Chapter 13.2

Question 1

Commercial banks

Answer 1

Financial institutions whose main functions are to hold deposits for their customers, make loans to their customers, transfer funds by cheque electronically from one bank to the other, and to buy government bonds

Question 2

Central bank

Answer 2

A government financial institution

Question 3

Responsibilities that a central bank has

Answer 3

Serve as banker to the government
Serve as banker to commercial banks
Regulator of commercial banks
Conduct monetary policy

Question 4

Goals of monetary policy

Answer 4

Low and stable rates of inflation
Low unemployment
Reduce business cycle fluctuations
Promote a stable economic environment for long term growth
External balance

Question 5

Inflation targeting

Answer 5

The public announcement of medium-term numerical targets for inflation with an institutional commitment by the monetary authority to achieve these targets

Question 6

Interest

Answer 6

The additional payment that must be made to repay a loan

Question 7

Interest rate

Answer 7

The amount of interest that is paid expressed as a percentage

Question 8

Money

Answer 8

Anything that is acceptable as payment for goods and services

Question 9

An increase in the supply of money leads to a __ in the rate of interest

Answer 9

fall

Question 10

A decrease in the supply of money leads to an __ in the rate of interest

Answer 10

increase

Question 11

Minimum reserve ratio

Answer 11

The funds that a bank must keep in their reserves, which are a legally determined fraction of total deposits

Question 12

What do banks do when they make new loans?

Answer 12

Create new money

Question 13

What does a lower minimum reserve requirement do and why?

Answer 13

Creates more new money because banks will have more excess reserves so can make more loans

Question 14

How do you determine the maximum amount of new money created from the minimum reserve ratio?

Answer 14

Find the monetary multiplier, which is one over the minimum reserve ratio and then multiply by the excess reserves

Question 15

Tools of monetary policy

Answer 15

Open market operations
Minimum reserve requirements
Changes in the central bank’s minimum lending rate
Quantitative easing

Question 16

Open market operations

Answer 16

The buying and selling of bonds by the central bank to influence money supply

Question 17

Minimum lending rate

Answer 17

The interest rate the central bank charges when it lends to commercial banks

Question 18

Quantitative easing

Answer 18

Similar to open market operations but on a much larger scale with more types of financial assets and in larger quantities

Question 19

Nominal rate of interest

Answer 19

The market rate of interest that prevails at any moment in time

Question 20

Real rate of interest

Answer 20

The interest rate that has been corrected for inflation

Question 21

Formula for the real interest rate

Answer 21

real interest rate = nominal interest rate - rate of inflation

Question 22

Expansionary monetary policy

Answer 22

An increase in the money supply by the central bank

Question 23

Contractionary monetary policy

Answer 23

A decrease in the money supply by the central bank

Question 24

Who carries out monetary policy and what is its goal?

Answer 24

Central banks carry out monetary policy in an attempt to change interest rates to influence C and I in aggregate demand

Question 25

In a deflationary gap, what kind of policy can the central bank use?

Answer 25

Expansionary monetary policy to shift AD to the right closer to the full employment level of real GDP

Question 26

In an inflationary gap, what kind of policy can the central bank use?

Answer 26

Contractionary monetary policy to shift AD to the left closer to the full employment level of real GDP

Question 27

Ratchet effect

Answer 27

When real GDP decreases due to contractionary monetary policy but price levels do not decrease in the Keynesian model