Podcast
Questions and Answers
Assume the U.S. economy is undergoing a recession. In its efforts to stimulate the economy by trying to influence short-term interest rates the Fed is most likely to take which two actions?
Assume the U.S. economy is undergoing a recession. In its efforts to stimulate the economy by trying to influence short-term interest rates the Fed is most likely to take which two actions?
- Buy Treasury securities and decrease bank reserve requirements. (correct)
- Sell Treasury securities and increase bank reserve requirements.
- Sell Treasury securities and decrease bank reserve requirements.
Which of the following policy tools is the least likely to be available to the U.S. Federal Reserve Board?
Which of the following policy tools is the least likely to be available to the U.S. Federal Reserve Board?
- Requiring the banking system to tighten or loosen its credit policies. (correct)
- Buying and selling Treasury securities in the open market.
- Setting the discount rate at which banks can borrow from the Federal Reserve.
Which of the following statements regarding U.S. Federal Reserve open market operations is least accurate?
Which of the following statements regarding U.S. Federal Reserve open market operations is least accurate?
- If the Fed wants to stimulate the economy, it will sell Treasury securities to banks. (correct)
- When the Fed sells Treasury securities, excess reserves decrease.
- When the Fed buys Treasury securities, short-term interest rates will generally decrease.
A central bank follows an inflation targeting monetary policy. If the permissible band is plus-or-minus 2% around the target inflation rate, the central bank is most likely to choose a target inflation rate of:
A central bank follows an inflation targeting monetary policy. If the permissible band is plus-or-minus 2% around the target inflation rate, the central bank is most likely to choose a target inflation rate of:
A country is experiencing a core inflation rate of 7% during a recessionary period of real GDP growth. If the central bank has a single mandate to achieve price stability and uses inflation targeting with an acceptable range of zero to 4%, its monetary policy response is most likely to decrease:
A country is experiencing a core inflation rate of 7% during a recessionary period of real GDP growth. If the central bank has a single mandate to achieve price stability and uses inflation targeting with an acceptable range of zero to 4%, its monetary policy response is most likely to decrease:
Silvano Jimenez, an analyst at Banco del Rey, is reviewing recent actions taken by the U.S. Federal Reserve (the Fed) in setting monetary policy. Recently, the Fed decided to increase the money supply, which has resulted in a decrease in real interest rates. At a staff meeting, Jimenez brings this matter to the attention of his colleagues and makes the following statements:
Statement 1: Although the money supply increase has led to a decrease in real interest rates, we should begin to see U.S. investors decrease their investments abroad and the U.S. dollar will appreciate in the foreign exchange market.
Statement 2: The Fed's increase in the money supply will increase the amount of imports into the U.S.
Are Statement 1 and Statement 2 as made by Jimenez CORRECT?
Statement 1 Statement 2
Silvano Jimenez, an analyst at Banco del Rey, is reviewing recent actions taken by the U.S. Federal Reserve (the Fed) in setting monetary policy. Recently, the Fed decided to increase the money supply, which has resulted in a decrease in real interest rates. At a staff meeting, Jimenez brings this matter to the attention of his colleagues and makes the following statements:
Statement 1: Although the money supply increase has led to a decrease in real interest rates, we should begin to see U.S. investors decrease their investments abroad and the U.S. dollar will appreciate in the foreign exchange market.
Statement 2: The Fed's increase in the money supply will increase the amount of imports into the U.S.
Are Statement 1 and Statement 2 as made by Jimenez CORRECT?
Statement 1 Statement 2
Central banks that are able to define how inflation is computed and determine its desired level are best described as having:
Central banks that are able to define how inflation is computed and determine its desired level are best described as having:
If a country's economy is growing at an unsustainably rapid rate and the central bank decreases its target overnight interest rate, the country's:
If a country's economy is growing at an unsustainably rapid rate and the central bank decreases its target overnight interest rate, the country's:
Central banks are most likely to pursue a target inflation rate:
Central banks are most likely to pursue a target inflation rate:
Which of the following is least likely a function or objective of a central bank?
Which of the following is least likely a function or objective of a central bank?
Central banks pursuing expansionary policies may:
Central banks pursuing expansionary policies may:
Which of the following policy combinations would most likely lead to private sector growth and a decreasing government share of GDP?
Which of the following policy combinations would most likely lead to private sector growth and a decreasing government share of GDP?
