Download - Janet Yellen

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Page 1: Janet  Yellen

Janet YellenJanet Yellen

1%?1%?2%?2%?1.5%?

1.5%?

The “Fed”The “Fed”

Monetary PolicyMonetary Policy

Page 2: Janet  Yellen

YYRR

DDMM

InvestmentDemand

no

min

al

Inte

res

t R

ate 88

4

0Money Market QID1QID1

MSMS11

ASASADAD11

PLPL11

8%8%

6%6%

4%4%

00

MSMS22

ADAD22

PL2

Pri

ce le

vel

If there is aIf there is a RECESSIONRECESSIONMS will beMS will beincreased.increased.

QID2QID2

DDII

Y*Y*

Buy Buy BBondsonds MSMS I.R.I.R. QIDQID ADAD YY//EEmp/mp/PLPL

I want a job I want a job as a Rocketteas a Rockette

Real GDPReal GDP

BuyBuy

FEDERAL RESERVE BANK OF THE U.S.FEDERAL RESERVE BANK OF THE U.S.

EE11E2E2

6%6%

Page 3: Janet  Yellen

DDII

ADAD11

Pri

ce level

YYII

Dm

InvestmentDemand

Nom

inal In

tere

st

Rate

1010%%

8%8%

6%6%

0Money MarketMoney Market QIDQID2 2 AS

10

88

66

0

ADAD22

PL2

MSMS11

PLPL11

MSMS22

If there isIf there isINFLATIONINFLATION,,MS will beMS will bedecreased.decreased.

SellSell

QIDQID11

YY**

““It’s cheaper It’s cheaper to burn moneyto burn moneythan wood.”than wood.”

SellSellBondsBonds MSMS I.R.I.R. QIDQID ADAD Y/EY/Empl.mpl./PL/PL

FEDERAL RESERVE BANK OF THE U.S.FEDERAL RESERVE BANK OF THE U.S.

like““money trees”money trees”

EE11

EE22

Page 4: Janet  Yellen

0 Real GDP

ADAD11ADAD22 AS1 ASAS22

PL1

PL2

PLPL33

Y*1 Y2 YY33

Can sustain a much greater increase in AD if the AS curve isCan sustain a much greater increase in AD if the AS curve isalso shifting to the right, due to also shifting to the right, due to increasing productivityincreasing productivity.

Economy’s Economy’s Speed LimitSpeed Limit at at FFull ull EEmploymentmployment isis 44%%,, instead ofinstead of 2.52.5%%..

2.52.5%%

In the early 90’s, at FE, 2.5%was the speed limit. AS shiftedslowly due to low productivity.

So, at FE, theSo, at FE, the “goldilocks“goldilockseconomy”economy” has expanded.has expanded.

PL1

Increasing productivityIncreasing productivity of theof thelate 90’s allowed more growthlate 90’s allowed more growthat full employment.at full employment.

Page 5: Janet  Yellen

If The Economy Is If The Economy Is Exceeding Exceeding TheThe FE GDPFE GDP Speed Limit Of Speed Limit Of 4%4%

Page 6: Janet  Yellen

““When the party gets too good, it’s When the party gets too good, it’s the job the job

of the Fed to take away the punch of the Fed to take away the punch

bowl.”bowl.”

The Fed’s policy is “If you see inflation, its The Fed’s policy is “If you see inflation, its too late. Whip it before it gets out of the box.”too late. Whip it before it gets out of the box.”

During a recession, the Fed is happy to During a recession, the Fed is happy to “spike the punch.”“spike the punch.”

I promise to I promise to control inflation…control inflation…

Page 7: Janet  Yellen

Should The Fed Chairman Show His Hand?Should The Fed Chairman Show His Hand?

Page 8: Janet  Yellen

Monetary PolicyMonetary Policy – America’s Main Stabilization Tool

Monetary Policy ToolsMonetary Policy Tools1.1. Discount RateDiscount Rate – – when when banks borrow banks borrow from thefrom the Fed Fed [“symbolic”][“symbolic”]

2.2. Reserve RatioReserve Ratio – currently 10%; the most powerful tool – currently 10%; the most powerful tool3.3. BuyingBuying [ [recessionrecession] & ] & sellingselling [ [inflationinflation] of bonds] of bonds

RecessionRecession

InflationInflation

NominalNominalInterestInterest

RateRate

Page 9: Janet  Yellen

BALANCE SHEET OF FED BANKSBALANCE SHEET OF FED BANKS

ASSETSASSETS•Securities [90%]Securities [90%]•Loans to Commercial BanksLoans to Commercial Banks

LIABILITIESLIABILITIES•Reserves of Commercial BanksReserves of Commercial Banks•Treasury DepositsTreasury Deposits•Federal Reserve Notes [90%]Federal Reserve Notes [90%]

Page 10: Janet  Yellen

AustraliaAustralia Reserve Bank of Australia [RBA]Reserve Bank of Australia [RBA]CanadaCanada Bank of CanadaBank of CanadaEuro ZoneEuro Zone Central Bank of Europe[CBE]Central Bank of Europe[CBE]Japan Japan The Bank of Japan [“BOJ”]The Bank of Japan [“BOJ”]Russia Russia Central Bank of RussiaCentral Bank of RussiaUnited KUnited Kingdomingdom Bank of EnglandBank of EnglandMexicoMexico Banco de Mexico (Mex Bank)Banco de Mexico (Mex Bank)Sweden Sweden Sveriges RibsbankSveriges Ribsbank

U.S. U.S. FFederal ederal RReserveeserve S Systemystem [“[“FedFed”]”]

Consolidated Balance Sheet Consolidated Balance Sheet of theof the Federal Reserve Banks Federal Reserve Banks[[millionsmillions]]

AssetsAssets[own][own] LiabilitiesLiabilities[owe][owe]SecuritiesSecurities *647,580*647,580 Reserves of commercial banks $28,678Reserves of commercial banks $28,678

Treasury depositsTreasury deposits 6,0506,050LLoans to oans to CCommercial ommercial BBanksanks 5959 Federal Reserve NotesFederal Reserve Notes *549,711*549,711

[when these notes are in circulation, they[when these notes are in circulation, they constitute claims against assets of the Fed]constitute claims against assets of the Fed]

All other assetsAll other assets 86,76886,768 All other liabilities & net worth All other liabilities & net worth 49,72349,723TotalTotal $734,407$734,407 TotalTotal $734,407 $734,407

FEDERAL RESERVE BANK OF THE U.S.FEDERAL RESERVE BANK OF THE U.S.

Page 11: Janet  Yellen

$97.50$97.50

+30%+30%

The Fed controls the banks’ ability to create new money to The Fed controls the banks’ ability to create new money to ensure the economy doesn’t get ensure the economy doesn’t get too much moneytoo much money, nor , nor too littletoo little..

OverfedOverfed Fed RightFed Right

19801980 19831983

$75.00$75.00

MoneyMoney PricesPrices

UnderfedUnderfed

Page 12: Janet  Yellen

And What Happens If You Feed A Dog too And What Happens If You Feed A Dog too MuchMuch

Page 13: Janet  Yellen

1. 1. Discount RateDiscount Rate – banks borrow from the Fed (symbolic)

2. 2. Required ReserveRequired Reserve - % of DD which cannot be loaned.3. BuyBuy//SellSell BondsBonds – government debt

- 3 mo., 6 mo., & 1 year; purchase price: $10,000$10,000

- 2 yr., 3 yr., 5 yr.,($5,000)($5,000), & 10 yr., ($10,000)($10,000)

- 30 years with purchase of $1,000$1,000

Federal Funds Target RateFederal Funds Target Rate – overnight lending rate between banks to correct a temporary imbalance in reserves.

