Lectures 14-17

Question 1

Uses of Money

Answer 1

1. Medium of Exchange
2. Unit of Account
3. Store of Value
4. Standard of deferred payment

Question 2

How do Banks make their money?

Answer 2

Difference between interest paid to depositors and charged to borrowers

Question 3

Reserve Ratio

Answer 3

% of deposits banks cannot lend out

Question 4

Money Multiplier

Answer 4

1/Reserve Ratio

Question 5

Banks assets

Answer 5

Loans and financial securities

Question 6

Bank Liabilities

Answer 6

Deposits

Question 7

Bonds

Answer 7

Debt instruments that pay fixed annual payments. If r rises, bond price falls

Question 8

Monetary Control Tools

Answer 8

• Reserve Requirements
• Open Market Operations (OMO)
• Interest Rate Policy

Question 9

How do Open Market Operations work?

Answer 9

Central bank buys bonds, increase cash in private sector, boosts lending

Question 10

Lender of Last resort

Answer 10

Central Bank provides emergency liquidity to banks in crises

Question 11

Bank Runs

Answer 11

Triggered by panic, deposit insurance reduces risk

Question 12

Moral Hazard and “Too big to fail”

Answer 12

May take extensive risks if guaranteed bailout

Question 13

What Affects Money Demand?

Answer 13

• Frequency of transactions (more transactions=more money)
• Nominal GDP (used to approximate volume of transactions)
• Real Income (higher income=higher demand for real money)
• Interest Rates (higher rates increase opportunity cost of holding money)

Question 14

Term Premium

Answer 14

Extra return demanded by investors for holding long term bonds, compensating risks

Question 15

Transmission to the Economy

Answer 15

Changes in Bank rate influence other key interest rates

Question 16

How Interest Rates influence the Economy?

Answer 16

• Wealth Effect
• Credit and Borrowing
• Investment Decisions

Question 17

What does low i do to Wealth effect, Credit & Borrowing, and Investment Decisions?

Answer 17

Wealth Effect - higher bond and share prices, meaning houses feel wealthier
Credit & Borrowing - Cheaper borrowing, increased consumption and investment
Investment Decisions - More future investment due to cheaper borrowing

Question 18

When does Money Market Equilibrium occur?

Answer 18

Money Supply=Money Demand

Question 19

How does Central Bank influence on Money Supply change between SR and LR?

Answer 19

SR - fixed prices, central bank can control supply
LR - real money supply adjusts, influence limited

Question 20

What is the Primary Goal of Interest Rates?

Answer 20

Price Stability

Question 21

What does IS and MP stand for?

Answer 21

Goods Market - IS
Money Market - MP

Question 22

What causes movements along the IS and MP curves?

Answer 22

IS - change in interest rates
MP - change in output/income

Question 23

What causes shifts in the IS and MP curves?

Answer 23

IS - change in G, T, future income expectations
MP - change in monetary policy

Question 24

What is the goal of the IS-MP model?

Answer 24

Show how monetary and fiscal policies interact to stabilise the economy

Question 25

Crowding Out effect

Answer 25

Higher Government spending discourages private investment

Question 26

What does Expansionary Fiscal Policy do to IS, Y and i

Answer 26

IS shifts right, causing Y and i to both increase

Question 27

As a result of Expansionary Fiscal Policy, what should be Monetary Policy's response?

Answer 27

Looser, therefore reducing MP and causing interest rates not to rise as much

Question 28

Fiscal Policy Financing Methods

Answer 28

- Borrowing from Central Bank - Borrowing from private sector

Question 29

Riccordian Equivalence

Answer 29

Rational consumers save more today if they expect future taxes to repay debt, limiting effectiveness of financial stimulus

Question 30

Why are Policies not fully effective

Answer 30

- Data Imperfections - Time Lags - 0 is the lower bound - If high public debt - Weak confidence

Question 31

UK Inflation Target

Answer 31

2%

Question 32

Which Economic models of AD-AS are more relevant in SR and LR

Answer 32

Keynesian in SR, Classical in LR

Question 33

In LR, output (Y)=

Answer 33

Potential output (Y*)

Question 34

What causes movements along AD curve

Answer 34

Inflation changes --> interest rates adjust --> AD responds

Question 35

What causes shifts of AD curve

Answer 35

- Fiscal Expansion - Change in NX - Monetary policy

Question 36

Monetary Neutrality in LRAS

Answer 36

Nominal changes only affect other nominal values

Question 37

Why are inflation rates never 0%

Answer 37

To avoid deflation, creates a slight buffer

Question 38

How does a positive supply shock boost AD

Answer 38

Deflationary, possibly reducing interest rates

Question 39

How do demand shocks influence interest rates

Answer 39

Increases AD and inflation, meaning higher interest rates are needed to cool AD

Question 40

Key Monetarist Insight

Answer 40

Growth in nominal money supply drives inflation in LR

Question 41

Liquidity Trap

Answer 41

Monetary Policy is ineffective at stimulating the economy, likely due to low interest rates.

Question 42

Why doesn't reducing interest rates in the liquidity trap cause consumers to spend?

Answer 42

Individuals and Businesses rather hold cash than borrow, despite cheap cost of borrowing. They are unsure of future and prefer not to be indebted.

Question 43

Monetary Base

Answer 43

Cash in circulation + cash in bank reserves

Question 44

M0

Answer 44

Cash in circulation (+cash in bank reserves in UK)

Question 45

M1

Answer 45

M0 + sight deposits (chequing accounts) in banks

Question 46

M2

Answer 46

M1+Bank short term deposits (savings accounts)

Question 47

M3

Answer 47

M2+Longer term time deposits in banks

Question 48

M4

Answer 48

M3+other deposits