Module 15.1- Central Bank Objectives

Question 1

What is the sole role of central banks regarding currency?

Answer 1

Central banks have the sole authority to supply money.

Money supplied by central banks was historically backed by gold; now it is considered fiat money.

Question 2

What is fiat money?

Answer 2

Money not backed by any tangible value

Fiat money holds value as long as it is accepted for transactions.

Question 3

What is the role of central banks as bankers?

Answer 3

Central banks provide banking services to the government and other banks in the economy.

Question 4

What is one of the regulatory roles of central banks?

Answer 4

To regulate the banking system by imposing standards of risk-taking and reserve requirements.

Question 5

What does it mean for central banks to be the lender of last resort?

Answer 5

Central banks can supply money to banks experiencing shortages to prevent runs on banks.

Question 6

What do central banks typically hold as reserves?

Answer 6

Gold and foreign exchange reserves.

Question 7

What is the primary objective of a central bank?

Answer 7

To control inflation and promote price stability.

Question 8

What are menu costs?

Answer 8

Costs to businesses of constantly having to change their prices due to high inflation.

Question 9

What are shoe leather costs?

Answer 9

Costs to individuals of making frequent trips to the bank to minimize cash holdings affected by inflation.

Question 10

What is the target inflation rate in most developed countries?

Answer 10

Around 2% to 3%.

Question 11

True or False: The U.S. Fed has an explicit target inflation rate.

Answer 11

False

The Fed focuses on maximum employment and moderate long-term interest rates instead.

Question 12

What does pegging refer to in terms of exchange rates?

Answer 12

Setting a target level for the exchange rate of a currency with another, primarily the U.S. dollar.

Question 13

What is the discount rate?

Answer 13

The rate at which banks can borrow reserves from the Fed.

Question 14

What is a repurchase agreement?

Answer 14

A method where the central bank purchases securities from banks with an agreement to repurchase at a higher price.

Question 15

What is the federal funds rate?

Answer 15

The rate that banks charge each other on overnight loans of reserves.

Question 16

What happens when reserve requirements are increased?

Answer 16

The funds available for lending decrease, which tends to increase interest rates.

Question 17

What are open market operations?

Answer 17

Buying and selling of securities by the central bank.

Question 18

What is the monetary transmission mechanism?

Answer 18

The ways in which a change in monetary policy affects the price level and inflation.

Question 19

What happens to banks’ short-term lending rates when the policy rate increases?

Answer 19

They increase in line with the policy rate.

Question 20

What effect does an increase in interest rates have on aggregate demand?

Answer 20

It decreases aggregate demand.

Question 21

What is the impact of a contractionary monetary policy?

Answer 21

Decreases aggregate demand and puts downward pressure on the price level.

Question 22

If money neutrality holds, what is the effect of changes in monetary policy on real output?

Answer 22

No effect on real output.

Question 23

What happens to currency value when real interest rates decrease?

Answer 23

The currency depreciates in the foreign exchange market.

Question 24

What is the relationship between lower interest rates and consumer behavior?

Answer 24

Consumers increase purchases of houses, autos, and durable goods.

Question 25

What does an increase in aggregate demand lead to?

Answer 25

Increases in inflation, employment, and real GDP.

Question 26

What does the monetary transmission mechanism refer to?

Answer 26

The ways in which a change in monetary policy affects the price level and inflation ## Footnote Specifically, it focuses on the central bank's policy rate and its impact through various channels.

Question 27

What are the four channels through which changes in the policy rate are transmitted to prices?

Answer 27

* Other short-term rates * Asset values * Currency exchange rates * Expectations ## Footnote These channels illustrate how monetary policy influences economic variables.

Question 28

How does an increase in the policy rate affect banks' short-term lending rates?

Answer 28

They will increase in line with the increase in the policy rate ## Footnote This leads to decreased aggregate demand as credit becomes more expensive.

Question 29

What effect does a higher policy rate have on aggregate demand?

Answer 29

It decreases aggregate demand ## Footnote This occurs as consumers reduce credit purchases and businesses cut investments.

Question 30

What happens to bond prices, equity prices, and asset prices when discount rates increase?

Answer 30

They will decrease ## Footnote This is due to the higher discount rates applied to future expected cash flows.

Question 31

What is the potential wealth effect from a decrease in household asset values?

Answer 31

It may increase the savings rate and decrease consumption ## Footnote Households may feel less wealthy and adjust their spending accordingly.

Question 32

How might expectations for future economic growth change in response to higher interest rates?

Answer 32

They may decrease ## Footnote This can lead both consumers and businesses to reduce their expenditures.

Question 33

What is the effect of increased interest rates on foreign investment?

Answer 33

It may attract foreign investment in debt securities ## Footnote This can lead to an appreciation of the domestic currency.

Question 34

What is the consequence of a domestic currency appreciation on exports?

Answer 34

It increases foreign currency prices of exports, reducing demand for export goods ## Footnote Higher prices can make domestic goods less competitive abroad.

Question 35

What happens to aggregate demand when the policy rate is decreased?

Answer 35

It increases ## Footnote This occurs through the same channels as an increase in the policy rate, but in the opposite direction.

Question 36

What is meant by money neutrality?

Answer 36

Changes in monetary policy will have no effect on real output ## Footnote This concept suggests that in the long run, money does not impact real economic variables.

Question 37

What is one short-run effect of a more expansionary monetary policy?

Answer 37

The central bank buys securities, increasing bank reserves ## Footnote This action is intended to stimulate economic activity.

Question 38

How does an increase in the supply of loanable funds affect interbank lending rates?

Answer 38

It causes the interbank lending rate to decrease ## Footnote Banks become more willing to lend to each other with increased reserves.

Question 39

What impact do lower real interest rates have on currency value?

Answer 39

They cause the currency to depreciate in the foreign exchange market ## Footnote A weaker currency can enhance export competitiveness.

Question 40

What effect does a decrease in long-term interest rates have on business investments?

Answer 40

It increases business investments in plant and equipment ## Footnote Lower borrowing costs encourage firms to invest.

Question 41

What do lower interest rates encourage consumers to purchase?

Answer 41

* Houses * Autos * Durable goods ## Footnote Lower borrowing costs typically lead to increased consumer spending on big-ticket items.

Question 42

What happens to foreign demand for domestic goods when the currency depreciates?

Answer 42

It increases ## Footnote A weaker currency makes domestic goods cheaper for foreign buyers.

Question 43

What are the effects of increases in consumption, investment, and net exports on aggregate demand?

Answer 43

They all increase aggregate demand ## Footnote These factors contribute to overall economic growth.

Question 44

What overall impact does an increase in aggregate demand have on inflation and employment?

Answer 44

It increases both inflation and employment ## Footnote A rising demand for goods and services typically leads to higher prices and more job opportunities.

Question 45

Roles of central bank

Answer 45

1. Formulate and apply monetary policy 2.monopoly supplier of currency 3.banker to central government and banking system 4. Lender of last resort 5. Regulator of payment system 6. Supervisor of banking system