RecessionRecession

LowerLowerLowerLowerBuyBuy

InflationInflationRaiseRaiseRaiseRaiseSellSell

YYRR YY**

ADAD

ASASLRASLRAS

ASASADAD

YY**YYII

3 Tools 3 Tools of of Monetary PolicyMonetary Policy

JuneJune, 2006, 2006 [5.25%] [5.25%]17 increases17 increases

AD

AD

Real GDP 1.6%Real GDP 1.6%

PrimePrime RateRate-loan rate to the best (prime)best (prime) customers.

Page 14: Janet  Yellen

YYRR Real GDPReal GDP

DDMM

InvestmentDemand

No

min

al I

nte

rest

Rat

e

10

8

6

0Money MarketMoney Market QQIID1D1

“ “Easy MoneyEasy Money” During ” During RecessionsRecessionsMSMS11

ASADAD11

P1

10

8

6

0

MSMS22

P2

Pri

ce l

eve

l

BuyBuy

If there isIf there is RECESSIONRECESSIONMS will beMS will beincreasedincreased..

QQIID2D2

DDII

Y*Y*

““Easy Money” Easy Money” – – ((Buy/Sell) Buy/Sell) bonds,bonds,whichwhich (increase/decrease)(increase/decrease) MS, MS, which which (increase/decrease) interest rates, (increase/decrease) interest rates, which (appreciate/depreciate)which (appreciate/depreciate)the the dollar, dollar, whichwhich (increase/decrease)(increase/decrease)C, C, IIg,g, & & Xn, Xn, which which (increase/decrease(increase/decrease))AD & therefore, PL, GDP, & emp. AD & therefore, PL, GDP, & emp. EE11

EE22

ADAD22

Jobs are Jobs are tough to get.tough to get.

LRASLRAS

““Students, should the Fed Students, should the Fed buybuy or or sell sell bonds to bonds to jumpstart this economy?”jumpstart this economy?”

Page 15: Janet  Yellen

DDII

ADAD11

YYII

DDmm

InvestmentInvestmentDemandDemand

Nom

inal In

tere

st

Rate

10

88

6

00Money MarketMoney MarketQIDQID2 2 ASAS

10

8

6

0

PP22

MSMS11

PP11

MSMS22

If there isIf there isINFLATIONINFLATION,,MS will beMS will bedecreased.decreased.

SellSell

QIDQID11

YY**

““Tight MoneyTight Money” during ” during InflationInflation

““Tight Money”Tight Money” – (Buy/Sell) – (Buy/Sell)bonds, bonds, whichwhich (incr/decr) the MS,(incr/decr) the MS,whichwhich (incr/decr) in. rates, (incr/decr) in. rates, whichwhich (apprec/deprec) the dollar,(apprec/deprec) the dollar,which (incr/decr) C, Ig, & Xn,which (incr/decr) C, Ig, & Xn,whichwhich (incr/decr) AD, PL, (incr/decr) AD, PL,&& GDP. GDP.

EE11

EE22

ADAD22

““Now, should Now, should I I buybuy or or sellsell?”?”

““I’ll get rid of I’ll get rid of some money.”some money.”

LRASLRAS

Page 16: Janet  Yellen

YYRR YY** Investment Demand

99%%

6%6%

33%%

0

Money MarketMoney Market $50$50 $60$60

AASS

ADAD11

PLPL11

99%%

66%%

33%%

00

MSMS22ADAD22

PLPL22

$70$70 YYII

ADAD33DDII

DDmm

PLPL33

MSMS11 MSMS33

$100$100 120120 140140 QQIIDD

II=$50]=$50] II=$60=$60

II=$70=$70

RDORDO

The ideal economy is ADAD22, with I.R. at 6%6% & Ig at $60$60 billion billion.

Page 17: Janet  Yellen

YYRR Investment Demand

99%%

0Money MarketMoney Market

$50$50

AS

ADAD11

PLPL11

99%%

00

MSMS22ADAD22

PLPL22

DI

DDmm

MSMS11

$100$100 QIDQID

II=$50]=$50] II=$60=$60

RDORDO

Recessionary GapRecessionary GapIncrease MS from $100$100 to $120$120, which lowers the I.R. from 9%9% to 6%6%,, which increases QID from $50$50 to $60$60, which increases AD from ADAD11 to ADAD22.

66%% 66%%

$120$120 $60$60 YY**

Page 18: Janet  Yellen

YY** Investment Demand

33%%

0Money MarketMoney Market

$60$60

AS

33%%

00

MSMS22ADAD22

PLPL22

$70$70 YYII

ADAD33DIDDmm

PLPL33

MSMS33

$140$140 QQIIDD

II=$60=$60

II=$70=$70

RDORDO

Inflationary GapInflationary GapDecrease MS from $140$140 to $120$120, which increases the I.R. from 3%3% to 6%6%.. which decreases QID from $70$70 to $60$60, which decreases AD from AD3AD3 to AD2AD2.

66%%66%%

$120$120

DI

Page 19: Janet  Yellen

GOALS OF MONETARY POLICYGOALS OF MONETARY POLICY

…to assist the economy in achieving a full employmentfull employment,

non-inflationarynon-inflationary level of outputoutput

Page 20: Janet  Yellen

1. 1. Open Market OperationsOpen Market Operations

- “nuts - “nuts and and bolts”bolts” of Monetary Policy [main tool]

- $60-$70 billion$60-$70 billion every day

Three Tools Of Monetary PolicyThree Tools Of Monetary Policy

Page 21: Janet  Yellen

2. 2. Reserve RequirementReserve Requirement - - most powerful (seldom used) - affects money creation by changing ER and the multiplier - an increase ofincrease of ½ of 1½ of 1%% would increaseincrease bank reservesbank reserves by by over $5 over $5 billionbillion

- RR was 20%20% from 1937-19581937-1958 Sledgehammer Sledgehammer of of MMonetaryonetary P Policyolicy

RR - RR - Atomic Bomb of Monetary PolicyAtomic Bomb of Monetary Policy

Page 22: Janet  Yellen

Reserve Requirement ExampleReserve Requirement ExampleSuppose the banking system has $500 billion $500 billion in in DDDD.The RR is 12%RR is 12% & TR are $60 billion$60 billion, which is 12%12% of the $500 billion$500 billion DDDD. So, there are no ERno ER.

Now, the Fed lowers the RR to 10%Fed lowers the RR to 10%. Now banks arerequired required to to keep keep only $50 only $50 billionbillion in RR. So, $10 billion$10 billion more ERmore ER is available to loan out.$10 billion X 10 = $100 billion in new DD$10 billion X 10 = $100 billion in new DD.So, 20% increase MS [DD]20% increase MS [DD] from $500 to $600$500 to $600 billion.

