Exam 2 Flashcards

Question

Subjective Time Preference

Answer 1

People have varying levels of time preference

Answer 2

present wants dominate

Answer 3

willing to delay present gratification and tend to future wants

Answer 4

An individual is more willing to trade for future goods when present goods are relatively abundant relative to claims for future goods

Answer 5

Savings = households’ supply of present goods net of consumption (Fisherian) Change the units from goods into monetary funds, and “present goods” become “loanable funds” Investment is firm’s demand for present goods The supply of LF comes from real savings and additions to the stream of money The market interest rate equates the current supply and demand for “loanable funds”. Meaning present funds offered in exchange for claims to future funds Supply of LF = demand for claims Demand for LF = supply of claims

Answer 6

Firms: Borrow to invest, Increased eagerness to invest shifts DLF out. Ditto for better investment opportunities Government: Governments are net borrowers, Treasuries no longer hold treasure Both entities are net sellers of claims: Stock and bonds issues

Answer 7

Households: Subtract borrowing (consumption) and dissaving households, This implies that an increased demand to hold money shifts the LF suppy curve to the left, while a reduction in desired money balances shifts it to the right Central Banks:New money created through open market purchases comes on the market as additional demand for bonds (shifts SLf to the right). Open market sales (QT) do the opposite

Answer 8

1) SR (Liquidity Effect): An increase in the money supply shifts out the Slf curve, reducing the nominal interest rate R 1a) Assume the nominal interest rate equals the real rate since inflation is zero at this point 2) LR (nominal income effect): The increase in the money supply causes Dlf to shift out 2a) High M leads to higher nominal income (Y) and price level (P) 2b) At higher P, firms demand to borrow more dollars to finance the same production 2c) Input and output prices have risen 2d) Real dollars borrowed are the same as before 3) The nominal income effect restores R to its original level

Answer 9

1) Liquidity effect: Gradually rising M gradually shifts out Slf curve, reducing R1 2) Nominal income: Pushes R back up and P and Y rise, shifting out Dlf 3)The inflation expectations effect: 3a) This occurs once a higher inflation rate is expected 3b) Lenders demand an inflation premium, raising R above the original R0 3c) To lend/borrow the same number of real dollars 3d) The inflation premium compensates for the loan being paid back in dollars with reduced purchasing power

Answer 10

Short-term real interest rates can vary from the LR natural rate, due to monetary disturbances. LR neutrality Recall, if market rates are below the natural rate, economic boom (output, prices up) If market rates are above the natural rate (output, prices down)

Answer 11

Utilizes Wicksell's concept of the natural interest rate Increases in the money supply and the provision of cheap credit undertaken by central banks temporarily lowers the real rate of interest

Answer 12

Economic boom that gives way to a bust

Answer 13

Default risk Risk that you lend to an entity that can’t pay you back. -Bank loans -Government bonds -CD’s and banking panic

Answer 14

In order to shore up a constant return: The risk of inflation/interest fluctuations must be priced into interest rates Gold standard and thicker bond markets.

Answer 15

increase in the general level of prices

Answer 16

when inflation reaches an very high level

Answer 17

Shoe-leather Coats, Menu Costs, Complicates Financial Planning, unpredictability of relative prices, rigid tax laws, unexpected inflation makes consequences of contracts unpredictable

Answer 18

the time and effort spent to minimize the effects of inflation on the eroding purchasing power of money.

Answer 19

the transaction costs of changing menu prices in response to inflation.

Answer 20

Redistributes from debtors to creditors and hurts people on fixed pensions

Answer 21

Hyperinflation happens through excessive growth in the money supply. Typically initiated to finance government debt. Hyperinflation causes tax revenue to fall, as there is a delay between time taxes are issued and the time tax revenue is received. Thus, there is a greater need for the gov’t to finance the debt by increasing the money supply. Deadly Downward Spiral Ensues!!

Answer 22

Menu prices become incredibly large. Extreme inconvenience and shoe-leather costs. Hyperinflation could decrease revenue due to lags between the issuing of taxes and the retrieval of tax revenue. Relative prices are distorted, affecting the ability to reflect relative scarcity. Currency ceases to function, as barter becomes more feasible as a means of exchange.

Answer 23

M*V=P*T 𝑀 is the quantity of money, and 𝑉 is the transactions velocity of money per period of time, so 𝑀𝑉 is also the number of dollars exchanged in a year. 𝑇 represents the amount of transactions per period of time, and 𝑃 represents the price of a transaction, so 𝑃𝑇 represents the number of dollars exchanged in a year. This relationship is an identity, which is true BY DEFINITION.

