Chapter 15 Flashcards by

short-term interest rates

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

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long-term interest rates

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

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The higher the short-term interest rate, ______________

the higher the opportunity cost of holding money

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The lower the short-term interes rate, _________________

the lower the opportunity cost of holding money

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What affects money demand?

short-term interest rates

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Money demand curve

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

slopes downward

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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

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Factors that shift money demand curve:

Changes in:

Aggregate price level

real GDP

Credit markets and banking technoogy

institutions

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higher prices =>

increase demand for money

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lower prices =>

decrease demand for money

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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%

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increase in GDP =>

increases demand of money

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decrease in GDP =>

decreases demand for money

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“revolving balance”

Credit card that allows customers to carry a balance from month to month

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Credit cards more available

banking technology increases

decreases the demand for money

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Changes in institutions: allow banks to pay interest on checking account funds

increase demand for money

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Liquidity preference model of the interest rate

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

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Money supply curve

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

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An increase in the money supply, ___________

drives the interest rate down

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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

1. Transparency - the public knows the objective of an inflation-targeting central bank 2. 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