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Monetary Economics: Very Extensive Summary '18/'19 (incl Assignments & Answers)
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Monetary EconomicsIndex
1 Lecture 1 4
1.1 Introduction (Chapter 1) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4
1.2 What is Money? (Chapter 3) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4
1.3 Defining Aggregate Output, Income, the Price Level, and the Inflation Rate (Appendix 1) . . . . . . . 6
2 Assignment 1 7
3 Lecture 2 8
3.1 Interest Rates, Bonds and the Money Market (Chapter 4 & 5) . . . . . . . . . . . . . . . . . . . . . . 8
3.1.1 Learning Objectives . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8
3.1.2 Determinants of Asset Demand . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8
3.1.3 Theory of Asset Demand . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8
3.1.4 Bond Prices and Interest Rates . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8
3.1.5 Supply and Demand in the Bond Market . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9
3.1.6 Shift in the Demand Curve for Bonds . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10
3.1.7 Shifts in the Supply of Bonds . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11
3.1.8 Fisher equation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11
3.1.9 The Liquidity Preference Framework . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12
3.1.10 Changes in Equilibrium Interest Rates in the Liquidity Preference Framework . . . . . . . . . . 13
3.1.11 Response to a Change in Income or the Price Level . . . . . . . . . . . . . . . . . . . . . . . . . 14
3.1.12 Response to a Change in the Money Supply . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14
3.1.13 Money and Interest Rates . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14
3.1.14 Does a Higher Rate of Growth of the Money Supply Lower Interest Rates? . . . . . . . . . . . 15
3.2 Chapter 4: Understanding interest rates . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16
3.2.1 Simple loan . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18
3.2.2 Fixed-payment loan . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18
3.2.3 Coupon bond . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 19
3.2.4 Discount bond . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20
3.2.5 Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 24
3.3 Chapter 5: The behaviour of interest rates . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 25
3.3.1 Wealth . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 25
3.3.2 Expected returns . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 25
3.3.3 Risk . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 25
3.3.4 Liquidity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 26
3.3.5 Demand curve . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 26
3.3.6 Supply curve . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 27
3.3.7 Shifts in the demand for bonds . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 28
3.3.8 Wealth . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 29
3.3.9 Expected returns . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 30
3.3.10 Risk . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 31
3.3.11 Liquidity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 31
3.3.12 Shifts in the supply of bonds . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 31
3.3.13 Expected profitability of investment opportunities . . . . . . . . . . . . . . . . . . . . . . . . . 32
3.3.14 Expected inflation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 32
3.3.15 Government budget . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 32
3.3.16 Supply and demand in the market for money: the liquidity preference framework . . . . . . . . 35
3.3.17 Shifts in the demand for money . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 37
3.3.18 Shifts in the supply of money . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 37
3.3.19 Changes in income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 39
3.3.20 Changes in price level . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 39
1
,INDEX
3.3.21 Changes in the money supply . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 39
4 Assignment 2 43
5 Lecture 3 44
5.1 The Money Supply Process (Chapter 14) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 44
5.1.1 Learning Objectives . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 44
5.1.2 Three players in the money supply process . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 44
5.1.3 The Central Bank’s Balance Sheet . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 44
5.1.4 Control of the Monetary Base . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 44
5.1.5 Open Market Purchase from a Bank . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 45
5.1.6 Open Market Purchase from the Nonbank Public . . . . . . . . . . . . . . . . . . . . . . . . . . 45
5.1.7 Open Market Purchase: Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 46
5.1.8 Open Market Sale . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 46
5.1.9 Shifts from Deposits into Currency . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 46
5.1.10 Loans to Financial Institutions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 46
5.1.11 Overview of the Central Bank’s Ability to Control the Monetary Base . . . . . . . . . . . . . . 47
5.1.12 Multiple Deposit Creation: A Simple Model . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 47
5.1.13 Creation of Deposits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 48
5.1.14 Deriving The Formula for Multiple Deposit Creation . . . . . . . . . . . . . . . . . . . . . . . . 48
5.1.15 Critique of the Simple Model . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 48
