Deck 14: Monetary Policy

Question 1

What are Federal funds? What is the Federal funds rate? Explain how the Fed uses the Federal funds rate as a target.

Answer 1

Federal funds are overnight loans of excess reserves banks make to one another.The Federal funds rate is the interest rate banks charge one another for Fed funds.The Federal Reserve uses the Federal funds rate as an indicator of whether money supply is too tight or too loose.The Fed sets a target zone it wants the Fed funds rate to be in.If the rate is above the target zone it tells the Fed monetary policy is too tight (money supply is too small); if the rate is below the target zone it tells the Fed monetary policy is too loose (the money supply is too large).

Question 2

What is the Taylor rule and why is it important for monetary policy?

Answer 2

The Taylor rule states that,if the economy is at the desired level of output and the desired level of inflation,the Federal Funds rate is 2% plus current inflation rate.If the inflation rate is higher than the desired level,the Fed Funds rate increases by 0.5 times the difference between desired and actual inflation.In addition,if the output is higher than its desired level,the rate increases by 0.5 times the deviation of output from potential.This rule is important for monetary policy because it gives businesses and the general public a rule of thumb to use to predict what the Fed policy action will be given the circumstances in the economy.(LO5)

Question 3

An expansionary monetary policy raises nominal income but never raises real income.True or false? Explain.

Answer 3

This is a false statement.An expansionary monetary policy definitely can increase nominal income.Its effect on real income,however,depends on how the price level responds.The general rule is: %Δreal income = % $\Delta$ nominal income - % $\Delta$ price level.If the % $\Delta$ nominal income is greater than the % $\Delta$ price level as a result of an expansionary monetary policy,real income will rise.Expansionary monetary policy will generally lead to a rise in real income when the economy is below full employment.

Question 4

What is the yield curve? What happens when one moves out along the yield curve? How does its shape reflect the fact that the Federal Reserve's ability to control the economy through controlling short-term interest rates is limited?

Question 5

Explain how the Fed uses the discount rate to influence the money supply

Question 6

What is the Federal funds rate and how does the Fed use it as an operating target? How does the Fed influence the Federal Funds rate?

Question 7

What is a central bank? What are its distinguishing characteristics and primary functions?

Question 8

Define open market operations,and explain how executing them can be used as a tool for the conduct of monetary policy.

Question 9

Give examples of central banks in two other countries and briefly explain how their conduct of monetary policy differs from the Fed.

Question 10

Briefly explain what goes on in a typical FOMC meeting.

Question 11

Describe how the Federal Reserve uses Open Market Operations to change the money supply.

Question 12

Explain the difference between expansionary and contractionary monetary policy.

Question 13

What is monetary policy?

Question 14

What are the duties given to the Fed by Congress?

Question 15

What is the monetary base? What role does it play in macroeconomic policy?

Question 16

How does monetary policy work in the context of the AS/AD model?

Question 17

Define the discount rate,and explain how it can be used as a tool for the conduct of monetary policy.

Question 18

Define reserve requirement,and explain how it can be used as a tool for the conduct of monetary policy.

Question 19

Briefly explain how the Fed is organized.What are the duties given to the Fed by Congress?

Question 20

Describe the various documents that are prepared for,and presented at,a typical FOMC meeting.

Question 21

(a)Show the effects of expansionary and contractionary open market operations on the interest rate using demand and supply curves and the market for government bonds.
(b)What should the Fed do if the interest rate is below its target rate? What should the Fed do if the interest rate is above its target rate?

Question 22

Suppose banks hold no excess reserves,the reserve requirement is 10%,and the cash-to-deposit ratio is 10%.
(a)If banks have $10 million in reserves what will the money supply be?
(b)How will your answer to (a)change if the Fed increases the reserve requirement to 20%?

Question 23

Suppose the banks acquire $100 billion in additional reserves,banks hold 10% reserves,and the cash-to-deposit ratio is 15%.
(a)What is the money supply?
(b)Suppose the Fed wants to increase the money supply so it undertakes a $10 billion open market purchase but at the same time people decide to hold twice as much cash as they did before.Will the Fed be successful in its attempt to increase the money supply? Explain.
(c)What lesson for monetary policy can you deduce from your answer to (b)?

Question 24

Demonstrate graphically and explain verbally that the impact of expansionary monetary policy on the economy depends upon the position of equilibrium output in relation to potential output.

Question 25

What are the Fed's ultimate targets? Explain how the Fed achieves ultimate economic targets using its available tools.

Question 26

Using the following AS/AD diagram,answer the question below.
If the economy is currently at point A,does the Fed have enough information to decide whether it should conduct expansionary or contractionary monetary policy?

Question 27

What are quantitative easing tools? Give some examples.Why would the Fed engage in quantitative easing?

Question 28

Suppose banks have $25 million in reserves,the reserve requirement is 5%,and people do not hold any cash outside of banks.If the Fed makes an open market sale of $1 million of government securities,by how much will the money supply change? (Assume that the public does not hold any of its money in the form of currency.)

Question 29

If inflation exceeds target inflation by 3%,target inflation is at 2%,and total output is 1% above its potential,what is the Federal Funds rate that the Fed will set according to the Taylor rule?

Question 30

Explain the difference between the Fed's offensive and defensive actions as parts of its control over monetary policy.Give an example of each type of action.

Question 31

What ultimately limits the amount of expansionary pressure the Fed can create? Has the Fed ever found itself up against this limit?

Question 32

Explain the difference between real and nominal interest rates.How are they related?

Question 33

Imagine you are a Federal Reserve board governor and you are examining the economy.You discover that the money supply is currently $2,000,000,that banks have $1,000,000 in reserves.You want to increase the money supply by $500,000 using an open market operation.What would you do?

Question 34

Suppose that the Fed has currently set the reserve requirement at 10%.Further suppose that banks do not hold any excess reserves.
(a)How much money can the banking system support if it currently has $1,000,000 in reserves?
(b)If the Fed wanted to cause the money supply to expand,how could it use the reserve requirement to achieve its goal? Give an example.
(c)You realize that the cash-to-deposit ratio is 40%.Redo your answers to (a)and (b).Explain why the answers change by referring to the multiplier process.

Question 35

Demonstrate graphically and explain verbally (using the AS/AD model)the effect of the Fed's sale of government bonds when the economy is below potential.

Question 36

Explain how the Fed influences the Federal Funds rate.

Question 37

List four problems often encountered in the conduct of monetary policy.

Question 38

Explain how distinction between the real and nominal interest rate poses problems for the conduct of monetary policy.