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money banking financial markets

Questions and Answers of Money Banking Financial Markets

you read in the financial press that the recent flight to quality is reversing. What will happen in the bond market?a. Yields of US Treasury bonds will decrease relative to the yields of corporate
Offer an explanation to someone with no training in economics for why the yield on US government bonds is used as a substitute for the risk-free rate.
Firms borrowing in developing countries such as Brazil often have to pay a higher default risk premium, ceteris paribus, than similar firms borrowing in the United States. Explain why this is the
You read in the financial press that the economy of Finland is sliding into a recession. What will happen in the bond market and the loanable funds market in Finland, ceteris paribus?a. Bond prices
Explain why a change in the demand for loanable funds may not change the supply of bonds.
Explain why changes in the demand for bonds change the supply of loanable funds.
Assume the loanable funds market is in equilibrium. An increase in the demand for loanable funds will result in a __________ equilibrium interest rate as the quantity of loanable funds demanded
During the Reagan Administration in the 1980s, while the US government was running large government budget deficits, the rest of the world was also bringing large amounts of their savings to the
During the Reagan Administration in the 1980s, the US government ran large government budget deficits, which many argued would slow down the US economy. Using the loanable funds framework, explain in
If the market price for bonds is higher than the equilibrium price, what is the result, and what will change to bring about equilibrium as price falls, ceteris paribus?a. Shortage; quantity
Stories appear in the financial press reporting two economic developments: Wealth levels in the United States are increasing, while at the same time the relative riskiness of bonds issued by American
You read in the financial press that market participants expect stock prices to increase dramatically in the near future, while at the same time business confidence is increasing. Explain in words
If a three-year bond with a $1,000 face value has a coupon rate of 3.5%, and the current market interest rate is 2%, what is the market price of the bond?a. $956.75b. $1,035.00c. $1,043.07 *d.
If you have a bond with a face value of $1,000 and a coupon rate of 2.5%, but the market interest rate for such bonds is 2.25%, will your bond sell at par, at a premium, or at a discount? Explain
If you have a bond with a face value of $1,000 and a coupon rate of 2.25%, but the market interest rate for such bonds is 2.5%, will your bond sell at par, at a premium, or at a discount? Explain
The rate of interest a bond pays is called the bond’s:a. Face value.b. Coupon rate.c. Bond rating.d. Rating rate.
The fact that the face value of a bond does not change over the life of the bond is generally considered a benefit to the borrower. Can you explain why?
Today, shoppers “clip coupons” before they go shopping. Explain how these modern coupons are similar and dissimilar to the “coupons” referred to in the bond market.
If the annual interest rate is 2%, what is the quarterly interest rate?a. 0.0204b. 0.0166c. 0.005d. 0.001
What is the future value of $500 in two years if the interest rate is 4%? How would you explain this to someone who has no training in economics?
Each person might have a different time preference. Explain why an older person might have a higher or lower time preference than a young person.
Which of the following is the most broad or most inclusive measurement of the money supply?a. M1b. M2c. M3d. M0
A critic of money economics once stated, “if you cannot measure the money supply accurately, it is not worth discussing at all.” How would you refute this statement?
Ricardo and Friedman agree that if the money supply increases “too quickly” the following happens:a. The rate of inflation decreases.b. The rate of real economic growth increases.c. The rate of
Proponents of the Gold Standard, or using gold as money, often argue that it will keep inflation under control. How does the experience of Europe in the sixteenth century raise doubts about that
Bobby is confused. He states: “Since prisoners are not allowed to smoke in prisons any longer, Radford’s examples of cigarettes in POW camps no longer applies.” How would you explain to Bobby
You read a news story about a country that is suffering from rapid, ongoing increases in the cost of living. Which characteristic of money is being directly negatively impacted in that economy?1.
How many prices must a barter economy have if the economy has four goods? What if it has 400 goods? Explain why having a money in the second case is beneficial.
What is the difference between money and currency? When are they the same? Why might they be different?
In a speech in 2016, Fed Chair Janet Yellen noted that there is some uncertainty in measuring the natural rate of unemployment:“it cannot be estimated precisely, and so it could be appreciably
An article in the Wall Street Journal in late 2015 noted: “One economic trend that hasn’t done its bit for this 6½-year recovery: capital spending.” Given that interest rates were at
If consumption spending becomes more sensitive to changes in the real interest rate, how will the slope of the IS curve be affected?
In testifying before Congress in mid-2012, then Fed Chairman Ben Bernanke noted that the economic recovery “could be endangered by the confluence of tax increases and [government] spending
A columnist in the Economist asserts: “I would argue that the Fed has been targeting very low inflation, and falling inflation expectations imply much lower interest rates in future.”a. Will
How would the size of the multiplier affect the slope of the IS curve?