5.1.16 Factors that Determine the Money Supply . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 48
5.1.17 The Money Multiplier . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 49
5.1.18 Quantitative Easing and the Money Supply, 2007-2014 . . . . . . . . . . . . . . . . . . . . . . . 50
5.2 Chapter 14: The money supply process . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 51
5.2.1 Three players in the money creation process . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 51
5.2.2 The central bank’s balance sheet . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 51
5.2.3 Control of the monetary base . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 52
5.2.4 Currency withdrawal . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 54
5.2.5 Loans to banks . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 54
5.2.6 Overview of the central bank’s ability to control the monetary base . . . . . . . . . . . . . . . . 55
5.2.7 Multiple deposit creation: a simple model . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 55
5.2.8 Deriving the formula for the multiple deposit creation . . . . . . . . . . . . . . . . . . . . . . . 59
5.2.9 Critique of the simple model . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 59
5.2.10 The money multiplier . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 60
5.2.11 Changes in the non-borrowed monetary base, M Bn . . . . . . . . . . . . . . . . . . . . . . . . 61
5.2.12 Changes in borrowed reserves, BR, from the central bank . . . . . . . . . . . . . . . . . . . . . 61
5.2.13 Changes in the required reserve ratio r . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 62
5.2.14 Changes in currency ratio, c . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 62
5.2.15 Changes in excess reserves ratio, e . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 62
5.2.16 Limits of the central bank’s ability to control the money supply . . . . . . . . . . . . . . . . . . 63
5.2.17 Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 64
6 Assignment 3 66
7 Lecture 4 67
7.1 Tools of Monetary Policy (Chapter 15) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 67
7.1.1 Learning Objectives . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 67
7.1.2 Conventional Monetary Policy Tools . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 67
7.1.3 Monetary Policy Tools of the European Central Bank . . . . . . . . . . . . . . . . . . . . . . . 67
7.1.4 Demand in the Market for Reserves . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 67
7.1.5 Supply in the Market for Reserves . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 67
7.1.6 How Changes in the Tools of Monetary Policy Affect the Overnight Interbank Rate . . . . . . 68
7.1.7 Application: How Standing Facilities Limit Fluctuations in the Overnight Interbank Rate . . . 69
7.1.8 Relative Advantages of the Different Monetary Policy Tools . . . . . . . . . . . . . . . . . . . . 70
7.1.9 On the Failure of Conventional Monetary Policy Tools in a Financial Panic . . . . . . . . . . . 70
7.1.10 Nonconventional Monetary Policy Tools During the Global Financial Crisis . . . . . . . . . . . 70
7.2 The goals and structure of Central Banks (Chapter 13) . . . . . . . . . . . . . . . . . . . . . . . . . . 71
7.2.1 Learning Objectives . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 71
7.2.2 The Price Stability Goal and the Nominal Anchor . . . . . . . . . . . . . . . . . . . . . . . . . 71
7.2.3 Other Goals of Monetary Policy . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 71
2
,INDEX
7.2.4 Should Price Stability Be the Primary Goal of Monetary Policy? . . . . . . . . . . . . . . . . . 72
7.2.5 Structure and Independence of the European Central Bank . . . . . . . . . . . . . . . . . . . . 72
7.2.6 Governing Council . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 72
7.2.7 How Independent is the ECB? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 72
7.2.8 Should Central Banks be Independent? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 72
7.2.9 Inflation and Central Bank Independence . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 73
7.3 Chapter 15: The tools of monetary policy . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 74
7.3.1 Demand and supply in the market for reserves . . . . . . . . . . . . . . . . . . . . . . . . . . . 74
7.3.2 How changes in the tools of monetary policy affect the overnight rate . . . . . . . . . . . . . . 76
7.3.3 Open market operations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 79
7.3.4 Standing facilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 81
7.3.5 Reserve requirements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 83
7.3.6 Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 84
8 Assignment 4 86
9 Lecture 5 87
9.1 The Conduct of Monetary Policy: Strategy and Tactics (Chapter 16) . . . . . . . . . . . . . . . . . . . 87
9.1.1 Preview . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 87
9.1.2 Learning Objectives . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 87
9.1.3 Inflation Targeting . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 87
9.1.4 Advantages of Inflation Targeting . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 88
9.1.5 Disadvantages of Inflation Targeting . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 88
9.1.6 Tactics: Choosing the Policy Instrument . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 88
9.1.7 Linkages between Central Bank Tools, Policy Instruments, Intermediate Targets and Goals of
Monetary Policy . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 89
9.1.8 Result of Targeting on Nonborrowed Reserves . . . . . . . . . . . . . . . . . . . . . . . . . . . . 89
9.1.9 Result of Targeting on the Short-Term Interest Rate . . . . . . . . . . . . . . . . . . . . . . . . 90
