Book: Chapter 14

Question 1

appreciation of a currency

Answer 1

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Question 2

federal funds rate

Answer 2

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Question 3

open market purchases

Answer 3

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Question 4

depreciation of a currency

Answer 4

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Question 5

illiquid

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Question 6

open market sales

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Question 7

discount rate

Answer 7

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Question 8

liquidity demand for money

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Question 9

speculative demand for money

Answer 9

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Question 10

exchange rate

Answer 10

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Question 11

money market

Answer 11

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Question 12

transaction demand for money

Answer 12

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Question 13

federal funds market

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Question 14

open market operations

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Question 15

We measure the opportunity cost of holding money
with
.

Answer 15

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Question 16

Money demand will
(increase/decrease)
as prices rise

Answer 16

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Question 17

The principle of
suggests that the
demand for money should increase as prices increase.

Answer 17

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Question 18

The
demand for money arises because
individuals and businesses use money in ordinary
business.

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Question 19

Checking Account Interest Rates. During the
1980s, banks started to pay interest (at low rates) on
checking accounts for the first time. Given what you
know about opportunity costs, how would interest
paid on checking affect the demand for money?

Answer 19

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Question 20

Pegging Interest Rates. Suppose the Federal Reserve
wanted to fix, or “peg,” the level of interest rates at 6
percent per year. Using a simple demand-and-supply
graph, show how increases in money demand would
change the supply of money if the Federal Reserve
pursued the policy of this fixed interest rate. Use
your answer to explain this statement: “If the Federal
Reserve pegs interest rates, it loses control of the
money supply.”

Answer 20

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Question 21

An ATM Next to Your Apartment Building.
Suppose an ATM connected to your own bank is
installed right next to your apartment building.
a. How will this affect the average amount of currency
you carry around with you?
b. If you withdraw funds at your ATM only from your
checking account, will your action have any effect
on total money demand?

Answer 21

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Question 22

Flea Markets and the Demand for Money. People
often like to visit flea markets to look for unexpected
opportunities. Flea markets also typically use cash.
Explain why this is an example of the liquidity demand
for money.

Answer 22

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Question 23

To increase the supply of money, the Fed should

bonds.

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Question 24

Increasing reserve requirements
the
supply of money.

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Question 25

Banks trade reserves with one another in the | market.

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Question 26

Banks borrow from the Fed at the | rate.

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Question 27

Purchasing Long-Term Government Bonds. What would happen to the supply of money if a central bank purchased long-term government bonds held by the public?

Answer 27

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Question 28

China’s Increase in Reserve Requirements. The Chinese government purchased U.S. dollars in the foreign exchange market with Chinese currency. During the same period, the Chinese sharply raised the reserve requirement on banks because they wanted to prevent the money supply from expanding too rapidly. Explain carefully how these two actions, taken together, could keep the supply of money in China from increasing.

Answer 28

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Question 29

Other Channels of Monetary Policy. Consider this quote: “Monetary policy does not work simply through lowering interest rates. Sometimes it can directly affect particular credit markets in the economy.” Can you give an example of actions that the Fed has taken that fit this quotation? (Related to Application 1 on page 299 .)

Answer 29

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Question 30

Interest rates typically fall in a recession because the demand for money depends on changes in real income.

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Question 31

If interest rates are 9 percent per year, the price of a bond that promises to pay $109 next year will be equal to .

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Question 32

Through its effect on money demand, an increase in prices will interest rates.

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Question 33

Open market purchases lead to rising bond prices and | interest rates.

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Question 34

Pricing a Bond. If a bond promises to pay $110 next year and the interest rate is 5 percent per year: a. What will the price of the bond be? b. What will the new price of the bond be if the interest rate falls to 3 percent?

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Question 35

Buy or Sell Bonds? If you strongly believed the Federal Reserve was going to surprise the markets and raise interest rates, would you want to buy bonds or sell bonds?

