978-1259663048 Chapter 29 Solutions Manual

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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

SAS

A D

LAS

Real output

A D

LAS

S A S

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Real output

A D

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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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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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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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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