When Congress established the Federal Reserve in 1913, its main responsibility was |
to make discount loans to banks suffering from large withdrawals by depositors |
Congress broadened the Fed’s responsibility since |
the 1930s as a result of the Great Depression. |
Which one of the following is not one of the monetary policy goals of the Fed? |
Reduce income inequality |
Why is the Fed sometimes said to have a "dual mandate"? |
maintaining price stability and high employment are the two most important goals of the Fed that are explicitly mentioned in the Employment Act of 1946 |
How can investment banks be subject to liquidity problems? |
they often borrow short term, sometimes as short as overnight, and invest the funds in longer-term investments |
What is a banking panic? |
A situation in which many banks experience runs at the same time |
Which of the following best explains how the Federal Reserve acts to help prevent banking panics? |
The Fed acts as a lender of last resort, making loans to banks so that they can pay off depositors |
An article in the Wall Street Journal quoted a Federal Reserve economist as referring to "the Fed’s existing dual mandate to achieve maximum sustainable employment in the context of price stability." "Maximum sustainable employment" means the economy is producing at its potential where |
unemployment includes frictional and structural unemployment |
"Price stability" means |
a low and stable inflation rate |
In the summer of 2015, many economists and policymakers expected that the Federal Reserve would increase its target for the federal funds rate by the end of the year. Some economists argued, though, that it would be better for the Fed to leave its target unchanged. At the time, the unemployment rate was 5.3 percent, close to full employment, but the inflation rate was below the Fed’s target of 2 percent. If it did not increase its target for the federal funds rate, the policy goal the Fed would be promoting is |
economic growth, because maintaining lower interest rates would stimulate the economy and raise the price level |
One of the goals of the Federal Reserve is price stability. For the Fed to achieve this goal |
the rate of inflation should be low, such as 1% to 3%, and should be fairly consistent |
Which of the following is not one of the monetary policy goals of the Federal Reserve ("the Fed")? |
a high foreign exchange rate of the U.S. dollar relative to other currencies |
Which of the following is a monetary policy target used by the Fed? |
Interest Rate |
The Fed uses policy targets of interest rate and/or money supply because |
it can affect the interest rate and the money supply directly and these in turn can affect unemployment, GDP growth, and the price level |
What do economists mean by the demand for money? |
It is the amount of money- currency and checking accounts deposits – that an individual holds |
What is the advantage of holding money? |
Money can be used to buy goods, services, or financial assets |
What is the disadvantage of holding money? |
Money, in the form of currency or checking account deposits, earns either no interest or a very low rate of interest. |
The federal funds rate is |
The interest rate that banks charge each other for overnight loans |
A former Federal Reserve official argued that at the Fed, |
stable prices make it easier to plan for the future, so expectations can be stable, which makes it less costly to make loans |
Additionally, the federal funds rate is |
very important for the Fed’s monetary policy because the Fed uses the federal funds rate as a monetary policy target since it can control the rate through open market operations |
In the graph of the money market shown on the right, what could cause the money supply curve to shift from MS1 to MS2 ? |
The Fed decreases the money supply by deciding to sell U.S. Treasury securities |
In the graph of the money market shown on the right, what could cause the money demand curve to shift from MD1 to MD2 |
An increase in the price level and An increase in Real GDP |
1. In 2015, one article in the Wall Street Journal discussed the possibility of "a September quarter-point increase in the Fed?s range for overnight target rates," while another article noted, "the U.S. central bank’s discount rate…has been set at 0.75% since February 2010." What is the name of the "target interest rate" mentioned in this article? 2.Who borrows money and who lends money at this "target interest rate"? 3.What is the discount rate? |
1.The federal funds rate 2. Banks borrow and banks lend 3. The discount rate is the rate at which the Fed lends to banks |
In response to problems in financial markets and a slowing economy, the Federal Open Market Committee (FOMC) began lowering its target for the federal funds rate from 5.25 percent in September 2007. Over the next year, the FOMC cut its federal funds rate target in a series of steps. Writing in the New York Times, 2.How does lowering the target for the federal funds rate "pour money" into the banking system? |
1.To decrease the federal funds rate, the Fed must increase the money supply 2. To increase the money supply, the Fed buys bonds on the open market, which increases bank reserves. |
