Economics 470/570 - Monetary Theory and Policy

Review Material for the Final

Review Material for the Final
Economics 470/570
Fall 2011

There are three sets of questions for the final, those for Midterms 1 and 2, and the definitions/questions over the material since the second midterm that are given below.

Review material  for Midterm 1
Review material for midterm 2

Definitions:

Natural rate of output and employment
Inflation, output, and interest rate targets
Taylor rule
Activists and non-activists
Data, recognition, legislative, implementation, and effectiveness lags
Federal reserve credibility

Questions:

1. Do monetary and fiscal policy become more or less effective when consumption, investment, or net exports become more responsive to changes in the interest rate? Explain.

2. Do monetary and fiscal policy become more or less effective when the MPC increases? Explain.

3. Do monetary and fiscal policy become more or less effective when the Fed raises interest rates more aggressively in response to changes in output? Explain.

4. Is the economy self-correcting? Explain.

5. 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?

6. Why does the SRAS slope upward? What causes the SRAS to shift?

7. Why is the LRAS vertical? What causes the LRAS to shift?

8. Show graphically that monetary and fiscal policy have no long-run effect on output when prices and wages are allowed to vary.

9. Show graphically how inflation and output adjust in the short-run and long-run in response to an improvement in technology.

10. Why does the Federal Reserve put so much emphasis on its credibility?

Review Material for Midterm 2

Review Material for Midterm 2
Economics 470/570
Fall 2011

These are review questions for the midterm exam which will be on Tuesday, November 15.

Definitions

Quantity equation
Velocity of money
Equation of exchange
Aggregate demand or expenditures
Expenditure multiplier
AE curve
MP curve
Inflation target
Interest rate target
Output target
Policy effectiveness
Crowding out
Debt monetization
Inflation
Government budget constraint

Questions

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

2. Use the supply and demand model for bank reserves to explain and illustrate the effects of (a) an open market operation to buy bonds, (b) a decrease in the discount rate, and (c) an increase in required reserves.

3. Describe the three traditional tools available to the Fed for controlling the money supply.

4. 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 rise.

5. Explain the quantity theory of money. What assumptions are imposed to arrive at a theoretical statement? Explain the Cambridge approach and illustrate that it leads to the same result as the quantity theory.

6. What is the money demand function in the classical model?

7. 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?

8. Show the money demand curve graphically and explain why it slopes downward. Show how the money demand curve shifts when income increases.

9. According to Baumol, 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?

10. What did Tobin add to Keynes theory of the speculative demand for money? Why was this development important?

11. Explain Friedman's Modern Quantity Theory of the Demand for Money.

12. Can budget deficits lead to inflation? Explain using the government budget constraint.

13. Derive the AE curve.

14. What makes the AE curve flatter or steeper?

15. What causes the AE curve to shift?

16. What is the MP curve?

17. Explain the difference between the MP curve used in the book and the MP curve used in class.

18. Show and explain how the MP curve shifts when there is a change in the inflation rate.

19. Using the MP curve from class, derive the dynamic AD curve.

20. Show graphically how the AD curve shifts when there is a change in government spending or taxes. In general, what causes the AD curve to shift?

Review Material for Midterm 1

Review Material for Midterm 1
Economics 470/570
Fall 2011

These are review questions for the first midterm exam which will be on Thursday, October 20.

Definitions

Financial Intermediary
Indirect finance
Direct finance
Adverse selection
Moral hazard
Financial Markets
Stocks and bonds
Medium of exchange/Double coincidence of wants
Unit of account/Multiplicity of prices
Store of value/Liquidity
Business cycle
Fully backed, fractionally backed, and fiat money
M1
FOMC
FAC
Discount window
Discount rate
Member bank
Type A, B, and C directors
Board of Governors
Beige book
Monetary base
Borrowed and Non-borrowed reserves
Federal funds rate
Margin requirement
Asset
Liability
Demand Deposit
Bank Reserves
Currency
Lender of Last Resort
Money multiplier 

Questions

Chapter 2

1. What are the functions of money, i.e. why does money exist? Relative to a barter economy, what problems are overcome by the use of money?

2. To be useful as a medium of exchange, what properties should money have?

3. Describe the evolution of money from barter to fiat money. How did paper money arise?

4. How is money measured? Why is there more than one definition of the money supply? Are data on the money supply reliable?

Chapter 3

5. Describe the main function of financial markets. Explain how direct finance and indirect finance differ.

Chapter 4

6. How do nominal interest rates, ex-ante real interest rates, and ex-post real interest rates differ? Of the two real rates, which is the most important for understanding economic decisions?

Chapter 11

7. Suppose that there are 100 individuals, each with $1,000 in savings that they would like to lend. Suppose there are also 100 different people who want to take out $1,000 loans. Assuming an expected default rate of 10%, use this example to show how pooling risk through financial intermediation can increase the efficiency of financial markets.

