Deck 15: Interest Rates and Monetary Policy

Question 1

How does an increase in the price level affect the equilibrium rate of interest?

Answer 1

An increase in the price level leads to an increase in the transactions demand for money since the public will need more money to pay for the higher priced products.Therefore,the total demand for money increases.The rightward shift of the demand for money causes demand to intersect the supply of money at a higher equilibrium rate of interest.

Question 2

Describe the relationship between bond prices and interest rates.

Answer 2

There is an inverse relationship.An increase in the interest rate causes bonds that pay a fixed amount in perpetuity (also called consols)to drop in price.

Question 3

The total demand for money is equal to the transactions demand plus the asset demand for money.
(a)Assume that each dollar held for transactions purposes is spent on the average five times per year to buy final goods and services.If nominal GDP is $1,000 billion (or $1 trillion),what is the transactions demand?
(b)The table below shows the asset demand at certain rates of interest.Using your answer to part (a),complete the table to show the total demand for money at various rates of interest.

Answer 3

(c)If the money supply is $260 billion,what will be the equilibrium rate of interest?
(d)If the money supply rises,will the equilibrium rate of interest rise or fall?
(e)If GDP rises,will the equilibrium rate of interest rise or fall?
(a)Transactions demand for money is $200 billion ($1,000/5).
(b)See above table.
(c)The equilibrium interest rate is 8% (where money supply is equal to total demand).
(d)If the money supply increases,the equilibrium interest rate will fall.
(e)The equilibrium interest rate will rise because transactions demand,hence total demand,will rise and intersect money supply at a higher rate of interest.

Question 4

Why is the transactions demand for money less than nominal GDP?

Question 5

Explain how the two principal tools of monetary policy are used.

Question 6

Use the table below to answer the questions.

Question 7

What are the two reasons that people want to hold money? In other words,what are the two types of demand for money?

Question 8

Identify the major items in the consolidated balance sheet of the Bank of Canada.

Question 9

Both the Bank of Canada and chartered banks buy and sell government securities,but for substantially different reasons.Explain.

Question 10

The Bank of Canada is the bankers' bank.Explain.

Question 11

Why is it important for the Bank of Canada to be an independent agency?

Question 12

What are the five functions of the Bank of Canada? Which one is most important?

Question 13

What is the difference between the Bank of Canada's purchases of securities from the chartered banking system and those from the public? Give an example.

Question 14

Identify two key tools of monetary policy.

Question 15

Use the graph below to answer the following questions.D_t is the transactions demand for money,D_m is the total demand for money,and S_m is the supply of money.

Question 16

How does an increase in nominal GDP affect the equilibrium rate of interest?

Question 17

What is the goal of monetary policy?

Question 18

Use the table below to answer the questions:

Question 19

The total demand for money is equal to the transactions demand plus the asset demand for money.
(a)Assume that each dollar held for transactions purposes is spent on the average five times per year to buy final goods and services.If nominal GDP is $800 billion,what is the transactions demand?
(b)The table below shows the asset demand at certain rates of interest.Using your answer to part (a),complete the table to show the total demand for money at various rates of interest.

Question 20

Explain how nominal GDP and the real interest rate are related to the transactions and asset demands for money.

Question 21

How do the lags associated with monetary policy differ from those associated with fiscal policy?

Question 22

Following are the consolidated balance sheets of the chartered banks.Assume that the desired reserve ratio for banks is 10%.The figures in column 1 show the balance sheets' condition prior to each of the following five transactions.Place the new balance-sheet figures in the appropriate columns and complete A,B,C,D,and E for each column.Start each part (2-4)with the figures in column 1.All figures are in billions of dollars.

Question 23

Differentiate between expansionary and restrictive monetary policies.

Question 24

Other things being equal,what effect will each of the following have on the equilibrium rate of interest? (a)an increase in the money supply; (b)an increase in nominal GDP; (c)a decrease in the money supply; (d)a leftward shift of the asset demand for money.

Question 25

How does monetary policy affect equilibrium GDP? How can it address the problem of recession or slow growth? Inflation?

Question 26

Explain the impact of each of the following upon chartered bank reserves: (a)the Bank of Canada sells government bonds in the open market to private buyers; (b)the chartered banks reduce their indebtedness to the Bank of Canada.

Question 27

What is meant by the Liquidity Trap? Provide an example.

Question 28

Trace the cause-effect chain that results from a tight money policy.

Question 29

Suppose the economy is experiencing a recession and high unemployment.Describe the transmission mechanism through which monetary policy could address these problems?

Question 30

Explain what is meant by cyclical asymmetry with regard to monetary policy effects.

Question 31

What is the relationship between the overnight lending rate and the prime interest rate? Why doesn't the Bank of Canada target the prime interest rate?

Question 32

Suppose the economy is experiencing inflation.Describe the transmission mechanism through which monetary policy could address this problem?

Question 33

The following are simplified balance sheets for the chartered banking system and the Bank of Canada.Perform the two following transactions, (1)and (2),making appropriate changes in columns (1)and (2)in each balance sheet.Do not cumulate your answers.Also,answer these three questions for each part: (a)What change,if any,took place in the money supply as a direct result of this transaction? (b)What change,if any,occurred in chartered bank reserves? (c)What change occurred in the money-creating potential of the chartered banking system if the reserve ratio is 20%? All figures are in billions of dollars.

Question 34

What are the two instruments the Bank of Canada has for influencing the money supply? Which instrument is more important?

Question 35

Use the below graphs to answer the following questions assuming the nominal GDP in the economy is given.

Question 36

What are the two strengths that monetary policy has over fiscal policy?

Question 37

Trace the cause-effect chain that results from an easy money policy.

Question 38

What key target has become the recent focus of monetary policy?

Question 39

How is the overnight lending rate established? What role does the Bank of Canada play?

Question 40

The following are simplified balance sheets for the chartered banking system and the Bank of Canada.Perform the two following transactions, (1)and (2),making appropriate changes in columns (1)and (2)in each balance sheet.Do not cumulate your answers.Also,answer these three questions for each part: (a)What change,if any,took place in the money supply as a direct result of this transaction? (b)What change,if any,occurred in chartered bank reserves? (c)What change occurred in the money-creating potential of the chartered banking system if the reserve ratio is 20%? All figures are in billions of dollars.

Question 41

Discuss the relative effectiveness of monetary policy in dealing with demand-pull inflation or recession.

Question 42

What is inflation targeting and what are its advantages?

Question 43

Describe the links between monetary policy and the international economy due to the net export effect,and its impact on the trade deficit.

Question 44

Explain how the net export effect strengthens the effects an easy money and a tight money policy.

Question 45

What is the net export effect of a tight monetary policy? Explain.

Question 46

When does the use of monetary policy create conflicts between the goals of macroeconomic stability and balance of international trade?

Question 47

What are the political and economic limitations upon (a)fiscal policy and (b)monetary policy?