Transcript Chapter 15 Monetary Policy

Monetary Policy
The “Fed”
Fed Chairman
Home of the 7 Board of Governors Ben Bernanke
 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.”
Start from a
PL
Balanced Budget
G & T = $2 Trillion
$2.2 tr.
$2 tr.
G
$2 tr. PL2
T
SRAS
AD2LRAS
AD1
D2
S
D1
r=8%
r=6%
F1 F2
“Now, this is better.”
“I can’t
get a job.”
PL1
Real In. Rate
[Incr G; Decr T][But we get negative Xn]
Loanable Funds Market
E1
E2
YR YF
Real
$2.2 GDP
$2.2
G
AD
Y/Empl./PL;
I.R.
$1.8
$1.8
T
LFM
G
DI
C
AD
Y/Emp/PL; T
LFM
IR
Nominal Interest Rate
If there is a
RECESSION
MS will be
increased.
DM MS1 MS
2
8%
8
6%
6%
4%
4
0
PL
Buy
Money Market
AD
AD
1
2
0
AS
Investment
Demand
QID1 QID2
I want a job
as a Rockette
PL2
PL1
E2
E1
Real GDP
Fed
Buy
Bonds
DI
MS
YR
I.R.
Y*
QID
AD
Y/Emp/PL
PL
SRAS
Start from a
Balanced Budget
G & T = $2 Trillion
$2.2 T tril.PL1
$2
$1.8
tril.
tril..
G
LRAS
AD2
Real In. Rate
[Decr G; Incr T ] [Again, we get negative Xn]
r=6%
r=3%
$2 T tril.
PL2
T
AD1
E2
GDP
[like we have
“money trees”]
$1.8
$1.8
Y/Empl./PL;
AD
LFM
G
I.R.
$2.2
$2.2
T
F2 F1
E1
YF YI Real
G
Loanable Funds Market
D1
D2
S
DI
C
AD
Y/Emp/PL;
T
LFM
IR
Nominal Interest Rate
“It’s cheaper
to burn money
10
than wood.”
Dm
MS2 MS1
DI
10%
8
Investment
Demand
8%
6
6%
Sell
If there is
0
Money Market
INFLATION,
AS
AD2AD1
MS will be PL
decreased.
PL1
0
like
“money trees”
QID2 QID1
E1
E2
PL2
Y* YI
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.
In the early 90’s, at FE, 2.5%
was the speed limit. AS shifted
slowly due to low productivity.
PL2
AD AD2 AS AS
2
1
1
PL3
PL1
So, at FE, the “goldilocks
economy” has expanded.
Increasing productivity
of the late 90’s allowed
more growth at FE GDP.
0
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
Nominal
Interest
Rate
Inflation
– America’s Main Stabilization Tool
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
ASSETS
• Securities [90%]
• Loans to Commercial Banks
LIABILITIES
• Reserves of Commercial Banks
• Treasury Deposits
• Federal Reserve Notes [90%]
Assets [own]
Securities
Liabilities
*758,551
Loans to Commercial Banks
19,250
Reserves of commercial banks
Treasury deposits
Federal Reserve Notes
[owe]
$14,923
4,463
*754,567
[when these notes are in circulation, they
constitute claims against assets of the Fed]
All other assets
Total
59,967
$837,768
Australia
Canada
Euro Zone
Japan
Russia
United Kingdom
Mexico
Sweden
U.S.
All other liabilities & net worth
Total
Reserve Bank of Australia [RBA]
Bank of Canada
Central Bank of Europe[CBE]
The Bank of Japan [“BOJ”]
Central Bank of Russia
Bank of England
Banco de Mexico (Mex Bank)
Sveriges Ribsbank [Nobel Pr.]
Federal Reserve System [“Fed”]
63,615
$837,768
The Fed controls the banks’ ability to create new money to
ensure the economy doesn’t get too much money, nor too little.
Fed just right
Underfed
Overfed
1983
1980
+30%
$75.00
Money
And – so it is
with money.
Not too much,
$97.50 not too little.
