Chapter 26:
1. Why is the private ownership of the Federal Reserve System essentially meaningless?
Answer:
2. How is central bank independence related to average inflation rates across countries? How is the Fed
insulated from executive branch pressures?
Answer: The more independent the central bank, the lower the average inflation rate
3. Why does the fact that the Fed finances its operations out of interest earned on its portfolio, with the
exces returned to the U.S. treasury, make it more independent of congressional pressure?
4. How does an open market purchase by the Fed increase bank reserves? How does it increase the
money supply?
Answer: When the Fed pays for an open market purchase and its check (electronic
5. Why would the Fed seldom do an open market purchase of government securities at the same time
that it raises the discount rate or the required reserve ratio?
Answer: Either an increase in the discount rate or the required reserve ratio would tend to
6. Why is a reduction in the required reserve ratio such a powerful monetary policy tool? Why is it so
seldom used?
Answer: Even a relatively small change in the required reserve ratio has a substantial
7. Why would a reduction in the required reserve ratio not be a powerful tool when banks choose to hold
substantial quantities of excess reserves?
Answer: When banks want to hold substantial excess reserves, a decrease in reserve
8. In which direction would the money supply change if
e. the Fed conducted an open market purchase of government bonds and raised reserve requirements?
9. Why would the transactions motive and the precautionary motive for holding money both tend to vary
directly with the price level? Why would the quantity of money people desire to hold for both motives tend
to vary inversely with interest rates?
Answer: The higher the price level, the more money will be needed to conduct a given real
10. In the move from a below equilibrium interest rate to the equilibrium interest rate, what happens in the
bond market and the loan market? In the move from an above equilibrium interest rate to the equilibrium
interest rate, what happens in the bond market and the loan market?
Answer: When the interest rate is below equilibrium, there is an excess demand for
11. How does a higher price level affect the money market? How does it affect aggregate demand?
Answer: A higher price level increases the demand for money, which, for a given supply
ply and the interest rate at the same time?
Answer: When the demand for money increases, if there is no change in the money
13. Answer the following questions.
a. What is the equation of exchange?
b. In the equation of exchange, if V doubled, what would happen to nominal GDP as a result?
c. In the equation of exchange, if V doubled and Q remained unchanged, what would happen to the price
level as a result?
d. In the equation of exchange, if M doubled and V remained unchanged, what would happen to nominal
GDP as a result?
e. In the equation of exchange, if M doubled and V fell by half, what would happen to nominal GDP as a
result?
14. Why have ATMs and online banking made savings accounts more liquid than they used to be?
Answer: ATMs and online banking have made the ability to convert savings account
15. Given that the Fed currently imposes reserve requirements on checking deposits, but not on savings
deposits, why would banks prefer to hold deposits as savings accounts rather than checking accounts,
other things equal?