Which one of the following Federal Reserve monetary policies, when pursued in line with the U.S. government's fiscal policies, would help increase aggregate demand during a period of high unemployment?
Which one of the following Federal Reserve monetary policies, when pursued in line with the U.S. government's fiscal policies, would help increase aggregate demand during a period of high unemployment?
To determine whether monetary policy is expansionary or contractionary, an analyst should compare the central bank's policy rate to the:
To determine whether monetary policy is expansionary or contractionary, an analyst should compare the central bank's policy rate to the:
When the Federal Reserve sells government securities on the open market, bank reserves are:
When the Federal Reserve sells government securities on the open market, bank reserves are:
Which of the following conditions is difficult for monetary policy to address because a central bank cannot reduce its nominal policy rate much below zero?
Which of the following conditions is difficult for monetary policy to address because a central bank cannot reduce its nominal policy rate much below zero?
A central bank has operational independence if it can independently determine:
A central bank has operational independence if it can independently determine:
If the Federal Reserve wishes to lower market interest rates without changing the discount rate, it can:
If the Federal Reserve wishes to lower market interest rates without changing the discount rate, it can:
A central bank is said to have credibility if:
A central bank is said to have credibility if:
If a monetary policy is focused on combating inflation, which open market actions by the Federal Reserve will most effectively accomplish this?
If a monetary policy is focused on combating inflation, which open market actions by the Federal Reserve will most effectively accomplish this?
The most likely reason for deflation to persist despite expansionary monetary policy is:
The most likely reason for deflation to persist despite expansionary monetary policy is:
Which of the following is the most likely result of a central bank's shift to an expansionary monetary policy?
Which of the following is the most likely result of a central bank's shift to an expansionary monetary policy?
An analyst has determined the projected trend rate of real GDP growth is 2.5% and the central bank's inflation target is 2.5%. If the central bank policy rate is 5.0%, monetary policy is most likely:
An analyst has determined the projected trend rate of real GDP growth is 2.5% and the central bank's inflation target is 2.5%. If the central bank policy rate is 5.0%, monetary policy is most likely:
An economy's long-term trend rate of real GDP growth is 3% and the central bank's target inflation rate is 2%. If the policy rate is 6%, monetary policy is:
An economy's long-term trend rate of real GDP growth is 3% and the central bank's target inflation rate is 2%. If the policy rate is 6%, monetary policy is:
The velocity of transactions in an economy has been increasing rapidly for the past seven years. Over the same time period, the economy has experienced minimal growth in real output. According to the equation of exchange, inflation over the last seven years has:
The velocity of transactions in an economy has been increasing rapidly for the past seven years. Over the same time period, the economy has experienced minimal growth in real output. According to the equation of exchange, inflation over the last seven years has:
What are the three essential qualities an effective central bank should possess?
What are the three essential qualities an effective central bank should possess?
Contractionary monetary policy is least likely to decrease consumption spending by decreasing:
Contractionary monetary policy is least likely to decrease consumption spending by decreasing:
Which of the following statements regarding the monetary policy transmission mechanism is most accurate?
Which of the following statements regarding the monetary policy transmission mechanism is most accurate?
The government is reducing its spending to balance the budget, while the central bank is lowering its official policy rate. What will most likely be the combined effect on the economy?
The government is reducing its spending to balance the budget, while the central bank is lowering its official policy rate. What will most likely be the combined effect on the economy?
A central bank that wants to increase short-term interest rates is most likely to:
A central bank that wants to increase short-term interest rates is most likely to:
Which of the following is currently the most-used target for central banks?
Which of the following is currently the most-used target for central banks?
If a bank needs to borrow funds from the Federal Reserve to fund a temporary shortage in reserves, it would borrow funds at the:
If a bank needs to borrow funds from the Federal Reserve to fund a temporary shortage in reserves, it would borrow funds at the:
Which of the following is least likely to be a function of the central bank?
Which of the following is least likely to be a function of the central bank?
The open market sale of Treasury securities by the Federal Reserve is least likely to result in:
The open market sale of Treasury securities by the Federal Reserve is least likely to result in:
Xanadu attempts to decrease its inflation rate by implementing contractionary monetary policy. Which of the following is most likely to be the long-run effect on Xanadu's trade balance as a result of the monetary policy change?
Xanadu attempts to decrease its inflation rate by implementing contractionary monetary policy. Which of the following is most likely to be the long-run effect on Xanadu's trade balance as a result of the monetary policy change?
