Fiscal & Monetary (Combo) Cheat Sheet

Fiscal & Monetary (Combo) Cheat Sheet

2017 AP Macroeconomics FRQ #2

2017 AP Macroeconomics FRQ #2

Watch me answer it here

https://youtu.be/tFNOUMUVzcM

(A) Draw a CLG of the money market and show the effect of the reduced holdings of money on the equilibrium nominal interest rate in the short-run.

Money Market = Monetary Policy

Reduced holdings of money = Demand for Money decreases

From the Monetary Policy cheat sheet here

Demand for Money falls, the Nominal Interest Rate (NIR) falls
The opportunity cost of holding cash has fallen.

Answer

(B) Based on the changes in the interest rate in part (A), what will happen to each of the following in the short-run?

(i) Prices of previously issued Bonds. ((Bond Prices will Increase)

MR. Waugh - If interest rates are falling then we must assume that the interest rates of previous bonds must be higher.

Jung Sub - What does that mean, Mr. Waugh?

Mr. Waugh - Well Jung Sub, each bond has an amount of interest that it pays to the owner of the bond every year. It could pay 5% of the face value to the owner every year. Bond holders are rational people. If the banks are only paying 1% to borrow your money a bond holder would be making a profit by having a bond paying 5%.

So, if the nominal interest rate falls to 1%, then the price of a bond paying 5% will increase as it is now a better value than bonds created and sold today with a yield rate of 1%.

Is that clear Jung Sub?

Jung Sub -  Not really Mr. Waugh, but I think we should move on.

Jung Sub's face when I start talking about Bonds.

(ii) The price level and real income.

Cause and effect - If the nominal interest rate falls then consumption increases which drives up AD and therefore the PL and causes the RGDP to increase which implies that real income (Y) increases also.

Answer - PL and Y (incomes) increase

Answer

(C) With a constant money supply, based on your answer in part (B)(ii), will the velocity of money increase, decrease, remain unchanged or will it be indeterminate?

Velocity of money is the rate that money exchanges for goods and services. If incomes are increasing we would expect that the velocity of money would increase.

AD is increasing along with RGDP and (Y) incomes so people are spending money faster than before. Velocity has increased.

Answer

(D) If the FED (central bank) wishes to reverse the changes in the interest rate identified in part (A), what open market operation (OMO) would it use?

If interest rates are falling (part A), then the FED would sell bonds, reducing the money supply and increasing the Nominal Interest Rate.

Answer

Fiscal & Monetary

Independence and Interdependence of Fiscal & Monetary Policy

It appears to me that the AP is interested as an explanation for the direction of the RIR using the Price Level as an explanation.

Let me take a shot at explaining. (This is not for the AP explanation)

 (If the Money Supply is increasing then the amount of money in circulation is increasing which with our understanding of supply and demand means that the value of the money decreases. (more money less value) The RIR is about purchasing power so if the quantity (supply) of money increases then the purchasing power of each dollar falls. As the more money supplied gets into people's hands they spend it,, more people spending money pushes the price level up, price levels increase. 

Next connection & clarification. 

If the money supply is increasing then the value of the currency is falling as more people have more of it and therefore demand for it falls reducing the value.  RIR is a direct reflection of the cost to purchase money (borrow, get a loan). So if the supply is increasing the banks want to make loans so they lower the cost to purchase money, RIR decreases. 

Next connection & clarification.

If the banks have more loanable funds then their opportunity cost of holding more cash increases and they therefore lower their interest rates (price to borrow) to entice more people to borrow. Remember that the demand curve is downward sloping on the purchasing of money (borrowing),, and to get more people to borrow the banks must lower their rates.

To explain for the AP, monetary policy expansion and the RIR, I think it is best to say that since the Price Level (PL) is increasing therefore the RIR must be falling.

Still easier than this stuff.

Fiscal Policy & Monetary (Contractionary) (2of3)

Fiscal Policy & Monetary (Contractionary) (2of3)

What does it look like when fiscal and monetary policies are contractionary.

Not many questions that have dealt with both being contractionary but possibly would reduce an inflationary economy.

Money Supply, Real Interest Rates & Aggregate Demand

Nominal Interest Rates, Price Level changes, and the Real Interest Rate

Nominal Interest Rates, Price Level changes, and the Real Interest Rate

Monetary Policy (money market, loanable funds, investment, AD/AS) & real interest rates

Monetary Policy (money market, loanable funds, investment, AD/AS) & real interest rates

So lately I've been trying to increase my understanding of how fiscal and monetary policies work in tandem. I've been a bit dismayed as many students can't understand the Real interest Rate questions on the AP exam and I haven't found any resources that string it all together.

