lOMoARcPSD 46016802 Scan to open on Studocu Scan to open on Studocu Econ 103 pt3 Semester 1 notes Vazquez notes Econ 103 pt3 Semester 1 notes Vazquez notes Macroeconomic Principles University of Illinois at Urbana Champaign Macroeconomic Principles University of Illinois at Urbana Champaign Studocu is not sponsored or endorsed by any college or university Studocu is not sponsored or endorsed by any college or university Downloaded by Michael Urso murso0425 gmail com lOMoARcPSD 46016802 11 28 22 Monetary Policy If the Fed is buying bonds then it wants bond prices to rise and the federal funds rate to fall Interest rates and bond prices move in opposite directions What is monetary policy Can only control the quantity of money Two contradicting goals can t happen at the same time Economic growth with low unemployment Stable prices with moderate long term interest rates Expansionary Monetary Policy used in times of economic downturn to boost AD Contractionary Monetary Policy used when inflationary pressures build up in economy Increase money supply reduce interest rate AD shifts to the right Control prices increase interest rates AD shifts to the left How does the FED implement monetary policy 1 Change the reserve requirement leave a particular percentage of deposits in the bank a Lower reserve ratio can create more money b Money multiplier formula 1 Reserve Requirement 2 Change the discount rate the cost banks pay to maintain the reserve requirement 3 Open market operations a Selling and buying bonds b Fed sets a lower interest rate target Fed buys bonds in the open market Price of bond increases Money supply increases interest rates fall AD increases c Fed sets a higher interest rate target Fed sells bonds in the open market Price of bond decreases Money supply decreases interest rates rise AD decreases Review Bond issued 10 years ago had a face value of 2000 a coupon rate of 5 and a yield of 6 when it was sold last year in the secondary bond market At what price did the bond sell in the secondary market Interest payment Face value x Coupon rate 2000 x 0 05 100 Price of bond Interest payment Yield 100 0 06 1666 Downloaded by Michael Urso murso0425 gmail com lOMoARcPSD 46016802 The federal government can finance its debt by all of these measures except increase the federal funds rate Monetary policy is the LEAST effective in reversing an adverse supply shock Government cannot control supply When interest rates rise exports fall and imports rise Not producing as many goods because of high interest rates Higher interest rates slower economic activity Lower interest rates lower economic activity Interest rates rise domestic investment is more attractive domestic currency appreciates If the Federal Reserve pursues an expansionary monetary policy US exports to other countries will rise Which of the following is likely to lead to higher interest rates anything that reduces supply or increases demand government program that provides taxpayers eiyh additional incentives to invest in their retirement plan Assume the reserve requirement is 10 and no excess reserves are held If an initial cash deposit of 10000 is made the money supply has a potential increase of Money Multiplier 1 Reserve Requirement 1 0 1 10 10000 10 100000 Suppose the economy is in full employment equilibrium Then a positive supply shock caused by a fall in oil prices hits the economy An expansionary monetary policy will stabilize prices but at a much higher output level in the short run If monetary policy is tight the value of the dollar will rise Increase in Federal Funds Rate USD appreciates exports decrease more difficult for firms to obtain loans If the Fed reduces the money supply through open market operations bond prices fall Reduce money supply higher interest rate less speculative demand for money When the Fed does begin to reduce bond purchases interest rates will rise As interest rates rise there is a movement upward along the supply curve for loanable funds If a country s currency appreciates what impact will it have on aggregate demand or aggregate supply SRAS will rise due to lower prices on imported goods Downloaded by Michael Urso murso0425 gmail com lOMoARcPSD 46016802 Which group benefits from an unanticipated rise in the inflation rate Homeowners with fixed rate mortgages Taxes are components of consumer spending that affect aggregate demans When an economy is at full employment expansionary fiscal policy produces no long run increase in real output Jody purchases a stock from her employer Acme Corporation This is an example of direct finance What is likely to happen if the government runs a budget surplus Additional loanable funds are provided to the market leading to lower interest rates As real interest rate rises the quantity demanded of loanable funds rises Decrease money supply sell bonds When the Fed buys bonds its demand increases the price of bonds decreasing nominal interest rates A lower interest rate increases consumption investment and exports which increases aggregate demand Which group is most likely to favor a tight monetary policy Importers With a negative supply shock the Federal Reserve has to decide whether to increase inflation and decrease unemployment or decrease inflation and increase unemployment Monetary policy is LEAST effective in maintaining low inflation and high GDP when there has been a supply shock In counteracting a negative supply shock the Federal Reserve could achieve full employment but not price stability by using expansionary monetary policy Suppose the economy is in full employment equilibrium Then a positive supply shock caused by a fall in oil prices hits the economy A contractionary monetary policy wil move the economy back to full employment output but at a much lower price level When prices are falling real GDP tend to be greater than nominal GDP for the same year Downloaded by Michael Urso murso0425 gmail com lOMoARcPSD 46016802 If interest rates fall the burden of a nation s public debt will fall and it will be less difficult to service its debt Financial intermediaries match borrowers with savers The reason bond prices and interest rates are inversely related is because the coupon payment is fixed for the life of a bond If the Federal Reserve decides to increase the money supply the federal funds rate will fall Which action is the Federal Reserve most likely to take to curb inflation Sell securities in the open market When the interest rate falls American