8. Suppose that there are 100 individuals, each with $1,000 in savings that they would like to lend. Suppose there are 10 different people who want to take out $10,000 loans. Use this example to show how pooling small deposits through financial intermediation can increase the efficiency of financial markets.

9. Suppose that there are 100 individuals, each with $1,000 in savings that they would like to lend. However, in any given year 10% of them will need the money for emergencies. Because of this possibility, and the dire consequences if they cannot access their money at such a time, they are unwilling to lend the money for long periods of time. Explain how financial intermediation can solve this problem of "borrowing short and lending long" and increase the efficiency of financial markets.

10. Besides pooling risk, pooling small deposits, and pooling over time, what else do financial intermediaries do to increase the efficiency of financial markets?

11. Briefly, what does the phrase “increase the efficiency of financial markets” mean?

12. What is adverse selection? Give an example of adverse selection in financial markets. How can the adverse selection problem be overcome?

13. What is moral hazard? Give an example of moral hazard in financial markets. How can the moral hazard problem be overcome?

Chapter 16

14. Describe the structure of Federal Reserve districts and Federal Reserve district banks.

15. Briefly describe the major functions of Federal Reserve district banks.

16. How do member banks differ from other banks? How did the difference change in 1980?

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

18. Describe the structure and function of the Board of Governors of the Federal Reserve System.

19. How has the power structure of the Federal Reserve System shifted over time?

20. 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.

Chapter 17

21. Use t-accounts to show that the Fed can control the monetary base better than it can control either currency or reserves. What does this result tell us?

22. Suppose that a bank has $100,000 in excess reserves that it loans out. Assuming that the required reserve ratio is 20%, use t-accounts to illustrate the multiple deposit creation process. Use this to obtain the simple deposit multiplier.

23. Suppose that the required reserve ratio is 20%, the currency to deposit ratio is .25, the excess reserve to deposit ratio is .05, and the monetary base is 1,000. (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.

24. Explain how and why the money multiplier changes when (a) the required reserve ratio increases, (b) the currency to demand deposit ratio increases, and (c) the excess reserve to demand deposit ratio increases.

Review Questions for the Final

These questions are for the topics we covered after the midterm. The review materials for the topics covered before the midterm are here (the final is comprehensive).

Definitions

Consumption, disposable income, MPC and MPS
Investment
Government spending
Aggregate demand or expenditures
Expenditure multiplier
IS curve
LM curve
Policy effectiveness
Crowding out
Potential or natural rate of output
Short-run aggregate supply
Long-run aggregate supply
Debt monetization
Inflation
Cost push inflation
Demand pull inflation
Activist/non-activist
Data lag
Recognition lag
Legislative lag
Implementation lag
Effectiveness lag
Monetary neutrality
Rational expectations
Price rigidity

Essay

1. What did Tobin add to Keynes theory of the speculative demand for money? Why was this development important?

2. Explain Friedman's Modern Quantity Theory of the Demand for Money.

3. Derive the IS curve. Explain intuitively why it slopes downward. What factors cause the IS curve to shift? In what direction do they shift the IS curve?

4. Derive the LM curve. Explain intuitively why it slopes upward.  What factors cause the LM curve to shift? In what direction do they shift the LM curve?

5. Show graphically and explain intuitively how an increase in government spending affects income and the interest rate in the IS-LM model.

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

7. Explain why the LM curve is vertical when money demand is unaffected by changes in the interest rate (as in the classical model). Explain and show graphically why the LM curve is horizontal in a liquidity trap.

8. Use the IS-LM model to show that monetary policy becomes more effective relative to fiscal policy as money demand becomes less sensitive to the interest rate (examine the cases where the LM curve is either vertical or horizontal). Explain the result intuitively. What does this imply about the use of monetary and fiscal policy over the business cycle?

9. Explain why investment is less sensitive to interest rate changes in recessions as compared to when the economy is operating closer to full employment. Explain why the IS curve is vertical when investment is completely insensitive to changes in the interest rate.

10. Use the IS-LM model to show that fiscal policy becomes more effective relative to monetary policy as investment becomes less sensitive to the interest rate (examine the cases where the IS curve is either vertical or horizontal). Explain the result intuitively. What does this imply about the use of monetary and fiscal policy over the business cycle?

11. Show that the Fed cannot continuously hit both a money supply target and an interest rate target, i.e. that it must choose one or the other.

12. Explain Poole's rules.

13. Do changes in the money supply and government spending affect output in the long-run? Explain using the IS-LM model.

14. Derive the aggregate demand curve from the IS-LM model and explain intuitively why it slopes downward. What factors cause the AD curve to shift? In what direction do they shift the AD curve?

