Chapter 15- Monetary Policy

Which of the scenarios best reflects the meaning of the term inflation targeting?

A central bank is expected to achieve a 3% annual inflation rate.

In anticipation of the upcoming election, the chairman of the Federal Reserve lowers interest rates, hoping to win support for the incumbent president.

Hoping to reduce inflation to improve public opinion, the Federal Reserve decides to lower interest rates.

A local shopping mall offers an "inflation discount," which compensates for the recent increase in prices, in the hopes of targeting savvy consumers.
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Which of the scenarios best reflects the meaning of the term inflation targeting?

A central bank is expected to achieve a 3% annual inflation rate.

In anticipation of the upcoming election, the chairman of the Federal Reserve lowers interest rates, hoping to win support for the incumbent president.

Hoping to reduce inflation to improve public opinion, the Federal Reserve decides to lower interest rates.

A local shopping mall offers an "inflation discount," which compensates for the recent increase in prices, in the hopes of targeting savvy consumers.
A central bank is expected to achieve a 3% annual inflation rate.
What does the term money neutrality mean?

Because the Federal Reserve is relatively free from oversight, it can take actions that are unpopular if they are in the best interest of the country.

Changes in the money supply impact everyone in an economy in a similar way.

Changes in the money supply have no real effects on the economy in the long run.

Changes in the money supply and the price level are inversely related and proportional, meaning that a 10% increase in the money supply decreases prices by exactly 10%.
Changes in the money supply have no real effects on the economy in the long run.
If money is neutral, what does this imply about the use of monetary policy?

Monetary policy can influence the price level but cannot be used to encourage economic growth.

Mechanisms should be introduced to ensure that the Federal Reserve is making sound decisions.

Monetary policy is more effective in the short term than the long term.
Monetary policy is more effective in the short term than the long term.
What happens to the aggregate price level when the central bank increases the money supply?

It increases.
There is not enough information.
It decreases.
It does not change.
It increases.
Classify each statement as either true or false.

a. If two short-term assets offer different interest rates, then investors will move their wealth towards the asset with the lower return.
false
Classify each statement as either true or false.

b. There is no practical difference between long-term interest rates and short-term interest rates.
false
Classify each statement as either true or false.

c. Money demand is affected by short-term interest rates and not long-term interest rates.
true
Classify each statement as either true or false.

d. Interest rates on financial assets that mature in ten months or less are long-term interest rates.
false
Classify each statement as either true or false.

e. The opportunity cost of holding money falls when short-term interest rates fall.
true
How can the Federal Reserve raise interest rates?

use open market operations to reduce the money supply

use open market operations to increase the money supply

raise fees for automatic teller machines (ATMs)

