Deck 15: Keeping Inflation Under Control: The Limits of Monetary Policy

Question 1

The First Federal Bank has demand deposit liabilities of $400,000, cash reserves of $75,000, loans of $225,000, and government securities of $100,000. The reserve requirement is 12 percent.
a. Show the bank's balance sheet.
b. Show the bank's balance sheet after the Fed buys $25,000 of securities from the bank.
c. After completion of the transaction in part b, how much excess reserves does the bank have? By how much did they increase?

Answer 1

a. b. c. $52,000

Question 2

Contrast the origins of demand-pull and cost-push inflation. What are the policies that can be used to address each?

Answer 2

Demand-pull inflation occurs when the demand for goods and services exceeds supply, leading to an increase in prices. This can be caused by factors such as increased consumer spending, government spending, or investment. On the other hand, cost-push inflation occurs when the cost of production increases, leading to higher prices for goods and services. This can be caused by factors such as rising wages, higher raw material costs, or increased taxes.

To address demand-pull inflation, policymakers can implement contractionary monetary and fiscal policies. Contractionary monetary policy involves increasing interest rates and reducing the money supply to decrease consumer spending and investment. Contractionary fiscal policy involves reducing government spending and increasing taxes to decrease overall demand in the economy.

To address cost-push inflation, policymakers can implement supply-side policies. These policies aim to reduce production costs and increase aggregate supply. This can be achieved through measures such as deregulation, tax cuts for businesses, and investment in infrastructure and technology to improve productivity.

In summary, demand-pull inflation is addressed through contractionary monetary and fiscal policies, while cost-push inflation is addressed through supply-side policies aimed at reducing production costs and increasing aggregate supply.

Question 3

Use the monetarist equation of exchange to explain why inflation is regarded by many economists as primarily a monetary phenomenon.

Answer 3

The monetarist equation of exchange is MV = PQ, where M represents the money supply, V represents the velocity of money (how quickly money circulates in the economy), P represents the price level, and Q represents the quantity of goods and services produced in the economy.

According to monetarist theory, changes in the money supply directly affect the price level and, consequently, inflation. When the money supply increases, individuals and businesses have more money to spend, leading to an increase in demand for goods and services. This increased demand can lead to higher prices, as producers may raise prices in response to the increased demand.

Conversely, a decrease in the money supply can lead to a decrease in demand for goods and services, which can result in lower prices.

Therefore, according to the monetarist equation of exchange, inflation is primarily a monetary phenomenon because changes in the money supply directly impact the price level. This is why many economists regard inflation as being primarily driven by changes in the money supply, and why monetary policy is often used as a tool to control inflation.

Question 4

Use a diagram of aggregate supply and aggregate demand to show the case of demand-pull inflation.

Question 5

Use a diagram of aggregate supply and aggregate demand to show the case of cost-push inflation.

Question 6

Trace the following transactions with the use of T-accounts:
a. $100,000 is deposited in Hemlock Community Bank, where the reserve requirement is 3 percent.
b. The bank lends a small business all its excess reserves through a loan-created demand deposit.
c. Excess reserves are paid out to cover the loan.

Question 7

Inflation is the increase in the general level of prices.

Question 8

During periods of inflation some prices may be rising while others remain the same or decline.

Question 9

The discount rate is a tool of monetary policy that involves the sales and purchases of securities in the open market.

Question 10

Demand-pull inflation is best represented by a leftward shift of the aggregate supply curve.

Question 11

Nominal income refers to the physical amounts of goods and services that can be purchased with a given dollar amount of income.

Question 12

The Federal Reserve System is responsible for managing the nation's fiscal policy.

Question 13

A bank's required reserves are not available for lending and other investment purposes.

Question 14

A monetary rule calls for establishing an unchanging rate of growth in the money supply on an annual basis.

Question 15

The consumer price index is a weighted average of prices for a market basket of various consumer goods and services.

Question 16

Inflation tends to foster efficiency.

Question 17

Inflation tends to redistribute income from creditors to debtors.

Question 18

Inflation benefits people on fixed money incomes.

Question 19

Inflation betters the balance of trade.

Question 20

Inflation raises nominal interest rates.

Question 21

Cost-push inflation originates from the supply side of the market.

Question 22

A tight money policy should be used to fight inflation.

Question 23

An easy money policy is the appropriate policy for fighting inflation.

Question 24

Core inflation excludes volatile components such a food and energy.

Question 25

The personal consumption expenditures index is favored by economists as a measure of price level and inflation because it captures the entirety of consumption spending.

Question 26

Inflation tends to increase the purchasing power one's money income.

Question 27

If the Fed were to use all the currently operational tools of monetary policy to pursue an easy-money policy, it would:

A) lower reserve requirements, lower the discount rate, buy securities in the open market, lower interest rates on required and excess reserve balances, make fewer term deposits available
B) raise reserve requirements, raise the discount rate, sell securities in the open market, increase interest rates on required and excess reserve balances, make more term deposits available
C) buy a huge volume of commercial paper
D) setup another "Maiden Lane" special purpose vehicle to conceal the Fed's balloning balance sheet
E) put the regional Federal Reserve Banks up for sale

Question 28

Management of the money supply is the role of the U.S. Treasury.