An article in the New York Times in 1993 stated the following about Fed Chairman Alan Greenspan’s decision to no longer announce targets for the money: |
1. federal funds rate 2. the relationship between money aggregates and other economic variables was becoming unreliable |
In the figure to the right, which of the following events is most likely to cause a shift in the money demand (MD) curve from MD 1 to MD 2(Point |
Increase in real GDP or increase in the price level |
Which of these variables are the main monetary policy targets of the Fed? |
the money supply and the interest rate |
When interest rates on Treasury bills and other financial assets are low, the opportunity cost of holding money is _________, so the quantity of money demanded will be _________. |
low; high |
If real GDP increases, |
the money demand curve shifts to the right. |
If the price level decreases, |
the money demand curve shifts to the left |
If the Federal Open Market Committee (FOMC) decides to increase the money supply, it orders the trading desk at the Federal Reserve Bank of New York to |
buy U.S. Treasury securities. |
If the FOMC orders the trading desk to sell Treasury securities, |
the money supply curve will shift to the left, and the equilibrium interest rate will rise |
Suppose that when the Fed decreases the money supply, households and firms initially hold less money than they want to, relative to other financial assets. As a result, households and firms will _________ Treasury bills and other financial assets, thereby _________ their prices, and _________ their interest rates. |
sell; decreasing; increasing |
When the Fed conducts monetary policy, the most relevant interest rate is the |
short-term nominal interest rate |
To affect economic variables such as real GDP or the price level, the monetary policy target the Federal Reserve has generally focused on is the |
federal funds rate |
The interest rate that banks charge each other for overnight loans is called the |
federal funds rate |
Which of the following statements is correct? |
The effect of a change in the federal funds rate on long-term interest rates is usually smaller than it is on short-term interest rates. A majority of economists support the Fed’s choice of the interest rate as its monetary policy target, but some economists believe the Fed should concentrate on the money supply instead. Changes in the federal funds rate usually will result in changes in both short-term and long-term interest rates on financial assets. ALL ARE CORRECT!!!! |
An increase in interest rates affects aggregate demand by |
shifting the aggregate demand curve to the left, reducing real GDP and lowering the price level. |
As the interest rate increases, |
consumption, investment, and net exports decrease; aggregate demand decreases |
If the Fed believes the economy is about to fall into recession, it should |
use an expansionary monetary policy to lower the interest rate and shift AD to the right |
If the Fed believes the inflation rate is about to increase, it should |
use a contractionary monetary policy to increase the interest rate and shift AD to the left |
What is "quantitative easing"? |
buying longer term Treasury securities that are not usually involved in open market operations |
What is "Operation Twist"? |
the Fed’s program to purchase $400 billion in long-term Treasury securities while selling an equal amount of shorter-term Treasury securities |
Which of the following was the Fed’s objective in using "quantitative easing" and "Operation Twist"? |
A. To keep interest rates on mortgages low. B. To increase aggregate demand. C. To keep interest rates on 10-year Treasury notes low. D. All of the above. ALL THE ABOVE IS CORRECT |
A student says the following: |
above potential GDP and the price level is rising |
According to an article in the New York Times, an increase in the reserves in banks. 2. But the real problem was that banks were not lending the reserves. 3. The reason for this may have been a lack of borrowers |
1. an increase 2. lending 3. borrowers |
1. An article in the Wall Street Journal discussing the Federal Reserve’s monetary policy included the following observation: "Fed officials have been signaling since last year that they expected to raise rates in 2015 … pushing up the value of the currency and contributing to the economic slowdown officials now confront." 2. By increasing U.S. interest rates, the Fed would cause the value of the currency to increase because 3. An increase in the value of the currency would contribute to a slowdown in the growth of the U.S. economy because |
1. increasing the exchange rate between the dollar and other currencies 2. international investors will demand more U.S. dollars to buy U.S. financial assets that now pay higher interest rates. 3. U.S. exports will fall and imports from other countries will rise, reducing net exports and aggregate demand. |
1. According to an article in the Wall Street Journal, "Brazil’s economy grew just 2.3% in 2013, compared with 7.5% in 2010. The country also has struggled with persistently high inflation, which has forced its central bank to raise interest rates." 2. The increase in interest rates |
