Term
| How do central banks set monetary policy? |
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Definition
- Set the discount rate
- Open Market Operations
This affects the market interest rates |
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Term
| How did the ECB respond to the economic crisis in Europe |
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Definition
1. Injected 95 billion Euros (provided cheap loans to banks)
2. Created long-term loas (3, 6, 12 months)
- These moves allowed the banks not to freeze its assets |
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Term
| What is the ECB's main goal and how did this affect their response to the financial crisis |
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Definition
To keep inflation stable
- Inflation was so high that they could not lower the interest rate for fear that it'd go higher
- Waited until inflation settled down and cut the interest rate to 1% so that there was room to decrease it even further |
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Term
| What was the ECB's analysis of the financial crisis problem? |
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Definition
Thought it was a problem of liquidity
- Turned out to actually be a credit crunch because banks held excess reserves and were hesitant to loan any money |
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Term
| Why did the ECB respond less aggressively to the financial crisis than the Fed |
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Definition
1. The Fed had a long reputation of maintaining inflation
2. ECB looks at an aggregate indicator therefore the problem looked less severe until some of the major banks began to fail |
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Term
| The case for the ECB buying the Greek debt |
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Definition
If the Greek's restructure their debt and default, the interest rates in the countries with uncertainty will see their interest rates sky rocket
- The failure of Greece would create panic in other shaky economies because the interest rate is often driven by fear |
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Term
| The case against the ECB bailing out Greece |
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Definition
Moral hazard because if the ECB buys the Greek debt, the monetary institution has fixed the problem and takes away the accountability of the fiscal institutions (Governments)
- Gives the governments a sense that there is a safety net because the ECB will bail them out |
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Term
| What are the merits of a floating exchange rate? |
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Definition
- Free capital flows- capital is allocated to the best possible investment because there are no restrictions
- Country maintains sovereign monetary policy and the ability to intervene and appreciate/depreciate their currency |
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Term
| What are the merits of a fixed exchange rate? |
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Definition
- Transparency
- Control inflation because you peg it to a more stable currency
- Monetary policy is taken away (good if your policymakers are not capable of making good decisions) |
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Term
| Loss of Monetary policy with a fixed exchange rate |
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Definition
A central bank can't print money when things aren't going well if it does not have the foreign reserves
- If foreign reserves shrink the money supply decreases |
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Term
| How could a country fix its BOP |
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Definition
| Devaluing currency to become more competitive in exports |
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Term
| How can a central bank help decrease unemployment |
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Definition
| Decreasing interest rates to create more investment and opportunity to expand business |
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Term
| Requirements of maintaining a currency board |
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Definition
| All domestic currency must be backed 100% by foreign reserves |
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Term
| Good implications of a currency board |
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Definition
- Increases transparency in monetary policy which is simplified
- Stabilizes prices |
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Term
| Bad implications in a currency board |
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Definition
| Could bring about a capital flight to the foreign currency due to increased uncertainty about the future of a currency |
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Term
| What is the IMF's position on the currency board for Indonesia |
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Definition
Basically said if Indonesia adopts it, they will revoke any bailout money offered
- This could decrease the IMF's credibility if it works
- Maximizes their bureaucratic power
IMF thought it was a quick fix to a more complicated problem and that Indonesia needed fiscal institution changes and not just monetary help |
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Term
| Why did the money supply decrease during the Great Depression Bank Panics |
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Definition
There was an outflow of bank deposits to currency
- Also an increase in excess reserves of banks
This caused the money multiplier to decrease because there is less money on deposit to multiply |
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Term
| Equation to support how the money supply decreased while the monetary base increased during the Bank Panics of 1929-1933 |
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Definition
| % change in MS= % change in MB + % change in Money Multiplier |
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Term
| How was the tripling of the monetary base offset during the financial crisis of 2007-2009 |
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Definition
- The currency ratio somewhat fell which would create an even higher money multiplier
- However, the amount of excess reserves increased so much that it decreased the money multiplier |
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Term
| Describe why the dollar initially depreciated, then appreciated during the financial crisis of 2007-2009 |
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Definition
The Fed had to initially lower interest rates which depreciated the dollar, while the ECB did not act as aggressively to lower rates
- when they eventually lowered rates, there was a flight to quality to the US dollar because the expected relative return of the US dollar was increasing |
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