Survey of Economics – Chapter 17 (Monetary Policy)

Question-and-Answer flashcards covering key points from Chapter 17 on monetary policy, including effects of interest-rate changes, Fed tools, QE, Operation Twist, timing issues, and AD–AS outcomes.

How does an increase in interest rates affect aggregate demand?

It shifts the AD curve to the left, reducing real GDP and lowering the price level.

What happens to consumption, investment, and net exports as the interest rate rises?

They all fall, so aggregate demand decreases.

If the Fed fears an approaching recession, which policy should it use?

Expansionary monetary policy to lower interest rates and shift AD to the right.

Which Fed action is appropriate when inflation is expected to rise?

Contractionary monetary policy that raises interest rates and shifts AD to the left.

What is meant by “quantitative easing” (QE)?

The Fed buys longer-term Treasury securities not normally used in open-market operations.

Describe “Operation Twist.”

The Fed bought about $400 billion of long-term Treasuries while selling an equal amount of short-term Treasuries.

Main objective of QE and Operation Twist?

All of the above—keep 10-year Treasury and mortgage rates low and boost aggregate demand.

When would the government want the economy to contract?

When real GDP is above potential GDP and the price level is rising (to curb inflation).

In Japan’s recession, officials said “money stays in banks.” What stayed in banks, and why was that a problem?

Bank reserves rose, but banks weren’t lending them, likely due to a lack of credit-worthy borrowers.

What did Fed Chair William McChesney Martin mean by “remove the punchbowl just as the party gets going”?

Use contractionary policy as real GDP exceeds potential, to prevent rising inflation.

When did German bond yields turn negative?

When the inflation rate exceeded the nominal interest rate, driving nominal yields below zero.

Why would investors buy bonds with negative yields?

They believed the government would not default and valued the safety of the bonds.

What did the 2008 outcome vs. forecast illustrate about economic policy?

Forecast-based policy is subject to frequent revisions and errors.

Why does the Fed still do active policy rather than follow a strict money‐growth rule?

Because, despite imperfections, active monetary policy is viewed as a stabilizing force.

Why is the claim "The Fed can raise real GDP just by raising the money supply $200 billion" wrong?

Money supply changes influence GDP only indirectly, through interest rates and AD.

Can the Fed eliminate recessions entirely?

No. It can only soften the magnitude of recessions, not eliminate them.

In the dynamic AD–AS model, what does contractionary monetary policy do?

Shifts AD left; both the price level and real GDP fall.

If the Fed raises the discount rate from long-run equilibrium, what is the short-run effect?

AD shifts left; price level and real GDP both decline.

Economy at point B above potential GDP—what action will the Fed take?

All of the above: raise interest rates, use contractionary policy, and sell government securities.

What happens if the Fed lowers the required reserve ratio?

AD shifts right, so both the price level and output rise (expansionary effect).

Which of the following is NOT caused by a U.S. money-supply increase?

Making U.S. financial assets more attractive to foreign investors (it actually makes them less attractive).

Example A (AD left) & Example B (AD right) illustrate what?

A shows contractionary, B shows expansionary policy—both descriptions are correct (E).

To move from AD2 to AD2,policy and reach point C, what should the Fed do?

Open-market purchase of government securities (expansionary).

The “purchases” Chairman Bernanke referred to in 2013 were what?

Open-market purchases of government securities.

Why would "premature tightening" of Fed purchases hurt recovery?

Because it is contractionary, reducing lending and economic activity.

When late expansionary policy fuels inflation after a recession, this is what kind of policy?

Procyclical policy.

What is the federal funds rate?

The interest rate banks charge one another for overnight loans.

As interest rates fall, how do stocks compare to bonds?

Stocks become more attractive, raising demand for—and prices of—stocks.

What is the Fed’s policy of raising the money supply to boost GDP called?

Expansionary monetary policy.

Why purposely use contractionary monetary policy to lower real GDP?

To reduce inflation when real GDP exceeds potential GDP.

If the Fed reacts too slowly to recession and eases while recovery has started, what happens?

Inflation will be higher than if the Fed had not acted.

Define a countercyclical policy.

A policy used to try to stabilize the economy, moving opposite the business cycle.

Must the Fed act exactly when data show a downturn to reduce cycle severity?

False. Perfect timing is impossible; policy can still help even without precision.

With expansionary monetary policy, investment, consumption, and net exports all , shifting AD .

Increase; to the right, raising real GDP and the price level.