9.1.10 Criteria for Choosing the Policy Instrument . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 90
9.1.11 Tactics: The Taylor Rule . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 90
9.2 Demand for Money (Chapter 19) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 91
9.2.1 Preview . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 91
9.2.2 Learning Objectives . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 91
9.2.3 Quantity Theory of Money . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 92
9.2.4 Keynesian Theories of Money Demand . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 93
9.2.5 Transactions Motive . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 93
9.2.6 Precautionary Motive . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 93
9.2.7 Speculative Motive . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 93
9.2.8 Putting the Three Motives together . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 93
9.2.9 Portfolio Theories of Money Demand . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 93
9.2.10 Empirical Evidence on the Demand for Money . . . . . . . . . . . . . . . . . . . . . . . . . . . 94
9.2.11 Interest Rates and Money Demand . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 94
9.2.12 Stability of Money Demand . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 94
9.3 Chapter 16: The conduct of monetary policy: strategy and tactics . . . . . . . . . . . . . . . . . . . . 95
9.3.1 Monetary targeting . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 95
9.3.2 Inflation targeting . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 99
9.3.3 Inflation targeting in New Zealand, Canada and the United Kingdom . . . . . . . . . . . . . . 100
9.3.4 Monetary policy with an implicit nominal anchor . . . . . . . . . . . . . . . . . . . . . . . . . . 102
9.4 Chapter 19: The demand for money . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 103
9.4.1 Quantity theory of money . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 103
9.4.2 Is velocity a constant? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 104
9.4.3 Keynes’s liquidity preference theory . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 106
9.4.4 Further developments in the Keynesian approach . . . . . . . . . . . . . . . . . . . . . . . . . . 108
9.4.5 Friedman’s modern quantity theory of money . . . . . . . . . . . . . . . . . . . . . . . . . . . . 111
9.4.6 Distinguishing between the Friedman and Keynesian theories . . . . . . . . . . . . . . . . . . . 113
9.4.7 Empirical evidence on the demand for money . . . . . . . . . . . . . . . . . . . . . . . . . . . . 114
9.4.8 Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 115
3
,1 Lecture 1
1.1 Introduction (Chapter 1)
Evidence suggests that money plays an important role in generating business cycles.
Recessions (unemployment) and expansions affect all of us.
Monetary theory ties changes in the money supply to changes in aggregate economic activity and the price level.
The aggregate price level is the average price of goods and services in an economy.
A continual rise in the price level (inflation) affects all economic players.
Data shows a connection between the money supply and the price level.
Interest rates are the price of money.
Prior to 1980, the rate of money growth and the interest rate on long-term Treasury bonds were closely tied.
Since then, the relationship is less clear but the rate of money growth is still an important determinant of interest rates.
Monetary policy is the management of the money supply and interest rates. Conducted by
− the Federal Reserve System (Fed) in the US
− the European Central Bank (ECB) in the eurozone
− the Bank of England in the UK
Fiscal policy deals with government spending and taxation
− Budget deficit is the excess of expenditures over revenues for a particular year
− Budget surplus is the excess of revenues over expenditures for a particular year
− Any deficit must be financed by borrowing.
1.2 What is Money? (Chapter 3)
Money (or the money supply): anything that is generally accepted as payment for goods or services or in the repayment
of debts. A rather broad definition.
Money (a stock concept) is different from:
− Wealth: the total collection of pieces of property that serve to store value
− Income: flow of earnings per unit of time (a flow concept)
Medium of Exchange: Eliminates the trouble of finding a double coincidence of needs (reduces transaction
costs).
Promotes specialization
A medium of exchange must:
− be easily standardized
− be widely accepted
− be divisible
− be easy to carry
− not deteriorate quickly
Unit of Account: Used to measure value in the economy
Reduces transaction costs
Store of value: Used to save purchasing power over time
Other assets also serve this function
Money is the most liquid of all assets but loses value during inflation.
4
,1.2 What is Money? (Chapter 3)
Commodity Money: valuable, easily standardized and divisible commodities (e.g. precious metals, ciga-
rettes)
Fiat Money Paper money decreed by governments as legal tender
Cheques: An instruction to your bank to transfer money from your account
Electronic Payment e.g. Online bill pay
E-Money (electronic money)
− Debit card
− Stored-value card (smart card)
− Mobile payment services
− E-cash
− Cryptocurrencies
Predictions of a cashless society have been around for decades, but they gave not come to fruition.
Although e-money might be more convenient and efficient than a payments system based on paper, several factors
work against the disappearance of the paper system.
However, the use of e-money will likely still increase in the future.
Bitcoin is type of electronic money created in 2009.
By "mining", Bitcoin is created by decentralized users when they use their computing power to verify and process
transactions.
