Test 2 Macro

Consumption is [blank] related to household income and wealth and households' expectations about the future, and [blank] related to interest rates.

A) positively; positively

B) negatively; positively

C) positively; negatively

D) positively; is not

C) positively; negatively

Assume there is no government or foreign sector. If the MPS is 0.25, a $10 billion decrease in

planned investment will cause aggregate output to decrease by:

A) $25 billion.

B) $40 billion.

C) $75 billion.

D) $250 billion.

According to the "paradox of thrift," increased efforts to save will cause a(n):

A) increase in income and an increase in overall saving.

B) increase in income but no overall change in saving.

C) decrease in income and an overall decrease in saving.

D) decrease in income but an increase in saving.

C) decrease in income and an overall decrease in saving.

What gives money value under a fiat system?

A) Fiat money is backed by gold.

B) The supply of fiat money is controlled by the government.

C) Fiat money is also a commodity.

D) Fiat money is the same as Treasury bonds.

B) The supply of fiat money is controlled by the government.

Which of the following is included in M1, but not included in M2?

A) currency held outside banks

B) travelers checks

C) demand deposits

D) none of the above

D) none of the above

At higher interest rates the:

A) money supply is higher.

B) money supply is indeterminate.

C) quantity demanded of money is higher.

D) quantity demanded of money is lower.

D) quantity demanded of money is lower.

In terms of the demand for money, the opportunity cost of holding money is represented by:

A) demand deposits.

B) the interest rate.

C) the reserve ratio.

D) excess reserves.

B) the interest rate.

Refer to Figure 11.1. A shift from Point D to Point E can be caused by:

A) a decrease in the interest rate.

B) an increase in income.

C) a decrease in the price level.

D) an increase in the interest rate.

C) a decrease in the price level.

Refer to Figure 11.1. A movement from Point A to Point C can be caused by:

A) a decrease in income.

B) an increase in the price level.

C) a decrease in the interest rate.

D) an increase in the interest rate.

D) an increase in the interest rate.

Refer to Figure 11.1. A shift from Point A to Point D can be caused by:

A) a decrease in income.

B) an increase in the interest rate.

C) a decrease in the interest rate.

D) an increase in income.

D) an increase in income.

Refer to Figure 11.5. If the Fed increases the Federal Funds Rate:

A) the money supply curve will remain at MS0.

B) the money supply curve will remain at MS1.

C) the money supply curve will shift from MS1 to MS0.

D) the money supply curve will shift from MS0 to MS1.

C) the money supply curve will shift from MS1 to MS0.

Refer to Figure 11.5. If the Fed decreases the IORB and ON RRP:

A) the money supply curve will remain at MS0.

B) the money supply curve will remain at MS1.

C) the money supply curve will shift from MS1 to MS0.

D) the money supply curve will shift from MS0 to MS1.

D) the money supply curve will shift from MS0 to MS1.

Refer to Figure 11.7. If the level of aggregate output increases, the demand for money curve

will:

A) shift from Md1 to Md0.

B) shift from Md0 to Md1.

C) remain at Md0.

D) remain at Md1.

B) shift from Md0 to Md1.

An increase in aggregate output, ceteris paribus, will cause the demand for money to [blank] and the interest rate to [blank].

A) increase; increase

B) increase; decrease

C) decrease; decrease

D) decrease; increase

A) increase; increase

A decrease in the price level, ceteris paribus, will cause the demand for money to [blank] and the interest rate to [blank].

A) increase; increase

B) increase; decrease

C) decrease; decrease

D) decrease; increase

C) decrease; decrease

In a period of [blank], the Fed would most likely tighten monetary policy.

A) recession

B) high inflation

C) economic stability

D) high unemployment

B) high inflation

Federal Funds Rate

Overnight rate banks to banks.

Inflation: Increase FFR = Decrease Money supply = Increase interest rates

recession: Decrease FFR = Increase Money supply = Decrease interest rates

Discount rates

The rate at which banks borrow from the FED. (The FED is the lender of last resort). IS KEPT HIGHER THAN THE FFR TO DISCOURAGE BORROWING FROM FED.

(IORB) Interest On Reserve Balances

Interest rate paid to banks by FED for keeping reserves with FED.

Inflation: Increase IORB = Decrease Money supply = Increase interest rates

recession: Decrease IORB = Increase Money supply = Decrease interest rates

(ON RRP) Overnight Reserve Repurchase Agreement

FED pays non-banks institutions. (Investment firms, Fannie Mac, Freddy MAC).

• “Park money overnight with FED“

Inflation: Increase ON RRP = Decrease Money supply = Increase interest rates

recession: Decrease ON RRP = Increase Money supply = Decrease interest rates

Opportunity cost of “holding money“ is the interest rates.

If interest rates are high, the opportunity cost of “holding money“ is high.

If interest rates are low, the opportunity cost of “holding money“ is low.

Open market operations; Buying of government bonds (securities) & selling.