Prices
Recession
Lower
Lower
Buy
LRAS
1. Discount Rate – banks borrow from the Fed (symbolic)
2. Required Reserve - % of DD which cannot be loaned.
3. Buy/Sell Bonds – government debt
Inflation
Raise
Raise
- 3 mo., 6 mo., & 1 year; purchase price: $10,000
Sell
AS
AD
- 2 yr., 3 yr., 5 yr.,($5,000), & 10 yr., ($10,000)
AD
AD AS
- 30 years with purchase of $1,000
AD
YR Y*
Prime Rate-loan rate to the best (prime) customers.
Federal Funds Target Rate – overnight lending rate between
banks to correct a temporary imbalance in reserves.
Y*YI
Real GDP .6%
4%
17 increases
Nominal Interest Rate
“Students, should the Fed
buy or sell bonds to
jumpstart this economy?”
Jobs are
tough to get.
DI
10
10
8
8
Buy
6
0
AD1
Money Market
AD2 LRAS
[C+Ig+G+Xn]
P2
P1
E1
Investment
Demand
6
DM
Price level
If there is
RECESSION
MS will be
increased.
MS1 MS2
0
QID1 QID2
AS “Easy Money” – (Buy/Sell) bonds,
which (increase/decrease) MS, which
(increase/decrease) interest rates,
which (appreciate/depreciate)
the dollar, which (increase/decrease)
E2 C, Ig, & Xn, which (increase/decrease)
AD & therefore, PL, GDP, & emp.
YR Y*
Real GDP
Nominal Interest Rate
“Now, should I
buy or sell?”
If there is
INFLATION,
MS will be
decreased.
“I’ll get rid of
some money.”
Dm
MS2 MS1
DI
10
10
8
8
6
6
Sell
0
Money Market
LRAS
AS
AD2
P1
Investment
Demand
E1
P2
E2
Y* YI
0
QID2 QID1
“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.
AD1
DI
Dm MS2
AD
A
S
I=$60
2
6%
6%
PL2
0
120
Money Market
0
$60
QID
Investment Demand
Ideal Economy
Y*
1.MS is at 120 billion, putting the
2. Interest rates at 6%, and
3. Investment is at $60 billion.
RDO
DI
MS1 MS2
9%
9%
6%
6%
AD1
AD
I=$60
I=$50] 2
A
S
PL2
PL
Dm
0
$100 $120
Money Market
0
1
$50 $60
QID
Investment Demand
YR
Y* RDO
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.
Dm
AD3
DI
MS2MS3
AD2 I=$70
AS
I=$60
6%
3%
0
$120
$140
Money Market
6%
PL3
3%
PL2
0
$60 $70 QID
Investment Demand
Y*YI
RDO
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
- $60-$70 billion every day
[main tool]
- 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 1937-1958
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.
[In 1980, the RR was set at 12%; stayed there until 1992; went to 10%]
Monetary Expansion
[10% RR] [1/.10=10]
“Easy Money”
AD1
AD2
AS
PL
$10,000
[$9,000+$1,000]
$729
$810
YR Y*
$900
[$900x10]
$1,000
Initial
deposit
$1,000
“Easy Money”
“Easy Money” – increase the money supply
Monetary Expansion
(20% RR) [1/.20=MD of 5]
“Tight Money”
$5,000
AD1 AS
AD2
$512
[$4,000+$1,000]
$640
PL
Y* YI
$800
$1,000
Initial
deposit
“Tight Money”
- decrease the money supply
- emergency Fed loans to banks
- symbolic (raises Prime Rate) FL borrowed $99
million In 1991
- Discount Rate was 1% from 1934-46
and the prime rate was 1.5%
Hurricane
EarthQuake
The Fed tends to change the D.R. in
lockstep with the fed funds target rate.
After the recession, the
unemployment rate still increased.
During this period, 1990-1992, the Fed did 4 things:
1.
2.
3.
4.
