AP Macroeconomics Flashcards: Monetary Policy

What this deck covers

This deck focuses on Monetary Policy, giving you a quick way to review the definitions, rules, and examples that matter most for AP Macroeconomics.

How to use these flashcards

Work through these flashcards in short sessions. Try to answer each prompt before flipping the card, then revisit any cards you miss until the explanation feels automatic.

Flashcard 1: What is the discount rate?

Answer: The interest rate charged to commercial banks on loans from the Fed. This rate influences banks' willingness to borrow from the Fed.

Flashcard 2: What is a central bank's balance sheet composed of?

Answer: Assets and liabilities including securities and currency in circulation. Reflects the central bank's monetary policy operations and financial position.

Flashcard 3: What is the effect of an increase in the federal funds rate?

Answer: Interest rates increase; borrowing decreases. Higher rates make loans more expensive, reducing economic activity.

Flashcard 4: What does a liquidity trap refer to?

Answer: When interest rates are low and savings rates are high, limiting monetary policy effectiveness. Occurs when monetary policy becomes ineffective near zero interest rates.

Flashcard 5: What effect does lowering reserve requirements have?

Answer: Increases money supply by allowing more loans. Fewer reserves required means banks can make more loans to borrowers.

Flashcard 6: What happens when the Federal Reserve raises the discount rate?

Answer: Banks borrow less; money supply decreases. Higher discount rates discourage borrowing, contracting credit availability.

Flashcard 7: Identify the term for the rate at which banks can borrow reserves from each other overnight.

Answer: Federal funds rate. This interbank lending rate influences broader economic interest rates.

Flashcard 8: How does inflation targeting work?

Answer: Central bank sets an explicit inflation rate as policy goal. Provides transparency and accountability by committing to specific inflation levels.

Flashcard 9: What is a 'repo' in monetary policy terms?

Answer: Repurchase agreement, a short-term loan for dealers in government securities. A key tool for injecting liquidity into the financial system temporarily.

Flashcard 10: Identify the term for the rate at which banks can borrow reserves from each other overnight.

Answer: Federal funds rate. This interbank lending rate influences broader economic interest rates.

Flashcard 11: What is the impact of high inflation on purchasing power?

Answer: Reduces purchasing power. Higher prices mean each dollar buys fewer goods and services.

Flashcard 12: What is the Phillips Curve?

Answer: Shows the inverse relationship between inflation and unemployment. Demonstrates the short-run trade-off between price stability and employment.

Flashcard 13: What is the impact of monetary policy on exchange rates?

Answer: Influences through interest rate changes affecting currency value. Rate changes affect capital flows, strengthening or weakening the currency.

Flashcard 14: What is the primary objective of monetary policy?

Answer: To control inflation and ensure economic stability. Central banks use this dual mandate to maintain price stability and full employment.

Flashcard 15: What is the purpose of contractionary monetary policy?

Answer: To reduce inflation and cool an overheating economy. Raises interest rates to slow down an overheated economy.

Flashcard 16: What is meant by 'crowding out' in the context of fiscal policy?

Answer: Government borrowing reduces private investment. Higher government spending raises interest rates, discouraging private investment.

Flashcard 17: How does the Federal Reserve decrease the money supply?

Answer: By selling government securities. Selling bonds removes money from banks, reducing available reserves.

Flashcard 18: What is open market operations?

Answer: Buying and selling government securities. The Fed's primary tool for implementing monetary policy through bond transactions.

Flashcard 19: What does a liquidity trap refer to?

Answer: When interest rates are low and savings rates are high, limiting monetary policy effectiveness. Occurs when monetary policy becomes ineffective near zero interest rates.

Flashcard 20: What happens when the Federal Reserve lowers the discount rate?

Answer: Banks borrow more; money supply increases. Lower discount rates encourage borrowing, expanding credit availability.

Flashcard 21: What is the primary objective of monetary policy?

Answer: To control inflation and ensure economic stability. Central banks use this dual mandate to maintain price stability and full employment.

Flashcard 22: What is the impact of negative interest rates?

Answer: Encourages spending and investment by making saving costly. Penalizes holding cash to stimulate economic activity during deflationary periods.

