Economics 470/570 - Monetary Theory and Policy

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Midterm 2

Economics 470/570
Winter 2005 (worth 1 point)
Midterm #2

Part I - Definitions. Define each of the following (3 points each, 18 points total).

1. Autonomous expenditures

2. Crowding out

3. Inflationary and recessionary gaps

4. Policy ineffectiveness proposition

5. Menu costs

6. Wealth effect

Part II - Short Answer. Answer THREE of the following questions (9 points each, 27 points total).

1. What is the expenditure multiplier? Why is it useful?

2. When is money demand more sensitive to changes in the interest rate, at full employment or in a recession? Explain.

3. Use the IS-LM model to show that the model is classical in the LR, i.e. that (a) output does not change in the LR, (b) monetary shocks do not affect the real interest rate in the LR, (c) real shocks do affect the real interest rate in the LR.

4. Derive the SRAS and LRAS curves for the New Classical model.

Part III – Essays and problems. Answer THREE of the following questions (18 points each, 54 points total)

1. Use the IS-LM model to examine how the relative effectiveness of monetary and fiscal policy changes as investment becomes less sensitive to the interest rate. Explain the result intuitively.

2. (a) What is a liquidity trap and how does it arise? Explain your answer intuitively and graphically. Is the economy more likely to be in a liquidity trap near full employment or in a recession? Explain. (b) Explain and show graphically using the IS-LM model how the economy can become stuck in a liquidity trap with output less than its full employment level. How can wealth effects overcome this problem?

3. Explain the activist and non-activist positions on the use of government policy to stabilize macroeconomic variables such as real output. What problems are encountered in the pursuit of activist policies? Are there substantial differences for monetary and fiscal policy?

4. Suppose the monetary authority wants to reduce the inflation rate. Compare the costs (in terms of output) of reducing inflation in the traditional Keynesian, New Classical, and New Keynesian models. Be sure to cover both an expected and an unexpected change in policy. Why is the credibility of policymakers important?

[Midterm 2 Solution]

Midterm 1

Economics 470/570
Winter 2005 (worth 1 point)
Midterm #1

Part I - Definitions. Define each of the following (3 points each, 18 points total).

1. Direct and indirect finance

2. Federal Funds rate

3. Bank Reserves

4. Monetary Base

5. Defensive and Dynamic Open Market Operations

6. Output gap

Part II - Short Answer. Answer THREE of the following questions (9 points each, 27 points total).

1. Who is on the FOMC? What does the FOMC do?

2. Write down the government budget constraint and explain each term.

3. (a) Explain why the demand curve for reserves slopes downward. (b) Explain the shape of the supply curve for reserves.

4. What is the Taylor rule? How is it used? How well does it predict Fed policy?

Part III – Essays and problems. Answer THREE of the following questions (18 points each, 54 points total)

1. How independent is the Fed? What factors contribute to independence? What factors work against independence? Discuss arguments for and against the independence of the Fed.

2. Show the t-accounts and the balance sheet for the following series of transactions. (i) Open a bank with 5 million dollars, put 2 million into buildings and equipment. (ii) Put 1 million of the cash into T-bills. (iii) Deposit .5 million into regional Fed bank. (iv) Collect 1.5 million in deposits from other banks. (v) Let the required reserve ratio be 10% and show what happens if the bank loans out all excess reserves.

3. What is meant by the phrase lender of last resort? Why is this important? Explain and show graphically how the Fed uses discount rate policy to act as a lender of last resort and how this limits the amount the federal funds rate can increase.

4. (a) State Say’s law. What is the significance of this in terms of government stabilization policy? Explain why Malthus does not believe in Say’s law. How does classical interest theory answer address Malthus’ criticism of Say’s law? (b) Explain why the investment function slopes downward and the saving function slopes upward.

[Midterm 1 Solution]

Midterm

Economics 470/570
Spring 2004
Midterm

Part I - Definitions. Define each of the following (3 points each, 30 points total).