Suppose the Fed is concerned that deflation will harm the economy over the long run. Use the IS–MP model (including the Phillips curve) to analyze how the Federal Reserve would fight deflation.a.
A Federal Reserve publication remarks: “For Okun’s law to be useful as a rule of thumb, the relationship between real GDP growth and the unemployment rate needs to be stable across time.”a.
In each of the following situations, briefly explain whether the IS curve will shift and, if it does shift, in which direction it will shift:a. Consumers become more optimistic about their future
In his memoirs, published in 2014, former Treasury Secretary Timothy Geithner observed:“Eventually, Congress will have to make some tough choices about the mortgage market—not just how to reduce
In each of the following situations, briefly explain whether the short-run Phillips curve with the unemployment rate on the horizontal axis will shift, and if it does shift, in which direction it
John Maynard Keynes wrote that one requirement for a stable economy was that “the multiplier … is greater than unity but not very large.” Why might a large value for the multiplier make an
An article on the U.S housing market in the Economist notes: “The status quo also means that, in the event of another crash, taxpayers would be landed with a big bill.” Explain what aspect of the
In a lecture, Fed Chair Janet Yellen remarked:“The Phillips-curve approach to forecasting inflation has a long history in economics, and it has usefully informed monetary policy decision making
Economists debate whether the Federal Reserve, Congress, and the president should adopt an activist stabilization policy that attempts to “finetune” the economy—that is, smooth almost every
An article in the Economist in 2016 argued: “If the Fed wants higher nominal rates in a world of low real rates, it must cultivate higher inflation.” Briefly explain the author’s reasoning.
Briefly explain whether you agree with the following argument:Potential GDP is the level of real GDP attained when all firms are producing at capacity. Firms have the capacity to operate 24 hours per
Use the following data to calculate the values of equilibrium output and the investment spending multiplier:C = MPC × Y = 0.75 × YI̅ = $2.3 trillionG̅ = $1.7 trillionN̅X̅ = - $0.5 trillio
For a brief period in 2008 and 2009, the U.S. Treasury guaranteed investors against losses on their holdings of money market mutual fund shares. If the program had become permanent, how would it have
John Hicks, in his original macroeconomic model, the IS–LM model, developed the LM curve to show the combinations of the real interest rate and output that result in equilibrium in the money
An article in the Wall Street Journal in 2016 noted:“The 2016 rally in government bond prices has taken U.S. real yields … on the 10-year Treasury … below zero for the first time since 2012.”
Give an example of a shock that could shift the IS curve to the left. Give an example of a shock that could shift the IS curve to the right.
Would you expect the bank lending channel (as it operates through commercial banks) to have a larger or a smaller effect in emerging economies, such as Brazil or India, than in the United States?
John Maynard Keynes developed a model, later elaborated by John Hicks, in which total output is determined solely by total spending with little consideration of the supply (production) side of the
What is Okun’s law, and how can it be used to derive an output gap Phillips curve?
Explain how the IS curve represents equilibrium in the goods market. Why is the IS curve downward sloping?
In the bank lending channel as it operates through commercial banks, an expansionary monetary policy is not dependent for its effectiveness on a reduction in interest rates, and a contractionary
Use the IS–MP model (including the output gap Phillips curve) to analyze how the Federal Reserve would respond to a large positive demand shock. Assume that the economy was in longrun macroeconomic
What factors cause the Phillips curve to shift?
Go to the web site of the Federal Reserve Bank of St. Louis Federal Reserve (FRED) (fred.stlouisfed.org) and download data from January 2003 to the most recent available month on the 10-year constant
When the Federal Reserve changes the real interest rate to affect the output gap and inflation rate, do each of the following monetary policy channels reinforce or partially offset the effect of the
Why is the MP curve a horizontal line? How is the Fed able to change the position of the MP curve?
What is the default risk premium, and why did it dramatically increase during the 2007–2009 recession? How did this increase affect the MP curve and the output gap?
When the Federal Reserve increases the real interest rate, is the result a movement up or down the IS curve? Does the value of the output gap increase or decrease?
Draw a 45°-line diagram showing an equilibrium in the goods market. Label the equilibrium level of real GDP, Y1. Now show on your graph each of the following two situations:1. Real GDP is equal to
Go to the web site of the Federal Reserve Bank of St. Louis Federal Reserve (FRED) (fred.stlouisfed. org) and download data on the interest rate on AAA rated corporate bonds (AAA) and the interest
If monetary policy does not cause a change in interest rates, can it still affect the output gap and the inflation rate? Briefly explain.
When the Federal Reserve lowers the real interest rate, what happens to the output gap and to the inflation rate?
Describe each of the three parts of the IS–MP model.