Atomic Bomb of Monetary PolicyAtomic Bomb of Monetary Policy

Page 23: Janet  Yellen

$10,000$10,000[$9,000+$1,000][$9,000+$1,000]

[In [In 19801980, , the the RRRR was set atwas set at 1212%%; stayed ; stayed there there untiluntil 1992 1992; ; went towent to 1010%%]]

““EEasy asy MMoneyoney””

ASASADAD11

ADAD22

YYRR YY**

PLPL

$1,000$1,000InitialInitial

depositdeposit

$900$900[$900x10][$900x10]

$1,000$1,000

$810$810

$729$729

Monetary ExpansionMonetary Expansion[10% RR] [1/.10=10][10% RR] [1/.10=10]

““Easy Money”Easy Money”

Reserve Requirement at 10% - Easy MoneyReserve Requirement at 10% - Easy Money

““Easy MoneyEasy Money”” – increase the money supply – increase the money supply

Page 24: Janet  Yellen

$5,000$5,000[$4,000+$1,000][$4,000+$1,000]

““Tight MoneyTight Money”” - decrease the money suply - decrease the money suply

RR at 20% - Tight MoneyRR at 20% - Tight MoneyMonetary ExpansionMonetary Expansion

(20% RR) [1/.20=M(20% RR) [1/.20=MDD of 5] of 5]

““Tight Money”Tight Money”

$1,000$1,000Initial Initial

depositdeposit

$800$800

$640$640$512$512

PLPL

YY* * YYII

ADAD22ADAD11 ASAS

Page 25: Janet  Yellen

3. Discount RateDiscount Rate -- emergency Fed loansemergency Fed loans to to banksbanks- - symbolic (raises Prime RatePrime Rate)- Discount Rate was 1% from 1934-46 and the prime rate was 1.5% HurricaneHurricane

EarthQuakeEarthQuake

FL borrowed $99FL borrowed $99million In 1991 million In 1991

The Fed tends to change the D.R. inThe Fed tends to change the D.R. inlockstep with the fed funds target rate.lockstep with the fed funds target rate.

Page 26: Janet  Yellen

Fed Funds Rate 1996-2006Fed Funds Rate 1996-2006

5.25%5.25%June, 2006

Page 27: Janet  Yellen

Relative Importance of Monetary PolicyRelative Importance of Monetary Policy

Relative Importance of Monetary PolicyRelative Importance of Monetary PolicyA. WWIIWWII--19791979–Fed targeted the interest rateinterest rate not the growth of MS.B. 1979-19821979-1982 – Fed targeted the growth of the MSgrowth of the MS not the in. rate.C. 1982-Present1982-Present-Fed targets the interest rateinterest rate, not the MS. 1. Discount RateDiscount Rate – not a primary tool of monetary policy. It does have an “announcement effect.” 2. Reserve RequirementReserve Requirement (1010%)-has changed one time in 2 decades (12% to 10% in 1992). It would affect bank profits so is seldom usedseldom used. 3. Open-market operationsOpen-market operations – evolved as the most effectivemost effective tool of monetary policy because of flexibilityflexibility. Securities can be bought or sold in large amounts & their impact on reserves is very prompt.

Effectiveness of Monetary PolicyEffectiveness of Monetary PolicyStrengths of Monetary PolicyStrengths of Monetary Policy 1. Speed and flexibilitySpeed and flexibility –can quickly be altered (compared to fiscal policy). This can occur on a daily basis and influence interest ratesinfluence interest rates and the MS. 2. Isolation Isolation from from political pressurespolitical pressures – because of the 14 year terms. They can enact unpopular policiesunpopular policies which might be best for our economy’s healthbest for our economy’s health.

Page 28: Janet  Yellen

Also, the Keynesians Keynesians don’t think the the lower interest ratelower interest rate is asis as important important asas “profit expectations.”“profit expectations.”

YR YY**

DDm(K)m(K)

InvestmentDemand

10%

88%%

66%%

0Money MarketMoney Market QID1 QID2

Monetarist ViewMonetarist View ofof Transmission MechanismTransmission Mechanism v.v. Keynesian ViewKeynesian View

AS

ADAD11

PL1

10

88%%

66%%

0

MSMS22

ADAD22

PLPL22

YYIIDDmm is more inelastic is more inelastic[I.R. moreI.R. more sensitivesensitive]

QIDQID22

DDII is more elastic is more elastic[or moreor more responsiveresponsive]

ADAD2(M)2(M)DI(K)

DDI(M)I(M)

DDm(Mm(M)) (K)(K)

PLPL22

Mainly, we end up just Mainly, we end up just getting inflation. getting inflation.

MSMS11

KKeynesian vieweynesian view is that DI is rather steepsteep so monetary policy is not that strong. F Fiscal policy iscal policy is “top banana.”“top banana.”

ASASADAD11

ADAD22

Page 29: Janet  Yellen

Strengths of Monetary PolicyStrengths of Monetary Policy

•Speed and flexibility• Isolation from political pressure•Successes in the 1980s & 1990sShortcomings and problems

Cyclical asymmetryCyclical asymmetry[better at fighting inflationfighting inflation than fighting fighting depressionsdepressions]

Fiscal Policy betterFiscal Policy better

Monetary Policy betterMonetary Policy better

I’d like one of those I’d like one of those 1% mortgages, but I 1% mortgages, but I don’t have a job.don’t have a job.

Page 30: Janet  Yellen

Cyclical AsymmetryCyclical Asymmetry (lack of balancelack of balance) – “Tight money during inflations is more effective than easy money policy during a depressions.” a. An easy money policy during depressioneasy 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[“You can lead a horse to water, but you can’t make him drink.”]water, but you can’t make him drink.”] b. The cyclical asymmetry has not created a majornot created a major difficultydifficulty for monetary policy except during times of depressionexcept during times of depression. c. Velocity of money may increaseVelocity of money may increase during inflationduring inflation when the fed is trying towhen the fed is trying to decrease the MSdecrease the MS & decrease during recession when the Fed is trying to increase MS. d. The lower interest rates during recessionlower interest rates during recession & depreciationdepreciation of the dollar may cause foreign investors to pull their money out of the U.S.foreign investors to pull their money out of the U.S. and reduce the MSreduce the MS. e. Banks may hold their ERBanks may hold their ER or the public may hold too much currencypublic may hold too much currency.

f. DDm curve may be more flatm curve may be more flat so that interest rate will not drop as muchso that interest rate will not drop as much, or the

DDI I curve may be more vertical so that investment will not increase ascurve may be more vertical so that investment will not increase as muchmuch.

Shortcomings and Problems of Monetary PolicyShortcomings and Problems of Monetary PolicyBut – I will eat But – I will eat spiked brownies.spiked brownies.

Page 31: Janet  Yellen

Fiscal PolicyFiscal PolicyRecessionRecession InflationInflationIncrease GIncrease G Decrease GDecrease GDecrease TDecrease T Increase T Increase T

Monetary PolicyMonetary PolicyRecessionRecession InflationInflationLower D. RateLower D. Rate Raise D. RateRaise D. RateLower R. RateLower R. Rate Raise R. RRaise R. RatioatioBuy BondsBuy Bonds Sell BondsSell Bonds

““Easy Money”Easy Money” “Tight M“Tight Moneyoney””

Page 32: Janet  Yellen

Monetary and Fiscal PolicyMonetary and Fiscal Policy

Page 33: Janet  Yellen

TOOLS OF MONETARY POLICYTOOLS OF MONETARY POLICYDiscount RateDiscount Rate

The Reserve RatioThe Reserve Ratio

Open Market OperationsOpen Market Operations

Easy Money PolicyEasy Money Policy• LowerLower Discount Rate• LowerLower Reserve Ratio• BuyBuy Bonds

““Easy Money”Easy Money”

FedFed

Page 34: Janet  Yellen

TOOLS OF MONETARY POLICYTOOLS OF MONETARY POLICY

Discount RateDiscount Rate

The Reserve RatioThe Reserve RatioOpen Market OperationsOpen Market Operations

Tight Money PolicyTight Money Policy• RaiseRaise Discount Rate• RaiseRaise Reserve Ratio• SellSell Bonds

““Got to Got to decrease decrease the MS.”the MS.”