Decreased discount rate from 10% to 3%;
Decreased the RR from 12% to 10%;
Decreased the Fed Funds Rate 24 times, and
Bought bonds
2.00%
“Easy”
Money
April, 2008
“Easy”
Money
“Tight”
Money
08’
Relative Importance of Monetary Policy
A. WWII-1979 – Fed targeted the interest rate not the growth of MS.
B. 1979 - 1982 – Fed targeted the growth of the MS not the in. rate.
C. 1982 - 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) Investment
MS1 MS2
10
10%
8%
6%
0
AD2(M)
A
AD1 AD2
S
Demand
DI(M)
8%
Dm(K)
PL2
PL2
PL1
6%
Dm(M)
Money Market
0
Dm is more inelastic
[I.R. more sensitive]
QID1 QID2
DI is more
(K)
QID2
elastic
[or more responsive]
Mainly, we end up just
getting inflation.
Keynesian view is that DI is rather steep so monetary
policy is not that strong. Fiscal policy is “top banana.”
Also, the Keynesians don’t think the
lower interest rate is as important
as “profit expectations.”
YR Y*YI
AD2 AS
AD1
• Speed and flexibility
• Isolation from political pressure
• Successes in the 1980s & 1990s
Shortcomings and problems
Monetary Policy better
I’d like one of those
1% mortgages, but I
don’t have a job.
I may not drink
water but I’ll eat
spiked brownies.
Fiscal Policy better
Cyclical asymmetry
[better at fighting inflation than fighting depressions]
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.
• 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
Recession
Increase G
Decrease T
Inflation
Decrease G
Increase T
Monetary Policy
Recession
Lower D. Rate
Lower R. Rate
Buy Bonds
Inflation
Raise D. Rate
Raise R. Ratio
Sell Bonds
“Easy Money”
“Tight Money”
Discount Rate
The Reserve Ratio
Open Market Operations
“Easy Money”
Fed
Easy Money Policy
• Lower Discount Rate
• Lower Reserve Ratio
• Buy Bonds
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
100,000
Fed., commercial bank ERs are increased $________.
PMC in the banking
400,000
400,000 TMS can be as much as $________.
system are increased by $_______.
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”]
NS 57-66
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]
DI
MS1 MS2 MS3
9%
9%
6%
6%
3%
3%
0
Dm
$100 120 140
Money Market
0
NS 67-70
AD3
AD1
AD
I=$60
I=$50] 2
I=$70
A
S
PL3
PL2
PL
1
$50 $60 $70 QID
Investment Demand
YR
Y* YI 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).
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
No
increase the MS? _____
No Does this loan increase the amount in RR?_____
ER? Yes
____ With 10% RR, PMC is $500,000
__________. TMS is $500,000
__________.
2. If the RR is 50% & the Fed buys $100 mil. of securities from the public,
mil.
mil. PMC is$100
mil. TMS is$200
then: MS is increased by$100
________.
_________.
________.
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
mil.
$10 mil. & PMC is _________.
40%, MS is increased by ________
________.
$15 mil. TMS is$25
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).
Nominal Interest Rate
“Students, should the Fed
buy or sell bonds to
jumpstart this economy?”
Jobs are
tough to get.
DI
10
10
8
8
Buy
6
0
AD1
Money Market
AD2 LRAS
[C+Ig+G+Xn]
P2
P1
E1
Investment
Demand
6
DM
Price level
If there is
RECESSION
MS will be
increased.
MS1 MS2
0
QID1 QID2
AS 9.“Easy Money” – (Buy/Sell) bonds,
which (increase/decrease) MS, which
(increase/decrease) interest rates,
which (appreciate/depreciate)
the dollar, which (increase/decrease)
E2 C, Ig, & Xn, which (increase/decrease)
AD & therefore, PL, GDP, & emp.
YR Y*
Real GDP
Nominal Interest Rate
“Now, should I
buy or sell?”
If there is
INFLATION,
MS will be
decreased.
“I’ll get rid of
some money.”
Dm
MS2 MS1
DI
10
10
8
8
6
6
Sell
0
Money Market
LRAS
AS
AD2
P1
Investment
Demand
E1
P2
E2
Y* YI
0
QID2 QID1
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.
