# AP Macroeconomics: Money Market, Loanable Funds, Central Bank Monetary Policy & Foreign Exchange

> High-yield AP Macroeconomics Units 4 & 6 review covering functions of money, M1/M2, fractional reserve banking, the money multiplier, Money Market vs. Loanable Funds graphs, Federal Reserve monetary policy (ample vs. limited reserves), Balance of Payments, and Foreign Exchange.

- **Canonical URL:** https://flashcards.world/flashcards/sets/dac0cbe0-6c8f-44d4-a694-c504cddf28c3/
- **Markdown URL:** https://flashcards.world/flashcards/sets/dac0cbe0-6c8f-44d4-a694-c504cddf28c3.md
- **Level:** advanced
- **Languages:** en → en
- **Total Cards:** 32

## Flashcards (32 Cards)

| # | Front (Term / Prompt) | Back (Definition / Answer) | Example | Multiple-Choice Options |
| :--- | :--- | :--- | :--- | :--- |
| 1 | Draw and label the Money Market Graph, and explain what shifts Money Demand ($MD$) versus Money Supply ($MS$). | • **Axes**: Vertical axis = **Nominal Interest Rate ($i$)** (the opportunity cost of holding liquid money instead of interest-bearing bonds); Horizontal axis = **Quantity of Money ($M$)**. • **Money Demand ($MD$)**: Downward-sloping because at high nominal interest rates ($i$), people hold less cash and more bonds (asset demand). **$MD$ Shifters** (Transaction Demand, proportional to Nominal GDP = $PL \times Y$):   1. **Change in Price Level ($PL$)**: $PL \uparrow \Rightarrow MD \uparrow$ (shifts right).   2. **Change in Real GDP ($Y$)**: $Y \uparrow \Rightarrow MD \uparrow$ (shifts right).   3. **Payment Technology** (credit cards/ATMs reduce cash needed $\Rightarrow MD \downarrow$). • **Money Supply ($MS$)**: **Vertical** (perfectly inelastic), controlled solely by the Central Bank (Federal Reserve). |  |  |
| 2 | Practice Bank Balance Sheet Problem: Suppose First National Bank has $\$100,000$ in Demand Deposits, $\$15,000$ in Total Reserves, and $\$85,000$ in Loans, with a Required Reserve Ratio $rr = 10\%$. What are (a) Required Reserves, (b) Excess Reserves, (c) the max new loans First National can make, and (d) the max increase in $M1$ across the entire banking system? | • **(a) Required Reserves ($RR$)**: $rr \times \text{Demand Deposits} = 0.10 \times \$100,000 = \mathbf{\$10,000}$. • **(b) Excess Reserves ($ER$)**: $\text{Total Reserves} - RR = \$15,000 - \$10,000 = \mathbf{\$5,000}$. • **(c) Max New Loans by First National Bank alone**: Equal to its Excess Reserves $= \mathbf{\$5,000}$. • **(d) Max Expansion of $M1$ across the Banking System**: $ER \times \frac{1}{rr} = \$5,000 \times \frac{1}{0.10} = \$5,000 \times 10 = \mathbf{+\$50,000}$. |  |  |
| 3 | What is the Money Multiplier ($1/rr$), and why does a $\$1,000$ Cash Deposit by a customer increase the Money Supply ($M1$) by LESS than a $\$1,000$ Federal Reserve Open-Market Bond Purchase? | • **Simple Money Multiplier**: $mm = \frac{1}{rr}$ (where $rr$ is the Required Reserve Ratio). • **Case 1: Customer Deposits $\$1,000$ Cash into Checking** (with $rr = 0.10$, $mm = 10$):   - **Immediate change in $M1 = \$0$** (composition shifts from currency to demand deposits).   - Bank must hold $10\%$ ($\$100$) as Required Reserves and gets **$ER = \$900$**.   - **Maximum New Loans / New Money Created**: $ER \times mm = \$900 \times 10 = \mathbf{\$9,000}$ (Total Demand Deposits rise by $\$10,000$, net $\Delta M1 = +\$9,000$). • **Case 2: Central Bank Buys $\$1,000$ of Bonds from a Bank** (with $rr = 0.10$):   - All $\$1,000$ goes directly into **Excess Reserves ($ER = \$1,000$)** because Demand Deposits did not change initially!   - **Maximum New Loans / $\Delta M1$**: $\$1,000 \times 10 = \mathbf{+\$10,000}$. |  |  |