1. if this was the only policy tool that could be used to reduce aggregate demand and the inflation rate 2. can be connected to the slowing rate of economic growth because it is a contractionary policy |
1 William McChesney Martin, who was Federal Reserve chairman from 1951 to 1970, was once quoted as saying, contractionary policy. 2. In terms of the economy, "just as the party gets going" refers to a situation in which real GDP is greater than potential GDP, which will result in an increase in the inflation rate. |
1. contractionary 2. is greater than an increase in |
1. An article in the Wall Street Journal in 2015 reported that the interest rate on five-year German government bonds had become negative: "The negative yield means investors are effectively paying the German state for holding its debt." The article quoted an investment analyst as saying: "The negative yield is not scaring investors away." 2. Investors were willing to buy bonds with a negative interest rate because |
1. the inflation rate exceeded the nominal interest rate 2. they believed there was no chance that the government would default |
[Related to the Making the Connection] An article in the Wall Street Journal notes that before the financial crisis of 2007minus |
federal funds rate |
The Fed expects that controlling that one interest rate would allow it to meet its goals for inflation and unemployment because lower short-term interest rates |
encourage lending and stimulate economic activity |
The article also notes that after the financial crisis, "the Fed is working through a broader spectrum of interest rates." |
longer term Treasury rates and mortgage rates. |
[Related to the Making the Connection] |
decreased |
The difference between what was expected and what actually occurred illustrates that the formulation of economic policy |
relies on economic forecasting that is subject to frequent revisions and errors |
The following appears in a Federal Reserve publication: |
although it is not perfect, active monetary policy is still a stabilizing force in the economy |
Consider the following statement: correct because an increase in the money supply does affect real GDP directly. |
incorrect does not |
An investment blog said about Fed Chair Janet Yellen, "She is arguably the world’s most powerful woman, and perhaps the most powerful person in the world. Can you name anybody with more might"? |
is generally accepted by economists because of the influence the Fed chair has on monetary policy and the effect monetary policy has on inflation, employment, and financial stability |
An article in BusinessWeek in 2013 reported that Fed Chairman Ben Bernanke testified to Congress that: |
open market purchases of government securities. |
A "premature tightening" of the "pace of purchases" would slow down the economic recovery because this action would be |
contractionary, reducing lending and economic activity. |
The Fed’s strategy of increasing the money supply and lowering interest rates in order to increase real GDP is called |
expansionary monetary policy. |
Why would the Fed intentionally use contractionary monetary policy to reduce real GDP? |
The Fed intends to reduce inflation, which occurs if real GDP is greater than potential GDP |
If the Fed is too slow to react to a recession and applies an expansionary monetary policy only after the economy begins to recover, then |
inflation will be higher than if the Fed had not acted |
A countercyclical policy is one that |
is used to attempt to stabilize the economy |
A procyclical policy |
increases the severity of a business cycle |
For the Fed to succeed in reducing the severity of business cycles, it must act precisely when a recession or an acceleration of inflation can be seen in the economic data. |
false |
With an expansionary monetary policy, investment, consumption, and net exports all ________, which results in the aggregate demand curve shifting to the ________, increasing real GDP and the price level. |
increase; right |
Which of the following is not a correct comparison between an expansionary monetary policy in the basic aggregate demand and aggregate supply model and in the dynamic aggregate demand and aggregate supply model? |
A. In the dynamic model, expansionary policy would be used when demand does not grow sufficiently; in the basic model, expansionary policy would be used when demand falls. B. The dynamic model assumes that potential GDP is constantly growing while the basic model assumes that it is static. C. If the economy is below full employment, expansionary monetary policy will cause an increase in the price level in both models. D. All of the above are correct statements about the two models. ALL ARE CORRECT |
Which of the following is not a correct comparison between a contractionary monetary policy in the basic aggregate demand and aggregate supply model and in the dynamic aggregate demand and aggregate supply model? |