increase the velocity of money

increase the opportunity cost of holding money by raising the rate of inflation
use open market operations to reduce the money supply
Select the answers that correctly complete the given statements. A decrease in real GDP causes a ______________ the money demand curve. An increase in technology which makes it easier to pay for goods and services without carrying lots of cash causes a_____________________ the money demand curve. A decrease in interest rates causes a _________________ the money demand curve. An increase in the aggregate price level causes a ____________________ the money demand curve. examples leftward shift of movement along rightward shift ofleftward shift of leftward shift of movement along rightward shift ofThe monetary transmission mechanism:how a change in monetary policy works its way through the economy, eventually affecting the economy's output and inflation rateZero lower bound for interest rates:interest rates can't go below zero without causing significant problems.Running up against the zero lower bound:when inflation is low and the economy is below potential, normal monetary policy runs out of room to operate because short-term interest rates are already at or near zero.Causality problem:high interest rates go along with a strong economy; low interest rates go along with a weak economy.When the economy is already at potential output, an increase in the money supply generates __________a positive short-run effect, but no long-run effect on real GDP.Monetary neutrality:changes in the money supply have no real effect on the economy.Money is __________ in the long run.neutralIn the ___________, changes in the money supply does not affect the interest rate.long runThe quantity equation definition:the relationship between nominal GDP and the amount of money exchangedWhat is the quantity equation and what does each letter mean ?M × V = P × Y M = the level of the nominal money supply V = velocity of money (the average number of times a dollar is spent per period) P = aggregate price level Y = aggregate real output (real income)When the central bank increases money supply, M × V ________, and the nominal GDP rises _____________.rises proportionatelyThe rise in nominal GDP must ____________________ in the aggregate price level, P.come entirely from a proportional increaseDo increases in the money supply really lead to equal percentage rises in the price level?It's not exact, but yes.Who is the most powerful person in the government?The governor of the Bank of Canada is arguably the most powerful position in the Canadian government. (Tiff Macklem, current governor)Short-term interest rates:the interest rates on financial assets that mature in less than a yearLong-term interest rates:interest rates on financial assets that mature a number of years in the futureThe higher the interest rate, The lower the interest rate,the higher the opportunity cost of holding money the lower the opportunity cost of holding moneyThe money demand curve shows the relationship ____________ What direction does it slope?the quantity of money demanded and the interest rate. It slopes downward. - A higher interest rate reduces the quantity of money demanded. - A lower interest rate increases the quantity of money demanded.Which demand curve slopes downward?Money Demand CurveWhat shifts the money demand curve? (4 changes)1. Changes in aggregate price level - Higher prices mean we need more money for transactions (and vice versa). 2. Changes in real GDP - More goods and services produced and sold means we need more money (and vice versa). 3. Changes in credit markets and banking technology - The ease of credit cards reduces the need for cash. 4. Changes in institutions - For example, when banks introduced new chequable savings accounts that payed interest, the opportunity cost of holding funds in chequing accounts fell and the demand for money rose.What model asserts that the interest rate is determined by the supply and demand for money? And how does It decide this?The liquidity preference model of the interest rate It combines the money demand curve, MD, with the money supply curve, MS, which shows how the quantity of money supplied varies with the interest rate.The target for the overnight rate: How does the Bank of Canada adjust the money supply to fix the Overnight rate?the desired level for the overnight rate Then the BOC adjusts the money supply by buying and selling Treasury bills until the overnight rate reaches the target.When the economy is producing at a short-run level of aggregate output that is less than potential output, it is most likely that the BOC will engage in open-market: a) purchases of Treasury bills. b) sales of Treasury bills.Answer is A) purchases of Treasury BillsLong-term rates reflect expected future monetary policy, which largely depends on________the future economic outlook.Are long-term or short-term rates usually higher? Why are they higher?Long-term rates are usually higher than short-term rates because long-term bonds and loans carry extra risk.Expansionary monetary policy:monetary policy that increases aggregate demand (also called loose monetary money policy)Contractionary monetary policy:monetary policy that reduces aggregate demand (also called tight monetary policy)If the interest rate on Ed's checking account is 0.50 percent and the interest rate on the certificate of deposit (CD) that he is considering is 3 percent, then the opportunity cost of holding money is _____ percent. 0 2 2.50 3.502.50When inflation is low and the economy is operating far below potential, expansionary monetary policy can run out of room to operate due to: too few Treasury bills. the zero bound for interest rates. too many Treasury bills. quantitative easing.the zero bound for interest rates.If the economy is in long-run equilibrium at potential output and the money supply ______, then in the long run, prices will _____ and output will remain the same. increases; remain the same decreases; increase decreases; remain the same decreases; decreasedecreases; decreaseWhen people offering to sell nonmonetary financial assets must increase the interest rate these assets pay in order to sell them, this reveals that the: quantity of money demanded is greater than the quantity of money supplied. money supply curve is unimportant in determining the equilibrium level of interest rates in the liquidity preference model. quantity of money demanded is less than the quantity of money supplied. quantity of money supplied equals the quantity of money supplied.quantity of money demanded is greater than the quantity of money supplied.The Bank of Canada will most likely raise the interest rate if the: inflation rate is falling. actual real GDP is below potential GDP. economy is experiencing a recessionary gap. economy is experiencing an inflationary gap.economy is experiencing an inflationary gap.If the Bank of Canada buys Treasury bills, as the economy adjusts to the long run equilibrium: the interest rate fluctuates wildly up and down. the interest rate rises .the interest rate falls .the interest rate does not change.the interest rate risesThe zero lower bound for interest rates implies that: there is a limit to contractionary monetary policy. there is a limit to expansionary monetary policy. negative interest rates are often targeted by central banks. the Bank of Canada cannot stimulate the economy by engaging in open market purchases.there is a limit to expansionary monetary policy.