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# AP Chapter 15 The Fed

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### AP Chapter 15 The Fed

1. 1. Monetary Policy Alan Greenspan the “ Fed ”
2. 2. RR Excess Reserves Total(Actual) Reserves PMC = M x ER, so 5 x .80 = \$4 TMS = PMC[\$4] + DD[\$1] = \$5 [MS = Currency + DD of public] Jennifer Garner deposits \$1 with A 20% RR . 20 80 cents One Dollar Jen Garner’s
3. 3. Excess Reserves Total(Actual) Reserves PMC = M x ER, so 5 x \$1 = \$5 TMS [\$5] = PMC [\$5] [MS = currency + DD of public] Jennifer’s Bank Borrows \$1 From The Fed [20% RR] 0 One Dollar RR One Dollar Jen Garner’s Fed
4. 4. Beating the Inflation Dragon
5. 5. If The Economy Is Exceeding The FE GDP Speed Limit Of 4% -
6. 6. “ When the party gets too good, it’s the job of the Fed to take away the punch bowl.” The Fed’s policy is “If you see inflation, its too late. Whip it before it gets out of the box.” During a recession, the Fed is happy to “spike the punch.”
7. 7. Should The Fed Chairman Show His Hand?
8. 8. “ For Richer or For Poorer ” For Andrea, it took 12 years to get a marriage proposal she could understand. [She got 3, but didn’t understand what he was saying]
9. 9. G reenspan S worn in for a 5 th 4 -year T erm
10. 10. Last P aragraph of Mr. Greenspan’s Marriage Proposal <ul><li>“ Despite these concerns, and in the final analysis, </li></ul><ul><li>the more preponderous weight of evidence considered in these deliberations falls on the side of a matrimonial rapproachement. I am prepared to act on these conclusions where warranted, with your consent, in a way that is consistent with my role as chairman of the Federal Reserve.” </li></ul>This was Fedspeak for, “Will You Marry Me?”
11. 11. Monetary Policy – America’s Main Stabilization Tool <ul><li>Monetary Policy Tools </li></ul><ul><li>Discount Rate – when banks borrow from the Fed </li></ul><ul><li>Reserve Ratio – currently 10%; the most powerful tool </li></ul><ul><li>Buying [recession] & selling [inflation] of bonds </li></ul>Recession Inflation Nominal Interest Rate
12. 12. CONSOLIDATED BALANCE SHEET OF FED BANKS ASSETS <ul><li>Securities [90%] </li></ul><ul><li>Loans to Commercial Banks </li></ul>LIABILITIES <ul><li>Reserves of Commercial Banks </li></ul><ul><li>Treasury Deposits </li></ul><ul><li>Federal Reserve Notes [90%] </li></ul>
13. 13. GOALS OF MONETARY POLICY … to assist the economy in achieving a full-employment, noninflationary level of total output
14. 14. TOOLS OF MONETARY POLICY Open-Market Operations Buying Securities ( Bonds of Course) From commercial banks... <ul><li>Bank gives up securities </li></ul><ul><li>FED pays bank </li></ul><ul><li>Banks have increased reserves </li></ul>From the public... <ul><li>Public gives up securities </li></ul><ul><li>Public deposits check in bank </li></ul><ul><li>Banks have increased reserves </li></ul>
15. 15. TOOLS OF MONETARY POLICY Open-Market Operations Selling Securities To commercial banks... <ul><li>FED gives up securities </li></ul><ul><li>Bank pays for securities </li></ul><ul><li>Banks have decreased reserves </li></ul>To the public... <ul><li>FED gives up securities </li></ul><ul><li>Public pays by check from bank </li></ul><ul><li>Banks have decreased reserves </li></ul>
16. 16. New reserves \$1,000 Excess Reserves \$ 5,000 PMC thru Bank System Lending Fed buys a \$ 1,000 Bond from a Bank TMS is \$5000 20% RR Fed
17. 17. Interest Rates Going Up and Up
18. 18. Recent GDP
19. 19. Current U.E., GDP Rates 5.1 % - March 08 0.6% GDP – 4 th Quarter 2007
20. 20. New reserves \$800 Excess Reserves \$4000 Bank System Lending FEDERAL RESERVE PURCHASE OF BONDS Purchase of a \$1000 bond from the public \$200 Required reserves \$1000 Initial Deposit Total Increase in Money Supply (\$5000)
21. 21. New reserves \$800 Excess Reserves \$ 4000 PMC thru Bank Lending Mischa Barton Deposits \$1,000 In Her Bank [ RR is 20 % ] \$ 200 RR \$ 1000 Initial Deposit TMS is \$ 5,000 Mischa from the O.C. [member of the public] Mischa Barton’s
22. 22. TOOLS OF MONETARY POLICY Open-Market Operations The Reserve Ratio <ul><li>Raising the Reserve Ratio </li></ul><ul><ul><li>Banks must hold more reserves </li></ul></ul><ul><ul><li>Banks decrease lending </li></ul></ul><ul><ul><li>Money supply decreases </li></ul></ul><ul><li>Lowering the Reserve Ratio </li></ul><ul><ul><li>Banks may hold less reserves </li></ul></ul><ul><ul><li>Banks increase lending </li></ul></ul><ul><ul><li>Money supply increases </li></ul></ul>