FED buying bonds: Increases Money supply = Decrease interest rates

FED SELLS bonds: Decreases Money supply = Increase interest rates

The Federal Funds Rate (FFR) is the interest rate that banks charge each other for overnight loans of reserves. (True or False)

True

When the Federal Reserve raises the Interest on Reserve Balances (IORB), banks are more likely to hold reserves instead of lending them. (True or False)

True

When the Fed buys government securities in the open market, it decreases the money supply. (True or False)

False

The discount rate is usually set higher than the federal funds rate to discourage frequent borrowing from the Fed. (True or False)

True

Lowering the ON RRP rate tends to put downward pressure on the federal funds rate. (True or False)

True

Increasing the IORB and ON RRP rates are examples of contractionary monetary policy tools. (True or False)

True

In times of high inflation, the Federal Reserve is more likely to decrease interest rates to stimulate borrowing and spending. (True or False)

False

The demand for money refers to the amount of wealth people want to hold as cash rather than as bonds or other assets. (True or False)

True

When interest rates rise, the opportunity cost of holding money decreases. (True or False)

False

The speculative motive for holding money arises because people expect bond prices to fluctuate with changes in interest rates. (True or False)

True

The precautionary motive for holding money is based on the desire to earn higher returns on bonds. (True or False)

False

Bond prices rise when interest rates fall, and fall when interest rates rise. (True or False)

True

The opportunity cost of holding money is the interest that could have been earned on bonds. (True or False)

True

When interest rates are low, people will reduce their holdings of money and increase their bond holdings. (True or False)

False

Commodity money

is any tangible item used as money that also has intrinsic value in other uses. Examples include gold, precious stones, jewelry, cigarettes, and countless other items.

Fiat (token) money

is intrinsically worth less than its face value and has full face value only because it is universally accepted as money. The dollar is intrinsically worthless and acquires value only because it is accepted in performing the functions of money.

Legal tender

is money that a government declares must be accepted to perform the various functions of money. It is used to fulfill debt obligations.

Explain what will happen to the size of both M1 and M2 in each of the following situations:

(a) Paul transfers $10,000 from his checking account to his savings account.

M1 decreases, and M2 stays the same.

• A checking account is part of M1, and a savings account is part of M2 but not M1.

• When Paul moves the money from checking to savings, M1 decreases. M2 stays the same because M2 includes everything in M1.

Explain what will happen to the size of both M1 and M2 in each of the following situations:

(b) Sarah takes $5,000 out of her money market account and transfers it to her checking account.

M1 increases, and M2 stays the same.

• A money market account is part of M2 but not M1.

• When Sarah moves the money to her checking account (part of M1), M1 increases. M2 stays the same because M2 includes everything in M1.

What is the purpose of the interest on reserve balances (IORB), and how does it affect bank lending?

The IORB pays banks interest on their reserve balances, giving them an incentive to hold reserves rather than make loans. Raising the IORB contracts the money supply and contributes to an increase in short-term market interest rates.

Explain how the overnight reverse repurchase agreement (ON RRP) facility helps the Fed control short-term interest rates.

The ON RRP pays institutions a set rate to lend funds to the Fed overnight, which establishes a lower limit for short-term interest rates. The Fed uses this tool when there is excess liquidity in the financial system to help raise or support market interest rates. This creates a floor for short-term interest rates in the market.

When the Federal Reserve sells U.S. Treasury securities in the open market, what is the most likely effect in today’s monetary policy framework?

In today’s ample-reserves framework, open market operations like selling Treasury securities are not the primary tool for setting interest rates, but they still matter through liquidity.

• When the Federal Reserve sells U.S. Treasury securities, bank reserves decrease, which puts upward pressure on short-term interest rates.

• However, in today’s system, this effect is secondary because the Fed primarily controls rates using IORB and ON RRP.

When the Federal Reserve buys U.S. Treasury securities in the open market, what is the most likely effect in today’s monetary policy framework?

When the Federal Reserve buys U.S. Treasury securities in the open market, it adds reserves to the banking system. This increases the money supply and lowers interest rates, easing overall monetary conditions.

• Open market operations are not the primary tool for setting interest rates today.

What causes a movement along the money demand curve?

Interest rates cause a movement along the money demand curve. If interest rates go up, we hold less money, because the opportunity cost of holding money is high. If interest rates go down, we hold more money, because the opportunity cost of holding money is low.

What causes a shift of the money demand curve?

Changes in the price level (PL) or income (Y) shift the money demand curve. If PL or Y (aggregate output or income) goes up, the money demand curve shifts to the right, which causes interest rates to go up. If PL or Y goes down, the money demand curve shifts to the left, which causes the interest rate to go down.

Transactions motive

People hold money to make everyday purchases and pay for goods and services.

• You keep cash in your wallet to buy groceries or pay bills.

Precautionary motive

people hold extra money for unexpected expenses or emergencies.

• You keep some savings in your checking account in case your car breaks down.

Speculative motive

people hold money to take advantage of future changes in interest rates or bond prices.

• You hold onto cash instead of buying bonds because you expect interest rates to rise (and bond prices to fall).

What is the opportunity cost of holding money?

The opportunity cost of holding money is forgone interest.

Explain how changes in market interest rates affect the price of existing bonds. In your answer, describe why the bond’s fixed payments become more or less valuable when interest rates rise or fall, and how this affects an investor’s decision to buy or sell the bond.

When market interest rates rise, existing bonds with fixed payments become less valuable because new bonds offer higher returns, so their prices fall. When rates fall, existing bonds with higher fixed payments become more valuable, so their prices rise.

• Investors buy or sell bonds based on these changes to take advantage of relative returns.