A. The static model assumes that potential GDP is constantly growing while the dynamic model assumes that it is static. B. In the dynamic model, contractionary policy would be used when demand grows too slowly; in the basic model, expansionary policy would be used when demand increases. C. If the economy is above full employment, contractionary monetary policy will cause a decrease in the price level in the static but not the dynamic model. D. All of the above are correct statements about the two models. E. None of the above are correct statements about the two models. NONE ARE CORRECT |
Explain whether you agree with this argument: |
The statement is false. A contractionary policy could result in a lower rate of inflation rather than a fall in the price level |
If the Fed decides to carry out an expansionary monetary policy because it believes aggregate demand will not increase enough to keep the economy at potential GDP, the inflation rate will most likely be lower than it would have been without the policy. |
false |
During 2005, the FOMC was concerned that the inflation rate would begin to accelerate due to the continued boom in the housing market, so the Fed started decreasing the target for the federal funds rate. |
false |
Consider the following choices and determine the correct definition for the monetary rule. |
A monetary rule is a plan for increasing the money supply at a constant rate regardless of the prevailing economic condition. |
Milton Friedman would have liked the Fed to follow a monetary rule where the |
money supply is increased every year by a percentage rate equal to the long-run growth rate of real GDP |
Support for a monetary rule of the kind advocated by Friedman declined since 1980 because |
the Fed’s performance since 1980 has been excellent even without a formal inflation target |
For more than 20 years, the Fed has used the federal funds rate as its monetary policy target. It has not targeted money supply at the same time because the |
Fed cannot target both at the same time: It has to choose between targeting an interest rate and targeting the money supply. |
What is the Taylor rule? |
It is a rule that links the Fed’s target for the federal funds rate to the current inflation rate, real equilibrium federal funds rate, inflation gap and output gap. |
What is the purpose of the Taylor rule? |
analyze and predict how the Fed targets the federal funds rate. |
In an interview, Paul Volcker, Chairman of the Federal Reserve’s Board of Governors from 1979 to 1987, was asked about the Fed’s use of monetary policy to reduce the rate of inflation. Volcker replied: |
if the Fed targets interest rates, they have to accept that inflation will fluctuate significantly, and Volker’s goal was to reduce inflation. |
In discussing the Taylor rule, John Taylor wrote: |
lower, because more weight would be given to the output gap |
Economists |
of differing views about the significance of inflation and unemployment. |
Two economists at the Federal Reserve Bank of Cleveland note that "estimates of potential GDP are very fluid, [which] suggests there is considerable error in our current measure." They conclude that "this lack of precision should be recognized when policy recommendations are made using a Taylor-type rule." |
the likelihood that potential output or the natural rate of unemployment cannot be accurately measured. |
While serving as the president of the Federal Reserve Bank of St. Louis, William Poole stated, even if the target chosen is not a zero rate of inflation? |
A. Better communication between the Fed and the public B. Improved accountability for the Fed C. More accurate expectations of future inflation D. All of the above ALL ARE CORRECT |
October 2015 was the forty-second consecutive month that the rate of inflation as measured by the personal consumption expenditures (PCE) price index was below the Federal Reserve’s target of 2 percent. |
the PCE does not measure food and energy prices, which are measured by the CPI. |
The |
one goal of monetary policy is price stability and, if the price index used to measure inflation is consistently wrong, monetary policies based on that information will be wrong. |
If the economy moves into recession, monetarists argue that the Fed should |
keep the money supply growing at a constant rate |
Which of the following statements is true about the Fed’s monetary policy targets? |
The Fed is forced to choose between the interest rate and the money supply as its monetary policy target |
The Taylor rule for federal funds rate targeting does which of the following? |
It links the Fed’s target for the federal funds rate to economic variables. |
According to the Taylor Rule, if the Fed reduces its target for the inflation rate, the result will be |
a higher target federal funds rate. |
When the central bank commits to conducting policy in a manner that achieves the goal of holding inflation to a publicly announced level, it is using |
inflation targeting. |
Which of the following were important developments in the mortgage market that took place during the 1970s? |
A. Fannie Mae and Freddie Mac began to act as intermediaries between investors and home buyers. B. Banks began to resell mortgages on the secondary market rather than holding them in their portfolios. C. Lending standards greatly loosened credit standards, enabling more borrowers to obtain mortgages. D. All of the above. E. A and B only. A AND B ONLY |