Answer 24

M*V=P*Y 𝑌 refers to total income (output), and 𝑃𝑌 refers to the dollar amount of output. 𝑉 now refers to the income velocity of money, or the amount of times a dollar bill enters someone’s income in a given period of time. By definition: V= P *Y/M

Answer 25

is defined as the amount of paper money and coins in circulation in the economy

Answer 26

M1 money stock = 𝐶 PLUS… Demand deposits at commercial banks (i.e., funds that people hold in checking accounts) excluding those amounts held by depository institutions, the U.S. government, and foreign banks and official institutions. Traveler's checks (antique before ATMs) Other checkable deposits (OCDs) Consisting of negotiable order of withdrawal (NOW) and automatic transfer service (ATS) accounts at depository institutions, share draft accounts at credit unions, and demand deposits at thrift institutions

Answer 27

M2 money stock = 𝑀1 PLUS… Savings deposits (including money market deposit accounts) Small-denomination time deposits (time deposits less than $100,000) Balances in retail money market funds (MMFs)

Answer 28

savings deposits not considered in both M1 and M2 thus M1=C+demand deposits at commercial banks+traveler's checks+other checkable deposits+saving deposits

Answer 29

Y=nominal aggregate income = annual money expenditure on final goods (GDP, GNP etc.) in $ per year

Answer 30

Y=Py Where P is an index of prices in $ per basket y= an index of real output in baskets/year Normalize to one basket at base year prices National income accounts do this when they calculate real GDP by using base-year prices paired with the current year’s output quantities.

Answer 31

CPI and GDP deflator

Answer 32

1. Take equation of exchange, PLUS some assumptions: -Assume that velocity is constant (𝑉=𝑉 ̅; %∆𝑉=0) -This is a simplification, but this is a USEFUL simplification. -It means that the dollar amount of an economy’s output (𝑃𝑌) is ONLY affected by the money supply (𝑀). 2. The desired ratio of money balances to income (M/Py) is determined by real factors, independent of the nominal quantity of money, except for the transitory effects of money growth. Marshall worked with k = M/Py Fisher with V = Py/M 3. Real income is determined by real factors independent of the nominal quantity of money (long-run neutrality), barring transitory short-run effects that money might have on income.

Answer 33

1. Exogenous changes in the level of M cause endogenous (equilibrating) changes in the price level. 2. The price level is proportional to the nominal quantity of money, ceteris paribus 3. Money is neutral in the long run It cannot permanently change V or y i.e. M only affects nominal variables in the long-run, not real variables

Answer 34

Measured in current $ Without reference to the purchasing power of the dollar Ex) Price level, nominal income (Py), nominal money stock (M)

Answer 35

Measured in “real” or “constant” dollars of defined purchasing power, or in non-monetary units. Ex) Real income (y), real money stock (m), unemployment rate

Answer 36

Serve as a buffer stock (think inventory) that are useful since we live in a world of positive transaction costs. With income, we let money balances rise within some range With purchases, we let money balances fall within some range We do this instead of immediately offsetting purchases or sales to maintain our exact amount of desired MB

Answer 37

Dollars, pounds, Euros

Answer 38

Expressed in purchasing power Real money balances relative to real income can be expressed as how much income is being held (M/Py or m/y)

Answer 39

if Y increase , P decrease , and vice versa. Real supply shocks affect scarcity, and therefore prices.

Answer 40

if M increase, V decrease, and vice versa. If more money is introduced to the economy, the speed at which individual units circulate will decline.

Answer 41

-Offset changes in V with changes in M, to maintain stable Py (nominal income i.e. Velocity increases as the economy re-opens during Covid, contract M. -Allow changes in y to to manifest in P changes, to reflect Real income falls while the economy is shut-down, allow prices to rise.

Answer 42

the desired average level of nominal money balances

Answer 43

Real income or wealth - if the quantity of money needed to serve the buffer stock role doesn’t increase with income + in shopping-time models of money demand These models take the time costs of “shopping” or engaging in consumption into account. Higher real money balances reduces the time or costs associated with shopping Higher income = more consumption = more shopping time = higher real money balances Opportunity costs: interest rates on alternative assets (-) Pecuniary interest yield on money deposits (+) Transaction costs of moving in and out of higher-yielding assets (+) Payment technology factors Simplified real money demand: Y is “scale”, r is “opportunity cost”

Answer 44

Demand deposits: -If the interest on deposit accounts moves with interest yields on substitute assets, such as short-term time deposits, bonds, or money market mutual funds, then perhaps hardly at all. -However, some policies reduce interest yields on checkable deposits -Increasing reserve requirements Increases banks demand for M0 instead of deposits -Regulation Due to “Regulation Q”, commercial banks were banned from paying interest on demand deposit accounts from 1933-2011. Cash: Currency pays no interest and therefore has a 0% rate of return. Therefore, paper currency will be much more interest-sensitive

Answer 45

1.Banker’s bank 2.Monopoly of note issue 3.Regulator of commercial banks 4.Lender of last resort 5.Monetary policy

Answer 46

The bank could lend the money out to borrowers, who are seeking money from the bank. The bank could deposit the money in a reserve for the saver.

