Chapter 8
Conduct of Monetary Policy: Tools, Goals, and Targets
◼ Multiple Choice Questions
1. Assets on the Fed’s balance sheet include
(a) government securities and currency in circulation.
(b) discount loans and reserves.
(c) government securities and discount loans.
(d) currency in circulation and reserves.
2. The monetary base consists of
(a) currency in circulation and reserves.
(b) government securities held by the Fed and discount loans.
(c) government securities held by the Fed and currency in circulation.
(d) discount loans and reserves.
3. An open market purchase of securities by the Fed will
(a) increase assets of the nonbank public and increase assets of the banking system.
(b) decrease assets of the nonbank public and increase assets of the Fed.
(c) decrease assets of the banking system and increase assets of the Fed.
(d) have no effect on assets of the nonbank public but increase assets of the Fed.
(e) increase assets of the banking system and decrease assets of the Fed.
4. An open market sale of securities by the Fed will
(a) decrease liabilities of the Fed and not affect assets of the banking system.
(b) decrease assets of the nonbank public and decrease assets of the Fed.
(c) increase liabilities of the banking system and increase assets of the Fed.
(d) have no effect on assets of the nonbank public but increase liabilities of the Fed.
(e) decrease assets of the banking system and increase assets of the Fed.
5. If the Federal Reserve wants to expand reserves in the banking system, it will
(a) purchase government securities.
(b) raise the discount rate.
(c) sell government securities.
(d) raise reserve requirements.
94 Mishkin/Eakins • Financial Markets and Institutions, Fifth Edition
6. If the Federal Reserve wants to lower the monetary base and the money supply, it will
(a) increase bank reserves.
(b) lower the discount rate.
(c) sell government securities.
(d) lower reserve requirements.
7. A discount loan by the Fed to a bank causes a(n) _________ in reserves in the banking system and
a(n) _________ in the monetary base.
(a) increase; decrease
(b) decrease; decrease
(c) decrease; increase
(d) increase; increase
8. When a bank repays a discount loan to the Fed, there is a(n) _________ in reserves in the banking
system and a(n) _________ in the monetary base.
(a) increase; decrease
(b) decrease; decrease
(c) decrease; increase
(d) increase; increase
9. The federal funds rate is
(a) the interest rate on loans from the Fed to a bank.
(b) the price the Fed pays for government securities.
(c) the interest rate on loans of reserves from one bank to another.
(d) the price banks pay the Fed for government securities.
(e) the interest rate on loans from a bank to the federal government.
10. The discount rate is
(a) the interest rate on loans from the Fed to a bank.
(b) the price the Fed pays for government securities.
(c) the interest rate on loans of reserves from one bank to another.
(d) the price banks pay the Fed for government securities.
(e) the interest rate on loans from a bank to the federal government.
Chapter 8 Conduct of Monetary Policy: Tools, Goals, and Targets 95
11. Holding everything else constant, if the federal funds rate rises, then the demand for
(a) excess reserves rises because they have a higher return.
(b) excess reserves falls because they have a higher cost.
(c) required reserves falls because the cost of borrowing from the Fed is relatively higher.
(d) required reserves rises because the cost of borrowing from the Fed is relatively lower.
(e) reserves will not change because the Fed sets the level of required reserves.
12. Holding everything else constant, if the federal funds rate falls, then the demand for
(a) excess reserves falls because they have a lower return.
(b) excess reserves rises because they have a lower cost.
(c) required reserves rises because the cost of borrowing from the Fed is relatively lower.
(d) required reserves rises because the cost of borrowing from the Fed is relatively lower.
(e) reserves will not change because the Fed sets the level of required reserves.
13. Bank reserves can be categorized as
(a) vault cash and deposits at the Fed.
(b) required reserves and excess reserves.
(c) borrowed reserves and nonborrowed reserves.
(d) all of the above.
14. An open market purchase
(a) shifts the supply curve for reserves to the right and causes the federal funds rate to fall.
(b) shifts the demand curve for reserves to the right and causes the federal funds rate to rise.
