Monetary Policy and Economic Indicators Quiz
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Questions and Answers

What is the bond price if the annual interest payment is $40 and the new market interest rate is 5%?

  • $800 (correct)
  • $600
  • $400
  • $1000

What is the federal funds target rate using the Taylor Rule if inflation is 3%, the target inflation rate is 2%, and the economy is 3% above its long-run output?

  • 6%
  • 8%
  • 5%
  • 7% (correct)

Which of the following assets is likely to show the greatest increase in value over time?

  • Government Bonds
  • Precious Metals
  • Real Estate
  • Blue Chip Stocks (correct)

What monetary policy should the Federal Reserve utilize during a severe recession?

<p>Expansionary Monetary Policy (B)</p> Signup and view all the answers

What does the equation of exchange imply about the relationship between M, V, P, and Q?

<p>M multiplied by V equals P multiplied by Q (C)</p> Signup and view all the answers

What happens to bond prices when interest rates rise?

<p>Bond prices decrease. (C)</p> Signup and view all the answers

What is a key characteristic of a Roth IRA?

<p>Contributions are made with after-tax income. (A)</p> Signup and view all the answers

Which entity sets the direction for monetary policy in the U.S.?

<p>FOMC (A)</p> Signup and view all the answers

What is the minimum age to collect Social Security benefits?

<p>62 years (A)</p> Signup and view all the answers

What type of interest calculation does compounding interest involve?

<p>Both the initial principal and accumulated interest (D)</p> Signup and view all the answers

Which tool of the Federal Reserve involves buying and selling bonds?

<p>Open Market Operations (A)</p> Signup and view all the answers

What does the Federal Funds Rate represent?

<p>The rate banks charge each other for loans (B)</p> Signup and view all the answers

What is the function of the Board of Governors within the Federal Reserve?

<p>Regulate and supervise member banks (C)</p> Signup and view all the answers

Which of the following is NOT a function of money?

<p>Credit risk assessment (A)</p> Signup and view all the answers

What is a characteristic of contractionary monetary policy?

<p>Discourage borrowing and spending (B)</p> Signup and view all the answers

What characterizes M2 in the money supply?

<p>Savings deposits (A)</p> Signup and view all the answers

What does liquidity measure?

<p>The speed at which assets can be converted to cash (C)</p> Signup and view all the answers

Which tool does the Federal Reserve use to influence the money supply the most directly?

<p>Conducting open market operations (D)</p> Signup and view all the answers

Which factor is on the supply side of the market for loanable funds?

<p>Savers providing funds (A)</p> Signup and view all the answers

If the Federal Reserve increases the interest on reserve balances, what is the likely result?

<p>Decrease in lending (A)</p> Signup and view all the answers

What likely happens to interest rates and loanable funds if the government promotes wider participation in retirement plans?

<p>Loanable funds increase; interest rates decrease (D)</p> Signup and view all the answers

What does the coupon rate of a bond represent?

<p>The bond's interest rate (A)</p> Signup and view all the answers

What is a consequence of lower reserve requirements under expansionary monetary policy?

<p>Banks will have more money to lend (C)</p> Signup and view all the answers

In the context of financial institutions, which of the following is NOT a function they serve?

<p>Set international exchange rates (C)</p> Signup and view all the answers

Which of the following best describes the real interest rate?

<p>The rate adjusted for inflation (A)</p> Signup and view all the answers

How does an increase in the discount rate affect borrowing?

<p>Makes borrowing more expensive (D)</p> Signup and view all the answers

An increase in the money supply generally has what effect on interest rates?

<p>Lowers interest rates (A)</p> Signup and view all the answers

What does it mean for something to be more liquid in financial terms?

<p>It can be converted into cash more easily (B)</p> Signup and view all the answers

What occurs when the Federal Reserve sells securities in the open market?

<p>Money supply decreases (B)</p> Signup and view all the answers

Flashcards

What are the functions of money?

Money serves as a medium of exchange, a unit of account, and a store of value.

What is liquidity?

Liquidity refers to how easily and quickly something can be converted into cash.

What are the components of M1 money supply?

M1 consists of currency in circulation and checkable deposits.

What are the components of M2 money supply?

M2 includes all of M1 plus savings deposits, money market accounts, small time deposits, and retail money market funds

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What is the market for loanable funds?

The market for loanable funds is where lenders and borrowers meet to exchange money.

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What is the real interest rate?

The real interest rate is the rate at which money is borrowed or lent, adjusted for inflation.

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What are the functions of financial institutions?

Financial institutions screen borrowers, reduce costs, provide standardized products, diversify assets, and pool funds.

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What is a bond's yield?

The bond's yield is the interest payment divided by the price of the bond.

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Bond Price vs Interest Rate

Bond prices move in the opposite direction of interest rates. When interest rates rise, bond prices fall, and vice versa.

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Risk-Return Relationship

Investments with higher risk potential generally offer higher returns to compensate for the increased uncertainty.

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401(k)

A retirement savings plan offered by employers where contributions are made through pre-tax payroll deductions.

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Traditional IRA

A retirement savings plan where contributions may be tax-deductible, but withdrawals are taxed as income.

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Compounding Interest

Interest earned on both the principal amount and previously accumulated interest, leading to exponential growth over time.

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Social Security

A government program funded by FICA taxes, providing retirement income benefits to eligible individuals.

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Federal Funds Rate

The interest rate at which banks lend reserves to each other overnight, indicating the general level of interest rates in the economy.

