Monetary Policy Flashcards

Flashcards about Monetary Policy

What is monetary policy?

The actions the Federal Reserve takes to manage the money supply and interest rates to pursue macroeconomic policy objectives.

What are the four main monetary policy goals of the Fed?

Price stability, high employment, stability of financial markets and institutions, and economic growth.

How does the Fed influence aggregate demand (AD)?

Through interest rates on mortgage loans, corporate bonds, and U.S. Treasury bonds—all long-term interest rates.

What interest rate can the Fed mostly affect?

Short-term interest rates.

Why do banks still hold reserves?

The interest they earn on reserves is risk-free, and large banks must maintain enough high-quality liquid assets to comply with regulations.

What is the federal funds rate?

The interest rate banks charge each other for overnight loans.

What is the name for the situation where banks keep as few reserves as regulations allow?

Scarce-reserves regime

What is the method for controlling the federal funds rate in a scarce-reserves regime?

Adjust the supply of reserves.

What is the name for the situation where banks keep more reserves than required?

Ample-reserves regime

What is the method for controlling the federal funds rate in an ample-reserves regime?

Adjust the interest rate on reserve balances (IORB).

What does a higher interest rate result in regarding money demand?

A lower quantity of money demanded.

In the money market, why is the money supply curve a vertical line?

For simplicity, we assume the Fed can completely control the money supply, so it does not depend on the interest rate.

What happens to the short-term interest rate when the Fed increases the money supply?

It must fall until it reaches a level at which households and firms are willing to hold the additional money.

What happens to firms and households when the Fed lowers the money supply by selling Treasury securities?

They hold less money than they want, relative to other financial assets.

What must banks do to retain depositors when the Fed decreases the money supply?

Offer a higher interest rate on interest-bearing accounts.

Can the Fed simultaneously target both interest rates and the money supply?

No, the two are linked through the money demand curve, which the Fed does not control.

What are the Fed’s three traditional monetary policy tools, listed?

Open market operations, discount rate, and reserve requirements.

What is the main tool the Fed used in a scarce-reserves regime?

Open market operations—buying and selling Treasury securities.

What is the discount rate?

The interest rate the Fed charges for discount loans, made to firms in the Fed’s capacity as the lender of last resort.

Until March 2020, what were reserve requirements?

A minimum percentage of checking deposits banks needed to keep, called the required reserve ratio.

Aside from open market operations, what are two other tools the Fed uses to control the federal funds rate?

Interest on reserve balances (IORB) and the interest rate on overnight reverse repurchase agreements (ON RRP).

What is the Interest Rate on Overnight Reverse Repurchase Agreements (ON RRP)?

Financial transactions in which the Fed borrows funds overnight from a financial firm.

What is the floor operating system?

The current system under which the Fed uses the interest rate on banks’ reserve balances and the interest rate on overnight loans with financial firms to establish a floor under the federal funds rate.

What are the Fed's two most important monetary policy tools?

Interest on reserve balances (IORB) and the interest rate on overnight reverse repurchase agreements (ON RRP).

What two tools does the Fed use when faced with a zero lower bound?

Quantitative easing and forward guidance.

What is quantitative easing?

The Fed policy that attempts to increase aggregate demand by buying long-term securities.

What is forward guidance?

Statements by the Federal Open Market Committee about how it will conduct monetary policy in the future.

Is the first link in the chain of monetary policy reliable?

Yes

How do lower interest rates affect consumption?

They encourage buying on credit, which typically affects the sale of durables, and they discourage saving.

How do lower interest rates affect investment?

They encourage capital investment by firms and new residential investment.

How do high U.S. interest rates affect net exports?

They attract foreign funds, raising the $US exchange rate, causing net exports to fall.

Does the Federal Open Market Committee (FOMC) control the federal funds rate directly?

No, but instead sets targets for it

What is the purpose of expansionary monetary policy?

Increase the growth of aggregate demand, real GDP, and employment.

What is the method of expansionary monetary policy?

Lower the target for the federal funds rate.

What is the purpose of contractionary monetary policy?

Decrease the growth of aggregate demand, real GDP, and employment.

What is the method of contractionary monetary policy?

Raise the target for the federal funds rate.

Why would the Fed perform contractionary monetary policy?

If it determines that inflation is a danger to long-run growth, it can contract the money supply to discourage inflation.

Is completely offsetting a recession realistic?

No, the best the Fed can hope for is to make recessions milder and shorter.

What can result from the Fed keeping interest rates low for too long?

High inflation and the next recession will be more severe.

Expansionary monetary policy is sometimes called what?

Loose or easy monetary policy.

Contractionary monetary policy is sometimes called what?

Tight monetary policy.

In the dynamic aggregate demand and aggregate supply model, what typically occurs annually?

Increases in long-run aggregate supply (potential GDP), larger annual increases in aggregate demand, smaller annual increases in short-run aggregate supply, and increases in the price level.

What is a bubble in a market?

A situation in which prices are too high relative to the underlying value of the asset.

What is herding behavior?

Failing to correctly evaluate the value of the asset and instead relying on other people’s apparent evaluations.

What is speculation?

Believing that prices will rise even higher and buying the asset intending to sell it before prices fall.

What are GSEs?

Government-sponsored enterprises that sell bonds to investors and use the funds to purchase mortgages from banks, allowing more funds to flow into mortgage markets.

What did the Fed announce it would temporarily make to primary dealers in March 2008?

Discount loans

What action did the Treasury move to have the federal government take in September 2008?

Take control of Fannie Mae and Freddie Mac.

What is a moral hazard problem?

When managers have less incentive to avoid risk due to the expectation of being saved from their own mistakes.

What two types of lending facilities did the Fed use in response to the Covid-19 Recession?

Liquidity facilities and credit facilities.