| 4 | Trace the complete Monetary Policy Transmission Mechanism for Expansionary and Contractionary Monetary Policy in a Limited Reserves Regime. | • **Expansionary (Easy Money) Policy** (Recessionary Gap):   Central Bank **buys bonds** (or lowers $rr$ / Discount Rate) $\rightarrow$ Bank Excess Reserves $\uparrow$ $\rightarrow$ Money Supply ($MS$) shifts **RIGHT** $\rightarrow$ Nominal Interest Rate ($i$) **FALLS** (and Real Interest Rate $r$ falls in the short run) $\rightarrow$ Interest-sensitive Investment ($I$) and Consumption ($C$) **INCREASE** $\rightarrow$ **$AD$ shifts RIGHT** $\rightarrow$ Real GDP ($Y$) $\uparrow$, Price Level ($PL$) $\uparrow$, Unemployment $\downarrow$. • **Contractionary (Tight Money) Policy** (Inflationary Gap):   Central Bank **sells bonds** (or raises $rr$ / Discount Rate) $\rightarrow$ Bank Reserves $\downarrow$ $\rightarrow$ $MS$ shifts **LEFT** $\rightarrow$ Interest Rate ($i$) **RISES** $\rightarrow$ $I$ and $C$ **DECREASE** $\rightarrow$ **$AD$ shifts LEFT** $\rightarrow$ $Y \downarrow$, $PL \downarrow$, Unemployment $\uparrow$. |  |  |
| 5 | What happens in the Money Market when the Price Level ($PL$) rises (e.g., from a rightward shift in $AD$ or leftward shift in $SRAS$)? | When the Price Level ($PL$) rises, households and firms need more money for everyday transactions (**Transaction Demand for Money increases**). On the **Money Market graph**, the **Money Demand ($MD$) curve shifts to the RIGHT**, while the vertical Money Supply ($MS$) stays fixed—driving the **equilibrium Nominal Interest Rate ($i$) UP**. |  |  |
| 6 | Wait—if Expansionary Fiscal Policy ($G \uparrow$) raises domestic Real GDP ($Y \uparrow$) AND raises Real Interest Rates ($r \uparrow$), why do BOTH effects reinforce a decrease in Net Exports ($X_n \downarrow$)? | • **Interest Rate Channel**: Deficit spending ($G \uparrow$) raises domestic real interest rates ($r \uparrow$) $\rightarrow$ attracts foreign financial capital inflows $\rightarrow$ **appreciates the domestic currency** $\rightarrow$ reduces Net Exports ($X_n \downarrow$). • **Income Channel**: Higher domestic Real GDP ($Y \uparrow$) means domestic consumers have more income and buy more imported goods ($M \uparrow$) $\rightarrow$ also reduces Net Exports ($X_n \downarrow$). Thus, Expansionary Fiscal Policy unambiguously pushes the **Trade Balance ($X_n$) toward a deficit** ('Twin Deficits': budget deficit + trade deficit). |  |  |
| 7 | What is the difference between a Floating (Flexible) Exchange Rate Regime and a Fixed (Pegged) Exchange Rate Regime? | • **Floating Exchange Rate** (U.S. Dollar, Euro, Yen, Pound): Exchange rate is determined freely by private supply and demand in the FOREX market, allowing the Central Bank to conduct independent domestic monetary policy. • **Fixed (Pegged) Exchange Rate**: The government/Central Bank commits to maintaining a fixed exchange rate against an anchor currency by buying/selling foreign currency reserves or adjusting domestic interest rates—surrendering independent monetary policy ('Impossible Trinity'). |  |  |
| 8 | Compare the Central Bank's Monetary Policy Tools in an Economy with LIMITED RESERVES vs. an Economy with AMPLE RESERVES (the current AP Macro framework). | • **Limited Reserves Regime** (traditional Money Market / Reserve Market steep slope): The Central Bank changes the money supply and the overnight policy rate (**Federal Funds Rate**) using three tools:   1. **Open-Market Operations (OMOs)**—**Buying** government bonds (**Expansionary**: increases reserves/money supply, lowers $i$) or **Selling** bonds (**Contractionary**: decreases reserves/money supply, raises $i$);   2. **Required Reserve Ratio ($rr$)**;   3. **Discount Rate** (interest rate the Fed charges banks for direct loans). • **Ample Reserves Regime** (flat lower portion of the Reserve Demand curve, like the U.S. Fed today): Small OMOs do *not* change the policy rate! Instead, the Central Bank adjusts its **Administered Interest Rates**—specifically **Interest on Reserves (IOR / IORB)** (and the overnight reverse repo rate)—moving the flat portion of the reserve curve up or down. |  |  |
