Midterm 2

Question 1

Phillips Curve, U & π

Answer 1

US SRPC shifted outward 1953-1983, was highest 1979-83.

US SRPC moved back down 1983-2008.

SRPC shifts when π^e shifts (π^e is the intercept of SRPC & LRPC)

U_N varies with U benefit:
Normally <= 26 weeks
Up to 99 weeks 2009-2012, back to normal 2013

Question 2

SRPC Tradeoff & M policy

Answer 2

Inflationary M policy: M ↑, M/P > m^d, π>π^e; by Walras’ Law, excess on money supply =excess in demand of real goods, D↑, Q↑, U↓, U_N (not changed by M policy), unchanged because M policy must be neutral on average.

Slope of SRPC: trade off between π-π^e & U-U_N

Question 3

Adaptive Learning & Rational Expectations

Answer 3

Adaptive Learning: when P=M/m^d, π^e drives π. Targeting U* < U is feasible, results in accelerated π, (Accelerate Hypothesis)

Rational Expectations: π^e is not dependent on past π, π^e adjusts immediately if M increases or decreases.

Question 4

Official M1, M1-S, M2 Pre 2020

Answer 4

Official M1 before 2020=Currency in circulation +checkable deposits (exclude Sweep Accts)

M1-S=Currency in circulation+Checkable Deposits (include Sweep Accts)

M2=M1+Saving Deposits (including MMDA)+Small Time Deposits (CDs)+Retail MMMFs

Question 5

Official M1, M1-S, M2 post 2020

Answer 5

New M1=Currency in circulation+Demand deposits+Other Liquid Deposits (Savings, NOWs, Sweeps, MMDAs, 66% of new M1)

M2=M1+Savings Deposits (including MMDA)+small time deposits(CDs)+Retail MMMFs (same)

Question 6

Type of Bank Deposit: Demand Deposits. Money Aggregate?

Answer 6

M1

Question 7

Type of Bank Deposit: Saving Accts. Money Aggregate?

Answer 7

M2, not in M1 until 2020

Question 8

Type of Bank Deposit: Large/Negotiable CDs (>=$100k). Money Aggregate?

Answer 8

Never in M1 or M2

Question 9

Type of Bank Deposit: Small CDs. Money Aggregate?

Answer 9

M2

Question 10

Type of Bank Deposit: NOW accounts (negotiable order of withdrawal). Money Aggregate?

Answer 10

M1 since checkable

Question 11

Type of Bank Deposit: MMDAs (Money market deposit accounts). Money Aggregate?

Answer 11

M2, not in M1 until 2020

Question 12

Type of Bank Deposit: Sweep Accts. Money Aggregate?

Answer 12

M2, not in M1 until 2020

Question 13

Comercial Bank Balance Sheet

Answer 13

CB assets:

• Cash Assets
• Debt Securities:
  
  • Corporate Bonds
  • State and local bonds
  • Real estate loans
  • Consumer loans
  • Commercial and industrial loans

CB Liabilities:

• Demand Deposits
• Other liquid Deposits (51% of total liabilities)(M1)
• Small TDs (M2)
• Large TDs
• Borrowings
• Net Worth=A-L

Question 14

Prime Rate vs 3 month T bill

Answer 14

Prime Rate: the rate banks charge their largest and most creditworthy customers

Since 1990, prime rate =~ 3 month T-Bill rate +3.25%

Question 15

Fed Fund Market and FDIC

Answer 15

Discount rate: the rate the fed lends directly to banks

Fed Fund Rate: the rate banks charge each other for short term fund; =~ 3 month T Bill rate

Fed Fund Market: allows banks with surplus reserves to lend to banks with shortage of reserves

FDIC Insures depositor to $100k pre 2008, to $250k/depositor since 2008
Brokered Deposits take your $10M & place in 40 banks paying high interest; this circumvents limit of insurance per depositor set by FDIC

Question 16

The Money Supply

Answer 16

M=C+D

B=C+R

M=kB

k=(c+1)/(c+f), c=currency/checkable deposits, f=reserves/checkable deposits
c↑, f remains constant, k↓
c↓, f remains constant, k↑

Question 17

Sweep Account

Answer 17

Sweep adjusted c experienced a great increase 1955-2007 due to the surge of underground economy

Sweep grew rapidly after 1995 but since accounts were converted official M1 & M1-S understated

