Money Market Equilibrium

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Questions and Answers

Which of the following is NOT considered a primary function of money in an economy?

Providing a store of value to preserve purchasing power over time.
Acting as a medium of exchange to facilitate transactions.
Functioning as a long-term investment vehicle for wealth accumulation. (correct)
Serving as a unit of account to measure value.

Why is money typically regarded as the most liquid asset compared to other forms of wealth?

Because its value is fully guaranteed and backed by a government entity.
Because it can be readily converted into goods and services without incurring significant transaction costs. (correct)
Because it consistently yields a higher rate of return compared to alternative investments.
Because it inherently possesses a higher intrinsic value than other assets.

When categorizing the money supply using M1, which of the following components is excluded?

Time deposits, which are savings accounts with a fixed term. (correct)
Demand deposits held in checking accounts at commercial banks.
Balances held in checking accounts, offering easy access to funds.
Physical currency in circulation, such as banknotes and coins.

In an economy, which entity is primarily responsible for exercising control over the money supply?

The Central Bank through monetary policy interventions. (B) Signup and view all the answers

How does an increase in interest rates typically influence the demand for money in an economy?

It leads to a decrease in the demand for money as the opportunity cost of holding cash rises. (A) Signup and view all the answers

Which of the following factors does NOT directly influence the demand for money in an economy?

The prevailing exchange rate between domestic and foreign currencies. (A) Signup and view all the answers

Which equation best represents the concept of real money demand, reflecting the quantity of goods which can be purchased?

<code>Md = P * L(Y, R)</code> (C) Signup and view all the answers

What condition signifies equilibrium in the money market?

The quantity of money supplied equals the quanitity of money demanded. (B) Signup and view all the answers

What is the likely effect on equilibrium interest rates when the central bank increases the money supply, all other factors being held constant?

Interest rates are likely to decrease due to the increased availability of loanable funds. (B) Signup and view all the answers

If the U.S. Federal Reserve increases the money supply, leading to a decrease in USD interest rates, what is likely the impact on the USD/EUR exchange rate?

The USD is likely to depreciate (decrease in value) relative to the EUR. (C) Signup and view all the answers

If the European Central Bank (ECB) increases the Eurozone money supply, intending to stimulate economic growth, what is the likely immediate impact on the exchange rate between the USD and EUR?

The EUR is likely to depreciate against the USD. (C) Signup and view all the answers

What is the long-run effect of a sustained increase in the money supply on an economy?

Inflation will rise and the currency will depreciate, diminishing purchasing power. (A) Signup and view all the answers

Which equation accurately represents the long-run equilibrium in the money market, considering the relationships between money supply (Ms), price level (P), liquidity preference (L), income (Y), and interest rates (R)?

<code>P = Ms / L(R, Y)</code> (B) Signup and view all the answers

What is the 'exchange rate overshooting' phenomenon?

A situation where the short-run exchange rate reacts more to a monetary policy change than its long-run value. (B) Signup and view all the answers

What economic factor primarily contributes to the exchange rate overshooting phenomenon following a monetary policy change:

Interest rates adjust more rapidly than price levels following monetary interventions. (D) Signup and view all the answers

Consider two countries, A and B. If country A experiences higher inflation than country B, what would the purchasing power parity (PPP) theory suggest about the exchange rate between their currencies?

Country A's currency should depreciate relative to country B's currency. (C) Signup and view all the answers

What is the Fisher effect's prediction regarding the relationship between inflation and nominal interest rates?

Nominal interest rates should increase proportionally with increases in expected inflation. (B) Signup and view all the answers

If a country's central bank aims to maintain a fixed exchange rate, what action must it take if there is an increase in demand for its currency?

Increase the domestic money supply. (C) Signup and view all the answers

What is the primary goal of inflation targeting as a monetary policy strategy?

To keep inflation within a desired range. (C) Signup and view all the answers

What is the likely impact of unanticipated inflation redistribute wealth in society?

From lenders to borrowers. (D) Signup and view all the answers

Flashcards

Function of Money

A generally accepted medium of exchange, unit of account, store of value, but not a long-term investment tool.

Liquidity of Money

It can be easily converted into goods and services without significant loss of value.