U17-Monetary Policy

definition of monetary policy is

changing the money supply and interest rates to promote maximum employment, stabilize prices, and promote economic growth

what effect does fiscal policy have on money supply?

there is no effect

what four tools are used for controlling money supply?

reserve requirements, discount rates, open market operations, and interest paid on reserves

what is appropriate expansionary monetary policy

increase money supply and lower interest rates

what is appropriate contractionary monetary policy

decrease money supply and raise interest rates

why is stable long-term interest rates good?

it promotes borrowing and lending

what does decrease in money supply affect in terms of nominal interest rates?

increases nominal intererst rates

what does increasing nominal interest rate cause in terms of borrowing costs?

higher borrowing costs

what does increase in money supply affect in terms of nominal interest rates?

decrease nominal interest rates

what does decreasing nominal interest rate cause in terms of borrowing costs?

lower borrowing costs

what is chain reaction of increase in money supply? (money supply to rates to borrowing/spending to aggregate demand)

increase in money supply lowers interest rates, which promotes borrowing and spending, which then increases aggregate demand

what is chain reaction of decrease in money supply? (money supply to rates to borrowing/spending to aggregate demand)

decrease in money supply raises interest rates, which then discourages borrowing and spending, which then decreases aggregate demand

why is monetary policy not perfect? (in terms of data)

recognition is delayed

why is monetary policy not perfect? (in terms of response)

an exact amount and strength of response needs to be determined

what is a liquidity trap?

when rates are so low the central bank can't lower it further

what do higher rates of anything do? (interest paid on reserves, federal fund rates, reserve requirement)

they discourage borrowing and spending by making borrowing more expensive

what does phillips curve do?

measure tradeoff between inflation and unemployment

what does decrease in AD cause on phillips curve?

movement down and along phillips curve

what does increase in short run aggregate supply cause on phillips curve?

phillips curve shifted left

what is the most effective monetary policy tool?

interest paid on reserves

what are the two most ineffective monetary policies?

reserve requirement and OMOs

monetary theorists believe that

money supply should be steadily increased as real gdp increases, and that using monetary tools to fine-tune the economy is bad

classical economists believe in what theory

quantity theory of money

what is the quantity theory of money associated with?

the equation of exchange

classic economists believe in what concept (in terms of supply)

aggregate supply is vertical

all beliefs held by economists include:

wages fluctuate quickly, say’s law is true, input and ouput prices stay with each other in the long run, and that the economy is relatively stable (so no need to maintain aggregate demand)

what does M1 include?

saving deposits, checkable deposits, and currency

what does M2 include?

everything in M1 plus money market funds, CDs, and other timed deposits

the federal reserve controls the federal funds rate by…

performing open market operations

what is the federal funds rate?

rate that banks charge each other for loans

what is the discount rate?

rate that the federal reserve charges bank for borrowing from federal rserve

what is the reserve market?

market where banks lend out and/or borrow for reserves

why is the discount rate the upper limit for reserve market?

because if banks charge each other higher than discount rate for loans, then the borrower would just borrow from the federal reserve

why is interest on reserves the lower limit for the reserve market?

because if banks can only lend out reserves lower than interest on reserve, they might as well just keep money in their reserves

what is quantity in reserve market?

quantity of reserves

what is the price in reserve market?

interest on borrowing