23. 23. TOOLS OF MONETARY POLICY Open-Market Operations The Reserve Ratio The Discount Rate <ul><li>Easy Money Policy </li></ul><ul><ul><li>Buy Securities </li></ul></ul><ul><ul><li>Decrease Reserve Ratio </li></ul></ul><ul><ul><li>Lower Discount Rate </li></ul></ul>
24. 24. TOOLS OF MONETARY POLICY Open-Market Operations The Reserve Ratio The Discount Rate Easy Money Policy <ul><li>Tight Money Policy </li></ul><ul><ul><li>Sell Securities </li></ul></ul><ul><ul><li>Increase Reserve Ratio </li></ul></ul><ul><ul><li>Raise Discount Rate </li></ul></ul>
25. 25. TOOLS OF MONETARY POLICY Open-Market Operations The Reserve Ratio The Discount Rate Easy Money Policy <ul><li>Tight Money Policy </li></ul><ul><ul><li>Sell Securities </li></ul></ul><ul><ul><li>Increase Reserve Ratio </li></ul></ul><ul><ul><li>Raise Discount Rate </li></ul></ul>
26. 26. MONETARY POLICY, REAL GDP, AND THE PRICE LEVEL Cause-Effect Chain <ul><li>Money supply impacts interest rates </li></ul><ul><li>Interest rates affect investment </li></ul><ul><li>Investment is a component of AD </li></ul><ul><li>Equilibrium GDP is changed </li></ul>
27. 27. Real domestic output, GDP D m Investment Demand Real rate of interest, i 10 8 6 0 Quantity of money demanded and supplied Amount of investment, i MONETARY POLICY AND EQUILIBRIUM GDP S m1 AS AD 1 (I=\$15) P 1 10 8 6 0 S m2 AD 3 (I=\$25) P 2 If the Money Supply Increases to Stimulate the Economy… <ul><li>Interest Rate Decreases </li></ul><ul><li>Investment Increases </li></ul><ul><li>AD & GDP Increases </li></ul><ul><li>with slight inflation </li></ul>Price level AD 2 (I=\$20) P 3 S m3 <ul><li>Increasing money supply </li></ul><ul><li>continues the growth – </li></ul><ul><li>but, watch Price Level. </li></ul>
28. 28. MONETARY POLICY IN ACTION Strengths of monetary policy <ul><li>Speed and flexibility </li></ul><ul><li>Isolation from political pressure </li></ul>Focus on the Federal Funds Rate The Federal Funds Rate The Prime Interest Rate Recent Monetary Policy
29. 29. Recession Lower Lower Buy Inflation Raise Raise Sell Y R Y * AD AS LRAS AS AD Y * Y I 1. Discount Rate – banks borrow from the Fed (symbolic) 2. Required Reserve - % of DD which cannot be loaned. 3. Buy / Sell Bonds – government debt T-bills –3 mo., 6 mo., & 1 year; purchase price: \$10,000 T-notes - 2 yr., 3 yr., 5 yr ., (\$5,000) , & 10 yr., (\$10,000) T-bonds – 30 years with purchase of \$1,000 Prime Rate – loan rate to the best (prime) customers Federal Funds Target Rate – banks borrow from one another 3 Tools of Monetary Policy 3.5 % 11 decreases Aug 05
30. 30. Y R Real GDP D M Investment Demand Reall Interest Rate 10 8 6 0 Money Market QID1 “ Easy Money” During Recessions MS 1 AS AD 1 P 1 10 8 6 0 MS 2 P 2 Price level Buy If there is RECESSION MS will be increased. QID2 D I Y* “ Easy Money” – ( Buy/Sell) bonds, which (increase/decrease) MS, which (increase/decrease) interest rates, which (appreciate/depreciate) the dollar, which (increase/decrease) C, Ig, & Xn, which (increase/decrease ) AD & therefore, PL, GDP, & emp. E 1 E 2 AD 2 “ Students, should the Fed buy or sell bonds to jumpstart this economy?” Jobs are tough to get. LRAS Illustrate the monetarist view
31. 31. D I AD 1 Y I D m Investment Demand Reall Interest Rate 10 8 6 0 Money Market QID 2 AS 10 8 6 0 P 2 MS 1 P 1 MS 2 If there is INFLATION , MS will be decreased. Sell QID 1 Y * “ Tight Money” during Inflation “ Tight Money” – (Buy/Sell) bonds, which (incr/decr) the MS, which (incr/decr) in. rates, which (apprec/deprec) the dollar, which (incr/decr) C, Ig, & Xn, which (incr/decr) AD, PL, & GDP. E 1 E 2 AD 2 “ Now, should I buy or sell ?” “ I’ll get rid of some money.” LRAS
32. 32. Y R Y * Investment Demand 9 % 6% 3 % 0 Money Market \$50 \$60 AS AD 1 PL 1 9 % 6 % 3 % 0 MS 2 AD 2 PL 2 \$70 Y I AD 3 D I D m PL 3 MS 1 MS 3 \$100 120 140 Q I D I =\$50] I =\$60 I =\$70 RDO The ideal economy is AD 2 , with I.R. at 6% & Ig at \$60 billion .
33. 33. Y R Y * Investment Demand 9 % 6% 0 Money Market \$50 \$60 AS AD 1 PL 1 9 % 6 % 0 MS 2 AD 2 PL 2 D I D m MS 1 \$100 120 Q I D I =\$50] I =\$60 RDO Recessionary Gap Increase MS from \$100 to \$120 , which lowers the I.R. from 9% to 6% , which increases QID from \$50 to \$60 , which increases AD from AD 1 to AD 2 .