FedFed

Page 35: Janet  Yellen

48. The 3 tools of monetary policy3 tools of monetary policy are open market operations, changes in RR, & (changes in T/changes in G/ changes in discount rate).

49. The main toolmain tool of theof the Fed Fed in regulating the MS is (open-market operations/DR/RR).

50. When the FeFedd[$$$$] sells securities to the PUBLICPUBLIC[T-bills], DDDD (don’t change/incr/decr) & banking system RR, ER & TR (incr/decr).51. When the FedFed[T-bills] buys securities from commercial bankscommercial banks[$$$$], DD (don’t change/increase/decrease) & ER and TR (increase/decrease).

52. When the commercial bankingcommercial banking systemsystem[$$$$] borrows from the FedFed, DD (don’t change/increase/decrease) but ER & TR (incr/decr).53. When commercial bankscommercial banks[$$$$] sell government securities to the FedFed[T-bills], DD (don’t change/incr/decr) but their ER & TR (do not change/incr/decr).54. When the PUBLICPUBLIC[T-bills] buys securities from the FedFed[$$$$], DD (don’t change/incr/decr) and RR, ER, & TR of banks (don’t change/incr/decr).55. When a commercial bankcommercial bank gets a loan from the FedFed, their lending ability (incr/decr).

56. Assume that the RR is 25% & the Thunder BankThunder Bank borrows $100,000 from the

FedFed., 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 purchasesdown payment on stock purchases. 58. If the Fed Fed were to increase the RR [10% to 20%]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”]

NS 48-58NS 48-58 ((MSMS == DDDD ++ CurrencyCurrency ofof PublicPublic))

100,000100,000400,000400,000 400,000400,000

Page 36: Janet  Yellen

59. When the RR is increased [10RR is increased [10% to% to 50 50%%]], the ER of member banks are (increased/decreased) and the monetary multiplier is (incr/decr).60. Assume the RR is 25% and the FedFed buys $4 M of bonds from the publicpublic. 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 Fed lends to commercial bankscommercial banks, this is called the (Fed Funds Rate/discount rate) and when commercial bankscommercial banks make loans to one another, this is the (Fed Funds Rate/ Discount Rate). 62. The Keynesian cause-effect chain of ancause-effect chain of an easy money policyeasy money policy would be to (buy/sell) bonds; which would (increase/decrease) the MS, which would (lower/raise) interest rates & (incr/decr) Ig, “C”, Xn, & Y.63. If the FedFed were to buy government securitieswere to buy government securities in the open marketin the open market, we would anticipate (lower/higher) interest rates, an (expanded/contracted)

GDP, and (appreciation/depreciation) of the dollar.64. If the FedFed were reducing demand-pull inflationwere 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 policyMonetary policy is is thought thought to beto be more effective more effective in (controlling inflation/

fighting depressions) and fiscal fiscal is is more effectivemore effective (controlling inflation/ fighting depressions).66.The “net export effect”“net export effect” of an “easy” money policy“easy” money policy (strengthens/ weakens) that policy, while the “net export effect” of “expansionary” fiscal policy (strengthens/weakens) that policy. [impact of interest rates]

NS 57-66NS 57-66

Page 37: Janet  Yellen

YYRR YY** Investment Demand

99%%

6%6%

33%%

0

Money MarketMoney Market $50$50 $60$60

AS

ADAD11

PLPL11

99%%

66%%

33%%

00

MSMS22ADAD22

PLPL22

$70$70 YYII

ADAD33DI

DDmm

PLPL33

MSMS11 MSMS33

$100$100 120120 140140 QQIIDD

II=$50]=$50] II=$60=$60

II=$70=$70

RDORDO

67. If 67. If AD is AD3AD is AD3, what must the Fed do to get to , what must the Fed do to get to AD2(FE GDP [Y*])AD2(FE GDP [Y*])?? (increase/decrease) the MS from ($120/$140) to ($100/$120).(increase/decrease) the MS from ($120/$140) to ($100/$120).68. If the 68. If the MS is MS1MS is MS1, & the goal of the Fed is , & the goal of the Fed is FE GDPFE GDP[[Y*Y*], they should], they should (increase/decrease) the MS from ($100/$120) to ($120/$140).(increase/decrease) the MS from ($100/$120) to ($120/$140).69. Which of the following would 69. Which of the following would shift the MS curve from shift the MS curve from MS3MS3 toto MS2 MS2?? (buying/selling) bonds.(buying/selling) bonds.70. If the 70. If the MS is MS2MS is MS2 and the goal of the Fed is and the goal of the Fed is FE GDP of Y*FE GDP of Y*, they should, they should (increase/decrease/don’t change) the Ms.(increase/decrease/don’t change) the Ms.

NS 67-70NS 67-70

Page 38: Janet  Yellen

71. 71. An An easy money policyeasy money policy will (apprec/deprec) the dollar & (incr/decr) U.S. Xn. will (apprec/deprec) the dollar & (incr/decr) U.S. Xn. A A tight money policytight money policy will (apprec/deprec) the dollar & (incr/decr) U.S. Xn. will (apprec/deprec) the dollar & (incr/decr) U.S. Xn.72. If the economy were in a 72. If the economy were in a severe recessionsevere recession, , proper monetary policyproper monetary policy would call would call for (lowering/raising) the discount rate, for (lowering/raising) the discount rate, (lowering/raising(lowering/raising) the RR, & (buying/selling)) the RR, & (buying/selling) bonds. Proper bonds. Proper fiscal policyfiscal policy would be to (incr/decr) “G” & (incr/decr) “T”, both of would be to (incr/decr) “G” & (incr/decr) “T”, both of which would result in a bugetary (deficit/surplus). which would result in a bugetary (deficit/surplus).

NS 71-72NS 71-72

Page 39: Janet  Yellen

1. If your bankbank borrows $50,000 from the FedFed, 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 FedFed buys $100 mil. of securities from the publicpublic, then: MSMS is increased by ________. PMC is _________. TMS is ________.3. What will cause the Dt(& total demand) for money curve to shift rightDt(& total demand) for money curve to shift right? (increase/decrease) in nominal (money) Y?4. When the FedFed buys bonds from banksbuys bonds from banks [or gives them a loan], DD are (incr/decr/ unchanged) but their ER & TR both (incr/decr/unchanged).5. If the FedFed buys $10 million of securities from the publicpublic, with a RR of 40%, MSMS is increased by ________ & PMC is _________. TMS is ________.6. If the FedFed decreased the RR from 20% to 10%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 systemcommercial banking system with TR of $40,000. PMC in the banking system is ($240,000/$60,000).8. If you are estimating your expensesestimating your expenses for the prom at $3,000for the prom at $3,000, money is functioning as (unit of account/medium of exchange/store of value).

MoneyMoney, , BankingBanking, , && FedFed Test Review 1-8Test Review 1-8

NoNo NoNoYesYes $500,000$500,000 $500,000$500,000

$100 $100 mil.mil. $100 $100 milmil.. $200$200 mil. mil.

$10 $10 mil.mil. $15 $15 mil.mil. $25 mil.$25 mil.

