Chapter 18 – Monetary Policy: Stabilizing the Domestic Economy
103. Discuss why the discount rate may be considered a penalty rate of interest charged to
banks.
104. Discuss the differences between permanent and temporary open market operations and
the instruments the FOMC uses for each.
Chapter 18 – Monetary Policy: Stabilizing the Domestic Economy
105. Discuss the evolution of discount lending from a tool of monetary policy to its current
role.
106. Since 2002, the Fed has set the primary discount rate at 100 basis points above the target
federal funds rate. Why is this likely to prevent the spikes in the market federal funds similar
to the ones that occurred in previous years?
Chapter 18 – Monetary Policy: Stabilizing the Domestic Economy
107. What is the difference between primary and secondary credit offered by the Fed and who
would use secondary credit?
108. There have been many changes made to the method for computing the required reserves
for banks over the years. Currently, the lagged reserve accounting used enables a bank and the
Fed to know the level of reserves required over a period of time well before the period of time
begins. Why is this method for computing reserves advantageous to banks as well as the Fed?
Chapter 18 – Monetary Policy: Stabilizing the Domestic Economy
109. The European equivalent of the U.S. market federal funds rate and target federal funds
rate are the overnight interbank rate and the target refinancing rate. Explain why the overnight
interbank rate would always be within a 200-basis-points band of the target refinancing rate.
110. What is the general consensus among economists and other monetary policy experts
regarding the usefulness of the monetary policy instruments available to central banks?
Chapter 18 – Monetary Policy: Stabilizing the Domestic Economy
111. Explain the three desirable features of a good monetary policy instrument.
112. In terms of desirable features of a monetary policy instrument, explain why the size of
the staff at the Fed is not a good policy instrument. Be sure to address which feature(s) it fits
and which one(s) it doesn’t.
Chapter 18 – Monetary Policy: Stabilizing the Domestic Economy
113. The Fed could use reserve requirements as a monetary policy instrument. In terms of
desirable features for policy instruments, assess the viability of using reserve requirements.
114. When was the last time the Fed used a quantity target? What was the reason it was
selected and what was the result?
Chapter 18 – Monetary Policy: Stabilizing the Domestic Economy
115. Discuss why the Fed can either select a quantity or a price (interest rate) target but not
both. If it helps, you can use the market for reserves for an example.
116. Consider the desirable features of monetary policy operating instruments and the use of
intermediate targets. What missing feature makes a target intermediate rather than operating?
Why did the Fed abandon the use of most intermediate targets?
Chapter 18 – Monetary Policy: Stabilizing the Domestic Economy
117. Consider the objective of flying a jet form New York to Paris. After takeoff, a pilot
would certainly check a few times to see if he or she is on course. Using this example, discuss
why, at least in theory, intermediate monetary policy targets may be useful.
118. We saw in Chapter 18 that many central banks have turned to a policy framework of
inflation targeting. Discuss if this would be effective in a country experiencing deflation.
Chapter 18 – Monetary Policy: Stabilizing the Domestic Economy
119. Discuss the key criteria for success and the advantages of a central bank adopting the
framework of inflation targeting.
120. Is the Taylor rule the specific formula followed by the FOMC? Explain.
Chapter 18 – Monetary Policy: Stabilizing the Domestic Economy
121. If the Taylor rule is expressed as:
Target federal funds rate = 2 + current inflation + ½(inflation gap) +½(output gap);
and the current rate of inflation is 4 percent while the target rate is 2 percent and the economy
is producing 1 percent above its full potential level, what should be the target federal funds
rate?
122. Given the following Taylor rule:
Target federal funds rate = real interest rate+ current inflation + ½(inflation gap) +½(output
gap);
The current rate of inflation is 2 percent and the target rate of inflation is 2 percent and the
economy is operating at full potential. The FOMC sets a target federal funds rate of 5 percent.
What is the real interest rate?
Chapter 18 – Monetary Policy: Stabilizing the Domestic Economy
123. Given the following Taylor rule:
Target federal funds rate = 2 + current inflation + 2x(inflation gap) +x(output gap);
What do the coefficients on the inflation and output gaps (2x, x) reveal?
124. Given the following Taylor rule:
Target federal funds rate = 2 + current inflation + ½(inflation gap) +½(output gap);
Since the coefficients on the inflation and output gaps are equal, does this mean the central
bank will respond to a one percent increase in inflation with the same change in the target rate
as they would initiate from a one percent increase in the output gap? Explain.
Chapter 18 – Monetary Policy: Stabilizing the Domestic Economy
125. Given the following Taylor rule:
Target federal funds rate = 2 + current inflation + ½(inflation gap) +½(output gap);
Explain what happens to the real interest rate and why it happens, each time inflation
increases by 1 percent.
126. What is your response to the following: “The Taylor rule shows a strong correlation
between the target rate actually set by the FOMC and the one predicted by the rule. Since the
Taylor rule would provide accountability, credibility, and transparency, the FOMC committee
should be dissolved and replaced by a form of the Taylor rule.”
Chapter 18 – Monetary Policy: Stabilizing the Domestic Economy
18–48
127. What were the 3 unconventional policy approaches used by the Fed during the financial
crisis of 2007-2009?
128. How do policy duration commitments influence the economy and inflation?
129. How does credit easing alter the outlook for the economy and inflation?
Essay Questions
Chapter 18 – Monetary Policy: Stabilizing the Domestic Economy
130. Could the Fed enter the federal funds market to make sure the market and target rates are
always equal, and if they could, why don’t they?
131. What are the advantages from the 2002 change in the Fed’s lending policy?
Chapter 18 – Monetary Policy: Stabilizing the Domestic Economy
132. Imagine the inflation rate begins to rise rapidly, the FOMC meets and it is believed that
the target interest rate needed to stem the inflation could easily exceed 20 percent. Many
members of the committee believe the Fed cannot announce this high of a target for political
reasons. Discuss what the FOMC could do in terms of targets and what change occurred in
2002 that is going to make their job a bit more difficult.
133. Discuss what experience concerning required reserves occurred during the Great
Depression that contributes to the decision today not to use required reserves as an active tool
of monetary policy.