Answer 47

100-percent reserve banking (i.e., 0% of the deposit is lent out to others) Fractional reserve banking (i.e., some non-zero percentage of the deposit is lent out to others)

Answer 48

financial intermediation (the process of transferring money from savers to borrowers)

Answer 49

is the total amount of money held by the public as currency (𝐶) and by the banks as reserves (𝑅) such that 𝐵=𝐶+𝑅. The monetary base is directly controlled by the Federal Reserve.

Answer 50

The federal reserve

Answer 51

is the fraction of deposits (𝐷) that banks hold in reserve (i.e., 𝑟𝑟=𝑅/𝐷). It is determined by business policies of banks and the laws regulating banks.

Answer 52

is the amount of currency (𝐶) people hold as a fraction of their holdings of demand deposits (𝐷; i.e., 𝑐𝑟=𝐶/𝐷)

Answer 53

m = (cr+1)/(cr+rr)

Answer 54

(1) The monetary base (𝐵) is proportional to the money supply (𝑀), and grows by the same percentage rate. (2) As the reserve-deposit ratio (𝑟𝑟) decreases, the more loans banks make, and the more money banks create from every dollar of reserves. Therefore, a decrease in 𝑟𝑟 INCREASES 𝑚 and 𝑀. (3) As the currency-deposit ratio (𝑐𝑟) decreases, the fewer dollars of the monetary base the public holds as currency, the more base dollars banks hold as reserves and the more money banks can create. Thus, a decrease in 𝑐𝑟 INCREASES 𝑚 and 𝑀.

Answer 55

Increases the policy rate FFR and IOR If using OMO, quantitative tightening Increases market interest rate Reduces the money supply

Answer 56

Lowers the policy rate (FFR) and IOR If using OMO, quantitative easing Lowers market interest rates Increases the money supply

Answer 57

Assets: Securities, loans to financial institutions Liabilities: currency in circulation, reserves

Answer 58

Influencing the monetary base and influencing the reserve-deposit ratio

Answer 59

(𝐵; recall 𝐵↑⇒𝑀↑) Open market operations, lender of last resort, discount rate

Answer 60

(𝑟𝑟; recall 𝑟𝑟↑⇒𝑚,𝑀↓) reserve requirements and interest on reserves

Answer 61

(𝐵; recall 𝐵↑⇒𝑀↑) Buying bonds -> “selling” currency -> 𝐵 increases. Selling bonds -> “buying” currency -> B decreases

Answer 62

(interest rate the Fed charges on loans) If the rate falls, it’s cheaper for banks to borrow from the Fed, so 𝐵 increases.

Answer 63

(banks have to have a minimum reserve amount) An increase in requirements tends to increase 𝑟𝑟, but is less effective when banks hold excess reserves.

Answer 64

(paid to banks for holding reserves) If the rate rises, it’s more beneficial for banks to hold reserves, so 𝑟𝑟 increases.

Answer 65

The Federal Deposit Insurance Corporation (FDIC) protects deposits up to $250,000 when a bank fails. It is intended to preserve public confidence in the banking system. Therefore, mitigates large swings of the currency-deposit ratio (𝑐𝑟), and allow the Fed to have more control over the money supply.

Answer 66

Bail out insolvent savings and loans institutions (1980s and early 90s) Moral Hazard. As the likelihood of being bailed out for risky behavior increases, the cost of engaging in risky behavior decreases.

Answer 67

A central bank is given a task or goal to pursue but is allowed to achieve that goal in whatever manner it sees fit. That is, the central bank can use any monetary policy tool, or combination of tools to achieve it. Seems to be intuitively a good thing I.e. Central banks should know better which levers to pull to achieve a given policy outcome, in comparison to politicians.

Answer 68

The central bank is free to choose what monetary policy goals it pursues Activist or stabilization policy Rule-based monetary policy Choice of rule and implementation

Answer 69

A central bank with goal independence is ostensibly immune to pressure from the government or treasury Without goal independence, this pressure often results (especially in developing countries) in the central bank being forced to directly finance government deficits Inflationary finance Currency, debt, and banking crises Being immune to political pressures has benefits

Answer 70

Political economy Lack of political accountability A central bank with goal independence is a technocratic institution It runs afoul of basic democratic notions regarding citizens in a representative democracy being able to directly/indirectly choose government policy. Public choice considerations Central banks hire loads of economists. If constrained to the enforcement/implementation of a simple monetary policy rule, the payroll could be decimated. The fact that inflation generates seigniorage presents an eternal conflict of interest And the Fed doesn’t send 100% of seigniorage revenue back to the treasury Fedwatching industry Time Inconsistency