CH12 - Money, Interest Rates, and Economic Activity Flashcards
What is the present value
The value now of one or more payments or receipts made in the future
Referred to as the Discounted present value
How is the present value of a bond related to the market interest rate?
Negatively
What type of government bond makes no coupon payments and only a single payment at some point in the future?
Treasury bills
What determines the equilibrium market price of any bond?
The present value of the income stream that it produces
True or False
Market interest rates and bond yields move in the same direction
True
As the bond price falls, its yield naturally ______
rises
What is a factor other than interest rate that can influence a bond’s price and yield?
Riskiness
A higher bond yield means ______ riskiness
greater
Who is the issuer of the bond?
The entity that borrows money
What is the coupon?
The annual rate of interest that the bond pays before it matures
What is the maturity?
When the face value is repaid to the bondholder
If the price of a bond with a $100 face value is $105.70, we say that it sells at a _________
Premium
What is the demand for money?
The total amount of money that the public wants to hold for all purposes
What are the 3 reasons why firms and households hold money?
- Transactions demand for money
- Precautionary demand for money
- Speculative demand for money
What is speculative demand for money
The expectation of increases in future interest rates will lead to the holding of more money now
As financial managers adjust their portfolios in order to preserve their values
What are the 3 determinants of money demand?
- Interest Rate
- Real GDP
- Price level
How is the money demand related to the interest rate?
Negatively
(movements along the line)
As the interest rate falls, bonds become _____ attractive and money ______ attractive
less
more
The demand for money is ______ related to the real GDP
What is the effect on the money demand curve?
positively
shift
(right when real GDP increases)
(left when real GDP decreases)
Why is the relationship between the price level and money demanded positive?
Because as P rises, households and firms need to hold more money in order to carry out an unchanged real value of transaction
What is the effect of a change in the price level on the money demand curve?
a shift in the money demand curve
What happens to the money demand if real GDP and the interest rate are constant?
The demand for money is proportional to the price level
Why do economists sometimes refer to the money demand function as a liquidity preference function?
Because it reflects firms’ and households’ preference to hold their wealth in the form of a liquid asset (money rather than bonds)
What happens when the perceived riskiness of the bonds arise (e.g., during an economic/financial crisis)
There is generally a sharp increase in the demand for money –>
Portfolio managers attempt to sell their bonds –>
Increase their cash holdings
True or False
The money supply is assumed to be independent of the interest rate
True
When does money equilibrium occur?
When the quantity of money demanded equals the quantity of money supplied
What are the 3 steps of the monetary transmission mechanism
- ∆ in money demand/supply cause a ∆ in the equilibrium interest rate (short-run)
- this ∆ leads to a ∆ in desired investment and consumption expenditure
- ∆ desired AE leads to a shift in the AD curve and thus short-run ∆ in real GDP and the price level
What is the monetary transmission mechanism?
The channels by which a change in the demand/supply for money leads to a shift of the AD curve
An increase in money supply leads to a/an _____ in the equilibrium interest rate?
decrease
An increase in money demand leads to a/an _____ in the equilibrium interest rate?
increase
The lower the interest rate, the ________ desired investment and consumption
greater
What happens to the interest rate when you have an excess supply of money? Why?
It falls
because firms/households buy bonds (get rid of money)
bond prices goes up –> interest goes down
The desire to sell Canadian dollars and purchase foreign currency causes the CAD to _____ relative to other currencies
depreciate
As the CAD depreciates, Canadian goods & services become _____ relative to the foreign ones
What does it cause?
cheaper
Canadian imports fall and exports rise
The increase in net exports strengthens the positive impact on AD already coming from the increase in desired investment
What are the 3 reasons why the AD curve is downward sloping?
As the price level changes:
1. domestic wealth changes
2. substitution of expenditure occurs between domestic and foreign products
3. the interest changes, which leads to changes in investment and net exports
(all three changes in the same direction as the price level)
_When there is an excess demand for money, households and firms will attempt to _____ bonds. This action will cause the price of bonds to ______ and the interest rate to ______
sell
decrease
increase
Suppose the economy is in equilibrium and then the Bank of Canada the money supply. The first effect will be an excess _________ money, which will then lead to ______ in the interest rate, which will in turn lead to
______ in desired investment.
demand for
increases
decreases
In an open economy with capital mobility, a decrease in the money supply causes interest rates to ______, which leads to a capital _______. This cause a/an ______ of the Canadian dollar
increase
inflow
appreciation
What is long-run money neutrality
The idea that a change in the supply of money has no long-run effect on any real variables; it only affects the price level
What is the classical Dichotomy
The “monetary side” of the economy is independent from the “real side” in the long run
What is hysteresis
The possibility that short-run changes in real GDP caused by changes in the money supply may have an influence on potential output
True or false
The rate of inflation and the growth rate of money supply are highly correlated
True
What is monetary policy
A central bank’s decisions regarding the money supply and interest rates used in its efforts to influence AD
Is money neutral in the short run?
No
If the money demand curve is steep, an increase in the money supply will lead to a ______ decrease in the equilibrium interest rate
large
The steeper the investment demand curve, the _____ investment will increase for any reduction in interest rates
less
What combination produces the largest shift in the AD curve for a given change in money supply?
Steep Md curve
Flat Id curve
= more effective monetary policy
Who believed that monetary policy was not a very effective method of stimulating aggregate demand?
What did they emphasized?
The Keynesians
The value of using fiscal policy