(c) shifts the supply curve for reserves to the left and causes the federal funds rate to rise.
(d) shifts the demand curve for reserves to the left and causes the federal funds rate to fall.
15. The supply curve for reserves is _________ when the federal funds rate is below the discount rate
and _________ when the federal funds rate is above the discount rate.
(a) upward sloping; horizontal
(b) upward sloping; vertical
(c) vertical; horizontal
(d) vertical; downward sloping
16. The supply curve for reserves shifts to the left and the federal funds rate rises when the Fed
(a) raises reserves requirements.
(b) does an open market purchase.
(c) does an open market sale.
(d) raises the discount rate.
96 Mishkin/Eakins • Financial Markets and Institutions, Fifth Edition
17. The demand curve for reserves shifts to the left and the federal funds rate falls when the Fed
(a) decreases reserve requirements or does an open market purchase.
(b) lowers the discount rate.
(c) lowers the discount rate or does an open market purchase.
(d) decreases reserves requirements.
(e) does an open market sale.
18. Under usual circumstances, an increase in the discount rate causes
(a) the federal funds rate to fall.
(b) the federal funds rate to rise.
(c) no change in the federal funds rate.
(d) the supply of reserves to increase.
(e) the supply of reserves to decrease.
19. If the Fed increases reserve requirements, the demand for reserves _________ and the equilibrium
federal funds rate _________.
(a) increases; drops
(b) decreases; rises
(c) decreases; drops
(d) increases; rises
20. The actual execution of open market operations is done at
(a) the Board of Governors in Washington, D.C.
(b) the Federal Reserve Bank of New York.
(c) the Federal Reserve Bank of Philadelphia.
(d) the Federal Reserve Bank of Boston.
21. The Federal Open Market Committee makes the Fed’s decisions on the purchase or sale of
government securities, but these purchases or sales are executed by the Federal Reserve Bank of
(a) Chicago.
(b) Boston.
(c) New York.
(d) San Francisco.
22. An open market transaction intended to change the level of bank reserves is a
(a) repurchase agreement.
(b) reverse repo.
(c) dynamic operation.
(d) defensive operation.
Chapter 8 Conduct of Monetary Policy: Tools, Goals, and Targets 97
23. If the Federal Reserve wants to drain reserves from the banking system, it will
(a) purchase government securities.
(b) lower the discount rate.
(c) sell government securities.
(d) raise reserve requirements.
24. The Federal Reserve will engage in an outright purchase if it wants to _________ reserves
_________ in the banking system.
(a) increase; permanently
(b) increase; temporarily
(c) decrease; temporarily
(d) decrease; permanently
25. If the Fed wants to temporarily drain reserves from the banking system, it will engage in
(a) a repurchase agreement.
(b) a matched sale-purchase transaction.
(c) a “pump” agreement.
(d) none of the above.
26. The Federal Reserve will engage in a matched sale-purchase transaction when it wants to
_________ reserves _________ in the banking system.
(a) increase; permanently
(b) increase; temporarily
(c) decrease; temporarily
(d) decrease; permanently
27. Discount loans to banks experiencing severe liquidity problems are called
(a) primary credit.
(b) secondary credit.
(c) seasonal credit.
(d) lender-of-last-resort credit.
28. Discount loans to healthy banks, who may borrow as much as they wish from the Fed, are called
(a) primary credit.
(b) secondary credit.
(c) seasonal credit.
(d) lender-of-last-resort credit.
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29. Financial panic was averted in October 1987 following “Black Monday” when the Fed
announced that
(a) it was lowering the discount rate on extended credit.
(b) it would provide discount loans to any bank that would make loans to the security industry.
(c) it stood ready to purchase common stocks to prevent a further slide in stock prices.
(d) all of the above.
30. Following the terrorist destruction of the World Trade Center on September 11, 2001, the Fed
(a) closed for a week to allow time for panic in financial markets to lessen.
(b) increased its discount lending and open market purchases by unusually large amounts to provide
liquidity to the financial system.
(c) reduced its discount lending and open market purchases to reduce fears that an inflationary
spiral might begin.
