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business
money banking financial markets

Questions and Answers of Money Banking Financial Markets

What is the primary reason that households and firms demand money? Why is the demand for real money balances downward sloping?
What policies might the Federal Reserve use to counteract an aggregate demand shock?
Suppose that the economy is initially in equilibrium at potential GDP. If there is a decrease in aggregate demand, use an AD–AS graph to show the effects on the price level and the output level in
What is meant by the term price stickiness in the new Keynesian view? What explains price stickiness?
Why is the AD curve downward sloping?
Why might attempts to fine-tune the economy be ineffective? Instead of fine-tuning, what do economists generally advocate that policymakers do?
When the economy is in a short-run equilibrium, with output greater than potential GDP, what will happen to the short-run aggregate supply curve? Briefly explain.
In the new classical view, why can’t firms distinguish between increases in the general price level and increases in the relative prices of their products?
Briefly describe each of the four components of aggregate expenditure.
Are all business cycles the same in terms of length and severity?
In a graph illustrating the AD–AS model, where does short-run equilibrium occur, and where does long-run equilibrium occur? At what level of output does long-run equilibrium occur?
How do the slopes of the short-run aggregate supply curve and the long-run aggregate supply curve differ?
Writing on his blog in 2016, former Fed Chairman Ben Bernanke noted: “Here is the trilemma in action: If China wants to use monetary policy to manage domestic demand and to simultaneously free up
An article in the New York Times in 2016 notes that both Hillary Clinton and Donald Trump “want to label China as a currency manipulator.”a. What is a currency manipulator? Why would China want
An article in the Wall Street Journal discussing the possibility that Greece might leave the eurozone observes: “Traditionally, devaluations are viewed as providing a short-run spur to growth.”a.
An article in the Economist in 2016 notes that the “euro crisis” didn’t keep four additional countries—Slovakia, Estonia, Latvia, and Lithuania—from joining the eurozone between 2009 and
An opinion column in the Washington Post notes that the U.S. dollar is “the world’s dominant international currency.” The column also argues that, as a result, “we constantly run sizable
In discussing the Bretton Woods system, Michael Klein, an economist at Tufts University, observes: “Investors face a ‘one-way bet’ against central banks when they perceive an increased
Evaluate the following argument:The United States did not really leave the gold standard in 1933. Under the Bretton Woods system, the United States stood ready to redeem U.S. currency for gold at a
What effect does each of the following have on the U.S. monetary base?a. The Fed purchases $10 billion of foreign assets.b. The Fed sells $10 billion of foreign assets and purchases $10 billion of
In discussing the situation of countries leaving the gold standard, or “unilaterally devaluing” during the 1930s, Barry Eichengreen of the University of California, Berkeley, and Jeffrey Sachs of
What is the difference between a sterilized foreign exchange intervention and an unsterilized foreign exchange intervention?
An article in the Wall Street Journal in June 2016 notes: “The Fed’s preferred measure of consumer prices has fallen short of the central bank’s 2% annual target for 48 consecutive months.”
If a country imposes capital controls that result in its financial account balance being zero, would it be possible for the country to run a current account deficit? Briefly explain.
Use T-accounts to show the effect on the Fed’s balance sheet of the Fed buying $2 billion in German government bonds, denominated in euros, and, at the same time, conducting an open market sale of
Under a gold standard, is inflation possible? Consider both the case for an individual country and the case for the world as a whole.
In 2016, Egypt was trying to keep the exchange rate between its currency (the Egyptian pound) and the U.S. dollar constant. An article in the Wall Street Journal observed that if the Egyptian
According to an article in the Wall Street Journal in 2016:Small changes in the yuan have touched off big swings in markets across the world, and the dollar has shot up against just about every
Use T-accounts to show the effect on the Fed’s balance sheet of the Fed selling $5 billion in Japanese government bonds, denominated in yen. What happens to the Fed’s international reserves and
What is the policy trilemma? How do U.S. policymakers deal with the policy trilemma?
Suppose that the U.S. government sells old warships worth $300 million to Japan, and Japan’s government pays for them with its official holdings of dollar assets. How is this transaction recorded
An article in the Wall Street Journal in 2016 noted:“Denmark’s central bank has sold Danish kroner to weaken its currency and keep the euro within a … target range.”a. What does it mean to
Allan Meltzer, an economist at Carnegie Mellon University, once argued:I have yet to see a study that shows that sterilized intervention, the most common type of intervention used by the Fed in the
What is pegging? What are the advantages of pegging? What are the disadvantages? Briefly discuss the controversy over China’s management of the yuan-dollar exchange rate.
