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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
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E. C + D total
$_____
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$_____
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$_____
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$_____
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$_____
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Chapter 16 - Interest Rates and Monetary Policy
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Chapter 16 - Interest Rates and Monetary Policy
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Chapter 16 - Interest Rates and Monetary Policy
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[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
$_____
_____
_____
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_____
$_____
_____
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$_____
_____
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_____
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
$_____
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$_____
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$_____
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_____
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
$_____
_____
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$_____
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$_____
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_____
Chapter 16 - Interest Rates and Monetary Policy
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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
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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
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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.
