Chapter 15

Question 1

short-term interest rates

Answer 1

interest rates on financial assets that mature within less than a year

ex:

federal funds rate

one-month CDs

Interest bearing demnd deposits

• rates tend to move together
• short term rates effect money demand
• higher interest rates = higher opportunity cost of holding money

Question 2

long-term interest rates

Answer 2

interest rates on financial assets that mature a number of years in the future

-don’t necessarily move with short-term rates

Question 3

money demand curve

Answer 3

shows the relationship between the interest rate and the quantity of money demanded

• slopes downward
• higher interest rate = less money demanded

Question 4

things that shift the money demand curve

Answer 4

• changes in the aggregate price level
• changes in real GDP

–changes in credit markets nad banking technology

-changes in institutions

Question 5

liquidity preference model of the interest rate

Answer 5

the interest rate is determined by the supply and demand for money

Question 6

money supply curve

Answer 6

shows how the quantity of money supplied varies with the interest rate

-verticle (money supply chosen by the fed)

Question 7

target federal funds rate

Answer 7

the federal reserve’s desired federal funds rate (set every 6 weeks)

-fed then adjusts money supply through the purchase and sale of T-bills to meet the target rate

Question 8

investors’ decisions between short-term and long term bonds

Answer 8

• if they expect short-term interest rates to rise–> buy short term bonds (1 yr) even if long-term bonds bought today offer a higher interest rate today
• if they expect short term interest rates to fall, investors may buy long-term bonds today even if short term bonds bought today offer a higher interest rate today

***when long term rates are higher than short term rates, it signals that the market expects short term rates to rise in the future***

Question 9

bond prices vs. interest rates

Answer 9

move in opposite directions

-if interest rates rise, bond prices fall and vice versa

Question 10

bonds and risk

Answer 10

• risky
• long term bonds offer higher rates bc of risk factor

Question 11

a lower interest rate will lead to…

Answer 11

more investment spending

which will lead to higher consumer spending

and to an increase in aggregate output demanded

Question 12

expansionary monetary policy

Answer 12

monetary policy that increases aggregate demand

-use when actual GDP is below potential output

Question 13

contractionary monetary policy

Answer 13

monetary policy that decreases aggregate demand

Question 14

price stabilitty

Answer 14

low, but not zero, inflation

Question 15

taylor rule for monetary policy

Answer 15

a rule that sets the federal funds rate according to the level of the inflation rate adn either the output gap or the umemployment rate

Question 16

inflation targeting

Answer 16

occurs when the central bank sets an explicit target for the inflation rate and sets monetary policy in order to hit that target

-US now tries to hit a 2% infaltion rate

Question 17

difference between taylor-rule method and inflation targeting

Answer 17

inflation targeting is forward-looking rather than backward looking. Taylor rule adjusts monetary policy to past inflation, but inflation targeting is based on a forecast of future inflation

Question 18

inflation targeting: benefits and drawbacks

Answer 18

benefits:

• transparency (economic uncertainty is reduced)
• accountability (success can be judged)

drawbacks:

-too restrictive bc sometimes stability should take precednet over acheiving a certain inflation rate

Question 19

zero lower bound for interest rates

Answer 19

interest rates cannot fall below zero

-sets limits to effects of monetary policy

Question 20

quantitative easing

Answer 20

• when fed couldnt lower interest rates because they were already near zero
• fed bought long term government debt rather than t-bills

Question 21

demand shock from a change in the money supply:

Answer 21

long run: changes in the quantitiy of money effect the aggregate price level, but they do not change real aggregate output or the interest rate

Question 22

money neutrality

Answer 22

changes in the money supply have no real effects on the economy

• only effect of an increase in money supply is to raise the aggregate price level by an equal percentage
• no one acts differently
• money is neutral in the long run