Page 40: Janet  Yellen

YYRR Real GDPReal GDP

DDMM

InvestmentDemand

No

min

al I

nte

rest

Rat

e

10

8

6

0Money MarketMoney Market QQIID1D1

NS 9. “NS 9. “Easy MoneyEasy Money” During ” During RecessionsRecessionsMSMS11

ASADAD11

P1

10

8

6

0

MSMS22

P2

Pri

ce l

eve

l

BuyBuy

If there isIf there is RECESSIONRECESSIONMS will beMS will beincreasedincreased..

QQIID2D2

DDII

Y*Y*

9.9. “Easy Money” “Easy Money” – – ((Buy/Sell) Buy/Sell) bonds,bonds,whichwhich (increase/decrease)(increase/decrease) MS, MS, which which (increase/decrease) interest rates, (increase/decrease) interest rates, which (appreciate/depreciate)which (appreciate/depreciate)the the dollar, dollar, whichwhich (increase/decrease)(increase/decrease)C, C, IIg,g, & & Xn, Xn, which which (increase/decrease(increase/decrease))AD & therefore, PL, GDP, & emp. AD & therefore, PL, GDP, & emp. EE11

EE22

ADAD22

Jobs are Jobs are tough to get.tough to get.

LRASLRAS

““Students, should the Fed Students, should the Fed buybuy or or sell sell bonds to bonds to jumpstart this economy?”jumpstart this economy?”

Page 41: Janet  Yellen

DDII

ADAD11

YYII

DDmm

InvestmentInvestmentDemandDemand

Nom

inal In

tere

st

Rate

10

88

6

00Money MarketMoney MarketQIDQID2 2 ASAS

10

8

6

0

PP22

MSMS11

PP11

MSMS22

If there isIf there isINFLATIONINFLATION,,MS will beMS will bedecreased.decreased.

SellSell

QIDQID11

YY**

NS 10. “NS 10. “Tight MoneyTight Money” during ” during InflationInflation

10. 10. “Tight Money”“Tight Money” – (Buy/Sell) – (Buy/Sell)bonds, bonds, whichwhich (incr/decr) the MS,(incr/decr) the MS,whichwhich (incr/decr) in. rates, (incr/decr) in. rates, whichwhich (apprec/deprec) the dollar,(apprec/deprec) the dollar,which (incr/decr) C, Ig, & Xn,which (incr/decr) C, Ig, & Xn,whichwhich (incr/decr) AD, PL, (incr/decr) AD, PL,&& GDP. GDP.

EE11

EE22

ADAD22

““Now, should Now, should I I buybuy or or sellsell?”?”

““I’ll get rid of I’ll get rid of some money.”some money.”

LRASLRAS

Page 42: Janet  Yellen

RR RR is is 20% Assets20% Assets DDDD (Liabilities)(Liabilities) TR[RR+ER]=$20 TR[RR+ER]=$20 mil.mil. $100 million$100 million

11. How much can this11. How much can this bankbank loan out? $______loan out? $______12. If Pam AndersonPam Anderson puts $1,000$1,000 in this bankbank(DDDD),ER will increase by $_______.

13. Possible Money Creation in the system could be $$_______.

14. Potential Total Money Supply could be as much as $$________.

00

800800

4,0004,000

5,0005,000

TR 11-14TR 11-14 MSMS = = CurrencyCurrency + + DDDD of of PublicPublic

Page 43: Janet  Yellen

RR RR is is 25% Assets25% Assets DDDD (Liabilities)(Liabilities) TR[RR+ER]=$25 TR[RR+ER]=$25 mil.mil. $100 million$100 million

1.1. How much can thisHow much can this bankbank loan out? $______loan out? $______2. If Pam AndersonPam Anderson puts $4,000$4,000 in this bankbank(DDDD),ER will increase by $_______.

3. Possible Money Creation in the system could be $$_______.

4. Potential Total Money Supply could be as much as $$________.

00

3,0003,000

12,00012,000

16,00016,000

MSMS = = CurrencyCurrency + + DDDD of of PublicPublic

Page 44: Janet  Yellen

RR RR is is 20% Assets20% Assets DDDD(Liabilities)(Liabilities)

TR[RR+ER] = TR[RR+ER] = $20 mil.$20 mil. $100$100 million million

11. How much can11. How much can Pam’s Pam’s bankbank loan out?loan out? $$____________12. If Pam Anderson’s BankPam Anderson’s Bank borrows $1,000 from the FedFed ER will increase by $$_______.

13. Possible Money Creation in the system could be $$_______.

14. Potential Total Money Supply could be as much as $$________.

00

1,0001,000

5,0005,000

5,0005,000

TR 11-14TR 11-14 MSMS = = CurrencCurrency + y + DDDD of of PublicPublic

PPam am AAnderson’snderson’s Bank Bank FedFed

Page 45: Janet  Yellen

RR RR is is 40% Assets40% Assets DDDD (Liabilities)(Liabilities) TR[RR+ER]=$40 TR[RR+ER]=$40 mil.mil. $100 million$100 million

1. How much can this bank loan out? $______1. How much can this bank loan out? $______2. If Cameron DiazCameron Diaz puts $10,000$10,000 in this bankbank(DDDD), ER will increase by $$_________.

3. Possible Money Creation in the system could be $$________.

4. Potential Total Money Supply could be as much as $$_________.

00

6,0006,000

15,00015,000

25,00025,000

Extra PracticeExtra Practice MSMS = = CurrencyCurrency + + DDDD of of publicpublic

Cameron fell in March, 2005 and had to haveCameron fell in March, 2005 and had to have

19 stitches19 stitches in her head but she is OK now.in her head but she is OK now.

Page 46: Janet  Yellen

RR RR is is 50% Assets50% Assets DDDD(Liabilities)(Liabilities)

TR[RR+ER] = TR[RR+ER] = $50 mil.$50 mil. $100$100 million million

11. How much can 11. How much can Cameron’s Cameron’s bankbank loan out? $______ loan out? $______12. If Cameron Diaz’s BankCameron Diaz’s Bank borrows $5,000 from the FedFed ER will increase by $$_______.

13. Possible Money Creation in the system could be $$________.

14. Potential Total Money Supply could be as much as $$________.

00

5,0005,000

10,00010,000

10,00010,000

Extra PracticeExtra Practice MSMS = = CurrencyCurrency + + DDDD of of PublicPublic

Cameron Diaz’s BankCameron Diaz’s Bank FedFed

Page 47: Janet  Yellen

15. If the 15. If the goal is F.E.goal is F.E., , & the& the interest rateinterest rate is is 9%9%, a(an) (recess/, a(an) (recess/ inflat) gap exists, the inflat) gap exists, the FedFed should (incr/decr) the in. rate. should (incr/decr) the in. rate.16. If the 16. If the interest rate isinterest rate is 3% 3%, a(an) (recess/inflat) gap exists, , a(an) (recess/inflat) gap exists, the the FedFed should (increase/decrease) the interest rate. should (increase/decrease) the interest rate.17. I17. If the f the interest rateinterest rate is is 6%6%, the the Fed Fed shoulshould d (incr/decr/do nothing)(incr/decr/do nothing) to the interest rate. to the interest rate. 18.18. To To reduce reduce inflationinflation,, the the Fed Fed should should (lower, lower, buy/raise, raise, sell)(lower, lower, buy/raise, raise, sell)

19. 19. To get out ofTo get out of a a recessionrecession, , the the Fed Fed should should (lower, lower, buy/raise, raise, sell)(lower, lower, buy/raise, raise, sell)