34. 34. Real GDP Q PL SRAS AD 2 Y R Y F Expansionary Fiscal Policy [ Incr G ; Decr T ]  P L1 AD 1 PL 2 G AD Y/Empl./PL; G LFM I .R. T D I C AD Y/Emp/PL; T LFM I R Start from a Balanced Budget G & T = \$2 Trillion \$ 2 T \$2 T “ I can’t get a job.” “ Now, this is better.” G T E 1 E 2 LRAS
35. 35. Y * Investment Demand 6% 3 % 0 Money Market \$60 AS 6 % 3 % 0 MS 2 AD 2 PL 2 \$70 Y I AD 3 D I D m PL 3 MS 3 \$ 120 140 Q I D I =\$60 I =\$70 RDO Inflationary Gap D ecrease MS from \$140 to \$120 , which increases the I.R. from 3% to 6% . which decreases QID from \$70 to \$60 , which decreases AD from AD3 to AD2 .
36. 36. GOALS OF MONETARY POLICY … to assist the economy in achieving a full employment , non-inflationary level of output
37. 37. 1. Open Market Operations - “nuts and bolts” of M onetary P olicy [main tool] - \$60-\$70 billion every day Three Tools Of Monetary Policy
38. 38. 2. Reserve Requirement - most powerful (seldom used) - affects money creation by changing ER and the multiplier - an increase of ½ of 1 % would increase bank reserves by over \$5 billion - RR was 20% from 1937-1958 Sledgehammer of M onetary P olicy RR - Atomic Bomb of Monetary Policy
39. 39. Reserve Requirement Example Suppose the banking system has \$500 billion in DD. The RR is 12% & TR are \$60 billion , which is 12% of the \$500 bilion DD . So, there are no ER . Now, the Fed lowers the RR to 10% . Now banks are required to keep only \$50 bil . in RR. So, \$10 billion more ER is available to loan out. \$10 billion X 10 = \$100 billion in new DD . So, 20% increase MS [DD] from \$500 to \$600 b illion . Atomic Bomb of Monetary Policy
40. 40. \$10,000 [\$9,000+\$1,000] [In 1980 , the RR was set at 12% ; stayed there until 1992 ; went to 10% ] “ E asy M oney ” AS AD 1 AD 2 Y R Y * PL \$1,000 Initial deposit \$900 [\$900x10] \$1,000 \$810 \$729 Monetary Expansion [10% RR] [1/.10=10] “ Easy Money” The Reserve Requirement “ Easy Money” – increase the money supply
41. 41. \$5,000 [\$4,000+\$1,000] “ Tight Money” - decrease the money suply RR at 20% - Tight Money Monetary Expansion (20% RR) [1/.20=M D of 5] “ Tight Money” \$1,000 Initial deposit \$800 \$640 \$512
42. 42. 3. Discount Rate - emergency Fed loans to banks - symbolic (raises Prime Rate ) - Discount Rate was 1% from 1934-46 and the prime rate was 1.5% Hurricane EarthQuake FL borrowed \$99 million In 1991 The Fed tends to change the D.R. in lockstep with the fed funds target rate.
43. 43. Part of Uncle Sam’s Menu
44. 45. Monetary Policy At Work During this period, 1990-1992, the Fed did 4 things : 1. Decreased discount rate from 10% to 3%; 2. Decreased the RR from 12% to 10%; 3. Decreased the Fed Funds Rate 24 times, and 4. Bought bonds
45. 46. Fed Funds Rate 1993-2004 3% May, 2005
46. 47. Relative Importance of Monetary Policy Relative Importance of Monetary Policy A. WWII - 1979 – Fed targeted the interest rate not the growth of MS. B. 1979-1982 – Fed targeted the growth of the MS not the in. rate. C. 1982-Present -Fed targets the interest rate , not the MS. 1. Discount Rate – not a primary tool of monetary policy. It does have an “announcement effect.” 2. Reserve Requirement ( 10 %)- has changed one time in 2 decades (12% to 10% in 1992). It would affect bank profits so is seldom used . 3. Open-market operations – evolved as the most effective tool of monetary policy because of flexibility . Securities can be bought or sold in large amounts & their impact on reserves is very prompt. Effectiveness of Monetary Policy Strengths of Monetary Policy 1. Speed and flexibility –can quickly be altered (compared to fiscal policy). This can occur on a daily basis and influence interest rates and the MS. 2. Isolation from political pressures – because of the 14 year terms. They can enact unpopular policies which might be best for our economy’s health .
47. 48. Also, the Keynesians don’t think the lower interest rate is as important as “profit expectations.” Y R Y * D m(K) Investment Demand 10 % 8 % 6 % 0 Money Market QID 1 QID 2 M onetarist V iew of Transmission Mechanism v. K eynesian V iew AS AD 1 PL 1 10 8 % 6 % 0 MS 2 AD 2 PL 2 Y I D m is more inelastic [ I.R. more sensitive ] QID 2 D I is more elastic [ or more responsive ] AD 2(M) D I(K) D I(M) D m(M ) (K) PL 2 Mainly, we end up just getting inflation. MS 1 K eynesian view is that D I is rather steep so monetary policy is not that strong. F iscal policy is “top banana.” AS AD 1 AD 2
48. 49. Cyclical Asymmetry ( lack of balance ) – “ Tight money during inflations is more effective than easy money policy during a depressions.” a. An easy money policy during depression does not guarantee that people will take out loans if they don’t have jobs. [“You can lead a horse to water, but you can’t make him drink.”] b. The cyclical asymmetry has not created a major difficulty for monetary policy except during times of depression . c. Velocity of money may increase during inflation when the fed is trying to decrease the MS & decrease during recession when the Fed is trying to increase MS. d. The lower interest rates during recession & depreciation of the dollar may cause foreign investors to pull their money out of the U.S. and reduce the MS . e. Banks may hold their ER or the public may hold too much currency . f. D m curve may be more flat so that interest rate will not drop as much , or the D I curve may be more vertical so that investment will not increase as much . Shortcomings and Problems of Monetary Policy But – I will eat spiked brownies.