Beginning in 2008, the Federal Reserve and the U.S. Treasury Department responded to the financial crisis by intervening in financial markets in unprecedented ways. |
Making loans to primary dealers and holders of mortgage-backed securities |
A newspaper article in the fall of 2007 reported stated that: |
the economy was slowing down and about to head into a severe recession. |
When the article refers to "credit availability," it means the ability of |
people to obtain credit. |
Problems of credit availability would affect a homebuilder such as Hovnanian Enterprises because |
most potential homeowners need mortgages to buy homes. |
An article in a Federal Reserve publication observes that |
the development of a secondary mortgage market; a decrease |
The Federal Reserve releases transcripts of its Federal Open Market Committee (FOMC) meetings only after a five-year lag in order to preserve the confidentiality of the discussions. When the transcripts of the FOMC’s 2008 meetings were released, one member of the Board of Governors was quoted as saying in an April 2008 meeting, "I think it is very possible that we will look back and say, particularly after the Bear Stearns episode, that we have turned the corner in terms of the financial disruption." |
incorrect. The economic situation worsened throughout 2008. |
The member’s prediction may have seemed reasonable at the time because |
there was a crisis atmosphere in April 2008, and once the crisis was resolved, it was reasonable to expect things to improve. |
In late 2012, the U.S. Treasury sold the last of the stock it purchased in the insurance company AIG. The Treasury earned a profit on the $22.7 billion it had invested in AIG in 2008. An article in Wall Street Journal noted that: |
it was the largest insurance company in the nation and the government feared the repercussions of a failure of AIG. |
The government bailout was controversial because |
it was expensive, and other companies suffered through bankruptcy and failure. |
Even though the |
not necessarily wrong, because it was an expensive and risky solution. |
Recall that "securitization" is the process of turning a loan, such as a mortgage, into a bond that can be bought and sold in secondary markets. An article in the Economist notes: |
Loans granted to borrowers with flawed credit histories; a higher interest rate |
Why would securitization give mortgage borrowers access to a deeper pool of capital? |
Since banks could resell mortgages to investors, they had access to more funds than just their own deposits |
In 2015, Richard Fuld, the last CEO of Lehman Brothers, gave a talk in which according to an article in the Wall Street Journal, "He outlined what he called the ‘perfect storm’ of events that led to the financial crisis, saying ‘it all started with the government’ and policies that subsidized cheap loans for people to buy homes in order to help them chase the American dream." |
a burst in a housing bubble in 2006 which led to mortgage defaults, and a disruption of the financial system resulting from the creation of complex packagings of mortgages. |
Government policies that could have been said to have been subsidizing cheap loans included |
the creation of a secondary mortgage market through Fannie Mae and Freddie Mac, and the low interest rates following the 2001 recession. |
During the expansion and deflation of the housing bubble, housing prices rose by |
60 percent between January 2000 and July 2005 and then fell by 80 percent between July 2005 and May 2010. |
At the beginning of 2005, Robert Toll, CEO of Toll Brothers, argued that the United States was not experiencing a housing bubble. Instead, he argued that higher house prices reflected restrictions imposed by local governments on building new houses. He argued that the restrictions resulted from "NIMBY"long dash |
It would keep the supply of housing from increasing. |
It would be possible to decide whether these factors or a bubble was the cause of rising housing prices by looking at the number of new home units sold. If the number of new home units sold rose noticeably over time, then the evidence supports the bubble argument. |
true |
Which of the following events was an important cause of the 2007dash |
the collapse of a housing bubble |
Two government-sponsored enterprises that stand between investors and banks that grant mortgages are the Federal National Mortgage Association and the Federal Home Loan Mortgage Corporation. |
true |
The decline in housing prices that began in 2006 led to rising defaults among which borrowers? |
A. borrowers with adjustable-rate mortgages B. alt-A and subprime borrowers C. borrowers who had made only small down payments D. All of the above. ALL OF THE ABOVE |
Which of the following is a monetary policy response to the economic recession of 2007dash |
A. The Fed purchased large amounts of mortgage-backed securities. B. The Fed provided loans directly to corporations by purchasing commercial paper. C. The Fed expanded the eligibility for discount loans to firms other than commercial banks. D. All of the above were responses. ALL OF THE ABOVE |