15. Why does the short-run aggregate supply curve slope upward? What factors cause the aggregate supply curve to shift?

16. What causes the LRAS curve to shift, i.e. what factors affect the natural rate of output? Explain.

17. Is the economy self-correcting? 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?

18. (a) Do Monetarists agree with Friedman's contention that inflation is always and everywhere a monetary phenomenon? Explain using the AD-AS model. (b) Do Keynesians agree with Friedman's contention that inflation is always and everywhere a monetary phenomenon? Explain using the AD-AS model.

19. Explain how the pursuit of a high employment target by policymakers can lead to inflation.

20. Can budget deficits lead to inflation? Explain.

21. What is debt monetization? Why might governments choose to monetize the debt?

22. Explain and give an example of the Lucas critique. Why is this important?

23. What are the essential differences between the Classical, Keynesian, New Classical, and New Keynesian models?

24. Show that it is possible in a model with expectations (e.g. using the New Classical model) for an increase in the money supply to reduce output if the change in the money supply is smaller than expected.

25. Compare and contrast the effects of an unexpected increase or decrease in the money supply on prices and output in the traditional Keynesian, New Classical, and New Keynesian models.

26. Compare and contrast the effects of an expected increase or decrease in the money supply on prices and output in the traditional Keynesian, New Classical, and New Keynesian models.

27. Suppose the monetary authority wants to stop 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?

Review Material for Midterm

Review Material for Midterm
Economics 470/570
Fall 2010

These are review questions for the midterm exam which will be on Tuesday, November 2. The list is extensive - it covers all the topics that you are responsible for.

Definitions

Financial Intermediary
Indirect finance
Direct finance
Adverse selection (omit)
Moral hazard (omit)
Financial Markets
Stocks and bonds
Medium of exchange/Double coincidence of wants
Unit of account/Multiplicity of prices
Store of value/Liquidity
Business cycle
Fully backed, fractionally backed, and fiat money
M1
Nominal anchor
FOMC
FAC
Discount window
Discount rate
Member bank
Type A, B, and C directors
Board of Governors
Beige book
Monetary base
Borrowed and Non-borrowed reserves
Federal funds rate
Margin requirement
Asset
Liability
Demand Deposit
Bank Reserves
Currency
Lender of Last Resort
Money multiplier
Quantity equation
Velocity of money
Equation of exchange

Questions

Chapter 2

1. Suppose that there are 100 individuals, each with $1,000 in savings that they would like to lend. Suppose there are also 100 different people who want to take out $1,000 loans. Assuming an expected default rate of 10%, use this example to show how pooling risk through financial intermediation can increase the efficiency of financial markets.

2. Suppose that there are 100 individuals, each with $1,000 in savings that they would like to lend. Suppose there are 10 different people who want to take out $10,000 loans. Use this example to show how pooling small deposits through financial intermediation can increase the efficiency of financial markets.

3. Suppose that there are 100 individuals, each with $1,000 in savings that they would like to lend. However, in any given year 10% of them will need the money for emergencies. Because of this possibility, and the dire consequences if they cannot access their money at such a time, they are unwilling to lend the money for long periods of time. Explain how financial intermediation can solve this problem of "borrowing short and lending long" and increase the efficiency of financial markets.

4. Besides pooling risk, pooling small deposits, and pooling over time, what else do financial intermediaries do to increase the efficiency of financial markets?

5. Briefly, what does the phrase “increase the efficiency of financial markets” mean?

Chapter 3

6. What are the functions of money, i.e. why does money exist? Relative to a barter economy, what problems are overcome by the use of money?

7. To be useful as a medium of exchange, what properties should money have?

8. Describe the evolution of money from barter to fiat money. How did paper money arise?

9. How is money measured? Why is there more than one definition of the money supply? Are data on the money supply reliable?

Chapter 4

10. How do nominal interest rates, ex-ante real interest rates, and ex-post real interest rates differ? Of the two real rates, which is the most important for understanding economic decisions?

Chapter 13

11. Briefly describe the major functions of Federal Reserve district banks.

12. How do member banks differ from other banks? How did the difference change in 1980?

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

14. Describe the structure of Federal Reserve districts and Federal Reserve banks.

15. Describe the structure and function of the Board of Governors of the Federal Reserve System.

16. How has the power structure of the Federal Reserve System shifted over time?

17. 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.

Chapter 14

18. Use t-accounts to show that the Fed can control the monetary base better than it can control either currency or reserves. What does this result tell us?

19. Suppose that a bank has $100,000 in excess reserves that it loans out. Assuming that the required reserve ratio is 20%, use t-accounts to illustrate the multiple deposit creation process. Use this to obtain the simple deposit multiplier.

20. Explain why the multiplier falls when people hold currency or when banks hold excess reserves.

21. Suppose that the required reserve ratio is 20%, the currency to deposit ratio is .25, the excess reserve to deposit ratio is .05, and the monetary base is 1,000. (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.