1. Discount rate

2. Open market operation

3. LM curve

4. Non-borrowed reserves

5. Velocity

6. Transactions demand for money

7. Partially backed paper money

8. Bank Reserves

9. Autonomous expenditures

10. Liquidity

Part II - Short Answer. Answer THREE of the following questions (8 points each, 24 points total).

1. What properties must money satisfy in order to be useful?

2. Who is on the FOMC? What does the FOMC do?

3. Explain why the demand curve for reserves slopes downward.

4. Derive the LM curve graphically and explain intuitively why the LM curve slopes upward.

Part III – Essays and problems. Answer THREE of the following questions (15 points each, 45 points total)

1. How independent is the Fed? What factors contribute to independence? What factors work against independence? Discuss arguments for and against the independence of the Fed.

2. Explain intuitively and show graphically how the quantity of reserves and the FF rate are affected by (a) open-market operations, (b) discount loans, and (c) changes in reserve requirements.

3. According to Baumol and Tobin, the transactions demand for money depends upon the interest rate as well as nominal income. Explain why the transactions demand for money depends upon the interest rate. Why is this important?

4. (a) Show that a decrease in taxes causes the IS curve to shift out using a 45 degree line diagram and an IS curve diagram. (b) Show graphically and explain intuitively how the slope of the IS curve changes when the responsiveness of investment to the interest rate (I_i) increases. A detailed mathematical answer can be substituted for the graphical analysis.

Midterm

Economics 470/570
Summer 2003
Midterm

Answer FIVE of the following six questions (20 points each). Put a large X on the page of the question you are omitting so as to clearly and unambiguously designate the skipped question.

1. (a) Derive the LM curve graphically. Explain intuitively why it slopes upward. (b) Consider points above or below the LM curve. Explain why there is excess demand or excess supply at each point and the forces that cause the interest rate to change so as to restore equilibrium.

2. According to Baumol and Tobin, the transactions demand for money depends upon the interest rate as well as nominal income. Explain why the transactions demand for money depends upon the interest rate. Why is this important?

3. Describe the three tools available to the Fed for controlling the money supply. Using T-accounts show that the Fed can increase the monetary base by (a) making discount loans to banks, (b) an open market purchase of government bonds from banks, or (c) an open market purchase of government bonds from an individual.

4. Describe the structure and function of the Board of Governors of the Federal Reserve System. What is the FOMC? What does it do?

5. What are the functions of money? Relative to a barter economy, what problems are overcome by the use of money? What properties must money satisfy in order to be useful?

6. Show that the Fed can control the monetary base better than it can control reserves. Can the Fed control the monetary base perfectly? Why or why not?

Midterm

Economics 470/570
Winter 2003
Dr. Thoma
Midterm

Answer each of the following questions (20 points each).

1. Discuss the transactions, precautionary, and speculative motives for holding money in Keynes liquidity preference theory. When all three motives are put together, what theory of money demand emerges?

2. What are the functions of money? Relative to a barter economy, what problems are overcome by the use of money? What properties must money satisfy in order to be useful?

3. Derive the money multiplier when the public is allowed to hold currency and banks are allowed to hold excess reserves. Explain how the money multiplier changes when (a) the required reserve ratio increases, (b) the currency to deposit ratio increases, and (c) the excess reserve to deposit ratio increases. What factors determine the quantity of excess reserves held by banks?

4. How independent is the Fed? What factors contribute to independence? What factors work against independence? Discuss arguments for and against the independence of the Fed.

5. Explain why the demand curve for reserves slopes downward. Explain why the supply curve for reserves slopes upward. Explain how the quantity of reserves and the FF rate are affected by (a) open-market operations, (b) discount loans, and (c) changes in reserve requirements.