Question 18

Reserve Requirement by Fed: Checking: $0-$14.5M

Answer 18

Discretionary Range: 0%
2015: 0%
3/22/20: 0%

Question 19

Reserve Requirement by Fed: Checking: $14.5M-$103.6M

Answer 19

Discretionary Range: 3%
2015: 3%
3/22/20: 0%

Question 20

Reserve Requirement by Fed: Checking: $103.6M and up

Answer 20

Discretionary Range: 8-14%
2015: 10%
3/22/20: 0%

Question 21

Reserve Requirement by Fed: Savings, Time & MMDA

Answer 21

Discretionary Range: 0-9%
2015: 0%
3/22/20: 0%

Question 22

Traditional Base Equation

Answer 22

B=S+L+I+C-D-NW

S: securities
L: net loans
I: international Reserves
C: treasury currency (coin)
D: other deposits

Question 23

Source of Base: Securities S

Answer 23

Fed sets B via OMO:
Open market sale: S↓, B↓ ⇒ P_bond ↓, yield ↑
Open market purchase: S↑, B↑ ⇒ P_bond↑, yield ↓

Or Fed sets yield via P_bond

Not both

Question 24

Interest on Reserve

Answer 24

Before 10/08, Fed paid no interest on reserves
Banks rushed to lend out excess reserves
Quintupling base would have quintupled M, P

Since 10/08, Fed has paid interest on both required and excess reserves at slightly over FFR
IORR=Interest on Required Reserves
IOER=Interest on Excess Reserves
IOER means banks are content to hold excess reserves, are in no rush to make new loans to public, so IOER has neutralized otherwise stimulative effect of M policy

Question 25

One-time change in nominal money stock

Answer 25

One time decrease in M Nominal interest rate to increase in SR, return to original value in LR (μ_0=π^e=0, i=r) Real interest rate to increase in SR, return to original value in LR

Question 26

permanent change in nominal money stock

Answer 26

Permanent decrease in M Nominal interest rate to increase in SR, decrease in LR (i=r_N+μ_0, μ_0<0) Real Interest rate to increase in SR, return to original value in LR

Question 27

Benchmark Taylor Rule

Answer 27

i*=1.0+1.5π+0.5ygap i*:Fed Fund Rate target, equilibrium real interest rate π : last 12 month average inflation Ygap: % deviation of y from trendline Derived from strong inflation feedback: i*=r*+π+a(π-π*)

Question 28

Effective Fund Rate

Answer 28

Peak 1980 =~ 19% | Low in 2009-2015 <=0.25%

Question 29

Forward Interest Rate

Answer 29

f(m,m+1)=(m+1) y(m+1) - m y(m) | y(m+1)=((m y(m)+f(m,m+1))/(m+1))

Question 30

Zero Lower Bound

Answer 30

If i* goes below 0, Fed can set y(m)=0 for some m below the normal 1/8 year (temporarily move into maturities greater than 1/8 year). (stimulus %)*(1/8)=(% below r*)*m If the FOMC only meets 8 times a year and always leaves its FFR target i* in place until the next meeting, it is effectively forcing interest rates y(m) to equal its target out to maturity m=⅛ year, and not directly intervening in the yield curve beyond that maturity.

Question 31

Friedman and Schwartz

Answer 31

The potentially long and variable gap between when a situation arises that calls for monetary stabilization policy and when the policy actually has its effect will tend to destabilize output and employment. Best to just stabilize P, π with M policy, let y, U take car of themselves. Paul Krugman: failure to provide easy M policy when inflation is on target (unnecessary restrictive M policy) constitutes “Sado-Monetarism”

Question 32

Liquidity Premium

Answer 32

Forward rates>corresponding future short rates r_long maturity>r_short maturity, longer maturity bonds have higher one period returns on average than short term one period returns.

Question 33

Inside and outside lag

Answer 33

Recognition Lag: Time it takes to recognize a problem exists EX: The time between the midpoint of a quarter and when an accurate GDP figure is available for that quarter Decision Lag: Time it takes to decide what to do about problem once it has been recognized Implementation Lag: Time it takes to implement policy once it has been decided upon The FOMC’s practice of ordinarily only changing its FFR target by 25 basis points at a time, rather than immediately moving it to the rate actually called for by its policy rule Outside lag: The time it takes change in policy instrument to affect economy, outside policy process