Lecture Note #6

Question 1

Why do banks have excess liquidity?

Answer 1

1) the benefit of having more liquidity to face depositors’ demand and avoiding default overshadows the opportunity cost
2) Liquid securities (as opposed to cash) and remunerated(pay) reserves do not carry such cost

Question 2

What is the equation for Quantity Theory of Money (QTM)?

Answer 2

M x V = P x Y

Question 3

What does (P x Y) mean in the QTM equation?

Answer 3

nominal GDP

Question 4

What does (M x V) mean in the QTM equation?

Answer 4

volume of monetary transactions

Question 5

What does the demand for money include?

Answer 5

cash

Question 6

What are other financial assets (OFA)?

Answer 6

bank deposits, bonds, stock, foreign currency

Question 7

What is monetary base?

Answer 7

a broad measure, influencing the amount of money banks can lend out through the multiplier effect

Question 8

What is currency in circulation?

Answer 8

is the subset of the monetary base that is actively used in day-to-day transactions by the public

Question 9

What is a currency mismatch?

Answer 9

in some countries, banks lend in foreign currency and accept deposits in local currency, a currency risk emerges in the event of depreciation

Question 10

What is the difference between inflationary tax and standard tax?

Answer 10

Inflationary tax is caused by inflation, which is made through monetary policy. Monetary policy is then controlled by the federal reserve.

Standard tax is a tax rate that is passed by Congress.

Question 11

What are six properties money should have?

Answer 11

1) Durability
2) Portability
3) Divisibility
4) Uniformity
5) Acceptability
6) Limited Supply

Question 12

What are beliefs held by economists concerning cryptocurrencies?

Answer 12

it is an unstable and risky form of currency so it will not substitute standard currencies any time soon

Question 13

What is true about the number of central banks over the past 200 years?

Answer 13

The number of central banks have risen

Question 14

When considering how a central bank works, what are the assets and liabilties?

Answer 14

Assets:
1) international reserves
2) credit to the treasury
3) securities
4) credit to the financial system

Liabilities:
1) monetary base
2) central bank securities

Question 15

What is needed to calculate the opportunity cost of holding cash?

Answer 15

1) nominal interest rate
2) interest rate on cash (is always zero)

Question 16

What is the formula needed to calculate the opportunity cost(OC) of holding cash?

Answer 16

OC = nominal interest rate - interest rate on cash

Question 17

What does income elasticity measure?

Answer 17

how much nominal money balances increase if nominal GDP increases by 1%

Question 18

Can V and Y be removed from the QTM equation (M x V = P x Y)?

Answer 18

No because V and Y cannot be fixed or constant

Question 19

What do central bankers do when the policy rate gets close to zero?

Answer 19

They start to implement unconventional methods like Quantitive Easing (QE) to inject money into the economy directly

Question 20

What makes up US commercial banks (percentage wise)?

Answer 20

Cash: 14%
Securities: 23%
Loans: 53%
Other assets: 10%

Question 21

According to QTM, why is it theoretically possible to have inflation even if the supply of money and the real GDP stay constant?

Answer 21

Reason being is that velocity of money could increase which would boost prices even if M and Y or constant.

Question 22

What are sterilization operations used for when considering deficits?

Answer 22

used to counteract money printing due to capital inflows to countries with fixed or manage exchange rate regimes

Question 23

How is the fiscal federal deficit financed?

Answer 23

buy and sell government securities and others

Question 24

What makes foreign investors extremely confident about the stability of the US dollar?

Answer 24

owed to the safety and stability of the currency issued by the largest economy in the world (US)

Question 25

How can seniorage be calculated?

Answer 25

Seniorage = Inflationary Tax + Change in Real Money Demand

Question 26

What is the relationship between money growth and inflation in the short term?

Answer 26

Weak short-term correlation

Question 27

What is the relationship of money growth and inflation in the long-term?

Answer 27

Strong long-term correlation

Question 28

Who and why are bank reserves retained?

Answer 28

Held by banks to face depositor’s demand for cash

Question 29

Who and why are international reserves retained?

Answer 29

Held by central banks to manage the exchange rate when deemed necessary