Suppose that a U.S. firm buys 10 Volkswagen cars for $20,000 each, and the German company uses the money to buy a $200,000 U.S. Treasury bond at a Treasury auction. How are these two transactions
Suppose the Bank of Japan sells $5 billion of U.S. Treasury securities. Use a graph of the demand and supply of yen in exchange for dollars to show the effect on the exchange rate between the yen
An article in the Wall Street Journal about the policies of the People’s Bank of China observes: “Currency intervention … expands the central bank’s balance sheet and adds to the money
What is the eurozone? How do the countries of the eurozone benefit from using a single currency? What are the disadvantages to using a single currency?
If the U.S. current account deficit is $400 billion, and if the statistical discrepancy is zero, what is the financial account balance? Does this financial account balance represent a net capital
On the foreign exchange market, who demands dollars—U.S. investors or foreign investors? Why does an increase in U.S. interest rates relative to Japanese interest rates increase the demand for
Under the Bretton Woods system, what were devaluations and revaluations? What is the difference between a devaluation and a depreciation? Why were countries hesitant to pursue a devaluation? Why were
How do central banks use official reserve assets?
What are capital controls, and why might a country impose them? What are the disadvantages of imposing capital controls?
Does a purchase of foreign assets by the Fed have a greater effect, the same effect, or a smaller effect on the monetary base than an open market purchase of government bonds by the Fed? Briefly
Go to the web site of the Federal Reserve Bank of St. Louis (FRED) (fred.stlouisfed.org) and download and graph the data series for the U.S. current account balance (BOPBCA) from the first quarter of
Briefly answer each of the following questions about the gold standard:a. Was it a fixed exchange rate system or a flexible exchange rate system?b. Were countries able to pursue active monetary
Why must the current account balance plus the financial account balance equal zero? Briefly explain in what sense a country can run a balance-of-payments surplus or a balance-of-payments deficit.
How does a sterilized central bank intervention affect the demand curve and the supply curve for a country’s currency?
If the Fed sells $2 billion of foreign assets, what happens to the Fed’s holdings of international reserves and to the monetary base?
Go to the web site of the Federal Reserve Bank of St. Louis (FRED) (fred.stlouisfed.org) and download and graph the data series for the yuan–dollar exchange rate (DEXCHUS) from July 2010 until the
Briefly explain how the gold standard operated. What were the key differences between the gold standard and the Bretton Woods system?
Distinguish between the types of transactions recorded in the current account and those recorded in the financial account. If a country runs a current account deficit, is the value of its exports of
To raise the exchange rate of its currency, would a central bank buy or sell foreign assets? What would be the effect on the monetary base? What would be the effect on domestic interest rates?
An article in the Wall Street Journal in 2016 notes: “Over 30% of euro-denominated investment-grade corporate bonds trade at a negative yield … while 84% yield less than 1%.” What caused so
An article in the Wall Street Journal in 2016 begins: “Hans Peter Christensen got some unusual news when he opened his most recent mortgage statement. His quarterly interest payment was negative
John Taylor has argued: “Considerable empirical work supports the view that interest rates were too low for too long in 2003–2005 and were a major factor in the housing boom and bust that
Using the Taylor rule, calculate the target for the federal funds rate for June 2016, using the following information: equilibrium real federal funds rate of 2%, target inflation rate of 2%, current
In June 2016, the Fed had a target range for the federal funds rate of 0.25% to 0.50%. An article in the Wall Street Journal noted: “It has set the rate it pays on bank reserves at the top of that
The January 22, 2008 press release of the FOMC states that the FOMC “decided to lower its target for the federal funds rate by 75 basis points to 3½ percent.” The press release goes on to say:
In 2016, in a Federal Reserve publication, Federal Reserve Bank President of San Francisco President John Williams wrote that one way to prepare for a future of chronically low real interest rates
According to an article in the Wall Street Journal in June 2016, Congressman Jeb Hensarling of Texas, chair of the House Financial Services Committee, criticized the Fed for paying banks an interest
The December 13, 2005, press release of the Federal Open Market Committee (FOMC) stated that the FOMC “decided today to raise its target for the federal funds rate by 25 basis points to 4¼
Achieving the goal of price stability with low and steady inflation allows the Fed to achieve other goals, such as stable interest rates and stable foreign exchange rates. If the Fed fails to achieve
An article in the Wall Street Journal notes that the Fed sets “the lower bound, or a floor under shortterm rates, with the interest rate it pays institutions like money-market funds on … reverse
Suppose that in equilibrium, the federal funds rate is equal to the interest rate the Fed is paying on reserves. Use a graph of the federal funds market to analyze the effect of an open market sale
What legislative changes and financial innovations occurred after 1979 that affected M1? How did these changes affect the short-run link between money and inflation?
