MBFINAL Flashcards
What is the Fisher equation?
Nominal interest rate = Real interest rate + expected inflation
What are the 5 monetary theories? QLIMR
QLIMR
- Quantity theory of Money
- Liquidity Preference Theory
- IS-LM model
- Modern Monetarism
- Rational Expectations
What is the quantity theory of money?
Mt * Vt = Pt * Yt
M = money supply
V = velocity of money
P = price level
Y = real output/GDP
t = period of interest
Real output is constant. Hence velocity of money must be constant. Thus Mt = Pt ⇒ Increases in money supply increases the price level (inflation).
What is the liquidity preference theory?
Money is better now than later.
The higher the short-term interest, the smaller money demand will be.
What is the IS-LM model?

What is modern monetarism?
Friedman.
Monetary authorities should focus SOLELY on maintaining price stability by increasing monetary supply with the exact same pace as economic growth of the economy.
What is the theory of rational expectations about?
That all agents are rational.
Meaning that they act with the long-run in mind and take all available information into expectations. Maximizing utilities based on rational expectations.
Which three players affect the money supply?
- Central Bank: monetary policy
- Banks (depository institutions): holding deposits and giving loans
- Depositors
What are on the Central Bank’s asset and liabilities relevant to the money supply?
- Assets:
- Securities
- Loans to financial institutions
- Liabilities:
- Currency in circulation
- Reserves (deposits by banks in the CB)
What does the monetary base / high-powered money consist of?
Central bank liabilities
Currency in circulation + Reserves (deposits by banks in the CB)
MB = C (currency) + Reserves)
What is an open market purchase and what happens on the t-account?
CB / FED’s purchase of bonds in the market (banking system)

What is an open market sale and what happens on the t-account?
CB / FED’s sale of bonds in the market (banking system)

What is the nonborrowed monetary base?
MBn = MB - BR (borrowed reserves from the FED)
Borrowed reserves from the FED is the part of the monetary base, which FED has less control of.
The FED has full control of the nonborrowed monetary base.
What is the simple deposit multiplier and its equation?
Measures the multiple increase in deposits generated from an increase in the banking system’s reserves.
Change in D (checkable deposits) = 1 /rr (required reserve ratio) * change in R (reserves for the banking system)
For example: if reserves increases by 100 and the required reserve ratio is 10 %:
change in D = 1/0.1 * 100 = 1,000.
Note: in real life it is not this simple as FED cannot completely control the monetary base. However, at large it works.
Which 5 factors affect the monetary base (MB) and are they positively or negatively related to MB?
- Changes in the nonborrowed monetary base, MBn (positive relation)
- Essentially open market purchases/sales
- Changes in borrowed reserves, BR, from the FED (positive relation)
- Loans from the FED to financial institutions
- Changes in the required reserve ratio, rr (negatively related)
- Change in D = 1 / rr * change in reserves. When rr increases, the effect is smaller.
- Changes in excess reserves (negatively related)
- When banks hold more excess reserves, they make less loans and thus reduce the multiplier effect
- Changes in currency holdings (negatively related)
- Currency holdings reduce the multiplier effect. The multiplier effect is strongest when all is deposited.

What does the money multiplier, m tell us?
The size of the change in money supply from a change in the monetary base, MB
MS = m * MB
m = 1 + c / (rr + e + c)
- c = currency in circulation (C) / checkable deposits (D)
- e = excess reserves (ER) / checkable deposits (D)
- rr = required reserve ratio
What is velocity?
Velocity of money; the average number of times in a year that a dollar is spent in buying the total amount of goods and services produced in the economy.
V = (P * Y) / M
Velocity = (Price * Output) / Quantity of Money
What, according to Fisher’s theory, determines the demand for money?
Only income level.
Md = k * (P*Y)
(not interest rates)
What is the equation for inflation in the quantity theory of inflation?
Inflation = % growth rate of money supply - % increase in aggregate output
Inflation = % change in M - % change in Y
(not really a good theory in the short run but holds better in the long run)
How can budget deficits source inflationary monetary policy?
Governments can just as individuals increase income (working = through taxes) or increase borrowing (bank loans = issuing bonds) to finance deficits.
Moreover, governments has a third option, create more money to use as payment (increase money supply).
DEF = G - T = Change in MB + Change in Bonds
If deficit is financed by an increase in bond holdings, there is no effect on MB. If not financed by bond holdings, both the monetary base and money supply increases = increases inflation.
What is the equation for money demand (Keynesian theory)?
Md / P = L (i, Y) (i is negatibely related, Y is positively related)
What are the 7 factors that affect the demand for money and how are they related? (Keynesian + portfolio theories). IIPWRIL

What are the main objectives of CBs?
- Price stability
- And then
- High employment and output stability
- Economic growth
- Stability of financial markets
- Interest-rate stability
- Stability in foreign exchange markets
- And then
What does Okun’s law say?
Okun’s law states that a one point increase in the cyclical unemployment rate is associated with two percentage points of negative growth in real GDP.
(Output - Potential output) / Potential output = c * (Unemployment % - Natural unemployment %)
(Y - Y*) / Y* = c * (U - U*)
c = around 2 depending on the country and time period.





















































