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CHAPTER 29: MONETARY POLICY
Questions and Exercises
1. Contractionary monetary policy shifts the
aggregate demand curve to the left. In the
2. a. In the short run, when the economy is significantly below potential, the shift of
b. When the economy is significantly above potential, the effect of the shift of the
Real output
Y0Y1
A D
0
SAS
A D
1
P0
P1
LAS
Real output
Y
0
Y
1
A D
0
A D
1
P
0
P
1
LAS
S A S
0
S A S
1
Y
2
P
2
A
C
B
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© 2017 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in
any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
Real output
Y0
Y1
A D
0
A D
1
LAS
3. It is neither completely private nor completely public. The Fed is a
semi-autonomous agency of the federal government. Although it is owned by
4. There are few regional Fed banks in the western part of the United States because
5. Six explicit functions of the Fed are: 1) conducting monetary policy; 2)
6. The Fed buys and sells bonds to increase and decrease the amount of reserves
7. The money multiplier is 1/r. If the Fed eliminated the reserve requirement, the
8. Banks can also borrow reserves from the Fed at the discount window. The rate
9. The Federal funds rate is the interest rate that banks charge one another for Fed
10. The Fed funds rate is rate at which banks lend to another; it is the interest rate that
is most directly affected by a change in the amount of reserves in the financial
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© 2017 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in
any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
11. Defensive policies are simply changes to offset fluctuations in the demand for
12. Because the current money multiplier is 5 (1/0.2), the Fed would buy $400,000
13. a. The money multiplier, would be one.
b. The money supply would decrease enormously.
c. This could be offset by the Federal government buying up Treasury bills, directly
14. a. The money multiplier is 1/r. If this is equal to 3, then the current reserve
b. Lowering the discount rate will encourage banks to borrow. This will increase the
amount of reserves in the system so that the money supply increases. If the Fed
c. To increase the money supply by using open market operations, the Fed should
15. To increase income by $240, investment should increase by $80 (the income
multiplier is 3). To increase investment by $80 requires decreasing the interest
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© 2017 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in
any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
16. a. Since the money multiplier is 10 (1/.1), the Fed must increase reserves. I would
b. We could have also reduced the discount rate and lowered the reserve
c. Using the AS/AD model, the effect of increasing the money supply in the short run
would be to increase real output and the price level. In the long run, the effect
17. The tools of monetary policy are those things over which the Fed has direct control
such as the open market operations. These tools have a direct effect on operating
18. Fed tools include open market operations, the discount rate, and the reserve
19. In Year 2, the Fed engaged in slightly contractionary policy, but for the remaining
20. The Taylor rule [2% + Current inflation + 1/2(Current inflation – Inflation target)
21. The Taylor rule is that the Fed funds target is 2 + current inflation + ½(current
a. Fed funds rate target will be 2.5 percent [2 + 2 + ½ (-1) + ½ (-2)].
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22. An inverted yield curve is when long-term bonds pay a lower interest rate than
23. You are more likely to see an inverted yield curve when the Fed is contracting the
24. Policy makers pay attention to the shape of the yield curve because it will tell
25. Expectations definitely matter to policy makers because expectations will alter
26. Real interest rate Nominal interest rate Expected inflation
a. 5 7 2
27. A monetary regime is a predetermined statement about what policies will be
followed in various situations. It ties the hands of policy makers and is meant to
28. An inflation target policy might make the Fed pursue a contractionary monetary
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29. With transparency, the Fed tells the people what it is doing and then the people
Questions from Alternative Perspectives
1. Austrian
His argument was that financial institutions can create an almost infinite number of
2. Feminist
a. Some feminists would argue that an almost exclusive focus on men in prominent
quotations perpetuates male bias in the economics profession. It ignores the
b. This is a judgment question and judgments differ. Most feminists believe that we
3. Institutionalist
a. When interest rates are very low, it is unlikely that they will go any lower, which
b. One possibility is to change the nature of money, making it lose value. There were
4. Post-Keynesian
If it were accepted that money were non-neutral, then there would be less focus on
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any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
5. Radical
a. This is a judgment question and judgments differ. Radical economists believe that the
b. This is a judgment question and judgments differ. Radical economists believe that the
Issues to Ponder
1. If we consider the example of an open market sale by the Fed, the initial
transaction or "splash" would be the Fed sells a bond, and in exchange a person
writes a check to the Fed, which the Fed presents to the person's bank for
2. When the Fed takes money out of the economy, banks are in violation of Fed
regulations and have no choice but to contract their loans in order to meet their
reserve requirements. When the Fed puts money into the economy, banks have
3. a. This would increase excess reserves enormously.
b. Banks would most likely favor this proposal because they would now earn interest
c. Central banks would likely oppose this because it would reduce their superiority
d. This would be expected to increase the interest rate paid by banks because the
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4. Treasury bills pay interest; cash does not.
5. a. This Act will reduce float because money will be transferred almost immediately
b. Because checks will be less likely to be transferred by truck or air, weather will be
c. If the variability of float declines, so will the level of defensive Fed actions
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