49. 50. Strengths of Monetary Policy <ul><li>Speed and flexibility </li></ul><ul><li>Isolation from political pressure </li></ul><ul><li>Successes in the 1980s & 1990s </li></ul>Shortcomings and problems [ better at fighting inflation than fighting depressions ]
50. 51. Only “fiscal or monetary policy” can get me back on my feet and allow “Sam” to get back up. “ Help”
51. 52. Fiscal Policy Recession Inflation Increase G Decrease G Decrease T Increase T Monetary Policy Recession Inflation Lower D. Rate Raise D. Rate Lower R. Rate Raise R. R atio Buy Bonds Sell Bonds “ Easy Money” “Tight M oney ”
52. 53. Monetary and Fiscal Policy
53. 54. Presidents try to put a positive spin on a struggling economy
54. 55. TOOLS OF MONETARY POLICY Discount Rate The Reserve Ratio Open Market Operations <ul><li>Easy Money Policy </li></ul><ul><ul><li>Lower Discount Rate </li></ul></ul><ul><ul><li>Lower Reserve Ratio </li></ul></ul><ul><ul><li>Buy Bonds </li></ul></ul>“ Easy Money” Fed
55. 56. TOOLS OF MONETARY POLICY Discount Rate The Reserve Ratio Open Market Operations <ul><li>Tight Money Policy </li></ul><ul><ul><li>Raise Discount Rate </li></ul></ul><ul><ul><li>Raise Reserve Ratio </li></ul></ul><ul><ul><li>Sell Bonds </li></ul></ul>“ Got to decrease the MS.” Fed
56. 57. NS 48-58 ( MS = DD + Currency of Public ) 48. The 3 tools of monetary policy are open market operations, changes in RR, & (changes in T/changes in G/ changes in discount rate). 49. T he main tool of the Fed in regulating the MS is (open-market operations/DR/RR). 50. When the Fe d [ \$\$ ] sells securities to the PUBLIC [T-bills], DD (don’t change/incr/decr) & banking system RR, ER & TR (incr/decr). 51. When the Fed [T-bills] buys securities from commercial banks [ \$\$ ], DD (don’t change/increase/decrease) & ER and TR (increase/decrease). 52. When the commercial banking system [ \$\$ ] borrows from the Fed , DD (don’t change/increase/decrease) but ER & TR (incr/decr). 53. W hen commercial banks [ \$\$ ] sell government securities to the Fed [T-bills], DD (don’t change/incr/decr) but their ER & TR (do not change/incr/decr). 54. When the PUBLIC [T-bills] buys securities from the Fed [ \$\$ ], DD (don’t change/incr/decr) and RR, ER, & TR of banks (don’t change/incr/decr). 55. When a commercial bank gets a loan from the Fed , their lending ability (incr/decr). 56. Assume that the RR is 25% & the Thunder Bank borrows \$100,000 from the Fed ., commercial bank ERs are increased \$________. PMC in the banking system are increased by \$_______. TMS can be as much as \$________. 57. The (margin requirement/discount rate) specifies the size of the down payment on stock purchases . 58. If the Fed were to increase the RR [10% to 20%] we would expect (higher/lower) interest rates, a (reduced/expanded) GDP and (appreciation/depreciation) of the dollar. [less “C”, “Ig”, & “Xn”] 100,000 400,000 400,000
57. 58. NS 57-66 59. When the RR is increased [10 % to 50 % ] , the ER of member banks are (increased/decreased) and the monetary multiplier is (incr/decr). 60. Assume the RR is 25% and the Fed buys \$4 M of bonds from the public . The MS is increased by (\$3/\$4/) million and the PMC is increased by (\$16/\$12) M. Potential TMS is (\$3/\$4/\$12/\$16) M. 61. When the Fed lends to commercial banks , this is called the (Fed Funds Rate/discount rate) and when commercial banks make loans to one another, this is the (Fed Funds Rate/ Discount Rate). 62. The Keynesian cause-effect chain of an easy money policy would be to (buy/sell) bonds; which would (increase/decrease) the MS, which would (lower/raise) interest rates & (incr/decr) I g , “C”, Xn, & Y. 63. If the Fed were to buy government securities in the open market , we would anticipate (lower/higher) interest rates, an (expanded/contracted) GDP, and (appreciation/depreciation) of the dollar. 64. If the Fed were reducing demand-pull inflation , the proper policies would be (lower/raise) the discount rate, (lower/raise) the RR and ((buy/sell) government bonds. 65. Monetary policy is thought to be more effective in (controlling inflation/ fighting depressions) and fiscal is more effective (controlling inflation/ fighting depressions). 66.The “net export effect” of an “easy” money policy (strengthens/ weakens) that policy, while the “net export effect” of “expansionary” fiscal policy (strengthens/weakens) that policy. [impact of interest rates]
58. 59. Y R Y * Investment Demand 9 % 6% 3 % 0 Money Market \$50 \$60 AS AD 1 PL 1 9 % 6 % 3 % 0 MS 2 AD 2 PL 2 \$70 Y I AD 3 D I D m PL 3 MS 1 MS 3 \$100 120 140 Q I D I =\$50] I =\$60 I =\$70 RDO 67. If AD is AD3 , what must the Fed do to get to AD2(FE GDP [Y*]) ? (increase/decrease) the MS from (\$120/\$140) to (\$100/\$120). 68. If the MS is MS1 , & the goal of the Fed is FE GDP [ Y* ], they should (increase/decrease) the MS from (\$100/\$120) to (\$120/\$140). 69. Which of the following would shift the MS curve from MS3 to MS2 ? (buying/selling) bonds. 70. If the MS is MS2 and the goal of the Fed is FE GDP of Y* , they should (increase/decrease/don’t change) the Ms. NS 67-70
59. 60. NS 71-72 71. An easy money policy will (apprec/deprec) the dollar & (incr/decr) U.S. Xn. A tight money policy will (apprec/deprec) the dollar & (incr/decr) U.S. Xn. 72. If the economy were in a severe recession , proper monetary policy would call for (lowering/raising) the discount rate, (lowering/raising ) the RR, & (buying/selling) bonds. Proper fiscal policy would be to (incr/decr) “G” & (incr/decr) “T”, both of which would result in a bugetary (deficit/surplus).