If a central bank implements an exchange rate targeting policy successfully, the country's inflation rate is most likely to be:
If a central bank implements an exchange rate targeting policy successfully, the country's inflation rate is most likely to be:
The primary objective of a central bank is typically to:
The primary objective of a central bank is typically to:
The Federal Reserve has decided to increase the federal funds rate (the interest rate that banks charge each other for overnight loans). To implement this policy, the Federal Reserve will most likely:
The Federal Reserve has decided to increase the federal funds rate (the interest rate that banks charge each other for overnight loans). To implement this policy, the Federal Reserve will most likely:
If a central bank's targeted inflation rate is above the current rate, the central bank is most likely to:
If a central bank's targeted inflation rate is above the current rate, the central bank is most likely to:
If the U.S. Federal Reserve decides to decrease the money supply, which of the following is most likely to occur in the short run?
If the U.S. Federal Reserve decides to decrease the money supply, which of the following is most likely to occur in the short run?
Which of the following fiscal and monetary policy scenarios is most likely to increase the size of the public sector relative to the private sector?
Which of the following fiscal and monetary policy scenarios is most likely to increase the size of the public sector relative to the private sector?
Flashcards
Decreasing the discount rate
Decreasing the discount rate
A decrease in the Fed's lending rate is a monetary policy. This will increase the money supply, increasing aggregate demand, especially in recessionary times.
Expansionary Monetary Policy
Expansionary Monetary Policy
Monetary policy is expansionary if central bank policy rate is less than the neutral interest rate.
Operational Independence
Operational Independence
Operational independence means the central bank can independently determine the policy rate.
Central Bank Credibility
Central Bank Credibility
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Deflation & Liquidity Trap
Deflation & Liquidity Trap
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Neutral Interest Rate
Neutral Interest Rate
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Price Stability Target
Price Stability Target
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Selling Gov. Securities
Selling Gov. Securities
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Exchange Rate Targeting
Exchange Rate Targeting
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Policy Mix for Growth
Policy Mix for Growth
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Central Bank Function
Central Bank Function
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Most Used Target
Most Used Target
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Primary Central Bank Objective
Primary Central Bank Objective
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Effective Central Bank Qualities
Effective Central Bank Qualities
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Increase Federal Funds Rate
Increase Federal Funds Rate
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Expansionary Policies
Expansionary Policies
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Target Independence
Target Independence
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Lowering Interest Rates
Lowering Interest Rates
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Buying Gov Securities Impact
Buying Gov Securities Impact
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Decreasing Money supply causes rates to?
Decreasing Money supply causes rates to?
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Study Notes
Stimulating a Recessionary Economy
- Buying Treasury securities and decreasing bank reserve requirements are actions the Federal Reserve (Fed) would likely take.
- The goal is to reduce short-term interest rates to stimulate economic activity.
U.S. Federal Reserve Policy Tools
- Requiring banks to tighten or loosen credit policies is the least likely available policy tool.
- The Federal Reserve can encourage banks to adjust credit policies but cannot mandate changes.
Open Market Operations
- Selling Treasury securities to banks is not a method to stimulate the economy.
- Buying Treasury securities injects reserves into the banking system to stimulate the economy.
- When the Fed buys Treasury securities, short-term interest rates generally decrease.
- When the Fed sells Treasury securities, excess reserves decrease.
Inflation Targeting Monetary Policy
- A central bank with an inflation target band of plus or minus 2% would likely target 3% to avoid deflation.
- Central banks usually avoid inflation targets that include negative rates due to concerns about deflation.
Monetary Policy Response to Inflation
- A central bank facing a 7% core inflation rate during a recession would likely decrease short-term interest rates.
- Decreasing the money supply combats inflation, even if it negatively impacts GDP growth.
Impact of Increasing Money Supply
- Increasing the money supply and decreasing real interest rates often lead U.S. investors to seek higher returns abroad causing the U.S. dollar to depreciate.
- A depreciated dollar increases U.S. exports by making U.S. products cheaper for foreign buyers.
Central Bank Independence
- Target independence is when a central bank defines how inflation is computed, sets a target level and specifies a horizon to achieve it.
- Operational independence allows the central banks to determine the policy rate.
- Transparency refers to how a central bank reports to the public on the economic environment.
Economic Growth and Interest Rates
- If an economy is growing unsustainably fast, the central bank should increase target interest rates, rather than decrease them.