YYRR YY** Investment Demand

99%%

6%6%

33%%

0

Money MarketMoney Market $50$50 $60$60

AS

ADAD11

PLPL11

99%%

66%%

33%%

00

MSMS22ADAD22

PLPL22

$70$70 YYII

ADAD33DDII

DDmm

PLPL33

MSMS11 MSMS33

$100$100 120120 140140 QQIIDD

II=$50]=$50] II=$60=$60

II=$70=$70

RDORDO

Page 48: Janet  Yellen

The EndThe End

Page 49: Janet  Yellen

Review of Money Creation,Review of Money Creation,The Fed, & Monetary PolicyThe Fed, & Monetary Policy

Page 50: Janet  Yellen
Page 51: Janet  Yellen

$1,000.00$1,000.00 600.00600.00

$1,000 DD by Katy [MSMS==CurrencyCurrency++DDDD ofof PublicPublic]

MSMS grows by multiple of 2.52.5

360.00360.00

216.00216.00

129.60129.60

600.00600.00

360.00360.00

216.00216.00

Katy’s DDKaty’s DD + + PMC PMC == TMSTMS

$400.00$400.00

$240.00$240.00

$144.00$144.00

$86.40$86.40

$1,000.00$1,000.00 + + $1.500.00$1.500.00 = = $2.500.00$2.500.00

$1,500.00$1,500.00PMC = ER[$800 x M[5]PMC = ER[$800 x M[5] PMC =PMC =

New DepositsNew Deposits[New Reserves][New Reserves]

DDDD

New RequiredNew RequiredReservesReserves

RR=40%RR=40%

DDDD Created By Created ByNew LoansNew Loans

[equal to new ER][equal to new ER]BankBank

AA

BB

CC

DD

$600 to Michael $600 to Michael Jackson for Jackson for

dance lessonsdance lessons

Prom dateProm datewith Britneywith Britney

PPracticeractice cigarette cigarettecessation lessonscessation lessonswith Bruce Willis with Bruce Willis

600.00600.00

Prom dateProm datewith with NapoleonNapoleon

DynamiteDynamite

Page 52: Janet  Yellen

Money SupplyMoney Supply = = DDDD ++ CurrencyCurrency of theof the PublicPublic “PMC” “PMC”“TMS”

ER Loans Crea. In “Potential”

$100$100[[1010% RR% RR]] [1st Bank] [1st Bank] System Total MSBanksBanks//Public Public DDDD [[$100$100]] $90$90 $90 $900 $1,000$90 $900 $1,000

FedFed //PublicPublic//BBanksanks DDDD[[$100$100] ] $90$90 $90 $900 $1,000$90 $900 $1,000 [[**FedFed buys bonds frombuys bonds from publicpublic who put the money in theirwho put the money in their DDDD]]

BBanksanks//FedFed FedFed LLoanoan[$[$100100]] $100$100 $100 $1,000 $100 $1,000 $1,000$1,000

[or sells bonds to[or sells bonds to FedFed]]

“ “PMC” “PMC”PMC” “PMC” “TMS” “TMS” ERER Loans Loans CCrea.rea. In “Potential” In “Potential”

$100$100 [[2020% RR% RR]] [1[1stst Bank] Bank] [[11stst Bank] Bank] SystemSystem Total MSTotal MSBanksBanks//PublicPublic DDDD [[$100$100]] $80 $80 $80 $400 $500$80 $400 $500

FedFed//PublicPublic//BBanksanks DDDD [[$100$100]] $80$80 $80 $400$80 $400 $500 $500 [[**FedFed buys bonds frombuys bonds from publicpublic who put the money in theirwho put the money in their DDDD]]

BanksBanks//FedFed FedFed L Loanoan[$100[$100]] $100$100 $100 $500$100 $500 $500 $500 [or sells bonds to[or sells bonds to FedFed]]

Page 53: Janet  Yellen

1. If the RR is 40% and the FedFed buys $100 M of bonds from the publicpublic[Matt][Matt], then the MSMS is increased by _____. ER are increased by ______. PMC is _______. TMS would be ______.2. RR is 50% and the Farrell BankFarrell Bank borrows $100 M from the FedFed. As a result, RR are increased by ______. ER is increased

by _______. PMC and TMS is increased by ________.3. BBrockmanrockman BankBank has DDDD of $400,000 and the RR is 25%. If RR and ER are equal, then TR are _______.4. The RobertsRoberts BankBank has ER of $60,000 & DD is $200,000. If the RR is 20%, TR are _________.5. RR is 20% & the FedFed buys $50 million of bonds from the publicpublic[Beau][Beau].. The MSMS is increased by ____. ER are increased by _______. PMC is _______. TMS would be _________.

Additional Practice on Money CreationAdditional Practice on Money Creation

$100 M$100 M

$60 M$60 M $150 M$150 M $250 M$250 M

$100 M$100 M $200 M$200 M

$200,000$200,000

$100,000$100,000

$50 M$50 M

$40 M$40 M $200 M$200 M $$250 M250 M

00

BanksBanks PublicPublic FedFed

Page 54: Janet  Yellen

Hard Money Quizzes Coming UpHard Money Quizzes Coming Up

Page 55: Janet  Yellen

1.1. RR are 10% & there are no ER in the RR are 10% & there are no ER in the Meehan BankMeehan Bank. Spencer. Spencer depositsdeposits ( (DDDD) $200.00 there. This one bank can increase) $200.00 there. This one bank can increase its loans by a maximum of $______.its loans by a maximum of $______.2. RR2. RR are are 20%; 20%; the the Suchta BankSuchta Bank borrowsborrows $80,000 from the $80,000 from the FedFed.. This bank can increase its loans by a maximum of $______.This bank can increase its loans by a maximum of $______.3. RR3. RR areare 25%;25%; the the Fed Fed buys $8,000buys $8,000 of bonds of bonds from thefrom the PublicPublic[[TonyTony]].. PMC in the banking system PMC in the banking system could be as muchcould be as much as $_________. as $_________.4. The 4. The Norwood BankNorwood Bank has DD of $10 million; has DD of $10 million; RR are 20%; RR & ER are equal. TR are $_____________.RR are 20%; RR & ER are equal. TR are $_____________.5. The 5. The McGahran BankMcGahran Bank, with no ER, borrows $20 M from the , with no ER, borrows $20 M from the FedFed.. WithWith a a RRRR of of 50%, PMC 50%, PMC in thein the banking system banking system could be could be $____.$____.6. RR6. RR are are 40%;40%; the the FedFed buys $100 M buys $100 M of bonds from the of bonds from the PublicPublic[[ErinErin].].