| 9 | Why do Bond Prices and Nominal Interest Rates ALWAYS move in OPPOSITE directions? | Existing bonds pay a **fixed annual dollar coupon** (e.g., $\$50$/year on a $\$1,000$ face-value bond $= 5\%$ yield). If market nominal interest rates **rise** to $10\%$, no investor will buy the old $\$50$-coupon bond unless its market price **falls** so that $\frac{\text{Fixed Coupon}}{\text{Bond Price}}$ matches the higher new market yield. Conversely, when interest rates **fall**, existing bond prices **rise**. |  |  |
| 10 | What is 'Quantitative Easing (QE)' and the 'Zero Lower Bound (Liquidity Trap),' and why did Central Banks use QE in 2008 and 2020? | When a severe recession drives the Central Bank's overnight nominal policy rate all the way down to **near $0\%$ (the Zero Lower Bound)**, conventional short-term rate cuts cannot go much lower (and banks/households hoard cash in a **Liquidity Trap**). Under **Quantitative Easing (QE)**, the Central Bank purchases massive quantities of **long-term Treasury bonds and mortgage-backed securities (MBS)** to drive up long-term bond prices and **lower long-term interest rates** (such as 30-year mortgage and corporate bond rates). |  |  |
| 11 | What are the three Functions of Money, and what assets are included in the M1 and M2 Monetary Aggregates (and the Monetary Base $MB$)? | • **Three Functions of Money**:   1. **Medium of Exchange** (eliminates the 'double coincidence of wants' of barter);   2. **Unit of Account** (yardstick for measuring prices and debts);   3. **Store of Value** (preserves purchasing power over time, though eroded by inflation). • **Monetary Base ($MB$, 'high-powered money')**: Currency in circulation + Bank reserves held at the Central Bank. • **M1 (Most Liquid)**: Currency/coins in circulation + Checkable deposits (demand deposits) + Savings deposits (including money market deposit accounts since May 2020). • **M2**: **All of M1** + Small-denomination time deposits (CDs $<\$100\text{k}$) + Retail money market mutual funds. (*Note*: Credit cards, stocks, and bonds are **NOT** money!). |  |  |
| 12 | Summarize the complete impact of a Recessionary Shock ($AD \downarrow$) across all 5 core AP Macroeconomics graphs ($AD\text{–}AS$, Phillips Curve, Money Market, Loanable Funds, and FOREX). | 1. **$AD\text{–}AS$ Graph**: $AD$ shifts **left** $\rightarrow$ Price Level ($PL$) falls and Real GDP ($Y$) falls below $Y_f$. 2. **Phillips Curve**: Movement **down and to the right along the $SRPC$** (lower inflation, higher unemployment). 3. **Money Market**: Lower $PL$ and lower $Y$ reduce transaction demand for money $\rightarrow$ **$MD$ shifts LEFT** $\rightarrow$ Nominal Interest Rate ($i$) falls. 4. **Loanable Funds**: Lower business demand for borrowing ($D_{LF} \downarrow$) lowers the **Real Interest Rate ($r \downarrow$)**. 5. **FOREX Market**: Lower domestic real interest rate ($r \downarrow$) reduces foreign capital inflows ($D_{\text{currency}} \downarrow$) $\rightarrow$ **domestic currency DEPRECIATES**, which gradually boosts Net Exports ($X_n \uparrow$). |  |  |
| 13 | What is Purchasing Power Parity (PPP), and how does it explain Long-Run Exchange Rates? | **Purchasing Power Parity (PPP)** is built on the **Law of One Price**: in the absence of transportation costs and trade barriers, an identical basket of goods should cost the exact same amount in any two countries when expressed in a common currency ($e = P_{\text{foreign}} / P_{\text{domestic}}$). If Country A experiences $5\%$ higher annual inflation than Country B, Country A's currency will **depreciate by approximately $5\%$ per year** in the long run. |  |  |
