Quiz #8 Review

Question 1

Federal Funds Rate

Answer 1

the interest rate banks charge each other for overnight loans

Question 2

expansionary monetary policy

Answer 2

the Federal Reserve’s decreasing interest rates to increase real GDP

Question 3

contractionary monetary policy

Answer 3

the Federal Reserve’s increasing interest rates to reduce inflation

Question 4

The Taylor Rule

Answer 4

a rule developed by John Taylor that links the Fed’s target for the federal funds rate to economic variables

Question 5

Taylor Rule formula

Answer 5

Federal Funds target rate = current inflation rate + real equilibrium federal funds rate + ((1/2) x inflation gap) + ((1/2) x output gap)

Question 6

inflation targeting

Answer 6

conducting monetary poilcy so as to commit the central back to achieving a publicly announced level of inflation

Question 7

The Four Goals of Monetary Policy

Answer 7

1. price stability
2. high employment
3. stability of financial markets and institutions
4. economic growth

Question 8

demand for money

Answer 8

the demand to hold money as money instead of holding it in some other form of wealth like a government bond

Question 9

demand for money is inversely related to _________

Answer 9

interest rates

Question 10

The Money Market X and Y axis’

Answer 10

• X axis is the quantity of money

- Y axis is the interest rate

Question 11

Demand for money curve slopes _______ and the supply of money curve slopes ________

Answer 11

down, trick question: its perfectly vertical

Question 12

2 things that shift the demand for money curve

Answer 12

1. a change in real GDP

2. a change in the price level

Question 13

if real GDP goes up, demand for money goes __________

Answer 13

up!

Question 14

if real GDP goes down, demand for money goes __________

Answer 14

down

Question 15

if the price level goes up, demand for money _______

Answer 15

rises

Question 16

if the price level lowers, the demand for money ________

Answer 16

decreases

Question 17

equilibrium interest rate

Answer 17

intersection for supply of money and demand for money curve

Question 18

If the money supply is increased, interest rates __________

if the money supply is decreased, interest rate ________

Answer 18

falls, rises

Question 19

the market for loanable funds is concerned with __________ interest rates

the money market is concerned with ______ interest rates

Answer 19

long-term interest rates

short-term interest rates (fed funds rate)

Question 20

what are long-term interest rates used for in the market for loanable funds?

Answer 20

investors buying corporate bonds, business undertaking investment, consumer buying a house

Question 21

what are the short-term interest rates used for in the money market?

Answer 21

things like the fed funds rate!

Question 22

How do interest rates affect aggregate demand? (HINT: 3 ways)

Answer 22

1. consumption
2. investment
3. net exports

Question 23

interest rates - aggregate demand - consumption

Answer 23

when rates are lower, people are more likely to buy houses, cars, furniture
-when rates are low, people are likely to save less and spend more

Question 24

interest rates - aggregate demand - investment

Answer 24

when rates are lower, firms will borrow more to undertake new projects
-when borrowing costs are lower, break even point for new projects is more easily attained

Question 25

interest rates - aggregate demand - net exports

Answer 25

when interest rates go down in the US, AD increases

Question 26

why goes a decrease in interest rates result in an increase in AD?

Answer 26

if interest rates go down, foreign investors buy bonds, this increase demand for US dollar in the international market, this makes the dollar stronger, this makes Americans buy more imports to save money, their domestic production goes down, AD decreases!

Question 27

example of Taylor Rule:
Current inflation is 3%, current real rate of interest is 1%, inflation is 2% higher than we want it to be, GDP is 6% lower than we want it to be

Answer 27

Fed Funds rate = 3 + 1 + (.5)(2) + (.5)(-6) = 2