Survey of Economics – Chapter 17: Money, the Fed, and Monetary Policy

30 question-and-answer flashcards summarizing key concepts from Chapter 17 on money demand, money supply, the Fed’s tools, and monetary-policy targets.

Which two variables serve as the Fed’s primary monetary policy targets?

The money supply and the interest rate (especially the federal funds rate).

Why does the Fed prefer targeting interest rates rather than a specific money-supply growth rate?

Because it can affect interest rates directly through open-market operations, and the link between monetary aggregates and economic variables became unreliable.

What is the demand for money in economic terms?

The amount of money—currency and checking-account deposits—that individuals choose to hold.

What is the main advantage of holding money?

Money is perfectly liquid and can immediately buy goods, services, or financial assets.

What is the main disadvantage of holding money?

Currency and checking deposits earn little or no interest, so holding money involves an opportunity cost.

Define the federal funds rate.

The interest rate banks charge each other for overnight loans of reserves.

Why is the federal funds rate so important for Fed policy?

The Fed uses it as a key policy target and can control it through open-market operations, influencing other interest rates and economic activity.

What is the discount rate?

The interest rate at which the Federal Reserve lends reserves directly to banks.

Who are the borrowers and lenders in the federal funds market?

Banks borrow and other banks with excess reserves lend.

How does the Fed lower the federal funds rate?

By buying U.S. Treasury securities on the open market, which increases bank reserves and the money supply, pushing the rate down.

What open-market action does the Fed take to increase the money supply?

It buys U.S. Treasury securities.

What open-market action does the Fed take to decrease the money supply?

It sells U.S. Treasury securities.

When the Fed conducts an open-market purchase, what happens to the money-supply curve and the equilibrium interest rate?

The money-supply curve shifts right, and the equilibrium interest rate falls.

When the Fed conducts an open-market sale, what happens to the money-supply curve and the equilibrium interest rate?

The money-supply curve shifts left, and the equilibrium interest rate rises.

What effect does cutting the federal funds rate have on the money supply?

To cut the rate, the Fed increases the money supply by injecting reserves (buying bonds).

What two macro variables shift money demand to the right?

An increase in real GDP and/or an increase in the price level.

What two macro variables shift money demand to the left?

A decrease in real GDP and/or a decrease in the price level.

If real GDP rises, how does the money-demand curve move?

It shifts to the right (higher money demand at each interest rate).

If the price level falls, how does the money-demand curve move?

It shifts to the left (lower money demand at each interest rate).

How does a lower interest rate affect the opportunity cost of holding money and the quantity of money demanded?

A lower interest rate lowers the opportunity cost of holding money, so the quantity of money demanded increases.

What are the Fed’s ultimate (long-run) policy goals?

High employment, price stability, and economic growth.

Which interest rate is most relevant to day-to-day monetary policy decisions?

The short-term nominal interest rate, particularly the federal funds rate.

Why can’t the Fed directly set a target for unemployment?

Because unemployment is influenced by many factors outside the Fed’s direct control; instead, the Fed manipulates money and interest rates to indirectly affect unemployment.

What happens to bank reserves when the Fed buys Treasury securities?

Bank reserves increase, enabling banks to lend more and expanding the money supply.

What happens to bank reserves when the Fed sells Treasury securities?

Bank reserves decrease, limiting lending and contracting the money supply.

Explain the relationship between the federal funds rate and other market interest rates.

Changes in the federal funds rate typically lead to similar movements in other short-term and, to some extent, long-term interest rates.

What monetary-policy move constitutes contractionary policy?

Selling Treasury securities to decrease the money supply and raise interest rates.

What monetary-policy move constitutes expansionary policy?

Buying Treasury securities to increase the money supply and lower interest rates.

Why did the Fed abandon strict money-supply targets in the early 1990s?

The correlation between money-growth targets and economic outcomes weakened, so targeting interest rates became more effective.

What is meant by the ‘opportunity cost’ of holding money?

The forgone interest that could have been earned by holding interest-bearing assets instead of money.