Please explain which one is true or false. a. Income is a flow variable while fi
ID: 1134920 • Letter: P
Question
Please explain which one is true or false.
a. Income is a flow variable while financial wealth is a stock variable.
b. Economists distinguish between investors as those who produce goods and services, and traders as those who buy and sell financial instruments.
c. The demand for money is determined by income but not by interest rates.
d. Eurodollars comprise of the proportion of U.S. currency that is held in Europe only.
e. The central bank can contract money supply by selling Treasury bonds in the market for bonds.
f. Monetary policy determines money supply while interest policy determines interest rates
g. As the price of a bond rises, its interest rate also rises.
h. The central bank can either increase the money supply or raise interest rates to boost GDP growth in the economy.
Explanation / Answer
A. True. Flow is a quantity measured with reference to a period of time. Income is aa flow variable as it has time dimension. For an individual, income is a flow that's earned in a weekly or monthly basis. National income is also a flow variable as it measures the flow of good & services available to a country in any time-frame. On the other hand, stock variable is one that can be measured at a particular point of time. Financial wealth is a stock variable aas it can be measured at a point of time.
B. True. Since this is purely the perspective of economists, an investor is one who produces or invests in assets that produce goods & services. On the other hand, a trader is one who invests in financial instruments. The general definition changes when we look at it from a general perspective (not economist perspective). The general perspective is that a trader invests in financial instruments for short-term and an investor invests for the long-term.
C. False. Demand for money is determined by interest rates as well. In general, as interest rates trend higher, the demand for money declines and when interest rates decline, the demand for money increases. The logic is that when interest rates rise, an individual can get higher returns by holding his/her wealth in bonds than holding money in the form of cash.
D. False. Eurodollars refers to the US dollar demonminated deposits at foreign banks. This can be at any country in the world. It is called Eurodollar because originally, all eurodollar was held exclusively in Europe. This has changed over time.
E. True. When there is excess liquidity in the financial or economic system, the policymakers can sell Treasury bonds that are purchased by financial intermediaries. This absorbs the liquidity and reduces overall money in the system. This is one method to control inflation through tightening of policies.
F. False. The monetary policy of the central baank involves controlling (increasing or decreasing) money supply through change in interest rates and through other methods like monetary base expansion or contraction. Monetary policy is in unision with interest rate policy. Just as an example, the financial crisis of 2008-09 required the policymakers to pursue expansionary monetary policies and the fed fend rate was cut to near-zero levels.
G. False. Bond prices increase translates into lower interest rates and lower bond prices takes the interest rates higher. In the context of US government bonds, the interest rates peaked out in 1981 on the 10-year bond. Subsequently, bond prices have trended higher and interest rates have declined. The logic is that as investors move to risk-free assets, the demand for bond and hence the bond price moves higher. Move by investors to risk-free assets is also aan indication of relatively weak economy or higher financial market risk. In such a scenario, investors are willing to buy bonds even for a lower rate of return.
H. False. The central bank can increase money supply to boost GDP growth. The best example is the financial crisis of 2008-09 when the central bank increased money supply to boost consumption and hence GDP growth. However, increasing interest rates is to tighten monetary policies and if central baank has to boost GDP growth, the policy should be to lower interest rates. The simple logic is that interest rate is the cost of money and when the cost of money is lower, business and individuals are more likely to borrow for investment or consumption spending. That triggers GDP growth.