Chapter 14 Part 2

Question 1

Coincident Economic Indicators

Answer 1

Employees on nonagricultural payrolls; Personal income less transfer payments (transfer payments represent aid for individuals in the form of Medicare, Social Security, and veterans’ benefits, to list a few.); The Index of Industrial Production; Manufacturing and trade sales

Question 2

The index of lagging indicators represents items that change

Answer 2

after the economy has moved through the various stages of the business cycle. The index of lagging indicators should confirm the economic condition portrayed by previous leading and coincident indexes.

Question 3

Lagging Economic Indicators

Answer 3

The average duration of unemployment; the relationship of inventories to sales, manufacturing, and trade; Labor cost per unit of output for manufactured goods; The average prime rate charged by banks; Commercial and industrial loans outstanding; The relationship of consumer installment credit to personal income; the consumer price index for services

Question 4

In reviewing the money rate table, some of the most important rates are the federal funds rate, the discount rate, broker loan or call money rate, and the prime rate. The usual order of these rates from lowest to highest is:

Answer 4

fed funds, discount, call, and prime

Question 5

example of a cyclical stock

Answer 5

The common stock of a machine tool company would be an example of a cyclical stock. As the economy expands, new orders for machinery increase and machine tool companies prosper. Other examples of cyclical stocks would include basic industries (e.g., rubber, steel, etc.), construction firms, and manufacturers of durable goods

Question 6

Examples of defensive companies would include

Answer 6

utilities, tobacco, alcohol, cosmetics, and food companies. Since people need basic services to exist, these companies are the last to be affected negatively as the economy moves through difficult periods

Question 7

Keynesian Economnic theory states that

Answer 7

government intervention in the economy is necessary for sustained economic growth and stability. Put forth by British economist John Maynard Keynes, this theory further states that the government should use fiscal policies (i.e., expenditure programs and raising taxes) to combat the effects of inflation and deflation, as well as to influence economic activity.

Question 8

Fiscal policy is the

Answer 8

government’s use of taxation and expenditure programs to maintain a stable, growing economy. If the economy is in a recession (trough). the government can increase its spending to stimulate demand. Alternatively, it can cut taxes which will increase the disposable income of consumers. This would also stimulate demand. If the economy is overheated (too much
demand), the government can cut its spending or increase taxes. Fiscal policy is set by the President and Congress.

Question 9

Supply-side economics places an emphasis on

Answer 9

reducing taxes and the size of government to stimulate the economy. reducing the size of government will allow for lower tax rates. By reducing taxes, individuals and corporations will have more money to invest, thus creating economic activity

Question 10

Monetary policy attempts to control the

Answer 10

supply of money and credit in the economy. This, in turn, will affect interest rates, causing an increase or decrease in economic activity. the primary focus of monetary policy is to control inflation. The Federal Reserve System implements monetary policy in the U.S.

Question 11

Money is

Answer 11

the unit of value by which goods and services are measured. It is the medium of exchange through which business is transacted. The Federal Reserve Board (the Fed/ fRB) attempts to control the money supply and credit to maintain a stable, growing economy with the aim of combating inflation.

Question 12

Each week the Fed compiles and publishes figures on the size of the money supply according to the

Answer 12

M1 measure. Once a month it publishes figures on M2, M3, and L.

Question 13

M1 =

Answer 13

Currency in circulation + demand deposits + other checkable deposits

Question 14

M2 =

Answer 14

M2 = M1 + money-market deposit accounts (MMOAs) + savings and relatively small time deposits +balances at money funds + overnight repurchase agreements at banks

Question 15

M3 =

Answer 15

M2 + large time deposits + term repurchase agreements at banks and savings and loans

Question 16

L =

Answer 16

M3 + other liquid assets such as term Eurodollars held by nonbank U.S. residents, bankers’ acceptances, commercial paper, Treasury bills, and other liquid government securities + U.S. Savings Bonds

Question 17

The FRB has various tools at its disposal through which it may implement its monetary policy. These tools are

Answer 17

Setting reserve requirements; Setting the discount rate; Implementing open market operations; Setting margin requirements; Using moral suasion

Question 18

Banks are required to keep a portion of their

Answer 18

deposits on reserve with the FRB. By adjusting the amount banks must keep on reserve at the FRB, the Fed can tighten or ease the money supply. If reserve requirements are lowered, the banks are able to extend more credit. Thus, the money supply increases. The opposite effect occurs with an increase in reserve requirements

Question 19

After meeting its reserve requirement, a bank will look to lend the remaining funds to

Answer 19

borrowers. the amount of funds a bank has above the reserve requirenment is called excess reserves. The money spent by the borrowers will eventually be deposited in another bank. This continues as money is deposited from bank to bank, creating a multiplier effect on deposits.

Question 20

In other words, the multiplier effect is the

Answer 20

rate at which banks can create new money by relending deposits and, in turn, creating new deposits. Changing the reserve requirements will have an impact on the multiplier effect within the banking system.