ,000 24,000 4 million 40 M 150 M 40 million 100 B 30 M illion 600 RR+ER=TR; TR-RR=ER; TR-ER=RR; MxER=PMC; PMC[ Public ]+1 st DD =TMS; PMC[Fed]= TMS

61 Commercial Bank Fed Public Commercial Bank Fed Public 1.RR are 50% & there are no ER in a Bank. Katy deposits ( DD ) $10.00 there. This one bank can increase its loans by ?____. $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 $_______. 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 $______. 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 $_______________. RR & ER are equal. Total Reserves are $_______________. 5. T he Baker Bank, with no ER, borrows $200,000 from the Fed. With RR of 40%, this one bank can increase its loans by $_________. 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 $_______________. Potential Money Creation in the banking system is $_______________. 7. RR are 10%; the Blasssingille Bank borrows $150 million from the Fed. This single banks ER are increased by $__________. Fed. This single banks ER are increased by $__________. 8. RR are 25%; Fed buys $200 M of securities from the Public. Potential Total Money Supply could be $_______________. Potential Total Money Supply could be $_______________. 9. RR are 25% & the Fed buys $40 M of bonds from the L awrence Bank. PMC and TMS are both $___________. PMC and TMS are both $___________. 10. RR are 20% & no ER in the Montes Bank. Steph deposits $ there. PMC in the banking system is $__________. $ there. PMC in the banking system is $__________ million 250, , ,000 60, million 800 million 160 million RR+ER=TR; TR-RR=ER; TR-ER=RR; MxER=PMC; PMC[ Public ]+1 st DD =TMS; PMC[Fed]= TMS

62 1.RR are 40% & there are no ER in a Ban k. Bo deposits ( DD ) $ there. T his can increase its loans by $____. $ there. T his 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 $_______. 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 $______. 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 $________________. RR & ER are equal. Total Reserves are $________________. 5. T he Richa Bank, with no ER, borrows $500,000 from the Fed. W ith RR of 20%, this one bank can increase its loans by $ _____. W ith 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 $______. Potential Money Creation in the banking system is $______. 7. RR are 10%; the McGahran Bank borrows $5 million from the Fed. This single banks ER are increased by $____________. Fed. This single banks ER are increased by $____________. 8. RR are 10%; Fed buys $10 M of securities from the Public. Potential Total Money Supply is $_____________. 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 $________. Potential Money Creation in the banking system is $________. 10. RR are 20% & no ER in the Norwood Bank. Steph deposits $ there. P otential Total Money Supply is $_________. $ there. P otential Total Money Supply is $_________. Commercial Banks Fed Public Commercial Banks Fed Public million 20,000 80, , ,000 5 million 100 million 32 million RR+ER=TR; TR-RR=ER; TR-ER=RR; MxER=PMC; PMC[ Public ]+1 st DD =TMS; PMC[Fed]= TMS

63 1.RR are 25% & there are no ER in a Ban k. Sami deposits ( DD ) $ there. T his can increase its loans by $_____. $ there. T his one bank can increase its loans by $_____. 2. RR are 10%; the McHenry Bank b orrows $20 mil. from the Fed. This bank can increase its loans by a maximum of $_______. 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 $______. 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 $________________. RR & ER are equal. Total Reserves are $________________. 5. T he Flores Bank, with no ER, borrows $750,000 from the Fed. W ith RR of 20%, this one bank can increase its loans by $ _____. W ith 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 $______. Potential Money Creation in the banking system is $______. 7. RR are 10%; the Lao Bank borrows $35 million from the Fed. This single banks ER are increased by $____________. Fed. This single banks ER are increased by $____________. 8. RR are 10%; Fed buys $50 M of securities from the Public. Potential Total Money Supply is $_____________. 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 $________. Potential Money Creation in the banking system is $________. 10. RR are 20% & no ER in the Bernet Bank. Katy deposits $ there. P otential Total Money Supply is $_________. $ there. P otential Total Money Supply is $_________. Commercial Banks Fed Public Commercial Banks Fed Public million 25, , , , million 500 million 160 million 2, RR+ER=TR; TR-RR=ER; TR-ER=RR; MxER=PMC; PMC[ Public ]+1 st DD =TMS; PMC[Fed]= TMS

64 Monetary Policy Questions from the 2005 Macro MC Exam Monetary Policy Questions from the 2005 Macro MC Exam (60%) U.S. government engages in deficit spending (60%) 44. When the U.S. government engages in deficit spending, that spending is financed by 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%) Fed buys government securities (75%) 45. When the Fed buys government securities on the open market, decrease in the shortrun 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%) central bank sells securities (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.

65 (41%) federal funds rate (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%) government implements a deficit-reduction policy (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 actionsreverse the changes monetary policy actions that reverse the changes in income and output caused by taxesgovernment fiscal policy action. Which of the following sets of changes in taxes, government spendingRRdiscount rate spending, the RR, and the discount rate is most consistent with these policies? GovernmentRequired TaxesSpendingReserve RatioDiscount Rate a. IncreaseIncreaseDecrease Increase b. IncreaseDecreaseDecreaseNo change c. IncreaseDecreaseIncreaseDecrease d. DecreaseIncreaseNo changeIncrease e. DecreaseDecreaseDecreaseIncrease (53) Fed institutes a policy to reduce inflation (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.