60. 61. Money , Banking , & Fed Test Review 1-8 1. If your bank borrows \$50,000 from the Fed , does this automatically increase the MS? _____ Does this loan increase the amount in RR?_____ ER? ____ With 10% RR, PMC is __________. TMS is __________. 2. If the RR is 50% & the Fed buys \$100 mil. of securities from the public , then: MS is increased by ________. PMC is _________. TMS is ________. 3. What will cause the Dt(& total demand) for money curve to shift right ? (increase/decrease) in nominal (money) Y? 4. When the Fed buys bonds from banks [or gives them a loan], DD are (incr/decr/ unchanged) but their ER & TR both (incr/decr/unchanged). 5. If the Fed buys \$10 million of securities from the public , with a RR of 40%, MS is increased by ________ & PMC is _________. TMS is ________. 6. If the Fed decreased the RR from 20% to 10% , we would expect (higher/lower) interest rates, (appreciation/depreciation) of the dollar, and an (increase/decrease) in GDP. 7. DD of \$100,000 and RR of 25% in a commercial banking system with TR of \$40,000. PMC in the banking system is (\$240,000/\$60,000). 8. If you are estimating your expenses for the prom at \$3,000 , money is functioning as (unit of account/medium of exchange/store of value). No No Yes \$500,000 \$500,000 \$100 mil. \$100 mil . \$200 mil. \$10 mil. \$15 mil. \$25 mil.
61. 62. Y R Real GDP D M Investment Demand Reall Interest Rate 10 8 6 0 Money Market QID1 NS 9. “Easy Money” During Recessions MS 1 AS AD 1 P 1 10 8 6 0 MS 2 P 2 Price level Buy If there is RECESSION MS will be increased. QID2 D I Y* 9. “Easy Money” – ( Buy/Sell) bonds, which (increase/decrease) MS, which (increase/decrease) interest rates, which (appreciate/depreciate) the dollar, which (increase/decrease) C, Ig, & Xn, which (increase/decrease ) AD & therefore, PL, GDP, & emp. E 1 E 2 AD 2 “ Students, should the Fed buy or sell bonds to jumpstart this economy?” Jobs are tough to get.
62. 63. D I AD 1 Y I D m Investment Demand Real Interest Rate 10 8 6 0 Money Market QID 2 AS 10 8 6 0 P 2 MS 1 P 1 MS 2 If there is INFLATION , MS will be decreased. Sell QID 1 Y * NS 10. “Tight Money” during Inflation 10. “Tight Money” – (Buy/Sell) bonds, which (incr/decr) the MS, which (incr/decr) in. rates, which (apprec/deprec) the dollar, which (incr/decr) C, Ig, & Xn, which (incr/decr) AD, PL, & GDP. E 1 E 2 AD 2 “ Now, should I buy or sell ?” “ I’ll get rid of some money.”
