CHAPTER 11
THE MACROECONOMIC ENVIRONMENT FOR INVESTMENT DECISIONS
Teaching Guides for Questions in the Text
11-1. Gross Domestic Product (GDP) is the sum of domestic spending by segments of the
11-2. Inflation is a general increase in prices while deflation is the opposite: a general decline in
Recession is a period of declining GDP. Declining GDP is usually accompanied by an increase in
11-3. In addition to expected inflation, the interest rate a borrower pays depends on (1) the yield
11-4. The Federal Reserve is the central bank of the United States. It controls the supply of
11-5. The major tools of monetary policy are the reserve requirements of banks, the discount
Selling securities has the opposite effect. It contracts the money supply and the reserves of banks,
which reduces their capacity to lend.
Open market operations will affect securities prices directly by altering the supply of credit and
interest rates. Since the price of fixed income securities moves inversely with changes in interest
rates, the Fed’s impact on interest rates affects the prices of fixed income securities. In addition,
11-6. While not a tool of monetary policy, the federal funds rate is the rate that banks charge
each other for overnight lending of reserves. The discount rate is the rate the Fed charges banks
for borrowing reserves from the Fed.
11-7. M1 is the narrow definition of the composition of the money supply while M2 is a broader
definition. M1 is the sum of cash (coins and currency in the hands of the public) plus demand
deposits. M2 adds to M1 savings accounts and small denomination time deposits. The Fed. alters
11-8. Monetary policy is altering the supply of money and credit by the Federal Reserve. Fiscal
policy is taxation, expenditures, and debt management by the federal government. While both
monetary and fiscal policy are used to pursue economic goals, their emphasis is different. Fiscal
Economic stimulus through deficit spending should generate increase economic growth and
employment. When the Fed finances the federal government’s deficit, the Fed buys government