(d) borrowed money from other central banks to provide liquidity to the financial system.
31. Disadvantages of using reserve requirements to control the money supply include
(a) their overly-powerful impact on the money supply.
(b) creating potential liquidity problems for banks with high levels of excess reserves.
(c) their overly-powerful impact on the monetary base.
(d) all of the above.
32. The Fed is reluctant to use reserve requirements to control the money supply because
(a) of their overly-powerful impact on the money supply.
(b) they have the potential to create liquidity problems for banks with low excess reserves.
(c) frequent changes in reserve requirements complicate liquidity management
for banks.
(d) of all of the above.
(e) of only (a) and (b) of the above.
33. When the Federal Reserve was created, its most important role was intended to be
(a) a storage facility for the nation’s gold.
(b) a lender-of-last-resort.
(c) a regulator of bank holding companies.
(d) none of the above.
34. At its inception, the Federal Reserve was intended to be
(a) the Treasury’s banker.
(b) the issuer of government debt.
(c) a lender-of-last-resort.
(d) a regulator of bank holding companies.
Chapter 8 Conduct of Monetary Policy: Tools, Goals, and Targets 99
35. Changes in the reserve requirement are an infrequently used monetary policy tool since
(a) this tool is too blunt.
(b) this tool is too weak.
(c) banks find it costly to adjust to such changes.
(d) both (a) and (c) of the above are true.
36. Open market operations as a monetary policy tool have the advantage that
(a) they are flexible and precise.
(b) they are easily reversed if mistakes are made.
(c) they can be implemented quickly without administrative delays.
(d) all of the above.
(e) only (a) and (b) of the above.
37. What actions did the Fed take following the terrorist attacks of September 11, 2001?
(a) It increased discount lending and conducted open market purchases to meet the liquidity needs
of the financial system.
(b) It decreased discount lending and conducted open market sales to meet the liquidity needs of the
financial system.
(c) It suspended monetary policy actions so as to avoid taking hasty actions which might ultimately
prove to be unwise.
(d) It reduced its monetary liabilities in order to stabilize the financial system.
38. Price stability is desirable because
(a) inflation creates uncertainty, making it difficult to plan for the future.
(b) everyone is better off when prices are stable.
(c) price stability increases the profitability of the Fed.
(d) it guarantees full employment.
39. The Federal Reserve desires interest rate stability because
(a) it allows for less uncertainty about future planning.
(b) interest rate volatility often leads to demands to curtail the Fed’s power.
(c) it guarantees full employment.
(d) of both (a) and (b) of the above.
40. When workers voluntarily quit a job or decline a job offer so they can search for a better one, the
resulting unemployment is called
(a) structural unemployment.
(b) frictional unemployment.
(c) cyclical unemployment.
(d) underemployment.
100 Mishkin/Eakins • Financial Markets and Institutions, Fifth Edition
41. When there is a mismatch between job requirements and the skills of available workers, the resulting
unemployment is called
(a) structural unemployment.
(b) frictional unemployment.
(c) cyclical unemployment.
(d) underemployment.
42. The goal for high employment should be a level of unemployment at which the demand for labor
equals the supply of labor. Economists call this level of unemployment the
(a) frictional level of unemployment.
(b) structural level of unemployment.
(c) natural rate level of unemployment.
(d) ideal level of unemployment.
43. Although the goals of high employment and economic growth are closely related, policies can be
specifically aimed at encouraging economic growth by
(a) encouraging firms to invest.
(b) encouraging people to save.
(c) doing both (a) and (b) of the above.
(d) doing neither (a) nor (b) of the above.
44. Although the goals of high employment and economic growth are closely related, policies can be
specifically aimed at encouraging economic growth by
(a) encouraging firms to invest and people to save.
(b) encouraging firms to limit their price increases.
(c) encouraging people to consume.
(d) doing all of the above.
(e) doing (a) and (c) only.
45. The Fed’s monetary policy strategy can be described as follows:
(a) The Fed uses its policy tools to adjust intermediate targets that directly impact its operating
targets in a way that allows the Fed to achieve its goals.