63. 64. RR is 20% Assets DD (Liabilities) TR[RR+ER] = \$20 mil. \$100 million 11. How much can Pam’s bank loan out? \$______ 12. If Pam Anderson’s Bank borrows \$1,000 from the Fed ER will increase by \$ _______. 13. Possible Money Creation in the system could be \$ _______ . 14. Potential Total Money Supply could be as much as \$ ________. 0 1,000 5,000 5,000 TR 11-14 MS = Currency + DD of Public P am A nderson’s Bank Fed
64. 65. RR is 50% Assets DD (Liabilities) TR[RR+ER] = \$50 mil. \$100 million 11. How much can Cameron’s bank loan out? \$______ 12. If Cameron Diaz’s Bank borrows \$5,000 from the Fed ER will increase by \$ _______. 13. Possible Money Creation in the system could be \$ ________ . 14. Potential Total Money Supply could be as much as \$ ________. 0 5,000 10,000 10,000 Extra Practice MS = Currency + DD of Public Cameron Diaz’s Bank Fed
65. 66. 15. If the goal is F.E., & the interest rate is 9% , a(an) (recess/ inflat) gap exists, the Fed should (incr/decr) the in. rate. 16. If the interest rate is 3% , a(an) (recess/inflat) gap exists, the Fed should (increase/decrease) the interest rate. 17. I f the interest rate is 6% , the Fed shoul d (incr/decr/do nothing) to the interest rate. 18. To reduce inflation , the Fed should (lower, lower, buy/raise, raise, sell) 19. To get out of a recession , the Fed should (lower, lower, buy/raise, raise, sell) Y R Y * Investment Demand 9 % 6% 3 % 0 Money Market \$50 \$60 AS AD 1 PL 1 9 % 6 % 3 % 0 MS 2 AD 2 PL 2 \$70 Y I AD 3 D I D m PL 3 MS 1 MS 3 \$100 120 140 Q I D I =\$50] I =\$60 I =\$70 RDO Test Review 15-19
66. 67. Additional Practice on Money Creation 1. If the RR is 40% and the Fed buys \$100 M of bonds from the public , then the MS is increased by _______. ER are increased by ______. PMC is _______. TMS would be ______. 2. RR is 50% and the Bishop Bank borrows \$100 M from the Fed . As a result, RR are increased by ______. ER is increased by _______. PMC and TMS is increased by ________. 3. Your bank has DD of \$400,000 and the RR is 25%. If RR and ER are equal, then TR are _______. 4. The Duck Bank has ER of \$60,000 & DD is \$200,000. If the RR is 20%, TR are _________. 5. RR is 20% & the Fed buys \$50 million of bonds from the public . The MS is increased by _______. ER are increased by _______. PMC is _______. TMS would be _________. \$100 M \$60 M \$150 M \$250 M \$100 M \$200 M \$200,000 \$100,000 \$50 M \$40 M \$200 M \$250 M 0 Banks Public Fed
67. 68. Q uiz 4 Commercial Bank Fed Public <ul><li>RR are 10% & there are no ER in the Riley Bank . Matt </li></ul><ul><li>deposits ( DD ) \$200.00 there. This one bank can increase </li></ul><ul><li>its loans by a maximum of \$______. </li></ul><ul><li>2. RR are 20%; the Rostro Bank borrows \$80,000 from the Fed . </li></ul><ul><li>This one bank can increase its loans by a maximum of \$___. </li></ul><ul><li>3. RR are 25%; the Fed buys \$8,000 of securities from the Public . </li></ul><ul><li>P otential M oney C reation in the banking system could be \$____. </li></ul><ul><li>4. The Tuason Bank has DD of \$10 million; </li></ul><ul><li>RR are 20%; RR & ER are equal. TR are \$_____. </li></ul><ul><li>5. The Tyll Bank , with no ER, borrows \$20 M from the Fed . </li></ul><ul><li>With a RR of 50%, PMC in the banking system could be \$___. </li></ul><ul><li>6. RR are 40%; the Fed buys \$100 M of securities from the Public . </li></ul><ul><li>P otential M oney C reation in the banking system could be \$____. </li></ul><ul><li>7. RR are 50%; the Volante Bank borrows \$40 M from the Fed ; </li></ul><ul><li>this single bank’s ER are increased by \$_______. </li></ul><ul><li>8. RR are 50%; Fed buys \$50 billion of securities from the Public . </li></ul><ul><li>P otential T otal M oney Supply (TMS) could be as much as \$____. </li></ul><ul><li>9. The RR is 40% & the Fed buys \$20 M of bonds from a bank . </li></ul><ul><li>Potential Money Creation in the banking system is \$_____. </li></ul><ul><li>10. No ER in a bank & RR is 25 %. DD of \$ 200 is made . PMC is \$__ </li></ul>Answ: 1. \$180.00 2. \$80,000 3. \$24,000 4. \$4 mil. 5. \$40 mil. 6. \$150 mil. 7. \$40 mil. 8. \$100 bil. 9. \$50 mil. 10. \$600.00
68. 69. Q uiz 5 C ommercial B ank Fed Public <ul><li>RR are 50% & there are no ER in a Bank . Suzy deposits ( DD ) </li></ul><ul><li>\$10.00 there. This one bank can increase its loans by ?____. </li></ul><ul><li>2. RR are 50%; the Luu Bank borrows \$1 mil. from the Fed . </li></ul><ul><li>This bank can increase its loans by a maximum of of \$_____. </li></ul><ul><li>3. RR are 40%; the Fed buys \$ 100,000 of securities from the Public . </li></ul><ul><li>Potential Total Money Supply could be as much as \$______. </li></ul><ul><li>4. The Gohsman Bank has DD of \$400,000 and RR is 25%. </li></ul><ul><li>RR & ER are equal. Total Reserves are \$_____. </li></ul><ul><li>5. T he Alvarado Bank , with no ER, borrows \$200,000 from the Fed . </li></ul><ul><li>With RR of 40%, this one bank can increase its loans by \$__. </li></ul><ul><li>6. RR are 50%; the Fed buys \$60,000 of securities from the Public . </li></ul><ul><li>Potential Money Creation in the banking system is \$_____. </li></ul><ul><li>7. RR are 10%; the Cochran Bank borrows \$150 million from the </li></ul><ul><li>Fed . This single bank’s ER are increased by \$_____. </li></ul><ul><li>8. RR are 25%; Fed buys \$200 M of securities from the Public . </li></ul><ul><li>Potential Total Money Supply could be as much as \$____. </li></ul><ul><li>9. RR are 25% & the Fed buys \$40 M of bonds from the Collins Bank . </li></ul><ul><li>Potential Money Creation in the banking system could be \$___. </li></ul><ul><li>10. RR are 20% & no ER in the Joseph Bank . Steph deposits </li></ul><ul><li>\$125.00 there. P otential M oney C reation in the system is \$____. </li></ul>Answ: 1. \$5.00 2. \$1 mil. 3. \$250,000 4. \$200,000 5. \$200,000 6. \$60,000 7. \$150 mil. 8. \$800 mil. 9. \$160 mil. 10. \$500.00
