Economics Chapter 16 2 What is the difference between the Federal Reserve Banks’ purchases of securities

Chapter 16 – Interest Rates and Monetary Policy

20. Identify the major items in the consolidated balance sheet of the Federal Reserve Banks.

21. Identify the four major instruments of monetary policy.

22. What are the four principal tools of monetary policy? Explain how they can be used.

23. What is the difference between the Federal Reserve Banks’ purchases of securities from the commercial

banking system and those from the public? Give an example.

Chapter 16 – Interest Rates and Monetary Policy

24. Both Federal Reserve Banks and commercial banks buy and sell government securities, but for

substantially different reasons. Explain.

25. Explain the impact of each of the following upon commercial bank reserves: (a) the Federal Reserve sells

government bonds in the open market to private buyers; (b) the commercial banks reduce their

indebtedness to the Federal Reserve Banks; (c) the Treasury makes a number of large disbursements in

accelerating space research.

26. Explain how a change in the reserve ratio affects the money supply.

27. What is the discount rate and how does changing it affect the money supply?

28. What is the term auction facility and how does it affect the excess reserves and the monetary multiplier of

the banking system?

Chapter 16 – Interest Rates and Monetary Policy

16–22

29. Following are the consolidated balance sheets of the commercial banks. Assume that the reserve ratio for

banks is 10%. The figures in column 1 show the balance sheets’ condition prior to each of the following

five transactions. Place the new balance-sheet figures in the appropriate columns and complete A, B, C, D,

and E for each column. Start each part (2–6) with the figures in column 1. All figures are in billions of

dollars.

(1) (2) (3) (4) (5) (6)

Assets:

Reserves $ 50

Securities 70

Loans 90

Liabilities:

Checkable deposits 200

Loans from Federal Reserve 10

A. Required reserves

B. Excess reserves

C. Change in M1

D. How much more can M1 change?

Chapter 16 – Interest Rates and Monetary Policy

16–23

E. C + D total

$_____

_____

$_____

_____

$_____

_____

$_____

_____

$_____

_____

Chapter 16 – Interest Rates and Monetary Policy

16–24

Chapter 16 – Interest Rates and Monetary Policy

16–25

Chapter 16 – Interest Rates and Monetary Policy

16–26

[text: E pp. 675-679; MA pp. 319–323]

30. The following are simplified balance sheets for the commercial banking system and the Federal Reserve

system. Perform each of the following three transactions, a, b, and c, making appropriate changes in

columns (1) through (3) in each balance sheet. Do not cumulate your answers. Also, answer these three

questions for each part: (a) What change, if any, took place in the money supply as a direct result of this

transaction? (b) What change, if any, occurred in commercial bank reserves? (c) What change occurred in

the money-creating potential of the commercial banking system if the reserve ratio is 20%? All figures are

in billions of dollars.

Consolidated Balance Sheet: Commercial Banking System

(1) (2) (3)

Assets:

Reserves $ 45

Securities 80

Loans 80

Liabilities:

Checkable deposits 200

Loans from FRBs 5

$_____

_____

$_____

_____

$_____

_____

Consolidated Balance Sheet: Federal Reserve Banks

(1) (2) (3)

Assets:

Securities $80

Loans to CBs 5

Liabilities:

Reserves of CBs 45

Treasury deposits 5

Chapter 16 – Interest Rates and Monetary Policy

16–27

Federal Reserve notes 35

$_____

_____

$_____

_____

$_____

_____

Chapter 16 – Interest Rates and Monetary Policy

16–28

Chapter 16 – Interest Rates and Monetary Policy

16–29

31. The following are simplified balance sheets for the commercial banking system and the Federal Reserve

System. Perform each of the following three transactions, a, b, and c, making appropriate changes in

columns (1) through (3) in each balance sheet. Do not cumulate your answers. Also, answer these three

questions for each part: (a) What change, if any, took place in the money supply as a direct result of this

transaction? (b) What change, if any, occurred in commercial bank reserves? (c) What change occurred in

the money-creating potential of the commercial banking system if the reserve ratio is 20%? All figures are

in billions of dollars.