22. Explain how and why the money multiplier changes when (a) the required reserve ratio increases, (b) the currency to demand deposit ratio increases, and (c) the excess reserve to demand deposit ratio increases. Who determines each of these quantities?

Chapter 15

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

24. Use the supply and demand model for bank reserves to explain and illustrate the effects of (a) an open market operation to buy bonds, (b) a decrease in the discount rate, and (c) an increase in required reserves.

25. Describe the three traditional tools available to the Fed for controlling the money supply.

26. 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 rise.

Chapter 19

27. Explain the quantity theory of money. What assumptions are imposed to arrive at a theoretical statement? Explain the Cambridge approach and illustrate that it leads to the same result as the quantity theory.

28. What is the money demand function in the classical model?

29. 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?

30. Show the money demand curve graphically and explain why it slopes downward. Show how the money demand curve shifts when income increases.

31. According to Baumol, 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?

[Many of these are also homework problems]

Review Material for the Final

This is for the topics we covered after the midterm. The review materials for the topics covered before the midterm are here (the final is comprehensive).

Definitions

Consumption, disposable income, MPC and MPS
Investment
Government spending
Aggregate demand or expenditures
Expenditure multiplier
IS curve
LM curve
Policy effectiveness
Crowding out
Potential or natural rate of output
Short-run aggregate supply
Long-run aggregate supply
Debt monetization
Inflation
Cost push inflation
Demand pull inflation
Activist/non-activist
Data lag
Recognition lag
Legislative lag
Implementation lag
Effectiveness lag
Policy ineffectiveness proposition
Rational expectations
Price rigidity

Essay

Chapter 19 [cont.]

1. What did Tobin add to Keynes theory of the speculative demand for money? Why was this development important?

2. Explain Friedman's Modern Quantity Theory of the Demand for Money.

3. Derive the IS curve. Explain intuitively why it slopes downward. What factors cause the IS curve to shift? In what direction do they shift the IS curve?

4. Derive the LM curve. Explain intuitively why it slopes upward.  What factors cause the LM curve to shift? In what direction do they shift the LM curve?

5. Show graphically and explain intuitively how an increase in government spending affects income and the interest rate in the IS-LM model.

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

7. Explain why the LM curve is vertical when money demand is unaffected by changes in the interest rate (as in the classical model). Explain and show graphically why the LM curve is horizontal in a liquidity trap.

8. Use the IS-LM model to show that monetary policy becomes more effective relative to fiscal policy as money demand becomes less sensitive to the interest rate (examine the cases where the LM curve is either vertical or horizontal). Explain the result intuitively. What does this imply about the use of monetary and fiscal policy over the business cycle?

9. Explain why investment is less sensitive to interest rate changes in recessions as compared to when the economy is operating closer to full employment. Explain why the IS curve is vertical when investment is completely insensitive to changes in the interest rate.

10. Use the IS-LM model to show that fiscal policy becomes more effective relative to monetary policy as investment becomes less sensitive to the interest rate (examine the cases where the IS curve is either vertical or horizontal). Explain the result intuitively. What does this imply about the use of monetary and fiscal policy over the business cycle?

11. Show that the Fed cannot continuously hit both a money supply target and an interest rate target, i.e. that it must choose one or the other.

12. Explain Poole's rules.

13. Do changes in the money supply and government spending affect output in the long-run? Explain using the IS-LM model.

14. Derive the aggregate demand curve from the IS-LM model and explain intuitively why it slopes downward. What factors cause the AD curve to shift? In what direction do they shift the AD curve?

15. Why does the short-run aggregate supply curve slope upward? What factors cause the aggregate supply curve to shift?

16. Is the economy self-correcting? What problems are encountered in the pursuit of activist policies?

17. What causes the LRAS curve to shift, i.e. what factors affect the natural rate of output? Explain.

18. (a) Do Monetarists agree with Friedman's contention that inflation is always and everywhere a monetary phenomenon? Explain using the AD-AS model. (b) Do Keynesians agree with Friedman's contention that inflation is always and everywhere a monetary phenomenon? Explain using the AD-AS model.

19. Explain how the pursuit of a high employment target by policymakers can lead to inflation.

20. Can budget deficits lead to inflation? Explain.

21. Why might governments choose to monetize the debt?

22. Compare and contrast the effects of an unexpected increase or decrease in the money supply on prices and output in the traditional Keynesian, New Classical, and New Keynesian models.

23. Compare and contrast the effects of an expected increase or decrease in the money supply on prices and output in the traditional Keynesian, New Classical, and New Keynesian models.

24. Suppose the monetary authority wants to stop 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?

Review Material for Midterm

Review Material for Midterm
Economics 470/570
Fall 2009

These are review questions for the midterm exam which will be on Thursday, November 5. The list is extensive - it covers all the topics we have covered in class that you are responsible for.  The test itself will be multiple choice, but a thorough understanding of these questions is a good study guide for the exam.