(b) The Fed uses its policy tools to adjust operating targets that directly impact its intermediate
targets in a way that allows the Fed to achieve its goals.
(c) The Fed uses its operating targets to adjust its intermediate targets that directly impact its policy
tools in a way that allows the Fed to achieve its goals.
(d) None of the above.
Chapter 8 Conduct of Monetary Policy: Tools, Goals, and Targets 101
46. If the Fed’s strategy for conducting monetary policy is thought of as a game plan that proceeds in
stages, then the game plan can be summarized as follows:
(a) The Fed selects its policy goals, then the intermediate targets consistent with achieving its
policy goals, then the operating targets consistent with its intermediate targets. Finally, it adjusts
its policy tools to effect the desired targets and goals.
(b) The Fed selects its policy goals, then the operating targets consistent with achieving its policy
goals, then the intermediate targets consistent with its operating targets. Finally, it adjusts its
policy tools to effect the desired targets and goals.
(c) The Fed selects its policy goals, then the intermediate targets consistent with achieving its
policy goals, then the policy tools consistent with its intermediate targets. Finally, it adjusts its
operating targets to effect the desired targets and tools.
(d) The Fed selects its policy tools, then the operating targets consistent with achieving its policy
tools, then the intermediate targets consistent with its operating targets. Finally, it adjusts its
policy goals to effect the desired targets and tools.
(e) None of the above.
47. An advantage of an intermediate targeting strategy is that it provides the Fed with
(a) more timely information regarding the effect of monetary policy.
(b) a slow adjustment process.
(c) a target that is precisely correlated with economic activity.
(d) all of the above.
(e) only (a) and (b) of the above.
48. Which of the following is not a requirement in selecting an intermediate target?
(a) measurability
(b) controllability
(c) flexibility
(d) predictability
49. Which of the following is a potential operating target for the Fed?
(a) The monetary base
(b) The M1 money supply
(c) Nominal GDP
(d) The discount rate
50. Which of the following is a potential operating target for the Fed?
(a) Nonborrowed reserves
(b) The federal funds rate
(c) The monetary base
(d) All of the above
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51. Which of the following is not an operating target?
(a) Nonborrowed reserves
(b) Monetary base
(c) Federal funds interest rate
(d) Discount rate
(e) All are operating targets.
52. When it comes to choosing an operating target, both the _________ rate and _________ aggregates
are easily controllable using the Fed’s policy tools.
(a) federal funds; monetary
(b) federal funds; reserve
(c) three-month Treasury-bill; monetary
(d) ten-year Treasury-bond; reserve
53. If the desired intermediate target is an interest rate, then the preferred operating target will be a(n)
_________ variable like the _________.
(a) interest rate; three-month Treasury-bill rate
(b) interest rate; federal funds rate
(c) reserve aggregate; monetary base
(d) reserve aggregate; nonborrowed base
54. If the desired intermediate target is a monetary aggregate, then the preferred operating target will be
a(n) _________ variable like the _________.
(a) interest rate; three-month Treasury-bill rate
(b) interest rate; federal funds rate
(c) reserve aggregate; monetary base
(d) reserve aggregate; nonborrowed reserves
55. If the Fed uses nonborrowed reserves, a reserve aggregate, as a target, fluctuations in the reserves
demand curve will cause _________ to fluctuate.
(a) nonborrowed reserves
(b) the federal funds interest rate
(c) monetary aggregates
(d) the inflation rate
56. If the Fed uses nonborrowed reserves, a reserve aggregate, as a target, an increase in the demand for
reserves will result in a(n) _________ in _________.
(a) increase; nonborrowed reserves
(b) decrease; nonborrowed reserves
(c) increase; the federal funds interest rate
(d) decrease; the federal funds interest rate
Chapter 8 Conduct of Monetary Policy: Tools, Goals, and Targets 103
57. If the Fed uses the federal funds rate as an interest rate target, fluctuations in the reserves demand
curve will cause _________ to fluctuate.