66 Monetary Questions From 2000 AP Exam Money and the Fed Keynesian modelexpansionary monetary policy 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 more money is 2. (58%) Which of the following will most likely occur in an economy if more money is demanded than is supplied 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 lefte. interest rates will increase. c. the demand curve for money will shift to the right. hold money rather than bonds because they expect the 3. (64%) When consumers hold money rather than bonds because they expect the interest rate to increase in the future interest rate to increase in the future, they are holding money for what purposes? a. transactionsc. speculation (asset) b. unforeseen expendituresd. illiquidity Money Creation checking deposit of $300 a banks ER increased by $ (80%) If on receiving a checking deposit of $300 a banks ER increased by $255, RR the RR must be: a. 5% b. 15% c. 25% d. 35% e. 45% When interest rates are too low, people will hold more asset (speculation) money. They dont 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.

67 money-creating ability of the banking systemwill be less than the 5. (62%) The money-creating ability of the banking system will be less than the maximum amount indicated by the money multiplier 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 $10,000 cash is deposited 6. (71%) RR is 20%. If a bank initially has no ER and $10,000 cash is deposited in the this bank may increase its loans bank, the maximum amount by which this bank may increase its loans is a. $2,000 b. $8,000 c. $10,000 d. $20,000 e. $50, (86%) RR is 15% and that bank receives a new DD of $200. Which of the following will most likely occur in the banks balance sheet? Liabilities(DD)Required Reserves a. increase by $200increase by $170 b. increase by $200increase by $30 c. increase by $200no change d. decrease by $200decrease by $30 e. decrease by $200decrease by $170 FedMonetary Policy The Fed and Monetary Policy Federal Reserve 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

68 increase in the money supply 9. (73%) An increase in the money supply is most likely to have which of the short-run effects on real interest rates and real output following short-run effects on real interest rates and real output? Real Interest RatesReal Output a. decrease decrease b. decrease increase c. increase decrease d. increase no change e. no change increase restrictive (contractionary) 10. (81%) Under which of the following conditions would a restrictive (contractionary) monetary policy 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 Fedchange the U.S. money supply 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 *money stock decreases but nominal GDP remains constant 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.

69 13. (54%) Policy-makers concerned about fostering long-run growth in an economy that recessionrecommend is currently in a recession would most likely recommend which of the following combinations of monetary and fiscal policy actions combinations of monetary and fiscal policy actions? Monetary PolicyFiscal 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 Open market operations 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 governments purchases and sales of municipal bonds e. the governments contribution to net exports open market sale of bonds by theFed 15. (58%) An open market sale of bonds by the Fed will most likely change the money supplyinterest ratevalue of the U.S. dollar money supply, the interest rate, and the value of the U.S. dollar in which of the following ways? Money SupplyInterest RateValue 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].

70 1995 AP Exam Commercial banks can create money 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 RR is 20%existence of $100 worth of ER 17. (65%) If the RR is 20%, the existence of $100 worth of ER in the banking system maximum expansion of the money supply can lead to a maximum expansion of the money supply equal to a. $20 b. $100 c. $300 d. $500 e. $750 Fed lowers the RRmost likely occur 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. publics desire to hold money as currency increases 19. (61%) If the publics desire to hold money as currency increases, what will the impact be on the banking system 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 More MS means lower I.R. & more Ig Holding currency means less ER & higher I.R. 5x$100=$500

71 combinationscure a severe recession 20. (86%) Which of the combinations is most likely to cure a severe recession? Open-Market OperationsTaxesGov. Spending a. Buy securitiesIncreaseDecrease b. Buy securitiesDecreaseIncrease c. Buy securitiesDecreaseDecrease d. Sell securitiesDecreaseDecrease e. Sell securitiesIncrease Increase demand for moneynational income increases 21. (61%) T he demand for money increases when national income increases because a. spending on goods and services increasesd. the MS increases b. interest rates increasee. the budget deficit increases c. the public becomes more optimistic about the future RR is 20%single bank with no ER receives a $100 DD 22. (76%) Suppose the RR is 20% and a single bank with no ER receives a $100 DD bank now has excess reserves equal to from a new customer. The bank now has excess reserves equal to a. $20 b. $80 c. $100 d. $400 e. $500 most likely to increasepublic decides to 23. (45%) Which of the following is most likely to increase if the public decides to increase its holding of currency increase its holding of currency? a. the interest rated. Employment b. The price levele. The reserve requirement c. Disposable personal income mild recessionreduce unemployment by 24. (47%) During a mild recession, if policymakers want to reduce unemployment by increasing investment 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.

72 monetary and fiscal policy combinations 25. (73%) Which of the following monetary and fiscal policy combinations would most likely result in a decrease in AD? Discount RateOpen-Market OperationsGov. Spending a. LowerBuy bondsIncrease b. LowerBuy bondsDecrease c. Raise Sell bondsIncrease d. RaiseBuy bondsIncrease e. RaiseSell bondsDecrease increasing the MS be 26. (35%) Under which of the following circumstances would increasing the MS be most effective in increasing real GDP most effective in increasing real GDP? Interest RatesEmploymentBusiness Optimism a. HighFullHigh b. HighLess than fullHigh c. LowFullHigh d. LowFullLow e. LowLess than fullLow monetaristsKeynesians 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. Allare components of the MSEXCEPT 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

73 Fed undertakes a policy to reduce interest ratesinternational capital 29. (47%) I f the Fed undertakes a policy to reduce interest rates, international capital flowswill be affected 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. Fedwishes to use monetary policy to reinforce Congress 30. (73%) If the Fed wishes to use monetary policy to reinforce Congress fiscal policy changes 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 This would keep the interest rate from going up. Lower U.S. interest rates will result in fewer capital inflows


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