69. 70. <ul><li>RR are 40% & there are no ER in a Bank . Bo deposits ( DD ) </li></ul><ul><li>\$100.00 there. This one bank can increase its loans by ?____ </li></ul><ul><li>2. RR are 10%; the Torres Bank borrows \$9 mil. from the Fed . </li></ul><ul><li>This bank can increase its loans by a maximum of of \$_____ </li></ul><ul><li>3. RR is 50%; the Fed buys \$10,000 of securities from the Public . </li></ul><ul><li>Potential Total Money Supply could be as much as \$____ </li></ul><ul><li>4. The John Bank has DD of \$100,000 and RR is 40%. </li></ul><ul><li>RR & ER are equal. Total Reserves are \$_____. </li></ul><ul><li>5. T he Martin Bank , with no ER, borrows \$500,000 from the Fed . </li></ul><ul><li>With RR of 20%, this one bank can increase its loans by \$___ </li></ul><ul><li>6. RR are 50%; the Fed buys \$500,000 of securities from the Public . </li></ul><ul><li>Potential Money Creation in the banking system is \$_____ </li></ul><ul><li>7. RR are 10%; the Matthews Bank borrows \$5 million from the </li></ul><ul><li>Fed . This single bank’s ER are increased by \$_____ </li></ul><ul><li>8. RR are 10%; Fed buys \$10 M of securities from the Public . </li></ul><ul><li>Potential Total Money Supply could be as much as \$____ </li></ul><ul><li>9. RR are 25% & the Fed buys \$8 M of bonds from the Weber Bank . </li></ul><ul><li>Potential Money Creation in the banking system could be \$____ </li></ul><ul><li>10. RR are 20% & no ER in the Clark Bank . Steph deposits </li></ul><ul><li>\$100.00 there. P otential Total Money Supply is \$____ </li></ul>Quiz 6 Commercial Banks Fed Public Answ: 1. \$60.00 2. \$9 mil. 3. \$20,000 4. \$80,000 5. \$500,000 6. \$500,000 7. \$5 mil. 8. \$100 mil. 9. \$32 mil. 10. \$500.00
70. 71. Monetary Questions From 2000 AP Exam Money and the Fed 1. (61%) In the Keynesian model , an expansionary monetary policy will lead to a. lower real interest rates and more investment b. lower real interest rates and lower prices c. higher real interest rates and lower prices d. higher real interest rates and higher real income e. higher nominal interest rates and more investment 2. (58%) Which of the following will most likely occur in an economy if more money is demanded than is supplied ? a. the amount of investment spending will increase. d. interest rates will decrease b. the demand curve for money will shift to the left e. interest rates will increase. c. the demand curve for money will shift to the right. 3. (64%) When consumers hold money rather than bonds because they expect the interest rate to increase in the future , they are holding money for what purposes? a. transactions c. speculation (asset) b. unforeseen expenditures d. illiquidity Money Creation 4. (80%) If on receiving a checking deposit of \$300 a bank’s ER increased by \$255 , the RR must be: a. 5% b. 15% c. 25% d. 35% e. 45% When interest rates are too low, people will hold more asset (speculation) money. They don’t want to tie their money into interest rate bearing assets (like CDs & bonds) getting low returns. They will hold the speculative money until interest rates go back up.
71. 72. 5. (62%) The money-creating ability of the banking system will be less than the maximum amount indicated by the money multiplier when a. interest rates are high b. the velocity of money is rising c. people hold a portion of their money in the form of currency d. the unemployment rate is low 6. (71%) RR is 20%. If a bank initially has no ER and \$10,000 cash is deposited in the bank, the maximum amount by which this bank may increase its loans is a. \$2,000 b. \$8,000 c. \$10,000 d. \$20,000 e. \$50,000 7. (86%) RR is 15% and that bank receives a new DD of \$200. Which of the following will most likely occur in the bank’s balance sheet? Liabilities(DD) Required Reserves a. increase by \$200 increase by \$170 b. increase by \$200 increase by \$30 c. increase by \$200 no change d. decrease by \$200 decrease by \$30 e. decrease by \$200 decrease by \$170 The Fed and Monetary Policy 8. (89%) The Federal Reserve can increase the money supply by a. selling gold reserves to the banks b. selling foreign currency holdings c. buying government bonds on the open market d. borrowing reserves from foreign governments
72. 73. 9. (73%) An increase in the money supply is most likely to have which of the following short-run effects on real interest rates and real output ? Real Interest Rates Real Output a. decrease decrease b. decrease increase c. increase decrease d. increase no change e. no change increase 10. (81%) Under which of the following conditions would a restrictive (contractionary) monetary policy be most appropriate? a. high inflation d. low interest rates b. high unemployment e. a budget deficit c. full employment with stable prices 11. (82%) The Fed can change the U.S. money supply by changing the a. number of banks in operation d. prime rate b. velocity of money e. discount rate c. price level 12. ( * 30%) If the money stock decreases but nominal GDP remains constant , which of the following has occurred? a. income velocity of money has increased. d. price level has decreased. b. income velocity of money has decreased. e. real output has decreased. c. price level has increased.
