Money and Interest Rates Overview
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Questions and Answers

What happens to the euro when there is an increase in the supply of euros?

  • The euro appreciates.
  • The euro depreciates. (correct)
  • The value of the euro remains unchanged.
  • The euro becomes more volatile.

How does an increase in the European money supply affect the dollar's return on euro deposits?

  • It decreases the dollar return. (correct)
  • It only affects the return based on European interest rates.
  • It has no effect on the dollar return.
  • It increases the dollar return.

In the short run, what can be said about prices and their adjustment to market conditions?

  • Prices are fixed in the short run.
  • Prices cannot adjust in the short run. (correct)
  • Prices adjust quickly to market conditions.
  • Prices decrease in the short run.

Which of the following statements is true regarding the long-run effects of money supply on output?

<p>Real output is determined by productive capacity, not money supply. (C)</p> Signup and view all the answers

What is predicted to occur with the average price level in the long run as the money supply changes?

<p>It adjusts proportionally to changes in money supply. (A)</p> Signup and view all the answers

How does the foreign money supply affect the U.S. money market?

<p>There is no change in the U.S. money market. (A)</p> Signup and view all the answers

What is the relationship between the inflation rate and changes in the money supply in the long run?

<p>There is a direct relationship. (D)</p> Signup and view all the answers

What does an increase in the supply of euros do to interest rates in the EU?

<p>It lowers interest rates. (B)</p> Signup and view all the answers

What happens to the interest rate when the money supply increases from M1 to M2?

<p>It decreases to R2. (B)</p> Signup and view all the answers

How does an increase in real income from Y1 to Y2 impact the interest rate?

<p>It raises the interest rate from R1 to R2. (C)</p> Signup and view all the answers

What is the expected effect on the dollar/euro exchange rate if the U.S. money supply is increased?

<p>The dollar depreciates against the euro. (C)</p> Signup and view all the answers

What is the relationship between money supply and domestic currency depreciation?

<p>Increase in money supply leads to depreciation of domestic currency. (C)</p> Signup and view all the answers

How do monetary policy actions by the Fed influence the foreign exchange market?

<p>They can change the dollar/euro exchange rate. (D)</p> Signup and view all the answers

What effect does ignoring risk have on the assumptions regarding the money market?

<p>It can lead to inaccurate conclusions about market behavior. (D)</p> Signup and view all the answers

What tends to occur in the exchange market when the U.S. experiences a lower money supply?

<p>Dollar interest rates increase. (D)</p> Signup and view all the answers

In the short run, how does an increase in money supply affect inflation?

<p>It can lead to an increase in inflation. (A)</p> Signup and view all the answers

What is the expected effect of a permanent decrease in a country's money supply on its currency in the long run?

<p>Proportional long-run appreciation of its currency (B)</p> Signup and view all the answers

How does a higher money supply influence inflation expectations among workers?

<p>They will demand higher wages to compensate for expected price rises (C)</p> Signup and view all the answers

What happens to the prices of output and inputs when there is excess demand for goods and services?

<p>Higher wages lead to increased prices for production (C)</p> Signup and view all the answers

What is the relationship between money supply growth and inflation?

<p>Higher money supply growth is associated with higher inflation (C)</p> Signup and view all the answers

What is a short-run effect of an increased money supply on employment?

<p>Higher employment due to increased production needs (B)</p> Signup and view all the answers

What is a common misconception regarding the relationship between money supply and price levels?

<p>Money supply has no influence on price levels (C)</p> Signup and view all the answers

What generally happens when inflationary expectations increase among producers?

<p>They expect to raise prices to match increased costs (B)</p> Signup and view all the answers

In the context of money supply and exchange rates, what is the immediate effect of a permanent increase in a country's money supply?

<p>Immediate depreciation followed by smaller appreciation (A)</p> Signup and view all the answers

Flashcards

Decrease in Money Supply

A reduction in the amount of money circulating in an economy.

Increased Euro Supply

More euros available in the market.

Euro Depreciation

A decrease in the value of the euro relative to another currency (like the dollar).

Short Run

A period where prices have not yet adjusted to market changes.

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Long Run

A period of time where prices have sufficient time to adjust to market or economic changes.

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Money Supply's Long Run Effect

The money supply, in the long run, only changes the average price level; output and interest rates are unaffected.

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Inflation Rate and Money Supply

A direct relationship exists between inflation and changes in the money supply in the long run.

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Real interest rate

Interest rate adjusted for inflation

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Money Market Equilibrium

The state where the aggregate demand for real monetary assets equals the real money supply at a given interest rate and income level.

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Increase in Money Supply Effect

Higher money supply leads to lower interest rates and currency depreciation.

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Real Income Impact

Higher real income results in higher interest rates.

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Exchange Rate Linkages

Monetary policies in one country affect the exchange rate with other currencies and their interest rates.

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Interest Parity Condition

The condition where the expected return on foreign assets equals the return on domestic assets, adjusted for exchange rate risk.

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Increase in Domestic Money Supply

This causes falling interest rates in the domestic country and depreciation of the currency

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Dollar/Euro Exchange Effect

Increased US money supply leads to a weaker US dollar against the Euro.

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Monetary Policy Impact

Central bank actions impact interest rates and exchange rates in linked markets.

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Effect of Money Supply Increase (Long Run)

A permanent increase in the money supply leads to a proportional decrease in the currency's value in the long run.

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Inflation and Money Supply

Generally, an increase in the money supply is associated with increased inflation.

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Money Supply and Price Levels

Although there isn't an exact relationship, increasing money supply often causes higher price levels.

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Inflationary Expectations

Expectations of future price increases influence actual inflation rates.

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Money Supply and Currency Depreciation

A lasting increase in the money supply results in the currency depreciating.

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Effect of Money Supply Increase (short run)

Initial price increases and wage increases occur due to higher demand for goods and services.

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Long-Run Price Adjustment

In the long run, prices adjust to reflect changes in the money supply.

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Money Demand

Aggregate demand of real monetary assets (L(R,Y))

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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!

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