Financial Assets, Interest Rates, and Money
Banking Clan
MP (Limited)
Money Market vs.Loanable Funds
MP (Ample)
100
What does it mean when a financial asset has high liquidity?
It can easily be turned into cash!
100
If the Reserve Requirement Ratio is .1, what is the multiplier?
10!
1/RR = 1/.1 = 10
100
What is the difference between the Federal Funds Rate and the Discount Rate?
FFR is the rate at which banks lend to one another, while Discount Rate is the rate at which the Fed lends to banks!
100
What are the determinants of supply and demand in the loanable funds market?
Demand - Borrowing!
Supply - Saving!
100
Draw and label an ample reserves framework graph!
200
What are the three functions of money? Give an example for each!
Medium of Exchange - Buying groceries at HEB
Unit of Account - Pricing goods like a candy bar is $1
Store of Value - money in your mattress
200
If the reserve requirement is 20%. Calculate the required reserves.
$20,000
$100,000*.2 = $20,000
200
What does the Federal Reserve do? Who is the Federal Open Market Committee?
The Federal Reserve regulates the economy through the use of Monetary Policy. The Federal Open Market Committee is comprised of 7 board of governors and the 12 presidents of the Federal Reserve Banks. They vote in rotation to set monetary policy and other regulations.
200
In the short run, government deficit spending will most likely
A) Raise the unemployment rate
B) Lower the inflation rate
C) Raise nominal interest rates
D) Lower private savings
E) Raise net exports
C!
200
To reduce inflation, the central bank would be most likely to
A) decrease the reserve requirement
B) decrease the income tax rates
C) buy government securities
D) increase the supply of money
E) increase its administered interest rates
E!
300
What is the difference between Fiat, Representative, and Commodity money? Which do we have in the U.S.?
Fiat - Money that is not backed by a commodity
Representative - Money that is backed by a commodity
Commodity - Things such as beans, corn, or shells that are used as money
Fiat!!!
300
If the reserve requirement is 20%. Calculate the maximum amount of additional loans this bank can make?
$10,000
$100,000*.2 = $20,000 in required reserves
Total Reserves = Required Reserves + Excess Reserves
Excess Reserves = $30,000 - $20,000 =$10,000
300
If aggregate demand is lagging behind the long-run aggregate supply, the Federal Reserve can do what...
Expansionary policy using one of the tools below!
Limited Framework - Buy Government Securities, Lower Discount Rate, Lower Reserve Requirement Ratio
Ample Framework - Lower Administered Rate
300
With a constant money supply, if the demand for money decreases, the equilibrium interest rate and quantity of money will change in which of the following ways?
Equilibrium interest rates will decrease while quantity of money doesn't change.
300
What is the primary monetary tool in an ample reserve framework?
Changing the administered rates -> Discount rate and Interest on Reserves!
400
The annual inflation rate is expected to be 5 percent over the next 3 years. Juan plans to take out a 3-year loan to purchase an automobile. If Juan decides not to take out the loan if the real interest rate exceeds 3 percent, the highest nominal interest rate he is willing to pay is..
8%!
Nominal = Real + Inflation
400
If the reserve requirement is 20%. Calculate the maximum change in money supply due to any new additional loans created.
$50,0000
Maximum change = Excess Reserves * Multiplier
= $10,0000 * 5
400
The graph above shows two aggregate demand curves, AD1 and AD2, and an aggregate supply curve, AS. The shift in the aggregate demand curve from AD1 to AD2 could be caused by what Federal Reserve Action?
Contractionary policy using one of the tools below!
Limited Framework -Sell Government Securities, Raise Discount Rate, Raise Reserve Requirement Ratio
Ample Framework - Raise Administered Rates
400
If the federal government reduces its budget deficit when the economy is close to full employment, which of the following will most likely result?
A) Inflation will increase.
B) Tax revenues will increase.
C) Interest rates will decrease.
D) Unemployment will decrease.
E) The international value of the dollar will increase.
C!
400
If a banking system has ample reserves, which of the following is an action taken by the central bank that would cause a decrease in the cyclical rate of unemployment in the short run?
A) An increase in required reserve ratio
B) An increase in interest on reserves
C) An increase in policy rate
D) A decrease in discount rate
E) A decrease in personal income taxes
D!
500
Assume that in a banking system in which banks hold no excess reserves, the public holds part of its money in cash and the rest in checking accounts. If the required reserve ratio is 10 percent, actual reserves are $10 million, and currency in circulation is equal to $20 million, M1 will be equal to...
$120 Million!
Reserve Ratio = Required Reserves/ Demand Deposits -> .1=$10/X -> X =$100 mil.
M1 = Currency + Bank (Demand) Deposits -> M1 = $20+$100 = $120
500
Assume that the banking system has limited reserves and commercial banks must hold a minimum of 20% of their deposits as reserves. Now suppose that the central bank of the country sells $100,000 of government bonds to commercial banks.
Calculate the maximum change and state the direction of change in the money supply as a result of the central bank bond sale. Show your work.
Money supply decreases by $500,000.
MS change = Bond Price * Multiplier
= -$100,000 * 1/.2 = -$500,000
500
What type of policy would the Federal Reserve adopt during an inflationary gap? Draw the effects of this policy using a money market graph and aggregate model.
E!
500
Assume an economy with no international sector and a banking system with limited reserves.
Using a correctly labeled money-market graph, show how a decrease in the money supply will affect interest rates.
Explain how the change in the interest rate you identified in part (a) will directly affect each of the three components of aggregate demand for this closed economy. (Hint: AD = C+ G + I + Xn)
1.
2. C will decrease due to interest sensitivity, I will decrease due to interest sensitivity, and G has no change OR will decrease due to cost of borrowing.
There is no Xn since there is no international sector.