Topic 4: Monetary Policy

Question 1

demand for money

Answer 1

quantity of monetary assets that people want to hold in their portfolios, depends on expected return, risk and liquidity

Question 2

Money: characteristics

Answer 2

most liquid, pays low return

Question 3

opportunity cost of holding money

Answer 3

nominal interest rate

Question 4

excess supply of money causes interest rates to

Answer 4

fall

Question 5

excess demand for money causes interest rates to

Answer 5

rise

Question 6

liquidity effect

Answer 6

money rises - IR fall – C and I rise

Question 7

credit channel

Answer 7

bank reserves and deposits rise – bank loans rise – C and I rise

Question 8

fisher hypothesis: relationship between interest rates and inflation

Answer 8

part of the nominal interest rate is compensated for the effects of inflation
i = r + ╥^e
i = nominal interest rate
r = real interest rate
╥^e = expected inflation rate

Question 9

M1

Answer 9

currency + travellers checks + demand deposits + other checkable deposits

Question 10

M2

Answer 10

M1 + small denomination time deposits + savings deposits and money market deposit accounts + money market mutal fund shares

Question 11

groups that affect money supply

Answer 11

central bank or federal reserve bank in US (monetary policy), depository institutions (accept deposits, make loans, hold reserves), the public (hold money as currency or bank deposits)

Question 12

federal reserve’s balance sheet

Answer 12

the sum of reserve deposits and currency held by nonbank public and by banks is called the monetary base

Question 13

mandate of the fed

Answer 13

ensure price stability & encourage real economic activity (prevent recession or limit impact in terms of decline in real GDP)

Question 14

policy targets of the fed

Answer 14

federal funds rate and inflation rate

Question 15

tools in monetary policy

Answer 15

open market operations, changes in discount rate, changes in reserve requirement, changes in interest paid on reserve balances

Question 16

Monetary Base

Answer 16

MB = C+R
c=currency in circulation
r= total reserves in the banking system

Question 17

simple money multiplier

Answer 17

sigma = reserve requirement
ΔR = initial change in reserves from OMO

assume no leakages (no excess reserves and no extended holdings of cash)

ΔD =(1/δ)(ΔR) —
ΔM1 = (1/δ)(ΔR)

Question 18

money multiplier

Answer 18

M = m x MB
M = money supply
MB = monetary base
m = money multiplier

Question 19

M1 money multiplier

Answer 19

c = C/D
e = ER/D
δ= RR/D

m1 = (1 + c)/δ+ c + e

Question 20

QE I

Answer 20

1. fed announces plans to purchase up to 100 bil in GSE debt and up to 500 bil of MBS debt 2. fed plans to purchase 300 bil of longer term treasuries and increase GSE and MBS purchases

Question 21

QE II

Answer 21

fed purchase 900 bil treasury bonds to reduce long term interest rate in nominal and real terms

Question 22

QE III

Answer 22

fed to purchase securities from private sector to keep long term IR low and support housing market

Question 23

functions of federal reserve banks

Answer 23

see slide

Question 24

liquidity vs interest rate effect

Answer 24

in short run, liquidity effect wins, in long run, unclear

Question 25

real return of holding money

Answer 25

negative inflation rate

Question 26

nominal return of holding money

Answer 26

0

Question 27

when interests rates high

Answer 27

want to hold less money and more bonds

Question 28

holding wealth as money

Answer 28

forgo interest but benefit from liquidity

Question 29

discount rate (fed)

Answer 29

interest rate charged by red when it loans directly to banks, set higher than federal funds target rate, meant to be a penalty for banks not being able to borrow from the market)

Question 30

starting in 2008, interest is paid on what?

Answer 30

reserves

Question 31

what does an increase in monetary base do to federal funds rate?

Answer 31

fed funds rate falls