PPotential otential MMoney oney CCreationreation in the banking system could be $____. in the banking system could be $____.7. RR 7. RR areare 50%; the 50%; the Fitzharris BankFitzharris Bank borrows $40 M from the borrows $40 M from the FedFed;; this single bank’s ER are increased by $_______________.this single bank’s ER are increased by $_______________.8. RR8. RR are are 50%; 50%; FedFed buys $50 billionbuys $50 billion of of bonds bonds from the from the PublicPublic[[NateNate]].. PPotentialotential T Total otal MMoneyoney Supply (TMS) could Supply (TMS) could be asbe as much as $____. much as $____.9. The RR9. The RR is is 40%. T40%. The he FedFed buys $20 Mbuys $20 M of of bonds bonds from the from the LittleLittle BBankank.. Potential Money Creation in the banking system is $______.Potential Money Creation in the banking system is $______.10. N10. No o ER ER in ain a bankbank & & RRRR is is 2525%. %. Lisa Lisa depositsdeposits ofof $$200. PMC200. PMC is is $____$____

Quiz 4Quiz 4 Commercial BankCommercial Bank FedFed PublicPublic

180.00180.00

80,00080,000

24,00024,000

4 million4 million

40 M40 M

150 M150 M

40 million40 million

100 B100 B

50 M50 Millionillion600600

RR+ER=TR; TR-RR=ER; TR-ER=RR; MxER=PMC; PMC[RR+ER=TR; TR-RR=ER; TR-ER=RR; MxER=PMC; PMC[PublicPublic]+1]+1stst DD=TMS; PMC[ DD=TMS; PMC[FedFed]= TMS]= TMS

Page 56: Janet  Yellen

Quiz 5Quiz 5 Commercial BankCommercial Bank FedFed PublicPublic

1.1. RRRR are are 50% & there 50% & there are noare no ER ER in ain a BankBank. Katy . Katy depositsdeposits ( (DDDD)) $10.00 there. This $10.00 there. This one bankone bank can increase its loans can increase its loans by by ?____.?____.2. RR are 50%; the 2. RR are 50%; the Bebeau BankBebeau Bank borrows $1 mil. from the borrows $1 mil. from the FedFed.. This bank can increase its loans This bank can increase its loans by aby a maximum of $_______. maximum of $_______.3. RR3. RR are are 40%;40%; the the FedFed buys $buys $100,000100,000 of of securitiessecurities from thefrom the PublicPublic.. Potential Total Money Supply could be as much as $______. Potential Total Money Supply could be as much as $______. 4. The 4. The Merkel BankMerkel Bank has DD of $400,000 and RR is 25%. has DD of $400,000 and RR is 25%. RR & ER are equal. Total Reserves are $_______________.RR & ER are equal. Total Reserves are $_______________.5. T5. The he Little BankLittle Bank, , with nowith no ER, borrows $200,000 ER, borrows $200,000 from thefrom the FedFed.. With RR of 40%, With RR of 40%, this onethis one bank can increase its loans bank can increase its loans by by $_________. $_________.6. RR6. RR are are 50%; 50%; the the FedFed buys buys $60,000$60,000 of of securities securities from thefrom the PublicPublic.. Potential Money Creation in the banking system is $_______________.Potential Money Creation in the banking system is $_______________.7. RR 7. RR areare 10%; the 10%; the Mosmeyer BankMosmeyer Bank borrows $150 million from the borrows $150 million from the FedFed. This single bank’s ER are increased by $__________.. This single bank’s ER are increased by $__________.8. RR are 25%; 8. RR are 25%; FedFed buys $200 M of securities from the buys $200 M of securities from the PublicPublic.. Potential Total Money Supply could be $_______________.Potential Total Money Supply could be $_______________.9. RR 9. RR are are 25% 25% & the& the FedFed buysbuys $40 M$40 M of of bonds bonds from thefrom the Flores BankFlores Bank.. PMC and TMS are both $___________.PMC and TMS are both $___________.10. RR 10. RR areare 20% & no ER in the 20% & no ER in the Edwards BankEdwards Bank. Steph . Steph depositsdeposits $125.00 there. PMC in the banking system is $__________.$125.00 there. PMC in the banking system is $__________.

5.005.00

1 million1 million

250,000250,000

200,000200,000

200,000200,000

60,00060,000

150 million150 million

800 million800 million

160 million160 million

500.00500.00

RR+ER=TR; TR-RR=ER; TR-ER=RR; MxER=PMC; PMC[RR+ER=TR; TR-RR=ER; TR-ER=RR; MxER=PMC; PMC[PublicPublic]+1]+1stst DD=TMS; PMC[ DD=TMS; PMC[FedFed]= TMS]= TMS

Page 57: Janet  Yellen

1.1. RRRR are are 40% & there 40% & there are noare no ER ER in ain a BanBankk. Bo . Bo depositsdeposits ( (DDDD)) $100.00 $100.00 there.there. T This his one bank can increase its can increase its loans by loans by $____.$____.2. RR are 10%; the 2. RR are 10%; the Farrell BankFarrell Bank borrows $9 mil. from the borrows $9 mil. from the FedFed.. This bank can increase its loans This bank can increase its loans by aby a maximum of $_______. maximum of $_______.3. RR3. RR is is 50%;50%; the the FedFed buys $10,000buys $10,000 of of securities securities from thefrom the PublicPublic.. Potential Total Money Supply could be as much as $______. Potential Total Money Supply could be as much as $______. 4. The 4. The Hovitz BankHovitz Bank has DD of $100,000 and RR is 40%. has DD of $100,000 and RR is 40%. RR & ER are equal. Total Reserves are $________________.RR & ER are equal. Total Reserves are $________________.5. T5. The he Richa BankRicha Bank, , with nowith no ER, borrows $500,000 ER, borrows $500,000 from thefrom the FedFed.. WWith ith RRRR of of 20%, 20%, this onethis one bank bank can increase its loans by $can increase its loans by $_____._____.6. RR6. RR are are 50%; 50%; the the FedFed buys buys $500,000$500,000 of of securities securities from thefrom the PublicPublic.. Potential Money Creation in the banking system is $______.Potential Money Creation in the banking system is $______.7. RR are 10%; the 7. RR are 10%; the McGahran BankMcGahran Bank borrows $5 million borrows $5 million from thefrom the FedFed.. This single bank’s ER are increased by $____________. This single bank’s ER are increased by $____________.8. RR are 10%; 8. RR are 10%; FedFed buys $10 M of securities from the buys $10 M of securities from the PublicPublic.. Potential Total Money Supply isPotential Total Money Supply is $_____________.$_____________.9. RR are 25% 9. RR are 25% & the& the FedFed buys buys $8 M$8 M of of bonds bonds from thefrom the Suchta BankSuchta Bank.. Potential Money Creation Potential Money Creation in the banking system isin the banking system is $________. $________.10. RR 10. RR are are 20% & no ER in the 20% & no ER in the Norwood BankNorwood Bank. Steph . Steph depositsdeposits $100.00 there. P$100.00 there. Potential otential Total Money Supply is $_________.Total Money Supply is $_________.

Quiz 6 Quiz 6 Commercial BanksCommercial Banks FedFed PublicPublic

60.0060.00

9 million9 million

20,00020,000

80,00080,000

500,000500,000

500,000500,000

5 million5 million

100 million100 million

32 million32 million

500.00500.00

RR+ER=TR; TR-RR=ER; TR-ER=RR; MxER=PMC; PMC[RR+ER=TR; TR-RR=ER; TR-ER=RR; MxER=PMC; PMC[PublicPublic]+1]+1stst DD=TMS; PMC[ DD=TMS; PMC[FedFed]= TMS]= TMS

Page 58: Janet  Yellen

Monetary Policy Questions from the 2005 Macro MC ExamMonetary Policy Questions from the 2005 Macro MC Exam(60%)(60%) 44. When the U.S. government engages in deficit spendingU.S. government engages in deficit spending, that spending is primarily financed byfinanced by a. increasing the required reserves ration b. borrowing from the World Bank c. issuing new bonds d. appreciating the value of the dollar e. depreciating the value of the dollar

(75%)(75%) 45. When the Fed buys government securitiesFed buys government securities on the open market, which of the following will decrease in the shortdecrease in the short runrun? a. Interest rates b. Taxes c. Investment d. The amount of money loaned by banks e. The money supply

(57%)(57%) 46. When a central bank sells securitiescentral bank sells securities in the open market, which of the following set of events is most likely to follow? a. An increase in the MS, a decrease in interest rates, and an increase in AD b. an increase in the MS, an increase in interest rates, and a decrease in AD c. An increase in interest rates, an increase in the government budget deficit, and a movement toward trade surplus d. A decrease in the MS, an increase in interest rates, and a decrease in AD e. A decrease in the MS, a decrease in interest rates, and a decrease in AD

Fed buying bonds incr MS, which decr the I.R.

