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60. During the 1990s many countries developed a monetary policy framework that focused on
inflation targeting. This is an example of policymakers:
a. focusing exclusively on an intermediate target that will effectively result in the final bojective.
b. focusing directly on an objective.
c. focusing on multiple numerical targets.
d. developing a new intermediate target that will effectively result in the final bojective.
61. Central banks that have a hierarchical mandate with inflation targeting basically are saying:
a. hitting the inflation target is the first priority after all other stated objectives are reached.
b. hitting the inflation target is the only objective.
c. the inflation target is the second most important goal after economic growth, which is always
the most important goal for monetary policymakers.
d. hitting the inflation target comes first, everything else comes second.
62. Inflation targeting does all of the following except:
a. increase policymakers’ credibility.
b. increase policymakers’ accountability.
c. communicate policymakers’ objectives clearly and openly.
d. hinder economic growth.
63. The Taylor rule is:
a. the monetary policy setting formula followed explicitly by the FOMC.
b. an approximation that seeks to explain how the FOMC sets their target.
c. an explicit tool used by the ECB but not the Fed.
d. a rule adopted by Congress to make the Fed’s monetary policy more accountable to the public.
64. The components of the formula for the Taylor rule includes each of the following, except:
a. the target federal funds rate.
b. the current inflation rate.
c. the 30-year U.S. Treasury bond rate.
d. the inflation gap.
65. The Taylor rule allows the real long-term interest rate to:
a. fluctuate with the natural rate of interest.
b. be zero.
c. be five percent less the inflation rate.
d. be one percent.
66. Given the following formula for the Taylor rule:
Target federal funds rate = natural rate of interest + current inflation + ½(inflation gap)
+½(output gap) if the current rate of inflation is 5%, the natural rate of interest is 2%, and the
target rate of inflation is 2%, and output is 3% above its potential, the target federal funds rate
would be:
a. 6.5%.
b. 2.5%.
c. 3.5%.
d. 10%.
67. Given the following formula for the Taylor rule:
Target federal funds rate = natural rate of interest + current inflation + ½(inflation gap)
+½(output gap)
If the current rate of inflation is 4%, natural rate of interest is 2%, and the target rate of inflation
is 2%, and output is 3% above its potential, the target federal funds rate would be:
a. 7%.
b. 8.5%.
c. 5%.
d. 4.5%.
68. Given the following formula for the Taylor rule:
Target federal funds rate = natural rate of interest + current inflation + ½(inflation gap)
+½(output gap)
If output in the economy were to fall by an additional one percent below potential, the target
federal funds rate would:
a. Increase by 1.5%.
b. Decrease by 1.5%.
c. Remain at 2.5%.
d. Decrease by 0.5%.
69. Given the following formula for the Taylor rule:
Target federal funds rate = natural rate of interest + current inflation + ½(inflation gap)
+½(output gap)
If the inflation rate in the economy were to fall by 2% below the target inflation rate, the target
federal funds rate would:
a. Decrease by 3.0%.
b. Remain at 2.5%.
c. Decrease by 1.0%.
d. Increase by 1.0%.
70. Given the following formula for the Taylor rule:
Target federal funds rate = natural rate of interest + current inflation + ½(inflation gap)
+½(output gap)
Every one percent decrease in the rate of inflation will:
a. raise the target federal funds rate by 1.5%.
b. lower the target federal funds rate by 0.5%.
c. lower the target federal funds rate by 1.5%.
d. raise the target federal funds rate by 0.5%.
71. Given the following formula for the Taylor rule:
Target federal funds rate = natural rate of interest + current inflation + ½(inflation gap)
+½(output gap)
Every one percent increase in the rate of inflation will:
a. increase the real federal funds rate by 1.5%.
b. increase the target federal funds rate by 1.5%.
c. increase the real federal funds rate by 0.5%.
d. increase the target federal funds rate by 1.5% and increase the real federal funds rate by 0.5%.
72. The measure for the actual rate of inflation used in the Taylor rule is the:
a. personal consumption expenditure index.
b. GDP deflator.
c. consumer price index.
d. producer price index.
73. Recent research by Fed researchers put the natural rate of interest at:
a. close to 0 percent.
b. negative one percent.
c. two percent.
d. five percent.