Definitions

Financial Intermediary
Indirect finance
Direct finance
Adverse selection
Moral hazard
Financial Markets
Stocks and bonds
Medium of exchange/Double coincidence of wants
Unit of account/Multiplicity of prices
Store of value/Liquidity
Business cycle
Fully backed, fractionally backed, and fiat money
M1
Nominal anchor
FOMC
FAC
Discount window
Discount rate
Member bank
Type A, B, and C directors
Board of Governors
Beige book
Monetary base
Borrowed and Non-borrowed reserves
Federal funds rate
Margin requirement
Asset
Liability
Demand Deposit
Bank Reserves
Currency
Lender of Last Resort
Money multiplier
Quantity equation
Velocity of money
Equation of exchange

Questions

Chapter 2

1. Suppose that there are 100 individuals, each with $1,000 in savings that they would like to lend. Suppose there are also 100 different people who want to take out $1,000 loans. Assuming an expected default rate of 10%, use this example to show how pooling risk through financial intermediation can increase the efficiency of financial markets.

2. Suppose that there are 100 individuals, each with $1,000 in savings that they would like to lend. Suppose there are 10 different people who want to take out $10,000 loans. Use this example to show how pooling small deposits through financial intermediation can increase the efficiency of financial markets.

3. Suppose that there are 100 individuals, each with $1,000 in savings that they would like to lend. However, in any given year 10% of them will need the money for emergencies. Because of this possibility, and the dire consequences if they cannot access their money at such a time, they are unwilling to lend the money for long periods of time. Explain how financial intermediation can solve this problem of "borrowing short and lending long" and increase the efficiency of financial markets.

4. Besides pooling risk, pooling small deposits, and pooling over time, what else do financial intermediaries do to increase the efficiency of financial markets?

5. Briefly, what does the phrase “increase the efficiency of financial markets” mean?

Chapter 3

6. What are the functions of money, i.e. why does money exist? Relative to a barter economy, what problems are overcome by the use of money?

7. To be useful as a medium of exchange, what properties should money have?

8. Describe the evolution of money from barter to fiat money. How did paper money arise?

9. How is money measured? Why is there more than one definition of the money supply? Are data on the money supply reliable?

Chapter 4

10. How do nominal interest rates, ex-ante real interest rates, and ex-post real interest rates differ? Of the two real rates, which is the most important for understanding economic decisions?

Chapter 13

11. Briefly describe the major functions of Federal Reserve district banks.

12. How do member banks differ from other banks? How did the difference change in 1980?

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

14. Describe the structure of Federal Reserve districts and Federal Reserve banks.

15. Describe the structure and function of the Board of Governors of the Federal Reserve System.

16. How has the power structure of the Federal Reserve System shifted over time?

17. 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.

Chapter 14

18. Use t-accounts to show that the Fed can control the monetary base better than it can control either currency or reserves. What does this result tell us?

19. Suppose that a bank has $100,000 in excess reserves that it loans out. Assuming that the required reserve ratio is 20%, use t-accounts to illustrate the multiple deposit creation process. Use this to obtain the simple deposit multiplier.

20. Explain why the multiplier falls when people hold currency or when banks hold excess reserves.

21. Suppose that the required reserve ratio is 20%, the currency to deposit ratio is .25, the excess reserve to deposit ratio is .05, and the monetary base is 1,000. (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.

22. Explain how and why the money multiplier changes when (a) the required reserve ratio increases, (b) the currency to demand deposit ratio increases, and (c) the excess reserve to demand deposit ratio increases. Who determines each of these quantities?

Chapter 15

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

24. Use the supply and demand model for bank reserves to explain and illustrate the effects of (a) an open market operation to buy bonds, (b) a decrease in the discount rate, and (c) an increase in required reserves.

25. Describe the three traditional tools available to the Fed for controlling the money supply.

26. 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 rise.

Chapter 19

27. Explain the quantity theory of money. Explain the Cambridge approach and illustrate that it leads to the same identity as the quantity theory. What assumptions are imposed to arrive at a theoretical statement?

28. What is the money demand function in the classical model?

29. 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?

30. Show the money demand curve graphically and explain why it slopes downward. Show how the money demand curve shifts when income increases.

31. According to Baumol, 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?

[Many of these are also homework problems]

Review Questions - Material after Midterm 2

Review for first midterm is here.
Review for second midterm is here.

Review questions for material since the second midterm:

Definitions

Potential or natural rate of output
Short-run aggregate supply
Long-run aggregate supply
Debt monetization
Inflation
Cost push inflation
Demand pull inflation
Activist/non-activist
Data lag
Recognition lag
Legislative lag
Implementation lag
Effectiveness lag
Policy ineffectiveness proposition
Rational expectations
Price rigidity

Essay

1. Show that the Fed cannot continuously hit both a money supply target and an interest rate target, i.e. that it must choose one or the other.

