Module 3: Monetary policy and interest rates

Question 1

why inverse relationship between bonds and interest rates?

Answer 1

if int. rates go up, bonds need bigger annual return, since coupon is fixed, it needs to be capital gan = bond down

Question 2

federal funds vs discount rate?

Answer 2

-federal funds (banks from banks overnight)
-discount rate (fed loans to banks)

Question 3

bond yield formula?

Answer 3

i = coupon + (face value - price) / price

Question 4

present value bond formula?

Answer 4

face + coupon / 1 + interest rate (0.04)

Question 5

sum transmission mechanism

Answer 5

int. rates up, AD up, keynesian multiplier, income up

Question 6

monetary vs fiscal policies, 2 differences

Answer 6

-timing: monetary is faster to implement, but takes longer to affect
-discrimination: fiscal policy (taxes at least) affects broadly, monetary affects housing especially or export

Question 7

nominal vs real int. rate explain

Answer 7

nominal = bank interest rate
real = nominal - expected inflation

Question 8

2 problems when targeting int. rates?

Answer 8

-fed may lose control over money supply (expanding when infl. is high)
-destabilize economy (raise M to lower int. rates when rates rise as stabilizer

Question 9

when do negative int. rates apply, what for? 2 situations and cons

Answer 9

-central bank trying to chase banks out of bonds and into private sector
-to weaken country’s currency to stimulate investment and trade
(risks infl. and desincentivize people to invest and save for the future)