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ECON102 > Week 22 - Stabilising the economy > Flashcards

Week 22 - Stabilising the economy Flashcards

(83 cards)

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1
Q

What is “Fed Watch”?

A

Analysts’ attempts to forecast Federal Reserve decisions about monetary policy.

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2
Q

What is an example of an old Fed Watch indicator?

A

The Greenspan briefcase indicator.

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3
Q

Why are Fed decisions important?

A

They have significant effects on financial markets and the macro economy.

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4
Q

Why is monetary policy considered a major stabilisation tool?

A

It can be quickly decided and implemented.

It is more flexible and responsive than fiscal policy.

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5
Q

What is the primary task of the FOMC (Federal Open Market Committee)?

A

Controlling the money supply.

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6
Q

How is the interest rate determined?

A

By the interaction of money supply and money demand.

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7
Q

How does the Fed influence the interest rate?

A

By manipulating the money supply.

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8
Q

What are portfolio allocation decisions?

A

Choices about how a person allocates wealth among different asset types.

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9
Q

What is diversification in the context of portfolio management?

A

Owning a variety of different assets to manage and reduce risk.

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10
Q

What is the demand for money?

A

The amount of wealth that people choose to hold in the form of money.

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11
Q

What is another term for the demand for money?

A

Liquidity preference.

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12
Q

How does the Cost-Benefit Principle apply to the demand for money?

A

People balance the marginal cost of holding money against the marginal benefit.

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13
Q

What is the primary benefit of holding money?

A

The ability to make transactions easily.

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14
Q

How does income affect the quantity of money demanded?

A

The quantity of money demanded increases with income.

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15
Q

How have technologies like online banking and ATMs affected the demand for money?

A

They have reduced the demand for money.

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16
Q

How has M1 changed relative to GDP from 1960 to 2017?

A

M1 has decreased from 26% of GDP in 1960 to 18% in 2017.

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17
Q

What is the marginal cost of holding money?

A

The interest income foregone by not investing in interest-bearing assets.

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18
Q

What is typically assumed about the nominal interest rate on money?

A

It is assumed to be 0%.

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19
Q

How do alternative assets like stocks and bonds differ from money?

A

They offer a positive nominal interest rate, unlike most forms of money.

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20
Q

How does the nominal interest rate affect the quantity of money demanded?

A

The higher the nominal interest rate, the smaller the quantity of money demanded.

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21
Q

How is business demand for money similar to individual demand?

A

Businesses also balance transaction needs against the cost of holding non-interest-bearing money.

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22
Q

How much of the money stock do businesses typically hold?

A

More than half.

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23
Q

hat are the three main factors that affect the demand for money?

A

Nominal interest rate (i)

Real income or output (Y)

Price level (P)

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24
Q

How does the nominal interest rate (i) affect the demand for money?

A

The higher the interest rate, the lower the quantity of money demanded.