AD1
MS = Currency + DD of PUBLIC
RR is 20%
Assets
DD (Liabilities)
TR[RR+ER]=$20 mil. $100 million
0
1. 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
$1,000 ER will increase by
much as ________;
$_______.
800
4,000
3. Possible Money Creation in the system could be $_______.
5,000
4. Potential Total Money Supply could be as much as $________.
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? $______
0
12. If Pam Anderson’s Bank borrows $1,000 from the Fed
ER will increase by $1,000
_______.
Pam Anderson’s Bank
Fed
5,000
13. Possible Money Creation in the system could be $_______.
5,000
14. Potential Total Money Supply could be as much as $________.
MS = Currency + DD of Public
RR is 25% Assets
DD (Liabilities)
TR[RR+ER]=$25 mil. $100 million
1. How much can this bank loan out? $______
0
2. If Pam Anderson puts $4,000 in this
bank(DD), Pam can write a check for as much as $4,000
_______;
ER will increase by $_______.
3,000
.
12,000
3. Possible Money Creation in the system could be $________.
16,000
4. Potential Total Money Supply could be as much as $________.
Extra Practice MS = Currency + DD of PUBLIC
RR is 40% Assets
DD (Liabilities)
TR[RR+ER]=$40 mil. $100 million
1. How much can this bank loan out? $______
0
2. If Cameron Diaz puts $10,000 in this bank(DD),
Pam can write a check [DD] for as much as
10,000
6,000
$__________;
ER can increase by $_________.
15,000
3. Possible Money Creation in the system could be $________.
25,000
4. Potential Total Money Supply could be as much as $_________.
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? $______
0
12. If Cameron Diaz’s Bank borrows $5,000 from the Fed
5,000
ER will increase by $_______.
Cameron Diaz’s Bank
Fed
10,000
13. Possible Money Creation in the system could be $________.
10,000
14. Potential Total Money Supply could be as much as $________.
9%
9%
6%
6%
3%
3%
0
Dm
$100 120 140
Money Market
AD3
DI
MS1 MS2 MS3
0
AD1
AD
I=$60
I=$50] 2
I=$70
A
S
PL3
PL2
PL
1
$50 $60 $70 QID
Investment Demand
YR
Y*YI RDO
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
$1,000 DD by Ashley [MS=Currency+DD of Public]
New Deposits
[New Reserves]
Bank
DD
DD Created By
New Loans
[equal to new ER]
New Required
Reserves
RR=40%
A
$1,000.00
$400.00
600.00
600.00
B
600.00
$240.00
360.00
C
360.00
$144.00
216.00
D
216.00
$86.40
129.60
PMC = ER[$800 x M[5]
PMC
$1,000.00 + $1.500.00
Katy’s DD +
PMC = $1,500.00
=
=
TMS
$2.500.00
$600 to Michael
Jackson for
dance lessons
Prom date
with Britney
Practice cigarette
cessation lessons
with Bruce Willis
Prom date
with Napoleon
Dynamite
MS grows by
multiple of 2.5
Money Supply = DD + Currency of the Public
ER
“PMC”
Loans
$100[10% RR] [1st Bank] [1st Bank]
Banks/Public DD [$100]
$90
$90
Fed /Public/Banks DD[$100]
$90
$90
“PMC”
Crea. In
“TMS”
“Potential”
System
Total MS
$900
$1,000
$900
$1,000
[*Fed buys bonds from public who put the money in their DD]
Banks/Fed
Fed Loan[$100]
$100
[or sells bonds to Fed]
ER
$100
“PMC”
Loans
$1,000
$100 [20% RR] [1st Bank] [1st Bank]
Banks/Public DD [$100]
$80
$80
Fed/Public/Banks DD [$100]
$80
$80
“PMC”
Crea. In
$1,000
“TMS”
“Potential”
System
Total MS
$400
$500
$400
$500
[*Fed buys bonds from public who put the money in their DD]
Banks/Fed
Fed Loan[$100]
$100
[or sells bonds to Fed]
$100
$500
$500
Additional Practice on Money Creation
1. If the RR is 40% and the Fed buys $100 M of bonds from
$100 M ER are
the public[Kate], then the MS is increased by _____.