Consolidated Balance Sheet: Commercial Banking System

(1) (2) (3)

Assets:

Reserves $ 50

Securities 75

Loans 75

Liabilities:

Checkable deposits 190

Loans from FRBs 10

$_____

_____

$_____

_____

$_____

_____

Consolidated Balance Sheet: Federal Reserve Banks

(1) (2) (3)

Assets:

Securities $90

Loans to CBs 10

Liabilities:

Reserves of CBs 50

Treasury deposits 10

Chapter 16 – Interest Rates and Monetary Policy

16–30

Federal Reserve notes 10

$_____

_____

$_____

_____

$_____

_____

Chapter 16 – Interest Rates and Monetary Policy

16–31

32. Which tool of monetary policy is most important? Why?

33. What interest rate has been the focus of monetary policy?

34. What is the relationship between the Federal funds rate and the prime interest rate? Why doesn’t the

Federal Reserve target the prime interest rate?

35. How is the Federal funds rate established? What role does the Federal Reserve play?

Chapter 16 – Interest Rates and Monetary Policy

36. What is the Federal funds rate and how does the Fed target it?

37. Describe how changes in the Fed’s major policy tool leads to expansionary and restrictive monetary

policies.

38. Define the Taylor rule.

39. How does monetary policy affect equilibrium GDP? How can it address the problem of recession or slow

growth? Inflation?

Chapter 16 – Interest Rates and Monetary Policy

16–33

40. Other things being equal, what effect will each of the following have on the equilibrium rate of interest?

(a) an increase in the supply of money; (b) an increase in the equilibrium level of national income; (c) a

decrease in the supply of money; (d) a leftward shift of the asset demand for money.

41. Use the below graphs to answer the following questions assuming the nominal GDP in the economy is

given.

(a) Look at graph A and suppose the supply of money increases from 100 to 200. What will be the

equilibrium rate of interest?

(b) Look at graph B which shows an investment-demand curve for this economy. Given the answer to part

(a) above, how much will investors plan to spend on capital goods?

(c) What will happen to aggregate demand?

(d) Now trace what will happen in parts (a)–(c) if the money supply increases to $300.

42. Trace the cause-effect chain that results from an expansionary monetary policy.

An expansionary monetary policy will cause bank reserves to grow and the money supply to expand.

Interest rates will fall and this encourages investment spending. Real GDP will rise by a multiple of the

increase in investment. [text: E p. 687; MA p. 331]

Chapter 16 – Interest Rates and Monetary Policy

16–34

43. Trace the cause-effect chain that results from a restrictive monetary policy.

44. Differentiate between expansionary and restrictive monetary policies.

45. Suppose the economy is experiencing a recession and high unemployment. What would be the

interpretation of how an expansionary monetary policy would address this problem?

46. Suppose the economy is experiencing inflation. What would be the interpretation of how a restrictive

monetary policy would address this problem?

47. Discuss the relative merits of monetary policy under conditions of demand-pull inflation or recession.

48. Explain two strengths of monetary policy for achieving economic stability.

49. What are the political and economic limitations upon (a) fiscal policy and (b) monetary policy?

Chapter 16 – Interest Rates and Monetary Policy

16–35

Chapter 16 – Interest Rates and Monetary Policy

50. Describe how the Federal Reserve handled the monetary policy from 2000–2006. What type of economic

events did it face and how did it use monetary policy to address them?

51. How did the Fed use the Federal funds rate to respond to the mortgage default crisis?

52. One of the advantages of monetary policy is its speed and flexibility, but there are limitations. Explain.

53. Explain what is meant by cyclical asymmetry with regard to monetary policy effects.

54. What are the implications of a liquidity trap for the Federal Reserve?

55. (Consider This) How did the consolidated balance sheet of the 12 Federal Reserve banks change during the

severe recession of 2007–2009?

Chapter 16 – Interest Rates and Monetary Policy

56. (Last Word) Explain the “big picture” of macroeconomics based on the components of aggregate supply

and aggregate demand.