| 14 | Compare Fiat Money and Commodity Money, and explain why Fiat Money has value. | • **Commodity Money** (gold coins, silver bullion, salt, cigarettes in POW camps): Has **intrinsic value**—the item has practical use or value even if it were not used as money. • **Fiat Money** (modern U.S. Federal Reserve Notes, Euros, Yen): Has **zero intrinsic value** and is not backed by gold or silver; its value derives solely from **government decree (legal tender laws)**, public confidence/trust, and the Central Bank keeping its supply scarce. |  |  |
| 15 | How does an increase in Foreign Direct Investment (e.g., a Japanese automaker building a new factory in Texas) affect the U.S. Balance of Payments, FOREX market, and $LRAS$? | 1. **Balance of Payments**: Recorded as a **credit (inflow) in the U.S. Capital and Financial Account (CFA Surplus)**. 2. **FOREX Market**: Japanese investors must exchange Yen for U.S. Dollars ($D_{\$} \uparrow, S_{\text{¥}} \uparrow$), causing the **U.S. Dollar to APPRECIATE** and the Yen to depreciate. 3. **$AD$ and $LRAS$**: The new factory construction increases U.S. physical capital ($I \uparrow, K \uparrow$), shifting U.S. **$LRAS$ to the RIGHT** (boosting long-run economic growth). |  |  |
| 16 | What are the four major shifters ('TIPS') of the Foreign Exchange (FOREX) Market, and how does each affect Currency Appreciation/Depreciation and Net Exports ($X_n$)? | • **T — Tastes & Preferences / Tourism**: Foreign tourists flock to the U.S. $\Rightarrow D_{\$} \uparrow \Rightarrow$ **Dollar appreciates**. • **I — Relative Real Interest Rates ($r$)**: If U.S. real interest rates rise relative to Europe ($r_{\text{US}} > r_{\text{EU}}$), foreign investors seek higher returns in U.S. bonds $\Rightarrow$ **Capital Inflow to U.S.** $\Rightarrow D_{\$} \uparrow$ (and $S_{\$} \downarrow$) $\Rightarrow$ **U.S. Dollar APPRECIATES**. • **P — Relative Price Levels (Inflation)**: Higher U.S. inflation makes U.S. goods uncompetitive $\Rightarrow D_{\$} \downarrow$ and $S_{\$} \uparrow$ (Americans buy cheaper foreign goods) $\Rightarrow$ **U.S. Dollar DEPRECIATES**. • **S — Speculation / Relative Income (GDP)**: If Europe's Real GDP booms, Europeans buy more U.S. imports $\Rightarrow D_{\$} \uparrow \Rightarrow$ **U.S. Dollar APPRECIATES**. |  |  |
| 17 | How is the 'Crowding-Out Effect' of Deficit-Financed Expansionary Fiscal Policy shown on the Loanable Funds Graph? | When the government increases spending ($G \uparrow$) or cuts taxes ($T \downarrow$) without an offsetting policy, the resulting **budget deficit** can be modeled on the Loanable Funds graph in either of two accepted AP ways: 1. **Demand for Loanable Funds shifts RIGHT ($D_{LF} \uparrow$)** as the Treasury borrows more; OR 2. **Supply of Loanable Funds shifts LEFT ($S_{LF} \downarrow$)** as national saving ($S_{\text{private}} + S_{\text{public}}$) decreases. In **BOTH** representations, the **Real Interest Rate ($r$) RISES**, which reduces private business **Investment ($I \downarrow$)** and slows long-run capital formation ($LRAS$). |  |  |
| 18 | How do Monetary Policy and Fiscal Policy interact when used together (Policy Mixes) to affect Real GDP ($Y$), the Interest Rate ($r$), and Investment ($I$)? | • **Expansionary Fiscal ($G \uparrow$) + Expansionary Monetary ($MS \uparrow$)** (both fight recession): Real GDP **$Y$ definitely increases**, while the effect on the **Interest Rate is indeterminate** ($G \uparrow$ pushes $i$ up via higher $MD$/borrowing, while $MS \uparrow$ pushes $i$ down). • **Contractionary Fiscal ($G \downarrow$) + Expansionary Monetary ($MS \uparrow$)**: Interest Rate **$i$ and $r$ definitely FALL**, which strongly boosts **Private Investment ($I \uparrow$)** and long-run economic growth! • **Expansionary Fiscal ($G \uparrow$) + Contractionary Monetary ($MS \downarrow$)**: Interest Rate **$i$ and $r$ definitely RISE**, severely **crowding out Private Investment ($I \downarrow$)**. |  |  |