73. 74. 13. (54%) Policy-makers concerned about fostering long-run growth in an economy that is currently in a recession would most likely recommend which of the following combinations of monetary and fiscal policy actions ? Monetary Policy Fiscal Policy a. sell bonds reduce taxes b. sell bonds raise taxes c. no change raise taxes d. buy bonds reduce spending e. buy bonds no change 14. (76%) Open market operations refer to which of the following activities? a. the buying and selling of stocks in the New York stock Market b. the loans made by the Fed to member commercial banks c. the buying and selling of government securities by the Federal Reserve d. the government’s purchases and sales of municipal bonds e. the government’s contribution to net exports 15. (58%) An open market sale of bonds by the Fed will most likely change the money supply , the interest rate , and the value of the U.S. dollar in which of the following ways? Money Supply Interest Rate Value of the Dollar a. increase decrease decrease b. increase decrease increase c. decrease decrease decrease d. decrease increase increase e. decrease increase decrease The reason you don’t incr G here is that it would push up interest rates and offset the lower interest rates of the Fed’s buying bonds.
74. 75. 1995 AP Exam 16. (82%) Commercial banks can create money by a. transferring depositors’ accounts at the Fed for conversion to cash b. buying Treasury bills from the Federal Reserve c. sending vault cash to the Fed d. maintaining a 100% reserve requirement e. lending excess reserves to customers 17. (65%) If the RR is 20% , the existence of \$100 worth of ER in the banking system can lead to a maximum expansion of the money supply equal to a. \$20 b. \$100 c. \$300 d. \$500 e. \$750 18. (71%) If the Fed lowers the RR , which of the following would most likely occur ? a. Imports will rise, decreasing the trade deficit. b. The rate of saving will increase. c. Unemployment and inflation will both increase. d. Businesses will purchase more factories and equipment. e. The budget deficit will increase. 19. (61%) If the public’s desire to hold money as currency increases , what will the impact be on the banking system ? a. Banks would be more able to reduce unemployment. b. Banks would be more able to decrease AS. c. Banks would be less able to decrease AS. d. Banks would be more able to expand credit. e. Banks would be less able to expand credit More MS means lower I.R. & more Ig Holding currency means less ER & higher I.R. 5x\$100=\$500
75. 76. 20. (86%) Which of the combinations is most likely to cure a severe recession ? Open-Market Operations Taxes Gov. Spending a. Buy securities Increase Decrease b. Buy securities Decrease Increase c. Buy securities Decrease Decrease d. Sell securities Decrease Decrease e. Sell securities Increase Increase 21. (61%) T he demand for money increases when national income increases because a. spending on goods and services increases d. the MS increases b. interest rates increase e. the budget deficit increases c. the public becomes more optimistic about the future 22. (76%) Suppose the RR is 20% and a single bank with no ER receives a \$100 DD from a new customer. The bank now has excess reserves equal to a. \$20 b. \$80 c. \$100 d. \$400 e. \$500 23. (45%) Which of the following is most likely to increase if the public decides to increase its holding of currency ? a. the interest rate d. Employment b. The price level e. The reserve requirement c. Disposable personal income 24. (47%) During a mild recession , if policymakers want to reduce unemployment by increasing investment , which of the following policies would be most appropriate? a. Equal increases in government expenditure and taxes b. An increase in government expenditure only c. An increase in transfer payments d. An increase in the reserve requirement e. Purchase of government securities by the Fed Holding MS; banks have less; higher I.R.
76. 77. 25. (73%) Which of the following monetary and fiscal policy combinations would most likely result in a decrease in AD? Discount Rate Open-Market Operations Gov. Spending a. Lower Buy bonds Increase b. Lower Buy bonds Decrease c. Raise Sell bonds Increase d. Raise Buy bonds Increase e. Raise Sell bonds Decrease 26. (35%) Under which of the following circumstances would increasing the MS be most effective in increasing real GDP ? Interest Rates Employment Business Optimism a. High Full High b. High Less than full High c. Low Full High d. Low Full Low e. Low Less than full Low 27. (57%) According to both monetarists and Keynesians , which of the following happens when the Fed reduces the discount rate? a. The demand for money decreases and market interest rates decrease. b. The demand for money increases and market interest rates increase. c. The supply of money increases and market interest rates decrease. d. The supply of money increases and market interest rates increase. e. Both the demand for money and the MS increase and market interest rates increase. 28. (79%) All of the following are components of the MS in the U.S. EXCEPT a. paper money b. gold bullion c. checkable deposits d. coins e. demand deposits
77. 78. 29. (47%) I f the Fed undertakes a policy to reduce interest rates , international capital flows (financial capital like CDs, bonds) will be affected in which of the following ways? a. Long-run capital outflows from the U.S. will decrease. b. Long-run capital inflows to the U.S. will increase. c. Short-run capital outflows from the U.S. will decrease. d. Short-run capital inflows to the U.S. will decrease. e. Short-run capital inflows to the U.S. will not change. 30. (73%) If the Fed wishes to use monetary policy to reinforce Congress’ fiscal policy changes , it should a. increase the MS when government spending is increased b. increase the MS when government spending is decreased c. decrease the Ms when government spending is increased d. increase interest rates when government spending is increased e. decrease interest rates when government spending is decreased This would keep the interest rate from going up. Lower U.S. interest rates will result in fewer capital inflows