(a) nonborrowed reserves
(b) the federal funds interest rate
(c) Treasury bill interest rates
(d) the inflation rate
58. If the Fed uses the federal funds rate as an interest rate target, an increase in the demand for reserves
will result in a(n) _________ in _________.
(a) increase; nonborrowed reserves
(b) decrease; nonborrowed reserves
(c) increase; the federal funds interest rate
(d) decrease; the federal funds interest rate
59. The policy that meant the Fed would make loans to member commercial banks whenever they
showed up at the discount window with “eligible paper” was known as
(a) free reserves targeting.
(b) the real bills doctrine.
(c) nonborrowed reserves targeting.
(d) leaning against the wind.
60. The real bills doctrine was the guiding principle for the conduct of monetary policy during the
(a) 1910s.
(b) 1940s.
(c) 1950s.
(d) 1960s.
61. By the end of World War I, the Fed’s policies of rediscounting eligible paper and keeping interest
rates low led to
(a) accelerating inflation.
(b) stable prices and strong economic growth, as predicted by the real bills doctrine.
(c) recession as reserves were steadily drained from the banking system.
(d) none of the above.
62. The Fed’s operating strategy that led to double-digit inflation following the end of World War I
was known as
(a) the free reserves policy.
(b) the federal-funds targeting strategy.
(c) the real bills doctrine.
(d) pegging the money supply.
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63. The Fed accidentally discovered open market operations in the early
(a) 1920s.
(b) 1910s.
(c) 1900s.
(d) 1890s.
64. The Fed accidentally discovered open market operations when
(a) it came to the rescue of failing banks in the early 1930s and found that its purchases of bank
loans injected reserves into the banking system.
(b) it purchased securities for income following the 1920–1921 recession.
(c) it attempted to slow inflation in 1919 by selling securities and found that its sales drained
reserves from the banking system.
(d) it reinterpreted a key provision of the Federal Reserve Act.
65. In the 1930s, the Fed
(a) failed to perform its role as lender of last resort.
(b) raised reserve requirements in three steps in 1936–37.
(c) was given broad authority over reserve requirements.
(d) all of the above.
(e) only (a) and (b) of the above.
66. In the 1930s, the Fed
(a) did not have enough power to perform the role of lender of last resort.
(b) raised reserve requirements in three steps in 1936–37.
(c) was given less authority over reserve requirements.
(d) all of the above.
(e) only (a) and (b) of the above.
67. During World War II, whenever interest rates would rise and the price of bonds would begin to fall,
the Fed would
(a) lower reserve requirements.
(b) raise reserve requirements.
(c) make open market purchases of government securities.
(d) make open market sales of government securities.
68. During World War II, the Fed in effect relinquished its control of monetary policy through its
policy of
(a) continually lowering reserve requirements.
(b) continually raising reserve requirements.
(c) pegging interest rates.
(d) targeting free reserves.
Chapter 8 Conduct of Monetary Policy: Tools, Goals, and Targets 105
69. A procyclical monetary policy causes the money supply to _________ during recessions and to
_________ when the economy is growing.
(a) increase; increase
(b) decrease; decrease
(c) increase; decrease
(d) decrease; increase
70. A policy of targeting free reserves is likely to be
(a) procyclical.
(b) stabilizing.
(c) too difficult to implement practically.
(d) none of the above.
71. In practice, the Fed’s policy of targeting _________ in the 1960s proved to be _________,
destabilizing the economy.
(a) money market conditions; countercyclical
(b) money market conditions; procyclical
(c) monetary aggregates; countercyclical
(d) monetary aggregates; procyclical
72. Although the Fed professed employment of a monetary aggregate targeting strategy during the
1970s, its behavior suggests that it emphasized
(a) free reserve targeting.
(b) interest rate targeting.
(c) a real bills doctrine.
(d) price index targeting.
73. The Fed’s use of the federal funds rate as an operating target in the 1970s resulted in
(a) countercyclical monetary policy.
(b) too slow growth in M1 throughout the decade.
(c) procyclical monetary policy.