| 19 | Trace the complete chain of effects from a rise in U.S. Real Interest Rates ($r \uparrow$) to U.S. Net Exports ($X_n$) and Aggregate Demand ($AD$). | 1. Higher U.S. real interest rate ($r_{\text{US}} \uparrow$) attracts foreign financial investors seeking higher bond yields (**Net Capital Inflow $\uparrow$**, Capital & Financial Account moves toward **Surplus**). 2. Foreigners increase the **Demand for U.S. Dollars ($D_{\$} \uparrow$)** (and U.S. investors supply fewer dollars abroad, $S_{\$} \downarrow$). 3. The **U.S. Dollar APPRECIATES** in the FOREX market. 4. A stronger dollar makes U.S. exports **more expensive** to foreigners ($X \downarrow$) and foreign imports **cheaper** to Americans ($M \uparrow$). 5. **U.S. Net Exports FALL ($X_n \downarrow$)** (Current Account moves toward **Deficit**), which shifts U.S. **Aggregate Demand to the LEFT ($AD \downarrow$)**. |  |  |
| 20 | How does a Protective Tariff or Import Quota imposed by Country A affect the Foreign Exchange Market and Country A's Exports? | When Country A imposes a tariff on imports from Country B: 1. Citizens of Country A buy fewer imports from Country B, so they **supply less of Currency A** in the FOREX market ($S_A$ shifts **LEFT**). 2. **Currency A APPRECIATES** relative to Currency B. 3. Because Currency A is now stronger (and Currency B is weaker), Country A's **exports become more expensive to foreigners and FALL ($X \downarrow$)**—partially or fully offsetting the drop in imports so **Net Exports ($X_n$) do not improve** in the long run! |  |  |
| 21 | What happens to a Commercial Bank's Balance Sheet immediately when a customer withdraws $\$2,000$ in cash from their checking account (with $rr = 10\%$)? | 1. **Liabilities**: Demand Deposits decrease by $\$2,000$. 2. **Assets**: Total Reserves (vault cash) decrease by $\$2,000$. 3. **Required Reserves ($RR$)**: Decrease by $0.10 \times \$2,000 = \$200$. 4. **Excess Reserves ($ER = \Delta TR - \Delta RR$)**: Decrease by $\$2,000 - \$200 = \mathbf{\$1,800}$ (if the bank had zero excess reserves before the withdrawal, it now has a **reserve deficiency of $\$1,800$** and must borrow in the federal funds market, sell bonds, or call in loans). |  |  |
| 22 | How do you draw and label a Foreign Exchange (FOREX) Market Graph for the U.S. Dollar ($\$) relative to the Euro ($\text{€}$), and why must Demand and Supply in the two currencies move together? | • **Market for U.S. Dollars ($\$)**:   - **Horizontal Axis**: Quantity of U.S. Dollars ($Q_{\$}$).   - **Vertical Axis**: Exchange Rate in **Euros per Dollar ($\text{€}/\$)** (always put the currency being graphed in the denominator!). • **Reciprocal Rule**: Whenever foreigners want to buy U.S. goods or U.S. financial assets, they **Demand U.S. Dollars ($D_{\$}$ shifts RIGHT)** in the Dollar market AND simultaneously **Supply their own currency ($S_{\text{€}}$ shifts RIGHT)** in the Euro market! Consequently, if the **Dollar Appreciates ($\text{€}/\$ \uparrow$)**, the **Euro MUST Depreciate ($\$/\text{€} \downarrow$)**. |  |  |
| 23 | Why must you be careful distinguishing between a change in the 'Demand for Money ($MD$)' and a change in the 'Demand for Loanable Funds ($D_{LF}$)' on AP Macro FRQs? | • **Demand for Money ($MD$ in the Money Market)**: The desire to hold wealth as **liquid cash/checking deposits** rather than bonds; shifts when **Price Level ($PL$)** or **Real GDP ($Y$)** changes. • **Demand for Loanable Funds ($D_{LF}$ in the Loanable Funds Market)**: The desire to **borrow money** to finance business capital investment ($I$) or a government budget deficit; shifts when business confidence, investment tax credits, or government deficits change. |  |  |