Question 29

Management of the money supply is the role of the Federal Reserve.

Question 30

If monetary authorities apply a "Taylor rule":

A) short-term interest rates are manipulated to meet a long-run inflation target that is consistent with full employment
B) an unchanging rate of growth in the money supply would be adopted
C) a series of monetary shocks are delivered to the economy to either speed it up or slow it down
D) the Federal Open Market Committee would as a rule always consult with economist John Taylor before implementing changes to monetary policy
E) monetary policy would have to accommodate federal deficits as a rule

Question 31

Real values differ from nominal values in that:

A) real values are less important
B) real values measure money value while nominal values measure physical amounts of goods and services
C) real values are computed with respect to base period prices while nominal values are stated in current prices
D) the terminology is different, but they measure the same thing

Question 32

The Federal Reserve's monetary policy during the period of the "Great Recession" from 2007-2009 can be categorized as:

A) a neutral monetary policy of "allowing the chips to fall where they may"
B) an easy-money policy oriented toward fighting recession and stimulating growth
C) a tight-money policy designed to fight recession and stimulate growth
D) a supply-side tax cut
E) monetary policy panic

Question 33

Which of the following statements is true?

A) inflation makes nominal interest rates rise
B) unanticipated inflation redistributes wealth from debtors to creditors
C) inflation increases the purchasing power of households on fixed incomes
D) the simple money multiplier is the inverse of the discount rate

Question 34

If the reserve requirement is 25 percent, the simple money multiplier is:

A) 1.25
B) 2
C) 4
D) .75

Question 35

If the simple money multiplier is 2, the reserve requirement must be:

A) 50 percent
B) 5 percent
C) zero
D) unknown based upon the information provided

Question 36

If the reserve requirement is 10 percent and the banking system has excess reserves of $9,000, the maximum amount of new deposits that can be created is:

A) $9,000
B) $90,000
C) $900
D) $900,000

Question 37

An easy money policy calls for:

A) selling securities in the open market and raising the discount rate
B) raising the reserve requirement
C) Federal Reserve Bank presidents handing out money in the streets
D) buying securities in the open market and lowering the discount rate

Question 38

Incomes policy attempts to slow inflation by:

A) mandatory wage-price controls
B) controlling the rate of growth in incomes
C) restraining growth in the money supply
D) indexing wages, rents, contracts, and taxes for inflation

Question 39

Supply-side economic policies used tax reductions in an attempt to:

A) stimulate aggregate supply, expand output, and lower inflation
B) stimulate aggregate demand to expand output, but tolerate higher price levels
C) stimulate both aggregate demand and aggregate supply to increase output, but with no specific goal for inflation
D) prove once and for all that Keynes is dead

Question 40

The expression MV = PQ is:

A) the equation for the simple money multiplier
B) a method of calculating the velocity of bundles of currency dropped from the top of the New York Federal Reserve Bank by the Chair of the Board of Governors
C) the equation for calculating the consumer price index
D) the incomes policy index
E) the monetarist equation of exchange

Question 41

The consumer price index was 113.6 in 1987 and 118.3 in 1988. The inflation rate
From 1987 to 1988 was:

A) 4.7 percent
B) 4.1 percent
C) 18.3 percent
D) impossible to determine with the data given

Question 42

The fact that the velocity of money has not been completely stable has:

A) made monetary policy more reliable
B) caused a switch to fiscal policy
C) stopped the bank-creation of money
D) made the task of formulating monetary policy more difficult

Question 43

Which of the following anti-inflation policies would use tax penalties and tax reductions to control wage increases?

A) tax-based incomes policy
B) wage and price guideposts
C) wage and price controls
D) indexation

Question 44

The recession of 2007-2009:

A) was rather run-of-the-mill
B) prompted the Federal Reserve to increase the number of its tools of monetary policy in order to ensure sufficient liquidity to a various segments of financial markets
C) kept the Federal Reserve on a tight money course
D) was fully countered by the Federal Reserve's monetary policy

Question 45

Which of the following formulas should be used to calculate the inflation rate between 2010 and 2009?

A) $\frac { \text { CPI } 2010 - \text { CPI } 2009 } { \text { CPI } 2010 } \times 100$
B) $\frac { \text { CPI } 2010 } { \text { CPI 2010-CPI 2009 } } \times 100$
C) $\frac { \text { CPI } 2010 - \text { CPI } 2009 } { \text { CPI } 2009 } \times 100$
D) $\frac { \text { CPI } 2010 - \text { CPI } 2009 } { \text { CPI base period} } \times 100$

Question 46

Anticipated inflation:

A) makes people feel good about the future
B) lowers nominal interest rates
C) leaves economic behavior unchanged
D) raises nominal interest rates