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Questions and Answers
What happens to the euro when there is an increase in the supply of euros?
What happens to the euro when there is an increase in the supply of euros?
How does an increase in the European money supply affect the dollar's return on euro deposits?
How does an increase in the European money supply affect the dollar's return on euro deposits?
In the short run, what can be said about prices and their adjustment to market conditions?
In the short run, what can be said about prices and their adjustment to market conditions?
Which of the following statements is true regarding the long-run effects of money supply on output?
Which of the following statements is true regarding the long-run effects of money supply on output?
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What is predicted to occur with the average price level in the long run as the money supply changes?
What is predicted to occur with the average price level in the long run as the money supply changes?
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How does the foreign money supply affect the U.S. money market?
How does the foreign money supply affect the U.S. money market?
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What is the relationship between the inflation rate and changes in the money supply in the long run?
What is the relationship between the inflation rate and changes in the money supply in the long run?
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What does an increase in the supply of euros do to interest rates in the EU?
What does an increase in the supply of euros do to interest rates in the EU?
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What happens to the interest rate when the money supply increases from M1 to M2?
What happens to the interest rate when the money supply increases from M1 to M2?
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How does an increase in real income from Y1 to Y2 impact the interest rate?
How does an increase in real income from Y1 to Y2 impact the interest rate?
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What is the expected effect on the dollar/euro exchange rate if the U.S. money supply is increased?
What is the expected effect on the dollar/euro exchange rate if the U.S. money supply is increased?
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What is the relationship between money supply and domestic currency depreciation?
What is the relationship between money supply and domestic currency depreciation?
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How do monetary policy actions by the Fed influence the foreign exchange market?
How do monetary policy actions by the Fed influence the foreign exchange market?
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What effect does ignoring risk have on the assumptions regarding the money market?
What effect does ignoring risk have on the assumptions regarding the money market?
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What tends to occur in the exchange market when the U.S. experiences a lower money supply?
What tends to occur in the exchange market when the U.S. experiences a lower money supply?
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In the short run, how does an increase in money supply affect inflation?
In the short run, how does an increase in money supply affect inflation?
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What is the expected effect of a permanent decrease in a country's money supply on its currency in the long run?
What is the expected effect of a permanent decrease in a country's money supply on its currency in the long run?
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How does a higher money supply influence inflation expectations among workers?
How does a higher money supply influence inflation expectations among workers?
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What happens to the prices of output and inputs when there is excess demand for goods and services?
What happens to the prices of output and inputs when there is excess demand for goods and services?
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What is the relationship between money supply growth and inflation?
What is the relationship between money supply growth and inflation?
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What is a short-run effect of an increased money supply on employment?
What is a short-run effect of an increased money supply on employment?
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What is a common misconception regarding the relationship between money supply and price levels?
What is a common misconception regarding the relationship between money supply and price levels?
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What generally happens when inflationary expectations increase among producers?
What generally happens when inflationary expectations increase among producers?
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In the context of money supply and exchange rates, what is the immediate effect of a permanent increase in a country's money supply?
In the context of money supply and exchange rates, what is the immediate effect of a permanent increase in a country's money supply?
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Study Notes
Money and Interest Rates
- Money is an asset widely used as a means of payment.
- Money can be broadly defined to include different liquid assets (currency, checking deposits, debit cards, savings, and time deposits) or narrowly defined to only include the first three, excluding other deposits and investments.
- Liquid assets are easily converted to cash, but generally earn little interest, while illiquid assets require substantial transaction costs and generally earn higher interest rates.
- Central banks control the money supply (for example, the Federal Reserve in the U.S.).
- Money demand is the amount of monetary assets people want to hold.
- Factors affecting money demand include interest rates (relative to non-monetary assets), risk (mostly from inflation), liquidity needs (price and quantity of transactions).
- Aggregate money demand depends on interest rates, prices, and national income. Higher income and prices lead to higher money demand.
Money Market Model
- The money market is where money is lent and borrowed.
- Equilibrium occurs when the money supply equals money demand (Ms = Md).
- An increase in the money supply lowers interest rates and causes the currency to depreciate.
- A decrease in the money supply raises interest rates and causes the currency to appreciate.
Money Market - Exchange Rate Linkage
- Exchange rates are determined by the interest rates of the involved currencies (Interest Parity).
- Interest parity implies that deposits in all currencies in the foreign exchange market have the same rate of return and no arbitrage is possible.
- The equilibrium in the foreign exchange market is when the expected return on deposits are equal.
- Monetary policy actions affect interest rates, thus changing exchange rates.
Long Run and Short Run
- Short run: Prices don't adjust immediately. Money supply changes immediately affect interest rates and exchange rates.
- Long run: Prices adjust proportionally to money supply changes. Money supply changes do not affect real income or interest rates. Inflation correlates with change in money supply.
Money and Prices
- In the long run, an increase in the money supply leads to a proportional increase in prices (inflation).
- When money supply increases, factors of production use more money to maintain output, resulting in higher labor demand, wages, and output prices.
- Inflationary expectations can affect wages and prices.
- A permanent change in money supply causes a proportional depreciation/appreciation in its currency in the long run.
Exchange Rate Overshooting
- Overshooting occurs when the immediate response of the exchange rate to a change is greater than its long-run response.
- This is due to the fact prices and inflation may take time to adjust.
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Description
This quiz covers essential concepts related to money and interest rates, including definitions of money, liquid vs. illiquid assets, and the factors affecting money demand. Additionally, it touches on the role of central banks and the money market model. Test your understanding of these crucial economic concepts!