Flashcard 23: What is the dual mandate of the Federal Reserve?

Answer: To promote maximum employment and stable prices. Balances the goals of full employment with price stability simultaneously.

Flashcard 24: How does the Federal Reserve decrease the money supply?

Answer: By selling government securities. Selling bonds removes money from banks, reducing available reserves.

Flashcard 25: What is the purpose of contractionary monetary policy?

Answer: To reduce inflation and cool an overheating economy. Raises interest rates to slow down an overheated economy.

Flashcard 26: Define reserve requirements.

Answer: Minimum reserves banks must hold, set by the Fed. This regulatory tool controls how much banks can lend relative to deposits.

Flashcard 27: What is the effect of a decrease in the federal funds rate?

Answer: Interest rates decrease; borrowing increases. Lower rates make loans cheaper, stimulating economic activity.

Flashcard 28: What is the impact of high inflation on purchasing power?

Answer: Reduces purchasing power. Higher prices mean each dollar buys fewer goods and services.

Flashcard 29: How does the Federal Reserve increase the money supply?

Answer: By purchasing government securities. Buying bonds injects money into banks, increasing available reserves.

Flashcard 30: What is the purpose of expansionary monetary policy?

Answer: To stimulate economic growth and reduce unemployment. Lowers interest rates to boost economic activity during recessions.

Flashcard 31: What is a 'repo' in monetary policy terms?

Answer: Repurchase agreement, a short-term loan for dealers in government securities. A key tool for injecting liquidity into the financial system temporarily.

Flashcard 32: What is the relationship between interest rates and bond prices?

Answer: They are inversely related. Rising rates decrease bond values; falling rates increase bond values.

Flashcard 33: What tool is used to measure the money supply?

Answer: Monetary aggregates like M1 and M2. These statistical measures track different components of money in circulation.

Flashcard 34: What happens when the Federal Reserve raises the discount rate?

Answer: Banks borrow less; money supply decreases. Higher discount rates discourage borrowing, contracting credit availability.

Flashcard 35: What happens when the Federal Reserve lowers the discount rate?

Answer: Banks borrow more; money supply increases. Lower discount rates encourage borrowing, expanding credit availability.

Flashcard 36: What is the equation for the quantity theory of money?

Answer: $MV = PY$, where $M$ is money supply, $V$ is velocity, $P$ is price level, and $Y$ is output. Demonstrates how money supply and velocity determine price level and output.

Flashcard 37: What effect does lowering reserve requirements have?

Answer: Increases money supply by allowing more loans. Fewer reserves required means banks can make more loans to borrowers.

Flashcard 38: What is a central bank's role in stabilizing the financial system?

Answer: Ensures liquidity and acts as a lender of last resort. Maintains financial stability by preventing bank runs and systemic crises.

Flashcard 39: How does inflation targeting work?

Answer: Central bank sets an explicit inflation rate as policy goal. Provides transparency and accountability by committing to specific inflation levels.

Flashcard 40: What is the concept of 'forward guidance'?

Answer: Communicating future monetary policy intentions to influence expectations. Shapes market expectations about future policy without immediate rate changes.

Flashcard 41: What is quantitative easing?

Answer: Large-scale asset purchases to inject money into the economy. Used when conventional monetary policy reaches the zero lower bound.

Flashcard 42: What is open market operations?

Answer: Buying and selling government securities. The Fed's primary tool for implementing monetary policy through bond transactions.

Flashcard 43: What effect does raising reserve requirements have?

Answer: Decreases money supply by restricting loans. More reserves required means banks must reduce lending capacity.

Flashcard 44: What is the role of the Federal Open Market Committee (FOMC)?

Answer: To oversee open market operations and monetary policy. The key Fed committee that meets regularly to set interest rate policy.

Flashcard 45: What is the impact of negative interest rates?

Answer: Encourages spending and investment by making saving costly. Penalizes holding cash to stimulate economic activity during deflationary periods.

Flashcard 46: What is the effect of an increase in the federal funds rate?

Answer: Interest rates increase; borrowing decreases. Higher rates make loans more expensive, reducing economic activity.

Flashcard 47: What effect does raising reserve requirements have?