Page 59: Janet  Yellen

(41%)(41%) 47. The federal funds ratefederal funds rate is the interest rate that a. the Fed charges the federal government on its loans b. banks charge one another for short-term loans c. banks charge their best customers d. equalizes the yield on government bonds and corporate bonds e. is equal to the inflation rate

(46%)(46%) 48. Assume that the government implements a deficit-reduction policygovernment implements a deficit-reduction policy that results in changes in aggregate income and output. Then the Fed engages in monetary policy actionsmonetary policy actions that reverse the changesreverse the changes in income and output caused by fiscal policy action. Which of the following sets of changes in taxestaxes, government government spendingspending, the RRRR, and the discount ratediscount rate is most consistent with these policies?

GovernmentGovernment RequiredRequiredTaxesTaxes SpendingSpending Reserve RatioReserve Ratio Discount RateDiscount Rate

a. Increase Increase Decrease Increase b. Increase Decrease Decrease No change c. Increase Decrease Increase Decrease d. Decrease Increase No change Increase e. Decrease Decrease Decrease Increase

(53)(53) 49. If the Fed institutes a policy to reduce inflationFed institutes a policy to reduce inflation, which of the following is most likely to increase? a. Tax rates b. Investment c. Government spending d. Interest rates e. GDP

The G would increase T and decr G to reduce the deficit which would reduce AD.To reverse this & incr AD, the Fed would decr the RR & decr the DR to lower the I.R.

Decr the MS to combat inflation would incr the I.R.

Page 60: Janet  Yellen

Monetary Questions From 2000 AP ExamMonetary Questions From 2000 AP ExamMoney and the FedMoney and the Fed1. (61%) In the Keynesian modelKeynesian model, an expansionary monetary policyexpansionary 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 ismore money is demanded than is supplieddemanded 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 thehold money rather than bonds because they expect the interest rate to increase in the futureinterest rate to increase in the future, they are holding money for what purposes? a. transactions

c. speculation (asset) b. unforeseen expenditures

d. illiquidity

Money CreationMoney Creation4. (80%) If on receiving a checking deposit of $300 a bank’s ER increased by $255checking deposit of $300 a bank’s ER increased by $255, the RRRR 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.

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5. (62%) The money-creating ability of the banking systemmoney-creating ability of the banking system will be less than thewill be less than the maximum amount indicated by the money multipliermaximum 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$10,000 cash is deposited in the bank, the maximum amount by which this bank may increase its loansthis bank may increase its loans is a. $2,000 b. $8,000 c. $10,000 d. $20,000 e. $50,0007. (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 FedFed and Monetary PolicyMonetary Policy8. (89%) The Federal ReserveFederal 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

Page 62: Janet  Yellen

9. (73%) An increase in the money supplyincrease in the money supply is most likely to have which of the following short-run effects on real interest rates and real outputshort-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)restrictive (contractionary) monetary policymonetary 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 FedFed can change the U.S. money supplychange 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 constantmoney 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.

Page 63: Janet  Yellen

13. (54%) Policy-makers concerned about fostering long-run growth in an economy that is currently in a recessionrecession would most likely recommend recommend which of the following combinations of monetary and fiscal policy actionscombinations 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 operationsOpen 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 theopen market sale of bonds by the FedFed will most likely change the money supplymoney supply, the interest rateinterest rate, and the value of the U.S. dollarvalue of the U.S. dollar in which of the following ways? Money SupplyMoney Supply

Interest RateInterest Rate

Value of the DollarValue of the Dollar a. increase

decrease

decrease b. increase

decrease

increase c. decrease

decrease

decrease d. decrease

increase

increase e. decrease

increase

decrease

Buying bonds will increase MS & decrease theBuying bonds will increase MS & decrease theinterest rate, increasing Ig. Reducing T wouldinterest rate, increasing Ig. Reducing T wouldcause a deficit, resulting in G borrowing andcause a deficit, resulting in G borrowing andhigher interest rates. Raising T or reducing Ghigher interest rates. Raising T or reducing Gwould would result in job losses, resultingresult in job losses, resulting in in negativenegativeprofit expectations, reducing Ig [LR growth].profit expectations, reducing Ig [LR growth].

Page 64: Janet  Yellen

1995 AP Exam1995 AP Exam16. (82%) Commercial banks can create moneyCommercial 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%RR is 20%, the existence of $100 worth of ERexistence of $100 worth of ER in the banking system can lead to a maximum expansion of the money supplymaximum expansion of the money supply equal to a. $20 b. $100 c. $300 d. $500 e. $750

18. (71%) If the Fed lowers the RRFed lowers the RR, which of the following would most likely occurmost 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 increasespublic’s desire to hold money as currency increases, what will the impact be on the banking systemimpact 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 More MS means means lower I.R. & more Iglower I.R. & more Ig

Holding currency means less ER & higher I.R.Holding currency means less ER & higher I.R.

5x$100=$5005x$100=$500

Page 65: Janet  Yellen

20. (86%) Which of the combinationscombinations is most likely to cure a severe recessioncure a severe recession? Open-Market OperationsOpen-Market Operations TaxesTaxes Gov. SpendingGov. 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 Increase21. (61%) The demand for moneydemand for money increases when national income increasesnational 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 future22. (76%) Suppose the RR is 20%RR is 20% and a single bank with no ER receives a $100 DDsingle bank with no ER receives a $100 DD from a new customer. The bank now has excess reserves equal tobank now has excess reserves equal to a. $20 b. $80 c. $100 d. $400 e. $50023. (45%) Which of the following is most likely to increasemost likely to increase if the public decides topublic decides to increase its holding of currencyincrease its holding of currency? a. the interest rate d. Employment b. The price level e. The reserve requirement c. Disposable personal income24. (47%) During a mild recessionmild recession, if policymakers want to reduce unemployment by reduce unemployment by increasing investmentincreasing 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; bankshave less; higher I.R.

Page 66: Janet  Yellen

25. (73%) Which of the following monetary and fiscal policy combinationsmonetary and fiscal policy combinations would most likely result in a decrease in AD? Discount RateDiscount Rate Open-Market OperationsOpen-Market Operations Gov. SpendingGov. 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 Decrease26. (35%) Under which of the following circumstances would increasing the MS be increasing the MS be most effective in increasing real GDPmost effective in increasing real GDP? Interest RatesInterest Rates EmploymentEmployment Business OptimismBusiness Optimism a. High Full High b. High Less than full High c. Low Full High d. Low Full Low e. Low Less than full Low27. (57%) According to both monetaristsmonetarists and KeynesiansKeynesians, 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%) AllAll of the following are components of the MSare components of the MS in the U.S. EXCEPTEXCEPT a. paper money b. gold bullion c. checkable deposits d. coins e. demand deposits

Page 67: Janet  Yellen

29. (47%) If the Fed undertakesFed undertakes a a policypolicy to to reduce interest ratesreduce interest rates, international capitalinternational capital flowsflows (financial capital like CDs, bonds) will be affectedwill 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 FedFed wishes to use monetary policy to reinforce Congress’ wishes to use monetary policy to reinforce Congress’ fiscal policy changesfiscal 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 interestrate from going up.

Lower U.S. interest rates will result in fewer capital inflows


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