Monetary Policy Flashcards

Which monetary policy tool involves the Fed buying or selling government securities in the open market?

Answer: Open market operations

Open market operations are the Fed's primary tool, where it buys or sells Treasury securities to expand or contract the money supply.

When the Fed purchases Treasury securities, what is the immediate effect on bank reserves?

Answer: Reserves increase, expanding credit capacity

Fed purchases inject reserves into the banking system, increasing banks' capacity to extend loans and expand the money supply.

The Taylor Rule suggests that the federal funds rate should rise when:

Answer: Inflation exceeds its target or output exceeds potential

The Taylor Rule prescribes higher rates when inflation is above target or when output (real GDP) exceeds its potential level.

Quantitative easing (QE) differs from conventional monetary policy primarily because QE:

Answer: Involves purchasing longer-term assets to lower long-term yields

QE targets long-term interest rates by purchasing longer-dated securities (e.g., MBS, 10-year Treasuries) when short-term rates are already near zero.

The 'zero lower bound' (ZLB) problem means that:

Answer: Nominal interest rates cannot fall significantly below zero, limiting conventional stimulus

Nominal interest rates face a practical floor near zero because savers can hold cash, constraining the Fed's ability to use conventional rate cuts.

Which of the following best describes the 'liquidity trap'?

Answer: Banks hoard reserves rather than lending, even at very low interest rates

A liquidity trap occurs when monetary easing fails to stimulate spending because banks and households prefer holding liquid assets despite low rates.

Forward guidance as a monetary policy tool works primarily by:

Answer: Shaping market expectations about the future path of interest rates

Forward guidance influences long-term rates and economic decisions today by signaling how the Fed intends to set rates in the future.