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25
How does real income or output (Y) affect the demand for money?
The higher the level of income, the greater the quantity of money demanded.
26
How does the price level (P) affect the demand for money?
The higher the price level, the greater the quantity of money demanded.
27
What determines the nominal interest rate?
The interaction of the aggregate demand for money and the supply of money.
28
What does the money demand curve show?
The relationship between the aggregate quantity of money demanded (M) and the nominal interest rate (i).
29
Why does the money demand curve slope downward?
As the nominal interest rate rises, the opportunity cost of holding money increases. Therefore, the quantity of money demanded falls.
30
What is the shape of the money demand curve?
It has a negative slope.
31
What causes the money demand curve to shift?
Changes in factors other than the nominal interest rate.
32
What are some factors that can cause an increase in money demand?
Increase in output (real income) Higher price levels Technological or financial advances Increased foreign demand for dollars
33
What is the effect of an increase in money demand on the curve?
It shifts the money demand curve to the right.
34
Do changes in the nominal interest rate shift the money demand curve?
No — they cause movements along the curve, not shifts.
35
How does the Fed primarily control the money supply?
Through open-market operations.
36
What happens when the Fed purchases bonds on the open market?
The money supply increases.
37
What happens when the Fed sells bonds on the open market?
The money supply decreases.
38
What is the shape of the money supply curve?
Vertical, because it is fixed by the Fed at any given time
39
How is the equilibrium interest rate determined in the money market?
Where money demand (MD) intersects money supply (MS) — point E on the graph.
40
How are bond prices related to the interest rate?
They are inversely related — when bond prices fall, interest rates rise.
41
What happens if the interest rate is below equilibrium (e.g., at i_1)?
Quantity of money demanded exceeds supply (e.g., at M_1) People sell bonds to obtain money Bond prices fall, interest rates rise toward equilibrium
42
What is the result of the adjustment process in the money market?
Interest rates rise until the quantity of money demanded equals the supply — equilibrium is restored at point E.
43
How does the Fed implement its interest rate policy?
By adjusting the money supply to meet its target interest rate.
44
What happens when the Fed increases the money supply (shift from MS to MS′)?
The money supply curve shifts right New equilibrium is at point F The interest rate falls from i to i'
45
Why does the interest rate need to fall when money supply increases?
To convince people to hold the larger quantity of money by lowering the opportunity cost.
46
What is the effect of the Fed selling bonds to the public?
Supply of bonds increases Bond prices decrease Interest rates increase Money supply decreases
47
What is the effect of the Fed buying bonds from the public?
Demand for bonds increases Bond prices increase Interest rates decrease Money supply increases
48
Why do bond prices and interest rates move in opposite directions?
Because bond interest is fixed — when the price of a bond falls, the yield (interest rate) rises, and vice versa.
49
Can the Fed set both the interest rate and money supply independently?
No — the Fed must choose one; setting one determines the other.
50
Why does the Fed announce policy in terms of interest rates rather than money supply?
The public is unfamiliar with money supply figures Monetary policy mainly affects the economy through interest rates Interest rates are easier to monitor than money supply
51
What is the main channel through which monetary policy affects the economy?
Interest rates
52
What is the Federal Funds Rate (FFR)?
The interest rate commercial banks charge each other for short-term (usually overnight) loans.
53
Is the FFR market determined or set directly by the Fed?
It is market determined, based on supply and demand, but targeted by the Fed.
54
What action does the Fed take to decrease the FFR?
It conducts open market purchases of Treasury securities, increasing bank reserves.
55
How do open market purchases lower the FFR?
Increase in reserves leads to excess reserves which can be loaned to other banks in the federal funds market Banks holding excess reserves are incentivized to lend to other banks to avoid holding idle reserves, leading to a downward pressure on interest rates as they compete to offer lower rates.
56
What happens to other interest rates when the Fed lowers the FFR?
Other rates (consumer, mortgage, prime) tend to fall as well.
57
Why does the Fed influence the FFR?
To achieve its monetary policy objectives, such as stable inflation, full employment, and economic growth.
58
What type of interest rate does the Fed directly control?
Fed controls the money supply to control the nominal interest rate, i
59
What do investment and saving decisions depend on — nominal or real interest rate?
The real interest rate (r).
60
What is the formula for the real interest rate?
r = i - π, where π is the rate of inflation
61
How can the Fed influence the real interest rate?
By controlling i (nominal rate) Since inflation changes slowly, changes in i affect r
62
Why does a change in the nominal interest rate often lead to a change in the real interest rate?
Because inflation (π) is relatively sticky, so short-term changes in i translate into changes in r.
63
What is the main tool the Fed uses to control the money supply?
Open-market operations.
64
What is the discount window?
A lending facility through which commercial banks can borrow reserves from the Fed.
65
What is the discount rate in terms of the discount window?
The interest rate the Fed charges banks to borrow through the discount window.
66
How does the discount rate compare to the federal funds rate?
It is typically higher — a penalty rate to encourage banks to borrow from each other instead.
67
What is the effect of discount window lending on the money supply?
It increases reserves, which can increase the money supply.
68
When is the discount window especially important?
During financial distress or instability, as a source of liquidity.
69
What does a change in the discount rate signal?
A potential tightening or loosening of monetary policy.
70
What are the three components that determine the money supply?
Currency held by the public Bank reserves Reserve-deposit ratio
71
What is the formula for the money supply?
Money Supply = Currency held by public + Bank Reserves/ Reserve-Deposit Ratio
72
How can the Fed influence the money supply?
By affecting: The amount of currency people hold The level of bank reserves The reserve-deposit ratio
73
How do open-market operations influence bank reserves?
The Fed buys government bonds → increases reserves It credits reserve accounts of banks, raising their balances
74
What happens to the money supply when the Fed purchases securities?
Bank reserves increase, leading to a potential increase in the money supply.
75
What is the reserve-deposit ratio?
The fraction of deposits that banks choose to hold as reserves.
76
What is the reserve requirement?
The minimum ratio of bank deposits that must be held in reserves by banks.
77
How often does the Fed change the reserve requirement?
It is rarely changed, as it is a powerful tool.
78
How can the Fed affect bank reserves?
Through: Reserve requirements Discount window lending
79
What is the role of the discount window in affecting bank reserves?
Banks can borrow reserves from the Fed if they are short The discount rate on these loans is set by the Fed
80
Can banks hold reserves above the required minimum?
Yes, banks can maintain reserve-deposit ratios well above the reserve requirement.
81
What are excess reserves?
Excess reserves are the reserves held by banks that exceed the required reserve ratio set by the central bank.
82
How do excess reserves affect the money supply?
Even if the Fed increases reserves, the money supply may not change if banks choose to hold onto excess reserves rather than lend them out.
83
Why might commercial banks hold onto their reserves?
Risk aversion Low interest rates, making lending less attractive

ECON102 (34 decks)

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