Interpret Economic Cycles And Policy - Series 65

1. When the Fed buys Treasury securities, what happens to bank reserves and rates?

   Reserves increase; short-term interest rates tend to fall. Purchasing securities injects liquidity into banks, boosting reserves and encouraging lending at lower rates to stimulate the economy.

2. What is fiscal policy?

   Government tax and spending policy. Fiscal policy uses taxation and expenditure decisions to influence aggregate demand, economic growth, and employment levels.

3. Which monetary policy stance is used to fight recession: expansionary or contractionary?

   Expansionary monetary policy. Expansionary policy increases money supply and lowers interest rates to stimulate borrowing, spending, and economic recovery during downturns.

4. What is the CPI primarily used to measure?

   Inflation in consumer prices (cost of living). The Consumer Price Index tracks changes in the price of a basket of goods and services, reflecting cost-of-living adjustments for consumers.

5. What is the relationship between bond maturity and interest rate risk?

   Longer maturity generally means greater interest rate risk. Longer-term bonds are more sensitive to interest rate changes, as their cash flows are discounted over extended periods, amplifying price volatility.

6. What is the relationship between interest rates and bond prices?

   They move inversely. Bond prices fall when interest rates rise because new bonds offer higher yields, making existing lower-yield bonds less attractive.

7. If the Fed raises the discount rate, is that generally expansionary or contractionary?

   Contractionary. A higher discount rate discourages banks from borrowing from the Fed, tightening credit conditions and slowing economic growth.

8. Identify the most likely effect on equities when interest rates rise sharply.

   Equity valuations tend to fall due to higher discount rates. Rising rates increase the cost of capital, discounting future earnings at a higher rate and thus lowering present value of stocks.

9. Which fiscal action is contractionary: cutting taxes or raising taxes?

   Raising taxes. Higher taxes reduce disposable income and spending, decreasing aggregate demand to combat inflation or overheating.

10. What is the formula for the real interest rate using the Fisher approximation?

    $r \approx i - \pi$. The Fisher equation approximates the real interest rate by subtracting expected inflation from the nominal rate to reflect true borrowing costs.

11. What is the term for falling prices across the economy over time?

    Deflation. Deflation increases the real value of money but can lead to reduced spending and economic slowdown as consumers delay purchases expecting lower prices.

12. What does the unemployment rate measure?

    Unemployed as a percent of the labor force. It calculates the proportion of the workforce actively seeking but unable to find employment, indicating labor market health.

13. What is the Federal Reserve's primary policy tool for targeting short-term rates?

    Open market operations. Through buying or selling government securities, the Fed influences the federal funds rate and overall liquidity in the banking system.

14. What is the standard definition of a recession used in many exam contexts?

    Two consecutive quarters of negative real GDP growth. This metric identifies a recession by measuring sustained decline in economic output, commonly used for its simplicity in financial exams.

15. What are the four standard phases of the business cycle in order?

    Expansion, peak, contraction (recession), trough. These phases represent the cyclical pattern of economic growth, reaching maximum output, slowdown with possible recession, and bottoming out before recovery.

16. If reserve requirements increase, what happens to banks' ability to lend?

    Ability to lend decreases. Higher reserve requirements force banks to hold more funds idle, limiting the money multiplier effect and reducing available credit.

17. What is the term for the total value of goods and services produced within a country?

    Gross domestic product (GDP). GDP quantifies a nation's economic activity by summing the market value of all final goods and services produced domestically in a given period.

18. What is the term for rising prices across the economy over time?

    Inflation. Inflation erodes purchasing power as the general price level increases, often due to excess demand or rising production costs.

19. What is the difference between nominal GDP and real GDP?

    Real GDP is inflation-adjusted; nominal GDP is not. Adjusting for inflation in real GDP provides a more accurate measure of economic growth by removing price level changes from nominal figures.

20. When the Fed sells Treasury securities, what happens to bank reserves and rates?

    Reserves decrease; short-term interest rates tend to rise. Selling securities withdraws liquidity from banks, reducing reserves and pressuring rates upward to cool economic activity.

21. If inflation expectations rise, what is the most likely direction for nominal yields?

    Nominal yields tend to rise. Higher inflation erodes the real return on bonds, prompting investors to demand higher nominal yields to compensate for reduced purchasing power.

22. Which fiscal action is expansionary: increasing spending or increasing taxes?

    Increasing government spending. Boosting government outlays injects money into the economy, increasing demand and stimulating production during periods of low activity.

23. What is stagflation?

    High inflation combined with high unemployment and weak growth. Stagflation combines stagnant growth with rising prices and joblessness, challenging traditional economic policies that address one issue at a time.

24. What is the typical effect on the U.S. dollar when U.S. interest rates rise relative to others?

    The U.S. dollar tends to appreciate. Higher U.S. rates attract foreign capital inflows, increasing demand for dollars and strengthening its value against other currencies.

25. Which monetary policy stance is used to fight inflation: expansionary or contractionary?

    Contractionary monetary policy. Contractionary policy reduces money supply and raises interest rates to curb excessive demand driving inflation.

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