So I've spent a few days working through the past FRQ's and Multiple choice sections of exams in hopes of clarifying exactly what the college board is testing.

1st Monetary Policy

On the left is an explanation of the causal chain of events. On the right is a graphical illustration of the left side. Sometimes seeing what happens in graphs makes the left side a bit more clear. Hope this helps,,, any mistakes, corrections, comments,, wcwaugh@aol.com

Monetary Policy (Reserve Requirements) FRQ's & MC

Monetary Policy (Reserve Requirements) FRQ's & MC

So I have started to try and create a google site for all of my information. Don't laugh.

I'm posting a link to the google site so you can download the FRQ's & MC questions for the Reserve Requirements (T-accounts) for the Monetary Policy section of the course.

Here is the link,, problems? e-mail me wcwaugh@aol.com

mjmfoodie - video - Reserve Requirements (Money Creation)

Excellent summary of monetary policy and how banks create money.

Take the time to read it as it touches upon most of what you will need to do well on the AP Exam.

Money Supply Notes

Let's go through a few and see if we can understand what the college board is testing.

Money Multiplier (Creation) Money Supply Increase

1995 AP Macro Exam

Answer (D) $500

(money already in excess reserves)

So, The Reserve Requirement is 20% (they must keep on reserve 20% of the checkable deposited amount), there is $100 dollars worth of excess reserves, how much money creation can happen within the money supply. (Think: money multiplier)

If the RR is 20% or .2 and the multiplier is (1/RRR) = 1/.2 = 5 ,, so the multiplier is 5

If there is $100 in excess reserves we simply take the 100 x 5 = $500 increase in the Money Supply.

1. Don't get confused,, you need the 20% RR to figure out the multiple (1/.2 = 5)
2. Not to subtract the 20% from the $100. 
3. As the $100 dollars is already in excess reserves. 
4. If the $100 dollars had been a checking deposit (deposited by someone) then you would have subtracted the $20 from the $100 and multiplied $80 x 5 and the money supply would have increased by $400.
5. AS the amount was already in excess reserves, the whole amount in excess reserves is multiplied by the 5.

2008 AP Macro Exam

Answer (C) $900

(money deposited in checking account)

So, the RR is 10%,,  and the multiplier is (1/RRR) =  1/.1 = 10 is the multiplier.

There is a checkable deposit of $100 - (the RRR = 10% of $100 = $10 dollars) = $100 - $10 = $90

So, now we have $90 in excess reserves, & the money supply is expanded by the multiplier x the change in the excess reserves.

$90 x 10 = $900

1. You needed the RR 10% to have the multiple
2. Since it was a deposit you have to subtract out the RR
3. The difference is it goes into excess reserves and can be re-loaned out again.
4. This is the essence of fractional reserve banking.
5. What if the RR had been 20%
6. If the RR was 20% the multiple would be 5 not 10 like above.
7. This makes sense as the higher the RR the less money creation (loans) can take place.
8. 20% would be subtracted from the $100 checkable deposit to leave $80
9. The $80 dollars would be placed in excess reserves to be re-loaned.
10. Then the MS would increase by 5 x 80 = $400

Monetary Policy Cheat Sheet

Monetary Policy

Purchasing Power of the US Dollar

M1 Money Supply

Monetary Policy Cheat Sheet

Monetary Policy (Money Supply) FRQ Cheat Sheet

Money Supply & The FED (Monetary Policy)

Here is a FRQ cheat sheet for Monetary Policy (money supply) and soon I will add a cheat sheet for this section of the AP Macroeconomics exam.

Notice we can see some trends:

Demand for Money 

• Increases or decreases based on people's desire to hold more or less currency (Cash)
• Incomes change (Income Increases, (C) Increases, (I) increases, (AD) Increases, Output increases, therefore DM Increases)
• Income change (Income Decreases, (C) Decreases, (I) Decreases, (AD) Decreases, Output Decreases, therefore DM Decreases)
• Show how this effects nominal interest rates and the price level.
• How the FED can counteract the effects.

    Money Supply

• What is the open market operation the FED will use? Expansionary(Buy bonds)
• What is the open market operation the FED will use? Contractionary (Sell bonds)
• Show what happens to the Nominal Interest Rate.
• What happens to the Price Level and the Real Interest Rate?
• What happens to Aggregate Demand (AD)?