$150 M TMS would be ______.
$60 M PMC is _______.
$250 M
increased by ______.
2. RR is 50% and the Bolding Bank borrows $100 M from the
0
Fed. As a result, RR are increased by ______.
ER is increased
$200 M
$100 M
by _______.
PMC and TMS is increased by ________.
3. Recsnik Bank has DD of $400,000 and the RR is 25%. If RR
$200,000
and ER are equal, then TR are _______.
4. The Green Bank has ER of $60,000 & DD is $200,000. If the
$100,000
RR is 20%, TR are _________.
5. RR is 20% & the Fed buys $50 million of bonds from the
$50 M ER are increased
public[Jenn]. The MS is increased by ____.
$200 M
$250 M
$40 M
by _______.
PMC is _______.
TMS would be _________.
Banks
Public
Fed
Hard Money Quizzes Coming Up
Commercial Bank Fed Public
RR+ER=TR; TR-RR=ER; TR-ER=RR; MxER=PMC; PMC[Public]+1st DD=TMS; PMC[Fed]= TMS
1. RR are 10% & there are no ER in the Hicks Bank. Trey
deposits (DD) $200.00 there. This one bank can increase
180.00
its loans by a maximum of $______.
2. RR are 20%; the Wells Bank borrows $80,000 from the Fed.
80,000
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].
24,000
PMC in the banking system could be as much as $_________.
4. The Secker Dead-Dog Bank has DD of $10 million;
4 million
RR are 20%; RR & ER are equal. TR are $_____________.
5. The Morell Bank, with no ER, borrows $20 M from the Fed.
40 M
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.].
150 M
Potential Money Creation in the banking system could be $____.
7. RR are 50%; the Cusimano Bank borrows $40 M from the Fed;
40 million
this single bank’s ER are increased by $_______________.
8. RR are 50%; Fed buys $50 billion of bonds from the Public[Conner].
100 B
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 $______.
30 Million
10. No ER in Gangel Bank & RR is 25%. Amy deposits $200. PMC is $___
600
Commercial Bank Fed Public
RR+ER=TR; TR-RR=ER; TR-ER=RR; MxER=PMC; PMC[Public]+1st DD=TMS; PMC[Fed]= TMS
1. RR are 50% & there are no ER in a Bank. Katy deposits (DD)
5.00
$10.00 there. This one bank can increase its loans by ?____.
2. RR are 50%; the Kilroy Bank borrows $1 mil. from the Fed.
1 million
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 $______.
250,000
4. The Sedillo Bank has DD of $400,000 and RR is 25%.
200,000
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 $_________.
200,000
6. RR are 50%; the Fed buys $60,000 of securities from the Public.
Potential Money Creation in the banking system is $_______________.
60,000
7. RR are 10%; the Blasssingille Bank borrows $150 million from the
150 million
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 $_______________.
800 million
9. RR are 25% & the Fed buys $40 M of bonds from the Lawrence Bank.
PMC and TMS are both $___________.
160 million
10. RR are 20% & no ER in the Montes Bank. Steph deposits
500.00
$125.00 there. PMC in the banking system is $__________.
Commercial Banks
Fed
Public
RR+ER=TR; TR-RR=ER; TR-ER=RR; MxER=PMC; PMC[Public]+1st DD=TMS; PMC[Fed]= TMS
1. RR are 40% & there are no ER in a Bank. Bo deposits (DD)
60.00
$100.00 there. This one bank can increase its loans by $____.
2. RR are 10%; the Eubanks Bank borrows $9 mil. from the Fed.
9 million
This bank can increase its loans by a maximum of $_______.
3. RR is 50%; the Fed buys $10,000 of securities from the Public.
20,000
Potential Total Money Supply could be as much as $______.
4. The Hovitz Bank has DD of $100,000 and RR is 40%.
80,000
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 $500,000
_____.
6. RR are 50%; the Fed buys $500,000 of securities from the Public.
Potential Money Creation in the banking system is $______.