In a speech to the Fed conference in Jackson Hole, Wyoming, mentioned in the chapter opener, Fed Chair Janet Yellen observed that the financial crisis revealed the Fed’s “inability to control the
Use graphs of the federal funds market to analyze each of the following three situations. Be sure that your graphs clearly show changes in the equilibrium federal funds rate, changes in the
U.S. Mint describes the demand for the gold, silver, and platinum coins it produces as being dependent on the prices of these metals as commodities. In addition, the Mint notes: “These commodity
Suppose that JPMorgan Chase sells $100 million in Treasury bills to the Fed.a. Use T-accounts to show the initial effect of this sale on the balance sheets of JPMorgan Chase and the Fed.b. Suppose
An article in the Wall Street Journal notes that by mid- 2016, the Bank of Japan owned about one-third of all Japanese government bonds, “with its balance sheet ballooning to 85% of gross domestic
A columnist for bloomberg.com observes: “The Fed is easily able to tell when unemployment or inflation is high, but inflated asset prices are much, much harder to identify.”a. Briefly explain
A column in the Wall Street Journal mentions the famous billionaire investor “Warren Buffet, who in 1999 and early 2000 was widely derided as ‘a dinosaur’ and ‘out of touch’ for his refusal
If the Fed uses the federal funds rate as a policy instrument, will increases in the demand for reserves lead to an increase or a decrease in the level of reserves? If the Fed uses the level of
In a statement explaining how it intended at some point to normalize monetary policy, the FOMC wrote:The Committee intends that the Federal Reserve will, in the longer run, hold no more securities
Suppose that the FOMC decides to lower its target for the federal funds rate. How can it use open market operations to accomplish this goal? How can the FOMC use open market operations to raise its
A columnist in the Wall Street Journal has argued in favor of changing the Fed’s dual mandate to a single mandate of price stability: “When an economy gets weak enough, extraordinary easing
State whether each of the following variables is most likely to be a goal, an intermediate target, an operating target, or a monetary policy tool:a. M2b. Monetary basec. Unemployment rated. Open
Following its meeting on July 27, 2016, the Federal Open Market Committee issued a statement that contains the following:The Committee is maintaining its existing policy of reinvesting principal
Use graphs of the federal funds market to illustrate the effect on the demand for reserves or the supply of reserves of each of the Fed policy actions listed below. Assume that reserves are scarce
Given that inflation erodes the value of money, should the Federal Reserve pursue a goal of deflation? Would deflation create some of the same problems as inflation in terms of the information
Which interest rates have some foreign central banks set at a negative level? Briefly explain why they have taken this action.
When it passed the Federal Reserve Act in 1913, Congress did not at first expect that the Fed would engage in open market operations. An article in a Federal Reserve publication notes that after the
What does it mean to say that bank reserves are scarce? In a period when bank reserves are not scarce, why have the interest rate the Fed pays on bank reserves and the interest rate the Fed offers on
If you owned a firm that did business internationally, why would large fluctuations in the foreign exchange value of the dollar make planning for your business and financial transactions more
How can the Taylor rule be used as a guide to evaluating Federal Reserve monetary policy over time?
What two groups of financial institutions are eligible to borrow and lend in the federal funds market? Briefly describe the procedures the Fed now uses to increase the federal funds rate.
Go to the web site of the Federal Reserve Bank of St. Louis (FRED) (fred.stlouisfed.org) and download and graph the data series for discount loans (DISCBORR) from January 2000 until the most recent
Briefly explain what determines the supply curve for reserves. Why does the supply curve have a horizontal segment?
Why do fluctuations in interest rates make investment decisions by households and firms more difficult?
Place the following in sequence, from what the Fed has the most influence on to what the Fed as the least influence on: policy goals, policy tools, policy instruments, intermediate targets.
What are the three categories of discount loans? During the financial crisis of 2007–2009, how did the Fed’s discount lending expand?
Go to the web site of the Bank of England, www. bankofengland.co.uk. The interactive database for the Bank of England has a section titled Monetary financial institutions’ balance sheets, income
Why does an increase in the federal funds rate decrease the quantity of reserves demanded? At what interest rate does the demand curve for reserves become perfectly elastic?
Which type of unemployment—frictional, structural, or cyclical—does the Federal Reserve seek to reduce? Why doesn’t the Fed seek to reduce the unemployment rate to zero percent?
What two timing difficulties does the Fed face in using its monetary policy tools?
What is quantitative easing, and why did the Fed begin using it? What effect did quantitative easing have on bank reserves?
What are the Fed’s three traditional monetary policy tools, and which is the most important?
What is the purpose of monetary policy? What is meant by economic well-being? Why is the Fed said to have a “dual mandate”?
What trade-offs does the Fed face, particularly in the short run, in attempting to reach its goals?

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