Midterm

Economics 470/570
Spring 2000
Midterm

I. Short Answer: Answer four of the following five questions. Each question is worth 8 points.

1. What are the three types of financial intermediaries? Give an example of each type.

2. Suppose that the excess reserve to deposit ratio increases. Explain how this will affect the money supply.

3. What is the federal funds rate?

4. Explain why the price of bonds and the interest rate are inversely related.

5. Explain the difference between direct and indirect finance.

II. Essay Questions: Answer each of the following four questions. Each question is worth 17 points.

1. How independent is the Fed? What factors contribute to the independence of the Fed? What factors work against independence? Discuss the arguments for and against the independence of the Fed.

2. Discuss the transactions, precautionary, and speculative motives for holding money in Keynes liquidity preference theory. When all three motives are put together, what theory of money demand results?

3. When using open-market operations, does the Fed have better control over the monetary base or bank reserves? Explain. Why can't the Fed control the money supply perfectly?

4. Discuss the evolution of the payments system from barter to fiat money. How did banking arise?

Midterm

Economics 470/570
Summer 1999
Midterm

I. Short Answer: Answer five of the following seven questions. Each question is worth 8 points.

1. What is the Fisher equation? Does it describe the ex-ante or ex-post real interest rate?

2. Why is currency in circulation listed as a liability on the Federal Reserve's balance sheet?

3. What are secondary markets? Why are they important? Give two examples of secondary markets for financial assets.

4. Explain intuitively why the IS curve slopes downward.

5. How reliable are data on the money supply?

6. What are non-borrowed reserves? How well can they be controlled by the Fed?

7. Suppose that the required reserve ratio is 15%, the currency to deposit ratio is .20, the excess reserve to deposit ratio is .05, and the monetary base is 20,000. (a) Find the money supply. (b) Let open market operations increase the monetary base by 200. Use the money multiplier to find the new value of the money supply.

II. Essay Questions: Answer four of the following five questions. Each question is worth 15 points.

1. What are the three functions of money? Describe the problems that are overcome by the use of money. What properties must money satisfy in order to be useful?

2. Using T-accounts, show that the Fed can increase bank reserves by making discount loans to banks, by purchasing government bonds from banks, or by purchasing government bonds from individuals. Explain intuitively how the creation of reserves leads to multiple deposit creation in banks.

3. Describe the structure and function of the Board of Governors of the Federal Reserve System. What role does the Board of Governors play on the FOMC?

4. According to Baumol and Tobin, the transactions demand for money depends upon the interest rate as well as nominal income. Explain why the transactions demand for money depends upon the interest rate. Why is this important?

5. Describe the three tools available to the Fed for controlling the money supply. What are the advantages and disadvantages of each tool?

Midterm

Economics 470/570
Summer 1998
Midterm

I. Short Answer. Answer five of the following seven questions. Each question is worth 8 points.

1. What is the federal funds rate?

2. Explain intuitively why the LM curve is positively sloped.

3. What are the three types of financial intermediaries? Give an example of each type.

4. How is M1 defined? Why might this definition be too narrow?

5. Explain the difference between direct and indirect finance.

6. What is the discount window and the discount rate? Who sets the discount rate?

7. Suppose that the currency to deposit ratio increases. Explain how this will affect the money supply.

II. Essay Questions. Answer four of the following five questions. Each question is worth 15 points.

1. How independent is the Fed? What factors contribute to the independence of the Fed? What factors work against independence? Discuss the arguments for and against the independence of the Fed.

2. Describe the Quantity Theory and Cambridge approaches to money demand. In what sense did Keynes follow in the Cambridge tradition? What did Baumol add?

3. Explain how financial intermediaries bring about more efficient use of financial resources.

4. What are the three functions of money? Describe the problems that are overcome by the use of money. What properties must money satisfy in order to be useful?

5. Show that the Fed can control the monetary base better than it can control reserves. Can the Fed control the monetary base perfectly? Why or why not?

