Survey of Economics – Chapter 17: Federal Reserve & Money Market

30 question-and-answer flashcards covering definitions, mechanisms, and policy tools related to the Federal Reserve, the money market, and monetary policy targets.

Which two variables are the Fed’s main monetary-policy targets?

The money supply and the interest rate.

What specific interest rate does the Fed usually target in day-to-day policy?

The federal funds rate.

Define the federal funds rate.

The interest rate that banks charge each other for overnight loans of reserves.

Why is the federal funds rate central to Fed policy?

Because the Fed can control it through open-market operations, and changes in the rate influence other rates and economic activity.

What is the discount rate?

The interest rate at which the Federal Reserve lends reserves directly to banks.

Who lends and who borrows in the federal funds market?

Banks with excess reserves lend; banks with reserve shortages borrow.

What do economists mean by the ‘demand for money’?

The amount of money—currency and checking-account deposits—that individuals and firms choose to hold.

Key advantage of holding money?

Money is immediately usable to buy goods, services, or financial assets (high liquidity).

Primary disadvantage of holding money?

Currency and checking deposits earn little or no interest.

Opportunity cost of holding money equals __.

The nominal interest rate that could have been earned on alternative assets.

When Treasury-bill rates are low, what happens to the quantity of money demanded and why?

Money demand rises because the opportunity cost of holding money is low.

Effect on the money-demand curve when real GDP rises:

The curve shifts rightward (MD increases).

Effect on the money-demand curve when the overall price level falls:

The curve shifts leftward (MD decreases).

Action by the Fed that shifts the money-supply curve right:

Buying U.S. Treasury securities in open-market operations.

Action by the Fed that shifts the money-supply curve left:

Selling U.S. Treasury securities in open-market operations.

Relationship between lowering the federal funds rate and the money supply:

To push the federal funds rate down, the Fed must increase the money supply (add reserves).

What happens to interest rates when the Fed conducts an open-market purchase?

The money supply increases and the equilibrium interest rate falls.

What happens to interest rates when the Fed conducts an open-market sale?

The money supply decreases and the equilibrium interest rate rises.

When the Fed sells bonds as part of contractionary policy, the money supply and interest rates .

Money supply decreases; interest rates increase.

Main reason the Fed abandoned strict money-supply targets in the early 1990s:

The link between monetary aggregates and economic goals had become unreliable.

If the FOMC wants to increase the money supply, its trading desk is instructed to __.

Buy U.S. Treasury securities.

If the FOMC wants to decrease the money supply, its trading desk is instructed to __.

Sell U.S. Treasury securities.

Which interest rate is most relevant for monetary policy decisions—short-term or long-term, real or nominal?

The short-term nominal interest rate.

Fed’s two longer-run policy goals written into law (dual mandate):

Maximum employment and stable prices.

When the money-demand curve shifts from MD1 to MD2 because both the price level and real GDP rise, what happens to the equilibrium interest rate (assuming MS fixed)?

The equilibrium interest rate increases.

How does an open-market purchase ‘pour money’ into the banking system?

The Fed credits banks’ reserve accounts when it buys bonds, raising reserves and expanding the money supply.

Why can’t the Fed set a target for unemployment directly?

Because it has no direct tools to control employment; instead it influences unemployment through interest rates and money supply.

When the opportunity cost of holding money falls, individuals will hold money balances.

Larger.

Which two events shift money demand rightward? (choose two)

An increase in real GDP and/or an increase in the price level.

How does a decrease in the price level affect the opportunity cost of holding money, other things equal?

Lower prices reduce transactions needs, shifting money demand left and lowering the opportunity cost.