Macroeconomics Final Exam Review

Flashcards reviewing key concepts for a macroeconomics final exam.

What is the Pigou effect?

Effect where a decrease in the price level leads to an increase in consumer spending because people feel wealthier.

What is a demand-induced recession?

A recession caused by a decrease in aggregate demand.

What are animal spirits of capitalists?

A term coined by Keynes to describe the psychological state of business confidence or pessimism that influences investment decisions.

What is overheating in economics?

A situation in which aggregate demand exceeds aggregate supply, leading to inflation.

What is stagflation?

A condition of slow economic growth and high unemployment (stagnation) while prices rise (inflation).

What is an adverse supply shock?

A sudden, unexpected event that decreases aggregate supply.

What is commodity money?

Money that takes the form of a commodity with intrinsic value.

What are M1 and M2?

M1 includes the most liquid portions of the money supply: currency in circulation and checkable deposits; M2 includes M1 plus savings accounts, money market accounts, and other near monies.

What is a medium of exchange?

An item that buyers give to sellers when they want to purchase goods and services.

What is the store of value?

An item that people can use to transfer purchasing power from the present to the future.

What is a unit of account?

A yardstick people use to post prices and record debts.

What are required reserves and excess reserves?

The fraction of deposits banks are required to hold as reserves and any reserves held beyond this level.

What is a liquidity problem in banking?

A situation in which a bank is unable to meet its immediate obligations, such as depositor withdrawals.

What is an insolvency problem in banking?

A situation in which a bank's liabilities exceed its assets, leading to bankruptcy.

What is a lender of last resort?

An institution, usually a country's central bank, that provides liquidity to financial institutions when they face difficulties.

What is the Fed’s Dual Mandate?

To promote maximum employment and price stability.

What are open market operations?

The purchase and sale of U.S. government bonds by the Fed.

What are open market purchase/open market sale?

Purchase: Fed buys government bonds to increase money supply; Sale: Fed sells government bonds to decrease money supply.

What is the Federal Open Market Committee?

The committee that makes key decisions about monetary policy.

What is the Federal funds rate?

The interest rate at which banks lend reserve balances to other banks overnight.

True or False: A depreciation of the US dollar on world currency markets raises the price of US exports and imports, typically leading to an expansion of aggregate supply.

False. It raises the price of US imports, typically leading to a decrease in aggregate supply.

True or False: In a demand-induced recession, aggregate demand collapses bringing output and employment down and price inflation up.

False. In demand-induced recession, aggregate demand collapses bringing output and employment down and price inflation down.

True or False: In the aggregate supply and demand model, an increase in stock and real estate prices expands aggregate supply by increasing household income.

False. It expands aggregate demand by increasing household income.

True or False: Paul Volcker tamed the stagflation of the 1970s by first using expansionary monetary policy to increase output and employment and then contractionary monetary policy to decrease inflation.

False. He first used contractionary monetary policy to decrease output and employment and decrease inflation.

True or False: In the aggregate supply and demand framework, an adverse supply shock is predicted to reduce output, employment, and price inflation.

False. It leads to an adverse supply shock.

True or False: The US macro economy has overheated during major wars because major wars decrease the aggregate supply curve, pushing output above potential output.

False. It decreases the aggregate supply curve, pushing output above potential output.

True or False: In a typical recession, output falls below potential output, the unemployment rate rises above the 4-5% range, and price inflation soars.

False. Price inflation decreases.

True or False: When money serves as a unit of account it permits traders to make purchases in the future.

False. When money serves as a unit of account it permits traders to easily compare the relative values of goods and services.

True or False: Banks can hold their reserves either as vault cash or loans.

False. Banks can hold their reserves either as vault cash or deposits at the Federal Reserve.

True or False: The main reason that banks use borrowed funds to finance the acquisition of loans is because borrowed funds are an extremely cheap source of funds.

False. Because borrowed funds are not a cheap source of funds and it is a method for banks to acquire loans

True or False: The Fed acts as a lender of last resort when it raises interest rates in times of financial difficulties to prevent excessive borrowing.

False. The Fed acts as a lender of last resort when it lowers interest rates in times of financial difficulties to prevent excessive borrowing.

True or False: The main reason banks hold bonds (securities) is because bonds provide banks with a high return.

False. The main reason banks hold bonds is because bonds provide banks with a stable return.

True or False: On a routine basis, banks borrow large sums of money from their creditors to pay for the withdrawal of funds by their depositors.

False. Banks do not routinely do this.

True or False: A run on a bank can lead to a panic if the bank is allowed to stay open and continue lending money to its clients.

False. A run on a bank can lead to a panic if the bank is forced to close.

True or False: If a bank's losses from its bad loans exceed the value of their capital, then the bank is said to have a liquidity problem.

False. It is an insolvency problem.

True or False: Open market operations are controlled in the Fed by the Board of Governors, which consists of the Presidents of the 12 regional Federal Reserve Banks.

False. Open market operations are controlled by the Federal Open Market Committee (FOMC).

True or False: The main form of money in the U.S. is government issued currency.

False. The main form of money is bank balances.

True or False: If a mid-size bank becomes insolvent, then government policy makers are likely to liquidate it.

False. Government policy makers may prevent its liquidation to prevent panic.

True or False: The Fed's dual mandate is to maintain price stability and free markets.

False. The Fed's dual mandate is to maintain price stability and maximum employment.

How do economists define money?

Economists define money as any asset that people generally accept in exchange for goods and services.

What are the three functions of money?

Medium of exchange, unit of account, and store of value.

What are the principal assets and liabilities of banks?

Principal assets include loans and securities; principal liabilities include deposits and borrowed funds.

What is the liquidity problem in banking?

A situation in which a bank has insufficient liquid assets to meet the demands of depositors or other creditors.

What is the insolvency problem in banking?

A condition in which a bank's liabilities exceed its assets.

How can government policy makers prevent a liquidity problem at a major bank from starting a panic?

Government policy makers can provide liquidity to the bank or guarantee deposits.

How can policy makers deal with insolvency problems in our financial system?

Policy makers can inject capital into the bank or nationalize it.

What is the Fed’s Dual Mandate?

To promote maximum employment and price stability.

What is the Fed’s open market operations?

Open market operations involve the purchase and sale of U.S. government bonds by the Fed.

How can the Federal Reserve use its open market operations to expand or contract the nation’s money and credit supply?

Purchasing bonds increases the money supply, while selling bonds decreases it.

Describe the chain of command at the Federal Reserve which oversees its open market operations.

The Federal Open Market Committee (FOMC) oversees open market operations.

Give a detailed account of how monetary policy works to impact interest rates, aggregate demand, and the macroeconomy.

Monetary policy impacts interest rates, which in turn affect aggregate demand and subsequently the macroeconomy. Lower interest rates stimulate borrowing and spending, while higher interest rates dampen them.