Go to the web site of the Federal Reserve Bank of St. Louis (FRED) (fred.stlouisfed.org) and download to the same graph data from January 1984 to the most recent available month on the nominal
What do economists mean by the “channels of monetary policy”?
Draw graphs showing long-run macroeconomic equilibrium in the IS–MP model. One of your graphs should show the output gap version of the Phillips curve. In long-run equilibrium, what does the output
How can changes in the federal funds rate cause changes in long-term real interest rates?
In 2016, a columnist for the Wall Street Journal wrote:For years, the world has looked to central banks to deploy whatever tools they had to prop up economic growth. Now, just as those tools reach
Economist Robert Gordon has written the following:During 1939, more than any other year in the dismal Depression decade, the American economy exhibited every evidence of slipping into a
Writing in the New York Times, economist Tyler Cowen of George Mason University argued:In short, expansionary monetary policy and wartime orders from Europe, not the well-known policies of the New
A Federal Reserve publication notes:During recessions, decreases in consumption [from an increase in saving] could inhibit economic recovery. However, in the long run, the accumulated money from
Hydraulic fracturing has caused a dramatic reduction in the cost of producing natural gas and petroleum.a. Briefly explain which industries are likely to be most directly affected by these cost
Shortly before leaving her position as chair of the President’s Council of Economic Advisers in the Obama administration, Christina Romer observed:“The only surefire ways for policymakers to
In a speech in June 2016, Jerome Powell, a member of the Federal Reserve’s Board of Governors, noted that the fraction of the U.S. population aged 25 to 54 who were working or actively looking for
Assume that the economy is initially in equilibrium at potential GDP. Suppose that there is a decrease in income in Europe that causes a decrease in demand for U.S.-produced goods. Use an AD–AS
If the long-run aggregate supply curve shifts, does the short-run aggregate supply curve also have to shift? If the short-run aggregate supply curve shifts, does the long-run aggregate supply curve
In the early to mid-2000s, stock prices and housing prices rose substantially. What effect would these increases in household wealth have on the saving rate and on consumption spending? How would the
Normally we think of the factors that cause the AD curve to shift as being different from the factors that cause the LRAS curve to shift. Is this still true in the case of hysteresis? Briefly explain.
Assume that the economy is initially in equilibrium at potential GDP. Use an AD–AS graph to show the effect of an increase in government purchases on the price level and the output level in the
In 2015, the Chinese government announced that it would switch from relying on stimulating the economy through expansions in aggregate demand to relying on expansions in aggregate supply. According
Stanley Fischer, vice-chair of the Federal Reserve, remarked that fluctuations in the exchange rate affects aggregate demand in the United States:“So that is the channel through which the exchange
Assume that the economy is initially in equilibrium at potential GDP. Then suppose that the economy is hit simultaneously with a positive aggregate demand shock and a negative aggregate supply shock:
Suppose that in Year 1 the price level equals 110 and the output level equals $14 trillion and that in Year 2 the price level equals 104 and the output level equals $13 trillion. In the AD–AS
In an opinion column on bloomberg.com, economist Tyler Cowen of George Mason University notes: “Keynesian economics focuses on sticky nominal wages as one obstacle to increasing production.”
Use a money market graph to explain the effect of a decrease in the price level on the equilibrium interest rate. How does the change in the interest rate affect planned investment spending,
Given that the economy can correct itself and return to potential GDP, why would the Federal Reserve pursue expansionary monetary policy following a negative aggregate demand shock? How could the Fed
In an opinion column in the Wall Street Journal in 2016, Harvard economist Martin Feldstein referred to “a possible negative shock—such as a sharp fall in exports or in construction—that could
Draw graphs to show the effect of each of the following on the short-run aggregate supply curve:a. A decrease in the expected price levelb. A decrease in oil pricesc. The development of laptop
Briefly explain whether each of the following events would shift the aggregate demand curve to the right or to the left.a. The Federal Reserve lowers the target for the federal funds rate.b. The
The Federal Reserve can use expansionary or contractionary policy to shift the aggregate demand curve. Use an AD–AS graph to show how monetary policy should be used to return output to potential
Can the economy be in a short-run macroeconomic equilibrium without being in a long-run macroeconomic equilibrium? Can the economy be in a long-run macroeconomic equilibrium without being in a
Use the equation Y = YP + a(P - Pe) to explain why in the new classical view, the shortrun aggregate supply curve is positively sloped and the long-run aggregate supply curve is vertical.
How does an increase in the interest rate affect each of the following categories of aggregate expenditure?a. Investment spending by firms on plant and equipment.b. Consumption spending by
What is hysteresis, and what problems might it pose for an economy?
Does monetary neutrality mean that changes in the money supply can never affect real GDP? Briefly explain.

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