Chapter 15 Flashcards
short-term interest rates
Interest rates on financial assets that mature within less than a year
long-term interest rates
Interest rates on financial assets that mature a number of years in the future
The higher the short-term interest rate, ______________
the higher the opportunity cost of holding money
The lower the short-term interes rate, _________________
the lower the opportunity cost of holding money
What affects money demand?
short-term interest rates
Money demand curve
Shows the relationship between the interest rate and the quantity of money demanded
slopes downward
Why is interest rate on the vertical axis for the money demand curve?
Because for most people the question is deciding whether to put the funds in the form of other assets that can quickly and easily be turned into money
Factors that shift money demand curve:
Changes in:
Aggregate price level
real GDP
Credit markets and banking technoogy
institutions
higher prices =>
increase demand for money
lower prices =>
decrease demand for money
The demand for money is ________ to the price level
proportional
If aggregate price level rises by 20%, the quantity of money demanded also rises by 20%
increase in GDP =>
increases demand of money
decrease in GDP =>
decreases demand for money
“revolving balance”
Credit card that allows customers to carry a balance from month to month
Credit cards more available
banking technology increases
decreases the demand for money
Changes in institutions: allow banks to pay interest on checking account funds
increase demand for money
Liquidity preference model of the interest rate
The interest rate is determined by the supply and demand for money
Money supply curve
Shows how the quantity of money supplied varies with the interest rate
An increase in the money supply, ___________
drives the interest rate down
A decrease in the money supply, ______________
drives the interest rate up
Target federal funds rate
The federal reserve’s desired federal funds rate
When long term rates are higher than short-term rates, _______________________
short-term rates are expected to rise in the future
Expansionary monetary policy
Monetary policy that increases aggregate demand
Contractionary monetary policy
Monetary policy that decreases aggregate demand
price stability
low (though usually not zero) inflation
When output gap is rising
raise interest rates
when output gap is falling
lower interest rates
Federal funds rate tends to be high when______________
inflation is high
Federal Funds rate tends to be low when __________________
inflation is low
Taylor rule formula
Federal funds rate =
2.07
+ (1.28 x inflation rate)
- (1.95 x unemployment gap)
Taylor rule for monetary policy
A rule that sets the federal funds rate according to the level of the inflation rate and either the output gap or the unemployment rate
inflation target
the inflation rate that they want to achieve
Inflation targeting
When the central bank sets an explicit target for the inflation rate and sets monetary policy in order to hit that target
Difference between inflation targeting and the Taylor rule
Taylor rule method adjusts monetary policy in response to past inflation
Inflation targeting is based on a forecast of future inflation (forward-looking)
Two advantages of inflation targeting over a Taylor rule
- Transparency - the public knows the objective of an inflation-targeting central bank
- Accountability - the central bank’s success can be judged by seeing how closely actual inflation rates have matched the inflation target, making banks accountable
price stability seeks
a 2% inflation
Critic of inflation targeting:
argue that it’s too restrictive because there are times when other concerns should take priority
quantitative easing
Buying longer0term government debt
Zero lower bound for interest rates
Means that interest rates cannot fall below zero
embedded inflation
inflation that people believe will persist into the future
monetary policy is used to get rid of embedded inflation
In the long run, changes in the quantity of money affect __________________________
the aggregate price level, but they do not change real aggregate output or the interest rate
increase in the money supply effect on GDP
positive short-run effect
no long-run effect
If the money supply falls 25%, _______________
the aggregate price level will fall 25% in the long run
money is _________ in the long run
neutral
Monetary neutrality
Changes in the money supply have no real effects on the economy
When a fall in the interest rate leads to higher investment spending, __________________________
the resulting increase in real GDP generates exactly enough additional savings to match the rise in investment spending
What is the equilibrium interest rate determined by in the long run?
by matching the supply and demand for loanable funds that arises when real GDP equals potential output