(d) too rapid growth in M1 throughout the decade.
(e) none of the above.
74. The Fed’s operating procedures employed between 1979 and 1982 resulted in _________ swings in
the federal funds rate and _________ swings in the M1 growth rate.
(a) increased; increased
(b) increased; decreased
(c) decreased; decreased
(d) decreased; increased
106 Mishkin/Eakins • Financial Markets and Institutions, Fifth Edition
75. Explanations for the Fed’s poor monetary control during 1979–1982 include
(a) the acceleration of financial deregulation.
(b) the suspension of credit controls in mid-1979.
(c) the Fed’s desire to fight inflation without taking all the criticism for the high interest rate policy.
(d) only (a) and (b) of the above.
(e) only (a) and (c) of the above.
76. The fluctuations in both money supply growth and the federal funds rate during 1979–1982 suggest
that the Fed
(a) had shifted to borrowed reserves as an operating target.
(b) had shifted to nonborrowed reserves as an operating target.
(c) had shifted to the monetary base as an operating target.
(d) never intended to target monetary aggregates.
77. The fluctuations in both money supply growth and the federal funds rate during 1979–1982 suggest
that the Fed
(a) never intended to target monetary aggregates.
(b) used the announced strategy of targeting nonborrowed reserves as a smoke screen to fight
inflation.
(c) had shifted to the monetary base as an operating target.
(d) both (a) and (b) of the above.
78. Monetary policy since 1982 suggests that the Fed is
(a) finally using a monetary aggregate as its intermediate target.
(b) less concerned with fluctuations in the federal funds rate than in the 1979–1982 period.
(c) more concerned with exchange rates than with interest rates.
(d) none of the above.
79. Fed policy since 1982 suggests that
(a) monetary aggregates continue to be rejected as its intermediate target.
(b) it is pursuing a policy of interest rate smoothing.
(c) it is now more concerned with exchange rates than with interest rates.
(d) all of the above are true.
(e) only (a) and (b) of the above are true.
80. By 1985, the strength of the dollar had caused a deterioration in American competitiveness with
foreign businesses. In response, the Fed _________ money growth to _________ the value of the
dollar.
(a) increased; raise
(b) increased; lower
Chapter 8 Conduct of Monetary Policy: Tools, Goals, and Targets 107
(c) decreased; raise
(d) decreased; lower
81. During the period 1985–87, the actions of monetary policy authorities indicate that they were most
directly concerned with
(a) stabilizing interest rates, even at the expense of losing control of monetary aggregates.
(b) eliminating even moderate inflation.
(c) lowering the value of the dollar.
(d) none of the above.
82. Volatile fluctuations in money supply growth in the United Kingdom in the 1970s suggest that the
Bank of England
(a) did not pursue its M3 monetary target seriously.
(b) did not pursue its M1 monetary target seriously.
(c) used the announced strategy of targeting the federal funds rate as a smoke screen to fight
inflation.
(d) did both (a) and (c) of the above.
(e) did both (b) and (c) of the above.
83. The Canadian experience with monetary policy during the 1970s and 1980s closely parallels that of
the United States in which respects?
(a) The Canadian central bank announced a strategy of targeting a monetary aggregate in the 1970s.
(b) The Canadian central bank abandoned its monetary targeting strategy because of exchange rate
concerns.
(c) The Canadian central bank’s announced strategy of targeting money was merely a smoke screen
to fight inflation.
(d) All of the above.
(e) Only (a) and (b) of the above.
84. The German Bundesbank’s experience with monetary policy during the 1970s and 1980s is similar
to that of Canada’s central bank in which respects?
(a) Both the German and Canadian central banks announced strategies to target monetary
aggregates in the 1970s.
(b) Both the German and Canadian central banks were willing to abandon monetary targeting due to
exchange rate concerns.
(c) Although the Canadian central bank abandoned its monetary targeting strategy permanently, the
Bundesbank has continued to target money.
(d) All of the above.
(e) Only (a) and (b) of the above.