500,000
7. RR are 10%; the McGahran Bank borrows $5 million from the
5 million
Fed. This single bank’s ER are increased by $____________.
8. RR are 10%; Fed buys $10 M of securities from the Public.
100 million
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 $________.
32 million
10. RR are 20% & no ER in the Norwood Bank. Steph deposits
500.00
$100.00 there. Potential Total Money Supply is $_________.
Commercial Banks Fed Public
RR+ER=TR; TR-RR=ER; TR-ER=RR; MxER=PMC; PMC[Public]+1st DD=TMS; PMC[Fed]= TMS
1. RR are 25% & there are no ER in a Bank. Sami deposits (DD)
300.00
$400.00 there. This one bank can increase its loans by $_____.
2. RR are 10%; the McHenry Bank borrows $20 mil. from the Fed.
20 million
This bank can increase its loans by a maximum of $_______.
3. RR is 40%; the Fed buys $10,000 of securities from the Public.
25,000
Potential Total Money Supply could be as much as $______.
4. The Manning Bank has DD of $200,000 and RR is 40%.
160,000
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 $750,000
_____.
6. RR are 50%; the Fed buys $600,000 of securities from the Public.
Potential Money Creation in the banking system is $______.
600,000
7. RR are 10%; the Lao Bank borrows $35 million from the
35 million
Fed. This single bank’s ER are increased by $____________.
8. RR are 10%; Fed buys $50 M of securities from the Public.
500 million
Potential Total Money Supply is $_____________.
9. RR are 25% & the Fed buys $40 M of bonds from the Burgess Bank.
160 million
Potential Money Creation in the banking system is $________.
10. RR are 20% & no ER in the Bernet Bank. Katy deposits
2,500.00
$500.00 there. Potential Total Money Supply is $_________.
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 Fed buying bonds incr MS, which decr the I.R.
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
(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
Increase
Decrease
Thec.GIncrease
would increase TDecrease
and decr G to reduce
the deficit which
would reduce AD.
d.
Decrease
Increase
No
change
Increase
To reverse this & incr AD, the Fed would decr the RR & NC the DR to lower the I.R.
e. Decrease
Decrease
Decrease
Increase
[decreasing
the Discount
Rate would have
been better but is
not a choice here]
(53) 49. If the Fed institutes a policy to reduce inflation, which of the following is
most likely to increase? Decr the MS to combat inflation would incr the I.R.
a. Tax rates b. Investment c. Government spending d. Interest rates e. GDP
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.
b. the demand curve for money will shift to the left
c. the demand curve for money will shift to the right.
d. interest rates will decrease
e. interest rates will increase.
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
b. unforeseen expenditures
c. speculation (asset)
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%
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. $2,000
b. $8,000
c. $10,000
d. $20,000
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
b. increase by $200
c. increase by $200
d. decrease by $200
e. decrease by $200
increase by $170
increase by $30
no change
decrease by $30
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
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
b. decrease
c. increase
d. increase
e. no change
decrease
increase
decrease
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
b. velocity of money
c. price level
d. prime rate
e. discount rate
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.
b. income velocity of money has decreased.
c. price level has increased.
d. price level has decreased.
e. real output has decreased.
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
b. sell bonds
c. no change
d. buy bonds
e. buy bonds
reduce taxes
raise taxes
raise taxes
reduce spending
no change
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].
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
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. $20
b. $100
c. $300
d. $500
e. $750
5x$100=$500
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. More MS means lower I.R. & more Ig
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 Holding currency means less ER & higher I.R.
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. $20
b. $80
c. $100
d. $400
e. $500
23. (45%) Which of the following is most likely to increase if the public decides to
increase its holding of currency?
Holding MS; banks
a. the interest rate
d. Employment
b. The price level
e. The reserve requirement have less; higher I.R.
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
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
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.
Lower U.S. interest rates will
d. Short-run capital inflows to the U.S. will decrease.
result in fewer capital inflows
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 This would keep the interest
b. increase the MS when government spending is decreased rate from going up.
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