Although Bitcoin functions as a medium of exchange it is unlikely to become the money of the future because it
performs less well as a unit of account and a store of value.
How do we measure money? Which particular assets can be called "money"?
Construct monetary aggregates using the concept of liquidity:
− M1 (contains the most liquid assets)
= currency + (overnight) demand deposits + other checkable deposits
− M2 (adds to M1 other assets that are less liquid)
= M1 + time deposits (2 year maturity) + deposits redeemable on short notice with low costs
− M3 = M2 + Repurchase agreements + Money market fund shares + Debt securities issued with a maturity of
up to two years
M1 versus M2 or M3: Does it matter which measure of money is considered?
M1 and M3 can move in different directions in the short run.
Conclusion: the choice of monetary aggregate is important for policymakers.
Figuur 1
5
,1.3 Defining Aggregate Output, Income, the Price Level, and the Inflation Rate (Appendix 1)
1.3 Defining Aggregate Output, Income, the Price Level, and the Inflation Rate (Ap-
pendix 1)
The most commonly reported measure of aggregate output, the gross domestic product (GDP), is the market value
of all final goods and services produced in a country during the course of a year.
Aggregate income, the total income of factors of production (land, labor and capital) from producing goods and ser-
vices in the economy during the course of the year, is equal to aggregate output.
When the total value of final goods and services is calculated using current prices, the resulting GDP measure is
referred to as nominal GDP. The word nominal indicates that values are measured using current prices.
A more reliable measure of economic production expresses values in terms of prices for an arbitrary base year. GDP
measures with constant prices is referred to as real GDP, the word real indicating that values are measured in terms
of fixed prices.
The aggregate price level is a measure of average prices in the economy.
Three measures of the aggregate price level are commonly encountered in economic data:
− The GDP deflator
− The PCE deflator
− The Consumer Price Index (CPI)
6
, 2 Assignment 1
Vraag 1: Everybody worse off when interest rates rise
Antwoord: False. Although people who borrow to purchase a house or a car are worse off because it costs them
more to finance their purchase, savers benfit because they can earn higher interest rates on their
savings.
Vraag 2: When interest rates decrease, how might business and consumers change their economic behavior?
Antwoord: Businesses would increase investment spending because the cost of financing this spending is now
lower, and consumers would be more likely to purchase a house or a car because the cost of financing
their purchase is lower.
Vraag 3: If history repeats itself and we see a decline in the rate of money growth, what might you expect
to happen to:
- Real output
- Price level
- Interest rate
Antwoord: Real output: I would expect it to fall. This can be seen in Figure 1.4 in Chapter 5.
Price level: I would expect it to fall. This can be seen in Figure 1.5 in Chapter 5.
Interest rate: I would expect it to fall.
Vraag 4: Rank the following assets from most liquid (1) to least liquid (6).
Antwoord: (1) Currency
(2) Checking account deposits
(3) Saving deposits
(4) Common stock
(5) Automobiles
(6) Houses
Vraag 5: Most of the time it is quite difficult to separate the three functions of money. Money performs its
three functions at all times, but sometimes we can stress one in particular. For each of the following
situations, identify which function of money is emphasised?
Antwoord: Medium of Exchange: Brooke accepts money in exchange for performing her daily tasks at her
office, since she knows she can use that money to buy goods and services.
Unit of Account:Tim wants to calculate the relative value of oranges and apples, and therefore
checks the price per pound of each of these goods as quoted in currency units.
Store of Value: Maria is currently pregnant. She expects her expenditures to increase in the future
and decided to increase the balance in her savings account.
Vraag 6: Counting the currency in circulation gives us an adequate measure of money.
Antwoord: False. Since a lot of other assets have liquidity properties that are similar to currency but can be used
as money to purchase goods and services, not counting them would understate an economy’s access
to liquidity for transactions purposes. For this reason, counting assets such as checking deposits or
saving accounts more accurately reflects the stock of assets that can be considered money.
Vraag 7: If you use an online payment system such as PayPal to purchase goods or services on the Internet,
does this affect the M1 money supply, the M2 money supply, both, or neither?
Antwoord: Neither. Although Paypal and many other e-money systems work as other forms of money do
to facilitate purchases of goods and services, it does not count in the M1 or M2 money supplies.
Because Paypal and similar payment systems are generally credit-based, this required payment at
a future date for funds used today; those future payments must be made using existing money that
is already in the system, such as currency or funds in a bank deposit account. In other words, the
M1 and M2 money supplies would theoretically remain the same, but money would move from your
checking account to a third party, one the credit transaction is settled.
7
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