Chapter 1

Question 1

Zero Lower Bound

Answer 1

An interest rate can’t be negative, because then nobody would want to hold bonds, and everyone would want to have cash instead. Because cash pays zero interest, but if the interest rate is negative it means that people will have to pay to hold bonds.

Question 2

Why are low interest rates a potential issue?

Answer 2

1. Because I limits the central banks possibilities to respond to a further decrease in demand.
2. Because they appear to lead to excessive risk taking by investors. Because the return from holding bonds is so low, investors are tempted to take too much risk to increase their returns. And too much risk taking can lead to financial crisis (as the one 2008).

Question 3

What is a closed economic circuit?

Answer 3

total firm sales = total household purchases
total return on input factors (wages, interest, profit) = total income paid to households
total value of production = total income paid to households
total household income = total household consumption expenditure

Question 4

Can inflation also be good?

Answer 4

Knowing that money will be worth less today than tomorrow encourages spending today. More spending means more income means more production means more economic growth. In this way, inflation fuels economic activity.
Inflation raises tax income, which helps governments that need to pay back debt.
Inflation means that there can be permanent growth in nominal wages without this hurting the economy. (This is of psychological importance.)