2. Explain Poole's rules.

3. Do changes in the money supply and government spending affect output in the long-run? Explain using the IS-LM model.

4. Derive the aggregate demand curve from the IS-LM model and explain intuitively why it slopes downward. What factors cause the AD curve to shift? In what direction do they shift the AD curve?

5. Why does the short-run aggregate supply curve slope upward? What factors cause the aggregate supply curve to shift?

6. Is the economy self-correcting? What problems are encountered in the pursuit of activist policies?

7. What causes the LRAS curve to shift, i.e. what factors affect the natural rate of output? Explain.

8. (a) Do Monetarists agree with Friedman's contention that inflation is always and everywhere a monetary phenomenon? Explain using the AD-AS model. (b) Do Keynesians agree with Friedman's contention that inflation is always and everywhere a monetary phenomenon? Explain using the AD-AS model.

9. Explain how the pursuit of a high employment target by policymakers can lead to inflation.

10. Can budget deficits lead to inflation? Explain.

11. Why might governments choose to monetize the debt?

12. Compare and contrast the effects of an unexpected increase or decrease in the money supply on prices and output in the traditional Keynesian, New Classical, and New Keynesian models.

13. Compare and contrast the effects of an expected increase or decrease in the money supply on prices and output in the traditional Keynesian, New Classical, and New Keynesian models.

14. Suppose the monetary authority wants to stop 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?

Review Questions for Midterm 2

Review Questions for Midterm 2
Economics 470/570
Fall 2008

Definitions

Money multiplier
Corridor or Tunnel System
Quantity equation
Velocity of money
Equation of exchange
Consumption, disposable income, MPC and MPS
Investment
Government spending
Aggregate demand or expenditures
Expenditure multiplier
IS curve
LM curve
Policy effectiveness
Crowding out

Essay

1. Suppose that a bank has $100,000 in excess reserves that it loans out. Assuming that the required reserve ratio is 20%, use t-accounts to illustrate the multiple deposit creation process. Use this to obtain the simple deposit multiplier.

Chapter 14

2. Explain why the multiplier falls when people hold currency or when banks hold excess reserves.

3. Suppose that the required reserve ratio is 20%, the currency to deposit ratio is .25, the excess reserve to deposit ratio is .05, and the monetary base is 1,000. (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.

4. Explain how and why the money multiplier changes when (a) the required reserve ratio increases, (b) the currency to demand deposit ratio increases, and (c) the excess reserve to demand deposit ratio increases. Who determines each of these quantities?

Chapter 15

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

6. Use the supply and demand model for bank reserves to explain and illustrate the effects of (a) an open market operation to buy bonds, (b) a decrease in the discount rate, and (c) an increase in required reserves.

7. Describe the three traditional tools available to the Fed for controlling the money supply.

8. 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 rise.

9. Explain the quantity theory of money. Explain the Cambridge approach and illustrate that it leads to the same identity as the quantity theory. What assumptions are imposed to arrive at a theoretical statement?

10. What is the money demand function in the classical model?

11. 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?

12. Show the money demand curve graphically and explain why it slopes downward. Show how the money demand curve shifts when income increases.

13. According to Baumol, 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?

14. What did Tobin add to Keynes theory of the speculative demand for money? Why was this development important?

15. Explain Friedman's Modern Quantity Theory of the Demand for Money.

16. Derive the IS curve. Explain intuitively why it slopes downward. What factors cause the IS curve to shift? In what direction do they shift the IS curve?

17. Derive the LM curve. Explain intuitively why it slopes upward.  What factors cause the LM curve to shift? In what direction do they shift the LM curve?

18. Show graphically and explain intuitively how an increase in government spending affects income and the interest rate in the IS-LM model.

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

20. Explain why the LM curve is vertical when money demand is unaffected by changes in the interest rate (as in the classical model). Explain and show graphically why the LM curve is horizontal in a liquidity trap.

21. Use the IS-LM model to show that monetary policy becomes more effective relative to fiscal policy as money demand becomes less sensitive to the interest rate (examine the cases where the LM curve is either vertical or horizontal). Explain the result intuitively. What does this imply about the use of monetary and fiscal policy over the business cycle?

22. Explain why investment is less sensitive to interest rate changes in recessions as compared to when the economy is operating closer to full employment. Explain why the IS curve is vertical when investment is completely insensitive to changes in the interest rate.

23. Use the IS-LM model to show that fiscal policy becomes more effective relative to monetary policy as investment becomes less sensitive to the interest rate (examine the cases where the IS curve is either vertical or horizontal). Explain the result intuitively. What does this imply about the use of monetary and fiscal policy over the business cycle?

