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26 Cards in this Set

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  • Back
What is monetary policy?
actions taken by the Fed to change interest rates and the money supply to affect the economy.
What is central bank independence?
central bank can make decisions without political interference.
How does the Fed implement monetary policy by changing interest rates?
Open-market operations: give banks more reserves or take reserves away from them to trigger an expansion or contraction of money supply.
What component of the graph of Interest Rates against quantity of bank reserves does the Fed control?
The position of the supply curve depends on Federal policy that controls the quantity of bank reserves.
Why do banks hold reserves?
Because government regulations require them to do so.
What is the federal funds rate?
The interest rates that banks pay and receive when they borrow reserves from one another. Any bank that wants to borrow reserves must pay the federal funds rate for the privilege.
Why does the demand curve slope down while the supply curve slopes up?
as interest rates go up, more expensive to borrow, fewer reserves demanded. when interest rates go up, more attractive to lend.
Where does the borrowing and lending between banks come from?
banks have developed an active market in which those with excess reserves lend them to those with reserve deficiencies.
What does the Fed do when it wants to reduce interest rates?
purchases T-bills to provide additional reserves to the market and shifting the supply curve outward.
Sure, the Fed can reduce interest rates by purchasing T-bills, but where does the Fed get the money?
Manufactures funds out of thin air. Adding appropriate sums to the reserve accounts that the banks maintain at the Fed.
So Fed buys the securities, which increases bank reserves, lowering interest rates. What do they ultimately hope to achieve by doing this?
Multiple expansion of the money supply, 1/m
What does the Fed control directly?
FFR, by buying just the right volume of securities.
What if the Fed wants to raise interest rates?
Sells government securities to banks, decreasing bank reserves because banks pay for it with deposits in Fed, leading to a multiple contraction of the banking system.
What happens, with reference to a relevant graph, to the price of a treasury bill when Fed buys most of it.
same thing. price naturally goes up.
What is the relationship between bond prices and interest rates?
When bond prices go up, interest rates fall because the purchaser of the bond spends more money than before to earn a given number of dollars of interest per year. Similarly, when bond prices fall, interest rates rise. BONDS PAY A FIXED NUMBER OF DOLLARS OF INTEREST PER YEAR!!!
Talk about the effect of an open-market purchase of T-bills by the Fed on:
a) Money supply
b) T-bill prices
c) Interest Rates
a) increases, excess reserves allowed to circulate and expand through the economy.
b) goes up, due to scarcer T-bills.
c) goes down, due to increase in supply of reserves.
What must have happened at the bank if there is an expansion of the money supply?
increase in excess reserves without increasing deposits. fed lends money to the bank.
What is the discount rate?
the interest rate Fed charges on loans made to banks.
How does the Fed influence the amount banks borrow? But is this reliable?
By manipulating the discount rate. Not very reliable because banks may not respond accordingly. The link between discount rate and the volume of the bank reserves may be a loose one.
What are other methods of monetary control?
Lending to Banks and Changing Reserve Requirements.
How does monetary policy work? Which components are the most sensitive to monetary policy?
could be expansionary or contractionary. mainly affects investment and interest rates, which affect total expenditure. investment and net exports are the most sensitive to monetary policy.
IN GENERAL, EXPANSIONARY MONETARY POLICY LEADS TO LOWER INTEREST RATES, AND THESE LOWER INTEREST RATES ENCOURAGE INVESTMENT (I), WHICH HAS MULTIPLIER EFFECTS ON AGGREGATE DEMAND. '

FED --> M & r --> I --> aggregate demand --> GDP
How does the interest rate affect total spending?
higher interest rate, higher cost of investing since higher interest paid on borrowings, less I, less total spending. Higher interest rate, lower expenditure schedule.
What would the Fed do in a recession?
Would try to expand money supply by purchasing government securities in an open market and increasing bank reserves. By increasing bank reserves shifts the supply curve outwards while the demand curve doesn't move. FFR falls.
So Fed can implement expansionary money policy by purchasing US government securities. But what might it give rise to?
We must also consider the price level. Inflation - which depends on the slope of the aggregate supply curve.

Keynesian model:
FED --> M & r --> I --> aggregate demand --> P & Y
What does investment spending I constitute?
Business Investment and investment in new homes. I is sensitive to interest rates (r). I is lower when r is higher.
Why does the aggregate demand curve slope downward?
Higher prices increase the demand for bank deposits, and hence for bank reserves. Given fixed supply for reserves, higher demand pushes interest rates up, which, in turn, discourages investment.