Financial markets

Question 1

Who determines the interest rate in the short run?

Answer 1

The Central Bank

The Central Bank’s policies directly influence interest rates.

Question 2

What is the quantity theory of money (QTM)?

Answer 2

The price of goods is directly proportional to the amount of money in circulation

Key figures associated with QTM include Locke, Hume, and Stuart Mill.

Question 3

What is fiat money?

Answer 3

Money whose value is not inherent but established by a human system

In the US, fiat money is established by the Federal Reserve.

Question 4

What does the term ‘neutrality of money’ imply?

Answer 4

Changes in the stock of money affect only nominal variables like prices, not real effects.

Question 5

Who regulates the money supply in modern economies?

Answer 5

The Central Banks

Central Banks are granted independence to avoid political influence.

Question 6

What are the two types of assets discussed in the financial market?

Answer 6

1. Bonds: profitable but not liquid
2. Money: liquid but not profitable

Question 7

What affects the demand for money?

Answer 7

1. Level of transactions
2. Interest rate on bonds

Question 8

What is the opportunity cost of holding money?

Answer 8

Missed opportunity payments from not holding bonds.

Question 9

How is financial wealth defined?

Answer 9

The value of all financial assets minus all financial liabilities

Financial wealth is a stock variable.

Question 10

What is the relationship between bond price and interest rate?

Answer 10

The higher the bond price, the lower the interest rate.

Question 11

What determines equilibrium in the money market?

Answer 11

Ms = Md, where Ms is the money supply and Md is the money demand.

Question 12

What happens when the interest rate is zero?

Answer 12

People are indifferent between bonds and currency, leading to a horizontal demand curve for money.

Question 13

What is an expansionary open market operation?

Answer 13

The central bank expands the supply of money by buying bonds.

Question 14

What is a liquidity trap?

Answer 14

A situation where increasing the money supply does not affect the interest rate.

Question 15

What are the primary methods through which the Central Bank can change the money supply?

Answer 15

1. Open market operations
2. Loans to commercial banks
3. Modifying the reserve ratio

Question 16

What is the money multiplier?

Answer 16

The ratio that determines how much the money supply increases based on the base money supplied by the Central Bank.

Question 17

What is the formula for money demand?

Answer 17

Md = €Y × L(i)

Where Md is money demand, €Y is nominal income, and L(i) is a function of the interest rate.

Question 18

What components make up the Central Bank’s balance sheet?

Answer 18

1. Bonds
2. Currency
3. Reserves

Question 19

What is the role of commercial banks?

Answer 19

Financial intermediaries that receive funds and use them to buy financial assets or make loans.

Question 20

What is the demand for currency represented as?

Answer 20

CUd = ꢀMd

CUd represents the demand for currency based on total money demand.

Question 21

What is the relationship between money demand and money supply at equilibrium?

Answer 21

H = Hd, where H is the supply of Central Bank money and Hd is the demand for Central Bank money.

Question 22

How does an increase in money supply (Ms) affect interest rates?

Answer 22

Generally leads to lower interest rates.

Question 23

Fill in the blank: The governor of the Bank of Italy is appointed by the _______.

Answer 23

President of the Republic.

Question 24

True or False: Federal Reserve notes are redeemable in gold or silver.

Answer 24

False

Federal Reserve notes have no backing by commodities.

Question 25

What is the equilibrium condition for the money market?

Answer 25

Md = H ## Footnote Where Md is money demand and H is high-powered money.

Question 26

Define the money multiplier (mm)

Answer 26

mm = 1 / (c + θ(1 - c)) ## Footnote Where c is the currency ratio and θ is the reserve coefficient.

Question 27

What happens when Md = Ms?

Answer 27

Md = H · mm ## Footnote This implies that the Central Bank's printing of H generates a higher money supply Ms.

Question 28

Fill in the blank: If c = 0 and θ = 0.1, then mm = ______.

Answer 28

10

Question 29

What is the increase in money supply (ΔMs) when H increases by €100?

Answer 29

ΔMs = ΔH * mm ## Footnote In this case, ΔMs = 100 * 10 = €1000.

Question 30

What is the formula for money demand in relation to income and interest rates?

Answer 30

Md = €Y L(i) ## Footnote Where €Y is income and L(i) is the liquidity preference function.

Question 31

What is the significance of the federal funds market in the US?

Answer 31

It's where banks with excess reserves lend to those with deficiencies ## Footnote The interest rate in this market is called the federal funds rate.

Question 32

True or False: The ECB controls several interest rates through a single refinancing rate.

Answer 32

True

Question 33

What does the ECB's refinancing rate influence?

Answer 33

All interest rates in the economy ## Footnote This is one way the ECB creates high-powered money (H).

Question 34

What are the components of the money supply (M)?

Answer 34

M = Currency CU + Deposits D

Question 35

What is the relationship between the money multiplier and deposits?

Answer 35

ΔD (= ΔMs) = 100 + 90 + 81 + ... = 100 * (1 + 0.9 + 0.92 + 0.93 + ...) ## Footnote This is a geometric series summation.

Question 36

What effect did the subprime crisis have on the money multiplier in the US?

Answer 36

It dropped significantly ## Footnote Banks increased their holding of excess reserves, leading to a credit crunch.

Question 37

What are the two main components of Central Bank money (H)?

Answer 37

Currency (CU) + Reserves (R)

Question 38

Fill in the blank: The Central Bank's expansionary open market operation involves buying ______.

Answer 38

Bonds

Question 39

What is the reserve coefficient (θ) in the example provided?

Answer 39

0.1