[Many of these are also homework problems]

Review Questions for Midterm 1

Review Questions for Midterm 1
Economics 470/570
Fall 2008

These are homework/review questions for the first exam which will be on Tuesday, October 21. The list is extensive - it covers all the topics we have covered in class that you are responsible for, so a thorough understanding of these questions is a good study guide for the exam.

Definitions

Financial Intermediary
Indirect finance
Direct finance
Financial Markets
Stocks and bonds
Medium of exchange/Double coincidence of wants
Unit of account/Multiplicity of prices
Store of value/Liquidity
Business cycle
Fully backed, fractionally backed, and fiat money
M1
FOMC
FAC
Discount window
Discount rate
Member bank
Type A, B, and C directors
Board of Governors
Beige book
Monetary base
Borrowed and Non-borrowed reserves
Federal funds rate
Margin requirement
Asset
Liability
Demand Deposit
Bank Reserves
Currency
Lender of Last Resort

Essay

Chapter 2

1. Suppose that there are 100 individuals, each with $1,000 in savings that they would like to lend. Suppose there are also 100 different people who want to take out $1,000 loans. Assuming an expected default rate of 10%, use this example to show how pooling risk through financial intermediation can increase the efficiency of financial markets.

2. Suppose that there are 100 individuals, each with $1,000 in savings that they would like to lend. Suppose there are 10 different people who want to take out $10,000 loans. Use this example to show how pooling small deposits through financial intermediation can increase the efficiency of financial markets.

3. Suppose that there are 100 individuals, each with $1,000 in savings that they would like to lend. However, in any given year 10% of them will need the money for emergencies. Because of this possibility, and the dire consequences if they cannot access their money at such a time, they are unwilling to lend the money for long periods of time. Explain how financial intermediation can solve this problem of "borrowing short and lending long" and increase the efficiency of financial markets.

4. Besides pooling risk, pooling small deposits, and pooling over time, what else do financial intermediaries do to increase the efficiency of financial markets?

5. Briefly, what does the phrase “increase the efficiency of financial markets” mean?

Chapter 3

6. What are the functions of money, i.e. why does money exist? Relative to a barter economy, what problems are overcome by the use of money?

7. To be useful as a medium of exchange, what properties should money have?

8. Describe the evolution of money from barter to fiat money. How did paper money arise?

9. How is money measured? Why is there more than one definition of the money supply? Are data on the money supply reliable?

Chapter 4

10. How do nominal interest rates, ex-ante real interest rates, and ex-post real interest rates differ? Of the two real rates, which is the most important for understanding economic decisions?

Chapter 12

11. Briefly describe the major functions of Federal Reserve district banks.

12. How do member banks differ from other banks? How did the difference change in 1980?

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

14. Describe the structure of Federal Reserve districts and Federal Reserve banks.

15. Describe the structure and function of the Board of Governors of the Federal Reserve System.

16. How has the power structure of the Federal Reserve System shifted over time?

17. 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.

Chapter 13

18. Use t-accounts to show that the Fed can control the monetary base better than it can control either currency or reserves. What does this result tell us?

Review Questions - Material after Midterm 2

Review Questions - Material after Midterm 2

Definitions

Potential or natural rate of output
Short-run aggregate supply
Long-run aggregate supply
Implicit and explicit contracts
Deficit and Debt
Debt monetization
Inflation
Cost push inflation
Demand pull inflation
Activist/non-activist
Data lag
Recognition lag
Legislative lag
Implementation lag
Effectiveness lag
Policy ineffectiveness proposition
Rational expectations
Natural rate hypothesis
Price rigidity

Essay

1. Explain the Monetarist view of aggregate demand. Explain why Monetarists do not believe that shifts in the IS curve affect aggregate demand.

2. Explain the Keynesian view of aggregate demand.

3. Why does the short-run aggregate supply curve slope upward? What factors cause the aggregate supply curve to shift?

4. Is the economy self-correcting?

5. What causes the LRAS curve to shift, i.e. what factors affect the natural rate of output? Explain.

6. Do Monetarists agree with Friedman's contention that inflation is always and everywhere a monetary phenomenon? Explain using the AD-AS model.

7. Do Keynesians agree with Friedman's contention that inflation is always and everywhere a monetary phenomenon? Explain using the AD-AS model.

8. Explain how the pursuit of a high employment target by policymakers can lead to inflation.

9. Can budget deficits lead to inflation? Explain.

10. Why might governments choose to monetize the debt?

11. 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?

12. Explain and give an example of the Lucas critique. Why is this important?

13. What are the essential differences between the Classical, Keynesian, New Classical, and New Keynesian models?

14. Show that it is possible in a model with expectations (e.g. using the New Classical model) for an increase in the money supply to reduce output if the change in the money supply is smaller than expected.

15. Compare and contrast the effects of an unexpected increase or decrease in the money supply on prices and output in the traditional Keynesian, New Classical, and New Keynesian models.