108 Mishkin/Eakins • Financial Markets and Institutions, Fifth Edition
85. The Bundesbank experience with monetary policy during the 1970s and 1980s is similar to that of
Canada’s central bank in which respects?
(a) Both the German and Canadian central banks announced strategies to target monetary
aggregates in the 1970s.
(b) Both the German and Canadian central banks were willing to abandon monetary targeting due to
exchange rate concerns.
(c) Although the German central bank abandoned its monetary targeting strategy permanently, the
Canadian central bank has continued to target money.
(d) Only (a) and (b) of the above.
86. Since 1978, the central bank of Japan has conducted monetary policy
(a) using an interest rate as its operating target.
(b) in a way that has produced relatively stable money growth.
(c) to successfully lower Japan’s inflation rate.
(d) to achieve all of the above.
(e) to achieve only (b) and (c) of the above.
87. Since 1978, the central bank of Japan has conducted monetary policy
(a) using the monetary base as its operating target.
(b) in a way that has produced relatively stable money growth.
(c) to help its exporters by lowering the value of the yen.
(d) to achieve all of the above.
88. Under inflation targeting, a central bank must pursue policies that
(a) keep the inflation rate at a target value of zero.
(b) keep the inflation rate at some specific target value.
(c) keep the inflation rate within a specific target range.
(d) lower the inflation rate, provided this can be done without raising the unemployment rate above
a specified target value.
89. The first country to mandate that its central bank adopt inflation targeting was
(a) the United States.
(b) the United Kingdom.
(c) Canada.
(d) New Zealand.
Chapter 8 Conduct of Monetary Policy: Tools, Goals, and Targets 109
◼ True/False
1. An objective of the Federal Reserve in its conduct of monetary policy is high employment.
2. When workers voluntarily leave work while they look for better jobs, the resulting unemployment is
called frictional unemployment.
3. The discount rate is an operating target.
4. The federal funds rate is an operating target.
5. Open market purchases by the Fed increase the supply of nonborrowed reserves.
6. Open market purchases by the Fed cause the federal funds rate to rise.
7. Flexibility is a requirement in selecting an intermediate target.
8. The real bills doctrine was the guiding principle for the conduct of monetary policy during
the 1910s.
9. The Fed accidentally discovered open market operations in the early 1890s.
10. During World War II, the Fed in effect relinquished its control of monetary policy through its policy
of pegging interest rates.
11. The Fed’s use of the federal funds rate as an operating target in the 1970s resulted in countercyclical
monetary policy.
12. The Fed policy since 1982 suggests that it is using a monetary aggregate as its intermediate target.
13. Since 1978, the central bank of Japan has conducted monetary policy in a way that has produced
relatively stable money growth.
14. Financial innovation, deregulation, and the breakdown of a stable relationship between M1 and
economic activity all contributed to the Fed abandoning M1 as an intermediate target.
15. Inflation targeting makes the central bank less accountable.
110 Mishkin/Eakins • Financial Markets and Institutions, Fifth Edition
◼ Essay
1. Explain how the Fed’s use of its three tool of monetary policy affect supply and demand in the
market for reserves and the equilibrium federal funds interest rate.
2. Distinguish between the three types of Fed discount loans: primary credit, secondary credit, and
seasonal credit.
3. Why does the Fed use open market operations to a greater extent than reserve requirements in its
conduct of monetary policy?
4. Explain why the use of an interest rate targeting strategy may result in procyclical monetary growth.
5. “The interest rate targeting strategy employed by the Fed in the 1960s and 1970s led to procyclical
money growth.” True, false, or uncertain? Why?
6. If inflation and unemployment are of direct concern to Fed officials, why do they make such a big
issue about money growth and interest rates? Why don’t they just target the unemployment rate and
the inflation rate directly? Explain.
7. Describe the goals of the Federal Reserve. What happens when these goals come into conflict? How
would one decide if lower inflation is more important than lower unemployment? Explain.
8. Can the Fed control the money supply? Has it done so? What evidence can you provide to support
your answer to each question?
9. Compare the advantages and disadvantages of monetary targeting and inflation targeting.