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?

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?

Expansionary Monetary Policy Signup and view all the answers

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

M multiplied by V equals P multiplied by Q Signup and view all the answers

What happens to bond prices when interest rates rise?

Bond prices decrease. Signup and view all the answers

What is a key characteristic of a Roth IRA?

Contributions are made with after-tax income. Signup and view all the answers

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

FOMC Signup and view all the answers

What is the minimum age to collect Social Security benefits?

62 years Signup and view all the answers

What type of interest calculation does compounding interest involve?

Both the initial principal and accumulated interest Signup and view all the answers

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

Open Market Operations Signup and view all the answers

What does the Federal Funds Rate represent?

The rate banks charge each other for loans Signup and view all the answers

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

Regulate and supervise member banks Signup and view all the answers

Which of the following is NOT a function of money?

Credit risk assessment Signup and view all the answers

What is a characteristic of contractionary monetary policy?

Discourage borrowing and spending Signup and view all the answers

What characterizes M2 in the money supply?

Savings deposits Signup and view all the answers

What does liquidity measure?

The speed at which assets can be converted to cash Signup and view all the answers

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

Conducting open market operations Signup and view all the answers

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

Savers providing funds Signup and view all the answers

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

Decrease in lending Signup and view all the answers

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

Loanable funds increase; interest rates decrease Signup and view all the answers

What does the coupon rate of a bond represent?

The bond's interest rate Signup and view all the answers

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

Banks will have more money to lend Signup and view all the answers

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

Set international exchange rates Signup and view all the answers

Which of the following best describes the real interest rate?

The rate adjusted for inflation Signup and view all the answers

How does an increase in the discount rate affect borrowing?

Makes borrowing more expensive Signup and view all the answers

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

Lowers interest rates Signup and view all the answers

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

It can be converted into cash more easily Signup and view all the answers

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

Money supply decreases Signup and view all the answers

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 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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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.