Answer 35

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Question 36

Recessions and Interest Rates. The economy starts to head into a recession. Using a graph of the money market, show what happens to interest rates. What happens to bond prices?

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Question 37

A Decrease in the Riskiness of the Stock Market. If investors began to think the stock market is becoming less risky, how will this belief affect the demand for money? Would this more likely affect M1 or M2?

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Question 38

Quantitative Easing How does a policy of quantita tive easing differ from conventional open-market purchases?

Answer 38

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Question 39

When the Federal Reserve sells bonds on the open market, it leads to (higher/lower) levels of investment and output in the economy.

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Question 40

To decrease the level of output, the Fed should conduct an open-market (sale/purchase) of bonds.

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Question 41

``` An open-market purchase the supply of money, which interest rates, which investment, and finally results in a(n) in output. ```

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Question 42

An increase in the supply of money will | (appreciate/depreciate) a country’s currency.

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Question 43

Interest Rates, Durable Goods, and Nondurable Goods. Refrigerators and clothing are to some extent durable. Explain why the decision to purchase a refrigerator is likely to be more sensitive to interest rates than the decision to buy clothing.

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Question 44

Where Is Monetary Policy Stronger? In an open economy, changes in monetary policy affect both interest rates and exchange rates. Comparing the United States and Switzerland, in which country would monetary policy have a more significant effect on GDP through changes in exchange rates?

Answer 44

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Question 45

Commodity Prices, the Dollar, and Monetary Policy. Suppose the U.S. is a major source of demand for world commodities and supplies of commodities are limited. Describe how an expansionary monetary policy could affect commodity prices, both through a domestic and international channel. What would be the relationship one would observe between the value of the dollar and commodity prices following a monetary expansion? (Related to Application 2 on page 302 .)

Answer 45

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Question 46

(Inside/Outside) lags are shorter for the | Fed.

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Question 47

Experimental evidence shows us that individuals perform than committees in making monetary policy decisions.

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Question 48

Long-term interest rates can be thought of as | of short-term rates.

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Question 49

The Fed directly controls long-term interest rates. | True/False

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Question 50

Open Economies and Outside Lags in Monetary Policy. Research suggests that the effects of monetary policy through interest rates, exchange rates, and net exports are more rapid than the effects of monetary policy on investment. As an economy becomes more open, how will this change affect the outside lag in monetary policy?

Answer 50

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Question 51

Asset Prices as a Guide to Monetary Policy? Some central bankers have looked at asset prices, such as prices of stocks, to guide monetary policy. The idea is that if stock prices begin to rise, it might signal future inflation or an overheated economy. Are there any dangers to using the stock market as a guide to monetary policy?

Answer 51

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Question 52

Rates on Two-Year Bonds and One-Year Bonds. Suppose the interest rate on a two-year bond was higher than the interest rate on a one-year bond. What does the market believe will happen next year to one-year interest rates?

Answer 52

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Question 53

International Influences on Fed Policy. As international trade becomes more important, monetary policy becomes more heavily influenced by developments in the foreign exchange markets. Go to the Web page of the Federal Reserve (www. federalreserve.gov) and read some recent speeches given by Fed officials. Do international considerations seem to affect policymakers in the United States today?

Answer 53

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Question 54

Are Federal Reserve Chairmen Too Powerful? Economic research has shown that the chairman of the Federal Reserve is more powerful, relative to other committee members, than the head of the central bank in other countries. Fed chairpersons have much more influence over actual decisions than other members. Recall Professor Blinder’s findings that committees make better decisions than individuals and that leaders of groups, per se, do not matter for the quality of decision making. Make an argument that the tradition of a strong chairman in the United States reduces the effectiveness of monetary policy. (Related to Application 3 on page 306 .)

Answer 54

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Question 55

Making Future Predictions Explicit Recently the members of the FOMC have been asked to make predictions for future interest rates and then these have been made public. What is the rationale for this policy?

Answer 55

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