Which of the following is NOT a monetary policy goal of the Federal Reserve bank (the Fed)? |
low prices |
When the Federal Open Market Committee (FOMC) decides to increase the money supply, it buys U.S. Treasury securities. If the FOMC wishes to decrease the money supply, it buys U.S. Treasury securities. |
buys sells |
As the figure to the right indicates, the Fed can affect both the money supply and interest rates. However, in recent years, the Fed targets interest rates in monetary policy more often than it does the money supply. Which interest rate does the Fed target? |
the federal funds rate |
The federal funds rate |
is the rate that banks charge each other for short-term loans of excess reserves |
In the figure to the right, when the money supply increased from MS 1 to MS 2 |
A. Increased demand for Treasury securities drives down their interest rate. B. Increased demand for Treasury securities drives up their prices. C. Initially, firms hold more money than they want relative to other financial assets. D. All of the above. ALL OF THE ABOVE |
The long-term real interest rate is considered the most relevant interest rate when conducting monetary policy. |
short-term nominal interest rate |
In the figure to the right, the opportunity costof holding money
increases when moving from Point A to Point B on the money demand curve. |
decreases |
In the figure to the right, which of the following events is most likely to cause a shift in the money demand (MD) curve from MD 1 to MD 2 (Point |
Increase in real GDP or increase in the price level |
The Fed uses monetary policy to offset the effects of a recession (high unemployment and falling prices when actual real GDP falls short of potential GDP) and the effects of a rapid expansion (high prices and wages). |
The Fed can only soften the magnitude of recessions, not eliminate them. |
Changes in interest rates affect aggregate demand. |
The value of the dollar Consumption of durable goods Business investment projects |
Suppose the economy is in equilibrium in the first period at point A. In the second period, the economy reaches point B. What policy would the Fed likely pursue in order to move AD 2 to AD Subscript 2 comma policy and reach equilibrium (point C) in the second period? (What policy will increase the price level and increase actual real GDP?) |
Open market purchase of government securities |
If the Federal Reserve is late to recognize a recession and implements an expansionary policy too late, the result could be an increase in inflation during the beginning of the next phase. Even though the goal had been to reduce the severity of the recession, the poor timing caused another problem: inflation. This is an example of what type of policy? |
Procyclical policy |
The figure to the right illustrates the economy using the Dynamic Aggregate Demand and Aggregate Supply Model
an expansionary monetary policy. |
contractionary |
The figure to the right illustrates the economy using the Dynamic Aggregate Demand and Aggregate Supply Model monetary policy. increases Potential real GDP increases Price level
increases Unemployment increases |
Actual real GDP decreases Potential real GDP does not change Price level decreases Unemployment increases . |
The figure to the right illustrates a dynamic AD-AS model Expansionary fiscal policy |
expansionary monetary policy |
If the Federal Reserve Bank’s policy is successful, what is the effect on the following macroeconomic indicators? |
actua; real GDP increases potential real GDP does not change price level increases unemployment decreases |
The figure to the right illustrates a dynamic AD-AS model to AD Subscript 2 comma policy and reach equilibrium (point C) in the second period? |
open market purchases of government securities |
What is inflation targeting? |
Committing the central bank to achieve an announced level of inflation. |
Nobel laureate Milton Friedman and his followers belong to a school of thought known as monetarism. What do the monetarists argue the Fed should target? |
The Fed should target the money supply, not the interest rate, and that it should adopt the monetary growth rule. |
Consider the figure to the right. Can the Fed achieve a $900 billion money supply (MS) AND a 5% interest rate (point C)? |
No. The Fed cannot target both the money supply and the interest rate simultaneously. |
According to the Taylor rule what is the federal funds target rate under the following conditions? |
3.5% |
What two institutions did Congress create in order to increase the availability of mortgages in a secondary market? |
"Fannie Mae" and "Freddie Mac" |
How do investment banks differ from commercial banks? (Mark all that apply.) |
Investment banks generally do not lend to households. Investment banks do not take deposits. |
Why did the Fed help JP Morgan Chase buy Bear Stearns? |
Failure of Bear Stearns would lead to a larger investment bank failure. Commercial banks would be reluctant to lend to investment banks. |
Macroeconomics Chapter 15
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