Chapter 4, Problem 1QAP

a)

To determine

Whether income and financial wealth are both examples of stock variables.

Explanation of Solution

A stock variable is measurable at a particular point of time, whereas a flow variable changes during a period of time.

Income is a flow variable, while the financial wealth is defined as a stock variable that would be related to the value of wealth during a given point of time.

Hence, the given statement is “False”.

b)

To determine

The term investment, as used by economists, refers to the purchase of bonds and shares of stock.

Explanation of Solution

Investments do not refer to the purchase of bonds and shares of stock as they are the financial assets.

It is a false statement as the term“investment” is used by economists for the purchase of new capital goods.

c)

To determine

The demand for money does not depend on the interest rate because only bonds earn interest.

Explanation of Solution

The demand for money is inversely related to interest rates. That is, the demand for money is a downward sloping curve depicting a negative relationship between the quantity of money demanded and the interest rates.

Thus, the given statement is “False”. Money demand describes the portfolio decision to hold wealth in the form of money rather than in the form of bonds. The interest rate on bonds is relevant to this decision.

d)

To determine

About 2/3 of U.S. currency is held outside the United States.

Explanation of Solution

A large proportion of the United States currency goes for the circulation outside the US.

The statement is “True” as the Treasury and Board of Governors have estimated that approximately there is 60 percent of all U.S. banknotes that are part of the circulation and are close to $500 billion, that has been held outside the United States.

So far, the U.S. banknotes have also held as an attractive asset to residents of nations due to political or economic uncertainty.

e)

To determine

The central bank can increase the supply of money by selling bonds in the market for bonds.

Explanation of Solution

If the Fed buys bonds in the open market, they would increase the money supply in the economy which would result in the swapping out bonds due to the exchange of the cash to the general public.

So, the statement is “False” as the money supply would decrease if the Fed sells bonds.

f)

To determine

The Federal Reserve can determine the money supply, but it cannot determine the interest rate − not even the Federal Funds rate − because interest rates are determined in the private sector.

Explanation of Solution

The Fed can directly or indirectly affect the interest rates in the market through open market operations or changes in the federal fund's rates/reserve requirement rates.

The statement is “False” as the reserve balances at the Federal Reserve would lead to the reserves below the system's requirements.  It would be targeted by the FOMC to define the federal funds rate, but actually, it is the market that determines the actual rate itself.

g)

To determine

Bond prices and interest rates always move in opposite directions.

Explanation of Solution

To summarize, interest rates and bond prices have an inverse relationship, which implies that a rise in the interest rate leads to a fall in the bond prices.

It is “True” as higher interest rates on bonds decrease the face value of bonds and vice-versa.

g)

To determine

Since the Great Depression, the United States has used federal deposit insurance to deal with bank runs.

Explanation of Solution

FDIC insurance is described as panic insurance which maintains confidence within the banking system.

So, it is “True”.During the market crash, the FDIC has helped in preventing bank panics for another period of Depression.