Monetary Policy Flashcards

According to the quantity theory of money (MV = PQ), if the money supply doubles and velocity and real output are constant, the price level will:

Answer: Double

With V and Q constant, doubling M must double P to maintain the equation's balance.

A bank has $10 million in deposits and a required reserve ratio of 10%. If it holds no excess reserves, how much can it lend?

Answer: $9 million

Required reserves = $1 million, so the bank can lend the remaining $9 million.

When the Fed pays interest on excess reserves (IOER), what incentive does this create for banks?

Answer: Banks are incentivized to hold more reserves rather than lending

IOER makes holding reserves risk-free and profitable, giving banks a reason to keep funds at the Fed instead of lending them out.

The 'outside lag' of monetary policy refers to:

Answer: The time between implementing policy and seeing its effects on the economy

The outside lag is the time it takes for a policy change to actually work its way through the economy and affect output and prices.

If the central bank unexpectedly tightens monetary policy, in the short run one would expect bond prices to:

Answer: Fall, because interest rates rise

Bond prices and interest rates move inversely; tighter policy raises rates, pushing existing bond prices down.

Which of the following best describes 'inflation targeting' as a monetary policy framework?

Answer: The central bank announces a specific inflation rate it aims to achieve

Inflation targeting involves a central bank publicly committing to keep inflation near a stated goal, typically 2%, to anchor expectations.

Stagflation creates a dilemma for monetary policymakers because:

Answer: Fighting inflation requires tighter policy, which worsens unemployment

Stagflation — high inflation combined with high unemployment — means policies to cure one problem aggravate the other.