Chapter 12 Flashcards
when the interest rate decreases, what happens to the money demand curve?
contractionary monetary policy could impact fiscal policy due to…
higher interest rates on the debt
which type of policy affects the economy through intended changes in the money supply?
monetary policy
if real GDP increases, what happens to the money demand curve?
it shifts to the right
who believed that changes in the money supply had the ability to create sharp changes in interest rates, which led to significant changes in investment spending, thus making monetary policy the superior choice in stimulating aggregate demand?
Monetarists
school of thought that believes the activist policies of the central bank EXACERBATE economic fluctuations
monetary theory
monetarists advocate a monetary growth rule where the money supply shifts by a fixed amount
what theory advocates for active government intervention via fiscal policy when economy is in recession?
Keynesians
Keynes believed that sticky wages and prices would keep the economy from adjusting without gov intervention
new classical theorists believe what?
that the public uses rational expectations to formulate opinions about inflation
and economic fluctuations
occur when those expectations differ from reality
they also advocate a monetary growth rule because it would help the public create better inflation forecasts
when the interest rate increases, what happens regarding the money demand curve?
there’s a movement DOWN the money demand curve
interest rates are the price of money - so a change in interest rates is merely a movement up or down an existing demand curve
monetarists advocate a monetary growth rule where…
where the money supply changes by a fixed amount
why does a decrease in the aggregate price level shift the money demand curve to the left?
because as prices decrease, people need to hold less money to buy goods and services
so the demand for money will fall, which is a leftward shift in the demand curve
how does contractionary monetary policy impact fiscal policy?
through HIGHER INTEREST RATES ON THE DEBT
bond
a debt security
that promises to make periodic payments for a specific period of time
rises in interest rates are associated with what in terms of bond prices?
a fall in bond prices
because holding money becomes more appealing
idea that a change in the supply of money has no effect on any real variable is called…
money neutrality
which type of money demand is reflected by the fact that expected future increases in the interest rate will induce people to hold of more money (and fewer bonds) now as financial managers adjust their portfolios in order to preserve their values?
speculative demand
when the interest rate decreases, what happens to the MD curve?
there’s a movement DOWN the money demand curve
a decrease in the money supply causes __________ in the interest rate and __________ in desired aggregate expenditure
INCREASE
DECREASE
(decrease in money supply causes increase in interest rate - this causes a decrease in investment expenditure - this causes a decrease in aggregate demand)
an increase in real GDP will do what to the money demand curve?
shift it to the right
the __________ the interest rate, the more investment projects firms can profitably undertake, and the _________ the money demand
LOWER
GREATER
interest payments made on a bond are known as…
coupon payments
when is the opportunity cost of holding money higher?
when the interest rates are high
because of the __________ in forecasting the economy, many economists believe the Bank of Canada __________ take a very active role in trying to stabilize the economy
DIFFICULTIES
SHOULD NOT
the economy has too many variables that cause an impact that are impossible to model with accuracy
for this reason, many economists believe the focus should be on keeping inflation low and stable
a rise in interest rates is associated with a fall in bond prices, resulting in capital losses on bonds whose terms to maturity are _____ their holding periods
LONGER THAN
A supply and demand diagram can be drawn for any type of bond because the interest rate and price of a bond are always _____
negatively related
if the price level increases, what happens to the money demand curve?
it shifts to the right
process by which changes in the Bank’s target interest rate or key policy rate effects the economy is called the
transmission mechanism
founder of monetarism
Milton Friedman
transmission mechanism
when BoC increases the target for the overnight rate, other interest rates go up
these higher interest rates dampen consumer spending and reduce business investment
thus, the change transmits through its impact on employment and GDP
Keynesians argued that changes in the __________ lead to small changes in interest rates, and that investment was __________ to changes in the interest rate
MONEY SUPPLY
INSENSITIVE
they emphasized the use of fiscal policy as a more effective method of stabilization policy
according to Keynesian theory, fiscal policymakers can combat the impact of recessions by
increasing government spending
an increase in interest rate leads firms to _______ their amount of investment
decrease
an increase in the real interest rate leads to ___ __________ in the amount of national savings because households reduce their _________
an increase
consumption
(because it’s more expensive for them to borrow so there’s less consumption of things like houses, cars, appliances etc)
where does equilibrium occur in the market for loanable funds?
occurs at the REAL INTEREST RATE where NATIONAL SAVINGS (NS) = INVESTMENT (I)
at this interest rate, the amount of desired national savings equals the amount of desired investment