| 24 | How does a decrease in the Required Reserve Ratio ($rr$) affect a bank's Total Reserves, Required Reserves, Excess Reserves, and the Money Multiplier? | When the Central Bank lowers $rr$ (e.g., from $10\%$ to $5\%$): • **Total Reserves**: **DO NOT CHANGE immediately**. • **Required Reserves ($RR$)**: **DECREASE** immediately. • **Excess Reserves ($ER$)**: **INCREASE** immediately by the exact amount that $RR$ fell. • **Money Multiplier ($1/rr$)**: **INCREASES** (from $10$ to $20$), allowing banks to create more new loans and expand $M1$. |  |  |
| 25 | On a commercial bank T-Account (Balance Sheet), distinguish between Assets and Liabilities, and between Required Reserves ($RR$) and Excess Reserves ($ER$). | • **Liabilities**: **Demand Deposits** (checkable deposits owed to customers), Savings/Time Deposits, Borrowings from the Fed/other banks, and Bank Capital (Net Worth / Owners' Equity). • **Assets**: **Total Reserves** (Vault cash + Reserve deposits at the Fed), **Loans** to customers, **Government Bonds (Treasury securities)**, and Physical Property. • **Reserves Formula**: $\text{Total Reserves (TR)} = \text{Required Reserves (RR)} + \text{Excess Reserves (ER)}$, where $\text{RR} = \text{Required Reserve Ratio } (rr) \times \text{Demand Deposits}$. A single bank can safely lend out **at most its Excess Reserves ($ER$)**. |  |  |
| 26 | Draw the Reserve Market Graph (Policy Rate vs. Quantity of Reserves) and explain how Expansionary vs. Contractionary Monetary Policy works under Ample Reserves. | • **Reserve Market Axes**: Vertical axis = **Policy Rate (Federal Funds Rate)**; Horizontal axis = **Quantity of Bank Reserves**. • **Demand for Reserves Curve**: Has a downward-sloping section (when reserves are limited, capped at the **Discount Rate**) and a **flat horizontal floor** (when reserves are **ample**, anchored at the **Interest on Reserves [IOR]** rate). • **Under Ample Reserves**:   - **Expansionary Monetary Policy** (to fight a Recession): The Central Bank **LOWERS Interest on Reserves (IOR)** $\rightarrow$ Policy Rate falls $\rightarrow$ nominal & real interest rates fall $\rightarrow$ $I$ and interest-sensitive $C$ increase $\rightarrow$ **$AD$ shifts RIGHT**.   - **Contractionary Monetary Policy** (to fight Inflation): The Central Bank **RAISES Interest on Reserves (IOR)** $\rightarrow$ Policy Rate rises $\rightarrow$ interest rates rise $\rightarrow$ $I$ and $C$ fall $\rightarrow$ **$AD$ shifts LEFT**. |  |  |
| 27 | How does an increase in Expected Inflation ($\pi^e \uparrow$) affect the Loanable Funds Market and the Nominal Interest Rate (the 'Fisher Effect')? | When borrowers and lenders expect higher future inflation ($\pi^e \uparrow$): 1. Borrowers want to borrow more today to repay with cheaper future dollars (**Demand for Loanable Funds $D_{LF}$ shifts RIGHT**). 2. Lenders are reluctant to lend unless compensated for lost purchasing power (**Supply of Loanable Funds $S_{LF}$ shifts LEFT**). 3. Result: The **Nominal Interest Rate ($i$) rises one-for-one with expected inflation ($i = r + \pi^e$)** while the equilibrium quantity of loanable funds and the real interest rate ($r$) remain unchanged. |  |  |