Midterm

Economics 470/570
Summer 1997
Midterm

I. Short Answer. Answer five of the following seven questions. Each question is worth 8 points.

1. How do bonds and equities differ? Which is more risky?

2. Explain intuitively why the IS curve is negatively sloped.

3. What defines a capital market instrument? Describe two capital market instruments.

4. What is the expenditure multiplier? Why is it useful?

5. Explain the difference between direct and indirect finance.

6. How is the monetary base defined? What are excess reserves?

7. Suppose that the required reserve ratio is 25%, the currency to deposit ratio is .10, the excess reserve to deposit ratio is .20, and the monetary base is 5,000. (a) Find the money supply. (b) Let open market operations increase the monetary base by 500. Use the money multiplier to find the new value of the money supply.

II. Essay Questions. Answer four of the following five questions. Each question is worth 15 points.

1. Describe the structure of federal reserve districts and federal reserve banks. How has the power structure of the federal reserve system shifted over time?

2. According to Baumol and Tobin, the transactions demand for money depends upon the interest rate as well as nominal income. Explain why the transactions demand for money depends upon the interest rate. Why is this important?

3. Derive the LM curve. Show graphically and explain intuitively how an increase in the money supply affects income and the interest rate in the IS-LM model.

4. How do financial intermediaries, through their ability to pool resources and economize on transactions costs, promote more efficient use of financial resources?

5. Show that the Fed can control the monetary base better than it can control reserves. How does the Fed use the monetary base to control the money supply?

Midterm

Economics 470/570
Summer 1996
Midterm

I. Short Answer.

Answer five of the following seven questions. Each question is worth 8 points.

1. How do money and capital markets differ? List two money market instruments and two capital market instruments.

2. What is the definition of the monetary base? What are non-borrowed reserves?

3. What is the discount window and the discount rate? Who sets the discount

rate?

4. What is the Fisher equation? Does it define the ex-ante or the ex-post real rate of interest?

5. What is the speculative demand for money?

6. What are the three types of financial intermediaries? Give an example of each type.

7. Suppose that the required reserve ratio is 10%, the currency to deposit ratio is .25, the excess reserve to deposit ratio is .15, and the monetary base is 1,000. (a) Find the money supply. (b) Let open market operations increase the monetary base by 100. Use the money multiplier to find the new value of the money supply.

II. Essay Questions. Answer four of the following five questions. Each question is worth 15 points.

1. Describe the three tools available to the Fed for controlling the money supply. What are the advantages and disadvantages of each tool?

2. Discuss the evolution of the payments system from barter to fiat money. How did banking arise?

3. What are the reasons for regulating financial markets? Discuss the types of regulations that have been imposed on financial markets.

4. Describe the Quantity Theory and Cambridge approaches to money demand. In what sense did Keynes follow in the Cambridge tradition? What did Baumol add?

5. How has the power structure of the Federal Reserve system shifted over time?

Midterm

Economics 470/570
Summer 1995
Midterm

I. Short Answer. Answer five of the following seven questions. Each question is worth 8 points.

1. What is the announcement effect?

2. What is the federal funds rate?

3. Define the transactions demand for money.

4. What is the difference between the ex-ante and ex-post real interest rates?

5. What is the theoretical definition of money?

6. What is the FOMC? Who is on the FOMC?

7. Suppose that the required reserve ratio is 8%, the currency to deposit ratio is .20, the excess reserve to deposit ratio is .02, and the monetary base is 5,000. (a) Find the money supply. (b) Let open market operations increase the monetary base by 100. Use the money multiplier to find the new value of the money supply.

II. Essay Questions. Answer four of the following five questions. Each question is worth 15 points.

1. What are the three functions of money? Describe the problems that are overcome by the use of money. What properties must money satisfy in order to be useful?

2. When using open-market operations, does the Fed have better control over the monetary base or bank reserves? Explain. Why can't the Fed control the money supply perfectly?

3. What are financial intermediaries? How do they promote the efficient use of financial resources?

4. How independent is the Fed? What factors contribute to the independence of the Fed? What factors work against independence? Discuss the arguments for and against the independence of the Fed.

5. Discuss the contributions of the Cambridge economists and Keynes to the theory of money demand.