74. Of the following, which would not be considered an unconventional monetary policy
approach?
a. Discount rate
b. Policy duration commitment
c. Quantitative easing
d. Credit easing
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75. Unconventional monetary policy tools include all but:
a. quantitative easing.
b. forward guidance.
c. targeted asset purchases.
d. reserve requirement.
76. The key to the success of forward guidance as a monetary policy tool is:
a. timing.
b. a favorable exchange rate.
c. transparency.
d. credibility.
77. Forward guidance is:
a. statements today about policy targets in the future.
b. expansion of the supply of aggregate reserves beyond the amount needed to maintain the
policy rate target.
c. asset purchases that shift the composition of the Fed’s balance sheet.
d. statements of policy changes and dates those changes will take effect.
78. Quantitative easing is:
a. statements today about policy targets in the future.
b. expansion of the supply of aggregate reserves beyond the amount needed to maintain the
policy rate target.
c. asset purchases that shift the composition of the Fed’s balance sheet.
d. expansion of the demand for aggregate reserves to drive down the IOER.
79. Targeted asset purchases are:
a. statements today about policy targets in the future.
b. expansion of the supply of aggregate reserves beyond the amount needed to maintain the
policy rate target.
c. asset purchases that shift the composition of the Fed’s balance sheet.
d. asset purchases that increase the reserves held by the federal government.
80. Unconventional policy tools are useful when:
a. lowering the target interest rate to zero is not sufficient to stimulate the economy.
b. conventional policy tools result in shifts in the economy that are too large.
c. conventional policy tools support only growth in the economy.
d. restrictive monetary policy is necessary.
81. Raising interest rates following the use of unconventional policy tools depend on
a. the size and composition of the central bank’s balance sheet.
b. the toolbox available to the central bank.
c. both the size and composition of the central bank’s balance sheet and the toolbox available to
the central bank.
d. neither the size and composition of the central bank’s balance sheet and the toolbox available
to the central bank.
Short Answer Questions
82. In 2001, the FOMC lowered the target federal funds rate eleven times, cutting the rate from
6½ percent to 1¾ percent. Why didn’t the Fed just cut the rate by larger amounts early on?
83. State and briefly define the tools of monetary policy available to the Federal Reserve.
84. Why is it necessary to distinguish between the target federal funds rate range and the market
federal funds rate?
85. Could the Fed impact the amount of borrowing in the federal funds market without changing
their target for the federal funds rate? Explain.
86. Why does the Federal Funds rate face a zero bound?
87. Compare the supply curve in the market for bank reserves prior to 2008 with the supply
curve following the financial crisis.
88. Is discount lending used to keep banks from failing? Explain.
89. Discuss why the discount rate may be considered a penalty rate of interest charged to banks.
90. Since 2002, the Fed has set the primary discount rate above the IOER rate. Why is this likely
to prevent the spikes in the market federal funds similar to the ones that occurred in previous
years?
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91. What is the difference between primary and secondary credit offered by the Fed and who
would use secondary credit?
92. What is the consensus among economists and other monetary policy experts regarding the
usefulness of the monetary policy instruments available to central banks in normal times?
93. Explain the three desirable features of a good monetary policy instrument.
94. 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.
95. 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.
96. Discuss why the Fed can either both a quantity and a price (interest rate) target unlike other
monopolies.
97. 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.
98. Discuss the key criteria for success and the advantages of a central bank adopting the
framework of inflation targeting.
99. Is the Taylor rule the specific formula followed by the FOMC? Explain.
100. Given the following Taylor rule:
Target federal funds rate = natural rate of interest + current inflation + 2x(inflation gap) +
x(output gap);
What do the coefficients on the inflation and output gaps (2x, x) reveal?
101. Given the following Taylor rule:
Target federal funds rate = natural rate of interest + 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.
102. Given the following Taylor rule:
Target federal funds rate = natural rate of interest + 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.
103. 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.”
104. What were the three unconventional policy approaches used by the Fed during the financial
crisis of 2007-2009?
105. How does policy forward guidance influence the economy and inflation?
106. How do targeted asset purchases alter the outlook for the economy and inflation?
Essay Questions
107. What are the advantages from the 2002 change in the Fed’s lending policy?
108. 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.
109. 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.