| 28 | Compare the Money Market Graph and the Loanable Funds Market Graph, including their axes, borrowers/lenders, and shifters. | • **Money Market** (Short-Run liquidity): Vertical axis = **Nominal Interest Rate ($i$)**; Horizontal axis = **Quantity of Money ($M$)**; $MS$ is vertical (set by Central Bank). • **Loanable Funds Market** (Long-Run saving & investment): Vertical axis = **Real Interest Rate ($r$)**; Horizontal axis = **Quantity of Loanable Funds ($Q_{LF}$)**.   - **Demand for Loanable Funds ($D_{LF}$, downward-sloping)**: Driven by **Private Business Borrowing for Investment ($I$)** and **Government Deficit Borrowing**.   - **Supply of Loanable Funds ($S_{LF}$, upward-sloping)**: Driven by **Private Household Saving**, **Public Saving (Government Budget Surplus)**, and **Foreign Capital Inflows (Net Capital Inflow)**. |  |  |
| 29 | What is the 'Federal Funds Rate,' and how does it differ from the 'Discount Rate' and 'Prime Rate'? | • **Federal Funds Rate**: The overnight interest rate that **commercial banks charge ONE ANOTHER** for short-term loans of bank reserves; it is the Federal Reserve's primary **target policy rate**. • **Discount Rate**: The interest rate that the **Federal Reserve itself charges commercial banks** for direct loans from the Fed's 'discount window' (serves as the upper ceiling of the reserve market). • **Prime Rate**: The benchmark interest rate commercial banks charge their most creditworthy corporate customers. |  |  |
| 30 | What three real-world leakages make the actual Money Multiplier smaller than the theoretical $\frac{1}{rr}$? | 1. **Banks hold Excess Reserves**: Banks may choose not to lend out 100% of their excess reserves (especially when the Fed pays interest on reserves or during economic uncertainty). 2. **Households hold Cash (Currency Drain)**: Borrowers keep part of their loans as physical currency in their wallets rather than redepositing 100% into checking accounts. 3. **Insufficient Borrower Demand**: Creditworthy consumers and businesses may be unwilling to take out loans. |  |  |
| 31 | How does Expansionary Monetary Policy affect the domestic currency's Exchange Rate and Net Exports ($X_n$) through the Interest Rate Channel? | 1. Expansionary Monetary Policy lowers domestic nominal and real interest rates ($r \downarrow$). 2. Lower domestic bond yields cause financial capital to flow **OUT** of the country toward higher-yielding foreign bonds (**Capital Outflow**, $S_{\text{domestic currency}} \uparrow$ and $D_{\text{domestic currency}} \downarrow$). 3. The **domestic currency DEPRECIATES** in the FOREX market. 4. A weaker domestic currency makes domestic exports **cheaper** to foreigners ($X \uparrow$) and imports **more expensive** ($M \downarrow$). 5. **Net Exports INCREASE ($X_n \uparrow$)**, which **reinforces** the rightward shift in Aggregate Demand ($AD \uparrow$)! |  |  |
| 32 | In the Balance of Payments (BOP) accounts, distinguish between the Current Account (CA) and the Capital and Financial Account (CFA), and explain why $\text{CA} + \text{CFA} = 0$. | • **Current Account (CA)**: Records flows of goods, services, income, and transfers:   1. **Net Exports ($X - M$, Balance of Trade)**;   2. **Net Investment Income** (dividends/interest earned by domestic citizens on foreign assets minus payments to foreigners);   3. **Net Unilateral Transfers** (foreign aid, remittances sent abroad). • **Capital and Financial Account (CFA)**: Records international purchases and sales of **financial and real assets** (foreign direct investment [building a factory], portfolio investment in stocks and government bonds). $\text{Net Capital Inflow} = \text{Foreign purchases of domestic assets} - \text{Domestic purchases of foreign assets}$. • Under floating exchange rates, **$\text{CA} + \text{CFA} = 0$**: a **Current Account Deficit (Trade Deficit, $X_n < 0$)** must be financed by an equal and opposite **Capital & Financial Account Surplus (Net Capital Inflow $> 0$)**! |  |  |

---
Study this deck interactively with FSRS-6 spaced repetition, audio review, and multiple-choice mode at [Flashcards World](https://flashcards.world/flashcards/sets/dac0cbe0-6c8f-44d4-a694-c504cddf28c3/).