Answer: Decreases money supply by restricting loans. More reserves required means banks must reduce lending capacity.

Flashcard 48: What is the effect of a decrease in the federal funds rate?

Answer: Interest rates decrease; borrowing increases. Lower rates make loans cheaper, stimulating economic activity.

Flashcard 49: What is the impact of monetary policy on exchange rates?

Answer: Influences through interest rate changes affecting currency value. Rate changes affect capital flows, strengthening or weakening the currency.

Flashcard 50: Which institution is primarily responsible for monetary policy in the U.S.?

Answer: The Federal Reserve System. The Fed is the central bank that implements U.S. monetary policy decisions.

Flashcard 51: What does 'lender of last resort' mean?

Answer: Central bank provides funds to financial institutions in crisis. Prevents financial system collapse by providing emergency liquidity when needed.

Flashcard 52: What is the concept of 'forward guidance'?

Answer: Communicating future monetary policy intentions to influence expectations. Shapes market expectations about future policy without immediate rate changes.

Flashcard 53: What is a central bank's role in stabilizing the financial system?

Answer: Ensures liquidity and acts as a lender of last resort. Maintains financial stability by preventing bank runs and systemic crises.

Flashcard 54: What is the difference between M1 and M2 money supply?

Answer: M1 includes cash and checkable deposits; M2 includes M1 plus savings deposits. M2 is broader, including less liquid forms of money than M1.

Flashcard 55: What is meant by 'monetary neutrality'?

Answer: Money supply changes do not affect real variables in the long run. Only affects nominal variables like prices, not real output or employment.

Flashcard 56: What is the equation for the quantity theory of money?

Answer: $MV = PY$, where $M$ is money supply, $V$ is velocity, $P$ is price level, and $Y$ is output. Demonstrates how money supply and velocity determine price level and output.

Flashcard 57: What is the difference between M1 and M2 money supply?

Answer: M1 includes cash and checkable deposits; M2 includes M1 plus savings deposits. M2 is broader, including less liquid forms of money than M1.

Flashcard 58: How does the Federal Reserve increase the money supply?

Answer: By purchasing government securities. Buying bonds injects money into banks, increasing available reserves.

Flashcard 59: What is meant by 'crowding out' in the context of fiscal policy?

Answer: Government borrowing reduces private investment. Higher government spending raises interest rates, discouraging private investment.

Flashcard 60: What is the relationship between interest rates and bond prices?

Answer: They are inversely related. Rising rates decrease bond values; falling rates increase bond values.

Flashcard 61: Define reserve requirements.

Answer: Minimum reserves banks must hold, set by the Fed. This regulatory tool controls how much banks can lend relative to deposits.

Flashcard 62: What is the role of the Federal Open Market Committee (FOMC)?

Answer: To oversee open market operations and monetary policy. The key Fed committee that meets regularly to set interest rate policy.

Flashcard 63: What is the Taylor Rule used for?

Answer: Guiding central banks in setting interest rates. Provides a formula for optimal interest rate based on economic conditions.

Flashcard 64: What is the dual mandate of the Federal Reserve?

Answer: To promote maximum employment and stable prices. Balances the goals of full employment with price stability simultaneously.

Flashcard 65: What is the purpose of expansionary monetary policy?

Answer: To stimulate economic growth and reduce unemployment. Lowers interest rates to boost economic activity during recessions.

Flashcard 66: What is the Fisher Effect?

Answer: The relationship between nominal interest rates, real interest rates, and inflation. Shows how expected inflation affects the gap between nominal and real rates.

Flashcard 67: What is meant by 'monetary neutrality'?

Answer: Money supply changes do not affect real variables in the long run. Only affects nominal variables like prices, not real output or employment.

Flashcard 68: What is the Fisher Effect?

Answer: The relationship between nominal interest rates, real interest rates, and inflation. Shows how expected inflation affects the gap between nominal and real rates.

Flashcard 69: Which institution is primarily responsible for monetary policy in the U.S.?

Answer: The Federal Reserve System. The Fed is the central bank that implements U.S. monetary policy decisions.

Flashcard 70: What is the Taylor Rule used for?

Answer: Guiding central banks in setting interest rates. Provides a formula for optimal interest rate based on economic conditions.