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OSB > Lecture 5 > Flashcards

Lecture 5 Flashcards

1
Q

What does the theory liquidity preference say?

A

the interest rates adjusts to balance the supply and demand for money

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2
Q

According to Keynes’ theory of liquidity preference, the equilibrium money _______ and money _________ determines the _________ interest rate

A

supply
demand
nominal

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3
Q

According to Keynes’ theory of liquidity preference, MS and MD are what shape and why?

A

MD is downward sloping because the nominal interest rate is the opportunity cost of holding money and MS is vertical because it is independent of the interest rate

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4
Q

What is nominal interest rate defined as according to Keynes’ theory of liquidity preference?

A

it is the opportunity cost of holding money

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5
Q

What four things can affect the demand for money?

A
  1. the level of income
  2. interest rates
  3. inflation
  4. uncertainty about the future
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6
Q

What are three motives for demanding money?

A
  • the transactions motive
  • the precautionary motive
  • the speculative motive
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7
Q

What is the transactions motive for demanding money?

What happens to the transactions demand for money as income or GDP increases?

A

Demand of money arises from the fact that most transactions involve an exchange of money so it is necessary to have money available for transactions, money will be demanded. Hence, as income or GDP rises, the transactions demand for money also rises

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8
Q

What is the precautionary motive for demanding money?

A

People often demand money as precaution against an uncertain future such as unexpected expenses which often require immediate payment (the need to have money available in such situations gives rise to the precautionary motive for demanding money

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9
Q

What is the speculative motive for demanding money?

  • money is one store value, this is an __________. Demand for an ______ depends on its rate of _________ and its _______ cost. Typically, money holdings provide ____ rate of ______ and often depreciate due to ________
  • the opportunity cost of holding money is the _______ rate that can be earned by lending or ________ one’s money _________.
  • the speculative motive for demanding money arises in situations where holding money is perceived to be __________ risky than the alternative of lending the money or investing it in some other asset
A
  • money is one store value, this is an asset. Demand for an asset depends on its rate of return and its opportunity cost. Typically, money holdings provide no rate of return and often depreciate due to inflation
  • the opportunity cost of holdings money is the interest rate that can be earned by lending or investing one’s money holdings.
  • the speculative motive for demanding money arises in situations where holding money is perceived to be less risky than the alternative of lending the money or investing it in some other asset
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10
Q

A shift in the money demand reflects a change in what?

A

monetary policy

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11
Q

What happens to the demand for money (and therefore interest rates) when nominal GDP increases?
* nominal GDP increasing is caused by a rise in economic growth, rising prices or both

A

Money demand increases so it shifts to the right meaning that interest rates (which are on the y axis of the graph) also increase

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12
Q

What happens to the demand for money (and therefore interest rates) which nominal GDP decrease?
* nominal GDP decreasing is caused by fall in economic growth, falling prices or both

A

Money demand decreases so it shifts to the left meaning that interest rates (which are on the y axis of the graph) also decrease

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13
Q

What are the three main mechanisms for influencing the money supply?

A
  • open market operations
  • reserve ratio requirements
  • discount rates
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14
Q

What are open market operations?

A

This is when the Reserve bank gives out a piece of paper with a promise to pay back the money that you give them in the future. You can take that bit of paper back to the bank later and they give you back your funds. In other words, the reserve bank can buy and sell securities to increase/decrease funds in the market.

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15
Q

What is the reserve requirement ratio?

A

The portion of deposits that banks must have on hand as cash and this amount is set by the central bank.

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16
Q

What does increasing the required reserve ratio do to the money supply?

A

Increasing the required reserve ratio increases the amount of cash that banks are required to hold in reserves which decreases the availability for loans and therefore decreases the money supply and works to decrease inflation. This is the opposite for decreasing the required reserve ratio

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17
Q

What is the discount rate?

A

The interest rate charged to commercial banks for loans received from the central bank.

18
Q

What is expansionary monetary policy and what does it do to the money supply?

A

this is when the central bank uses monetary policy in such as way as to cause an increase in the supply of money
this shifts it to the right on the diagram

19
Q

What does contractionary monetary policy and what does it do to the money supply?

A

this is when the central bank uses monetary policy in such as way as to cause a decrease in the supply of money
this shift it to the left on the diagram

20
Q

Why is the central bank’s control of money not be very precise?

A

Because it can not control household preferences for cash or the reserve ratio held by banks

21
Q

An increase in household’s preference for cash will ___________ deposits at the bank and ultimately __________ decrease the money supply

A

decrease

decrease

22
Q

An increase in bank’s reserve ratio will _______ the money supply

A

decrease

23
Q

Due to problems in controlling the money supply, the RBNZ targets the interest rate using the OCR rather than the money supply. True or false?

A

true

24
Q

When the RBNZ lowers the OCR, what happens to reserves? Why is this? How is this seen in the general money market?

A

They increase because settlement cash with the RBNZ decrease

this can be seen as a vertical shift to the right in MS

25
Q

What happens to the amount of loans that private banks lend out when the OCR decreases? How is this seen in the general money market?

A

Since their reserves are increasing, the loans are also increasing which can be seen as a vertical shift to the right in MS

26
Q

What happens to the money supply when the OCR decreases?

A

it increases

27
Q

What do expansions in money and credit do to output and prices?

A

it leads to higher output and upward pressure on prices

28
Q

What do contractions in money and credit do to output and prices?

A

it leads to lower output and downward pressure on prices

29
Q

How do banks control the amount of lending now in comparison to what they used to do?

A

Banks used to target the amount of reserves in the banking system to control the amount of lending. These days, they use a completely different system and look to target interest rates at which banks borrow and lend

30
Q

How can banks influence the quantity of money available in the economy?

A

by choosing how much to lend from its reserves

31
Q

What is fractional banking?

A

This is a system where banks hold a fraction of their deposits as reserves and lend out the rest

32
Q

What are reserves?

A

these are deposits that the banks have received but have not lent out yet

33
Q

What is the reserve ratio?

A

the fraction of reserves that banks hold

34
Q

What are liabilities?

A

a banks deposits

35
Q

What are assets?

A

a banks’ reserves plus loans issued

36
Q

What is the money multiplier? How does this affect the amount of money in the money supply?

A

1/ORR

a $1 change in deposits leads to a $1 x (1/ORR) change in the money supply

37
Q

Private banks have accounts at the Reserve Bank called what?

A

settlement cash accounts

38
Q

The bank’s deposit with the RBNZ earns daily interest called what?

A

the OCR

overnight cash rate? not official cash rate?

39
Q

Banks can borrow or lend at the OCR, true or false?

A

true

40
Q

Banks HOLDING settlement cash are paid the OCR, true or false?

A

true

41
Q

Banks BORROWING settlement cash pay the OCR, true or false?

A

true

OSB (26 decks)

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