- Decreasing rates in this scenario can accelerate inflation, harming long-term growth.
Target Inflation Rate
- Central banks typically aim for a stable inflation rate of 2% to 3%.
- A 0% target is generally avoided because of the risk of deflation.
Central Bank Functions
- Lending money to government agencies is not a typical central bank function.
- Central Bank functions include: issuing currency, regulating banks, controlling the money supply to control inflation, and promoting economic growth.
Expansionary Monetary Policies
- Expansionary policies include decreasing the policy rate and making open market purchases of securities.
- These actions aim to stimulate economic activity.
Fiscal and Monetary Policy Combinations
- Contractionary fiscal policy paired with expansionary monetary policy tends to increase private sector growth and reduce the government's share of GDP.
Increasing Aggregate Demand
- Decreasing the discount rate increases the money supply
- This increases aggregate demand during periods of high unemployment.
Identifying Monetary Policy Stance
- To assess if monetary policy is expansionary or contractionary, compare the central bank's policy rate to the neutral interest rate.
- The neutral interest rate is the sum of the real economic growth rate and the target inflation rate.
Federal Reserve Actions and Bank Reserves
- When the Federal Reserve sells government securities, bank reserves decrease, raising the federal funds rate.
Challenges for Monetary Policy
- Deflation is difficult to address because central banks can't lower nominal policy rates far below zero.
- Stagflation is difficult given monetary policy can't pursue higher growth and lower inflation at the same time.
Operational Independence
- A central bank has operational independence when it can independently determine the policy rate.
Lowering Market Interest Rates
- Open market purchases of treasury securities increases money supply, which decreases interest rates.
Central Bank Credibility
- Central bank credibility is when economic actors base decisions on the central bank's stated inflation targets.
Combating Inflation
- To combat inflation, the Federal Reserve sells Treasury securities to decrease aggregate demand.
Deflation Persistence
- Deflation often persists because of a liquidity trap where demand for money is highly elastic, expansionary monetary policy has little effect in this situation.
Expansionary Monetary Policy Results
- Expansionary monetary policy results in a depreciation of the domestic currency.
- This leads to increased exports.
Central Bank Policy Rate
- When trend rate of real GDP growth is 2.5%, the central bank's inflation target is 2.5%, and the central bank policy rate is 5.0%, monetary policy is neutral.
- Neutral rate = real trend rate + inflation target.
Monetary Policy Examples
- Long-term real GDP growth is 3%, target inflation is 2%, and the policy rate is 6%, monetary policy is contractionary.
- Rate is contractionary if the policy rate is greater than the neutral rate.
Velocity of Transactions
- If the velocity of transactions increases faster than real output, inflation increases more than the money supply.
Central Bank Essential Qualities
- An effective central bank should possess independence, credibility, and transparency.
Decreasing Consumption Spending
- Contractionary monetary policy is least likely to decrease consumption spending by decreasing the foreign exchange value of the currency as this would increase exports.
Monetary Policy Control
- Central banks can directly control short-term interest rates, but long-term rates are beyond their control.
Combined Economic Effects
- If the government cuts spending and the central bank lowers the official policy rate, the private sector's percentage of GDP will likely increase.
Increasing Short-Term Interest Rates
- Selling government securities increases short-term interest rates.
Central Bank Targets
- Inflation targeting is currently the most used target.
Borrowing Funds
- Banks borrow funds at the discount rate to fund a temporary shortage in reserves from the Federal Reserve.
Central Bank Functions
- Collecting tax payments is least likely to be a function of central banks.
Federal Reserve Treasury Securities
- Open market sales of Treasury securities results in decreased exports.
Contractionary Monetary Policy
- Xanadu trade balances worsen in the long run.
Exchange Rate Targeting Policy
- A successful exchange rate targeting policy results in the same inflation rate.
Central Bank Primary Objective
- Primary objective is to control inflation, promote price stability.
Federal Reserve Increasing Federal Funds Rate
- To increase the federal funds rate, the Federal Reserve sells government securities.
Central Bank Targeting Rates
- If the targeted inflation rate is above the current rate, central banks buy government securities.
Decreasing Money Supply
- If the U.S. Federal Reserve reduces the money supply, then the real interest rate will increase.
Fiscal and Monetary Policies
- Public sector will increase if policy is expansionary fiscal and contractionary monetary policies.
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