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Open Market Operations

The Fed's buying and selling of government securities to influence the money supply and interest rates.

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Bond Price Calculation

The price of a bond is calculated by dividing the annual interest payment by the new market interest rate.

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Expansionary Monetary Policy

A policy aimed at stimulating economic growth by increasing the money supply and lowering interest rates.

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Impact of Interest Rate Increase on Bond Value

When interest rates rise, the value of existing bonds decreases because investors demand a higher return for their money.

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Contractionary Monetary Policy

A policy aimed at curbing inflation by decreasing the money supply and raising interest rates.

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Federal Funds Rate Targeting

The Federal Reserve uses the Federal Funds Rate as its primary tool to manage the money supply and influence the overall economy.

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Expansionary Monetary Policy

During a recession, the Federal Reserve implements expansionary monetary policy, which lowers interest rates and increases the money supply to stimulate economic growth.

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Lowering Interest Rates

Reduces the cost of borrowing money for individuals and businesses, encouraging investment and spending.

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Equation of Exchange

The equation of exchange (MxV=PxQ) describes the relationship between the money supply (M), velocity of money (V), price level (P), and real output (Q).

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Increasing the Money Supply

Makes more money available for borrowing and spending, potentially leading to economic growth.

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Discount Rate

The interest rate at which commercial banks can borrow money directly from the Federal Reserve.

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Reserve Requirements

The percentage of deposits that banks are required to hold in reserve.

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How does the Fed influence interest rates?

The Federal Reserve doesn't directly control interest rates, but it influences them through tools like the discount rate and open market operations.

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Study Notes

Money

  • Money is not backed by a commodity; its acceptance is due to government issuance.
  • Money must be divisible, durable, and widely accepted by many people. It should also be easy to determine its value.
  • Money functions as a medium of exchange, a unit of account, and a store of value.
  • Liquidity refers to how easily and reliably something can be converted into cash. More liquid assets are easier to convert.

Money Supply

  • M1 includes currency in circulation and checkable deposits.
  • M2 adds savings deposits, money market deposit accounts and shares of retail money market mutual funds to M1.

Market for Loanable Funds

  • Loanable funds are the funds available for borrowing.
  • The real interest rate is the rate at which money is borrowed or lent.
  • The supply of loanable funds comes from savers.
  • The demand for loanable funds comes from borrowers.
  • Equilibrium is the point where supply and demand for loanable funds intersect.

Financial Institutions

  • Financial institutions screen and evaluate the credit worthiness of borrowers, reduce information and transaction costs, and diversify assets to reduce risk. Additionally, they pool funds from many savers and lend to many borrowers.

Bonds

  • Bond yield is the interest payment divided by the bond's price.
  • Key bond terms include maturity date (when principal is repaid), coupon rate (interest rate), face value (amount repaid at maturity). Bond price is inversely related to interest rates; higher interest rates lead to lower bond prices.

Stocks

  • Stocks represent ownership in a company, entitling owners to a share of profits.
  • Riskier stock assets generally provide higher returns.

Retirement Accounts

  • 401(k)s are tax-advantaged employer-sponsored retirement plans.
  • Traditional IRAs may offer tax deductible contributions, but withdrawals are taxed as income.

Compounding Interest

  • Compound interest is calculated on both the initial principal and accumulated interest.
  • Compound interest causes investments and debt to grow (or reduce) faster over time.

Social Security

  • Social Security is a government program funded by FICA that provides retirement income.
  • Eligibility for Social Security begins at age 62, and payments may increase with later collection.

Monetary Policy

  • The Federal Open Market Committee (FOMC) directs monetary policy, targeting interest rates.
  • The Federal Funds Rate is the overnight borrowing rate among banks.

Federal Reserve (Fed) Functions

  • The Fed provides a nationwide payment system.
  • The Fed distributes coins and currency and regulates member banks, serving as a banker for the U.S. Treasury.
  • The Board of Governors is composed of seven members appointed by the President for 14-year terms.
  • The Fed uses tools such as open market operations (buying and selling securities), the discount rate (interest charged for overnight loans), and reserve requirements (the percentage of deposits banks must hold as reserves) to influence interest rates and money supply.

Expansionary vs. Contractionary Monetary Policy

  • Expansionary policy lowers interest rates, increases money supply and encourages borrowing/spending to stimulate the economy.
  • Contractionary policy increases interest rates, reduces money supply and discourages borrowing/spending to curtail economic activity.

Federal Reserve Tools and Dynamics

  • The Fed influences lending, money supply and interest rates via tools.
  • Interest on Reserve Balances (IORB) can encourage or discourage lending.
  • The Discount Rate influences borrowing costs for banks.
  • Open Market Operations (buying or selling securities) control money supply.
  • Reserve Requirements dictate the portion of deposits banks need to hold.

Key Takeaways

  • The Federal Reserve indirectly influences interest rates.
  • Increasing money supply lowers rates, while decreasing supply raises rates.
  • Monetary policy balances economic growth and price stability.

Practice Questions

  • Government incentives for retirement plans increase loanable funds and decrease interest rates.
  • A $1,000 bond with a 4% coupon and new 5% market rate is now worth $800.
  • Blue Chip Stocks are assets likely to appreciate in value over time.

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Related Documents

ECON 103 Exam 4 Review PDF

Description

Test your knowledge on key monetary policy concepts and economic indicators. This quiz covers bond pricing, the Taylor Rule, and the implications of the equation of exchange. Assess your understanding of these fundamental financial topics in economics.

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