16. Compare and contrast the effects of an expected increase or decrease in the money supply on prices and output in the traditional Keynesian, New Classical, and New Keynesian models.

17. 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?

Review Questions for Midterm 2

Definitions

Quantity equation
Velocity of money
Equation of exchange
Consumption, disposable income, MPC and MPS
Investment
Government spending
Aggregate demand or expenditures
Autonomous expenditures
Expenditure multiplier
Autonomous money demand
IS curve
LM curve
Policy effectiveness
Crowding out
Short-run and long-run in AD/AS model

Essay

These are from the first set of review questions and cover the material we didn't get to for the first exam:

21. Use the supply and demand model for bank reserves to explain and illustrate the effects of (a) an open market operation to buy bonds, (b) a decrease in the discount rate, and (c) an increase in required reserves.

22. Describe the three tools available to the Fed for controlling the money supply. How do defensive and dynamic open-market operations differ? How do primary, seasonal, and secondary credit differ? What are the advantages of open-market operations relative to the other tools?

23. 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 serves to limit the amount the federal funds rate can rise.

And here are the rest:

1. Explain the quantity theory of money. Explain the Cambridge approach and illustrate that it leads to the same identity as the quantity theory. What assumptions are imposed to arrive at a theoretical statement?

2. Is velocity a constant in Keynes liquidity preference theory? When actual data is examined, does velocity appear to be a constant? Why is this important?

3. What is the money demand function in the classical model?

4. 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?

5. Show the money demand curve graphically and explain why it slopes downward. Show how the money demand curve shifts when income increases.

6. According to Baumol, 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?

7. What did Tobin add to Keynes theory of the speculative demand for money? Why was this development important?

8. Explain Friedman's Modern Quantity Theory of the Demand for Money.

9. What is the 45 degree line diagram? What is the expenditure multiplier? What is the slope of the expenditure function? What factors cause the expenditure function to shift?

10. Derive the IS curve. Explain intuitively why it slopes downward. What factors cause the IS curve to shift? In what direction do they shift the IS curve?

11. Derive the LM curve. Explain intuitively why it slopes upward.  What factors cause the LM curve to shift? In what direction do they shift the LM curve?

12. Is the equilibrium in the IS-LM model stable? Explain.

13. Show graphically and explain intuitively how an increase in government spending affects income and the interest rate in the IS-LM model.

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

15. Explain why the LM curve is vertical when money demand is unaffected by changes in the interest rate (as in the classical model).

16. Use the IS-LM model to show that monetary policy becomes more effective relative to fiscal policy as money demand becomes less sensitive to the interest rate. Explain the result intuitively.

17. Explain why investment is less sensitive to interest rate changes in recessions as compared to when the economy is operating closer to full employment. Explain why the IS curve is vertical when investment is completely insensitive to changes in the interest rate.

18. Use the IS-LM model to show that fiscal policy becomes more effective relative to monetary policy as investment becomes less sensitive to the interest rate. Explain the result intuitively. What does this imply about the use of monetary and fiscal policy over the business cycle?

19. Show that the Fed cannot continuously hit both a money supply target and an interest rate target, i.e. that it must choose one or the other.

20. Explain Poole's rules.

21. Do changes in the money supply and government spending affect output in the long-run? Explain using the IS-LM model.

[End of material for midterm 2. Question 22, and definitions related to AD-AS, will not be on this test.]

22. Derive the aggregate demand curve from the IS-LM model and explain intuitively why it slopes downward. What factors cause the AD curve to shift? In what direction do they shift the AD curve?

Review Questions for Midterm 1

These are homework/review questions for the first exam which will be on Tuesday, October 16. The list is extensive - it covers all the topics we have covered or will cover in class. A thorough understanding of these questions is a good study guide for the exam.

Definitions

Medium of exchange/Double coincidence of wants
Unit of account/Multiplicity of prices
Store of value/Liquidity
Business cycle
fully backed, fractionally backed, and fiat money
M1
FOMC
FAC
Discount window
Discount rate
Member bank
Type A, B, and C directors
Board of Governors
Beige book
Monetary base
Borrowed and Non-borrowed reserves
Federal funds rate
Margin requirement
Asset
Liability
Demand Deposit
Bank Reserves
Reserve Requirement
Required Reserves
Excess Reserves
Currency
Lender of Last Resort
Money multiplier
Dynamic and defensive open-market operations
Primary, secondary, and seasonal credit

Essay

Chapter 3

1. What are the functions of money, i.e. why does money exist? Relative to a barter economy, what problems are overcome by the use of money?

2. To be useful as a medium of exchange, what properties should money have?

3. Describe the evolution of money from barter to fiat money. How did paper money arise?

4. How is money measured? Why is there more than one definition of the money supply? Are data on the money supply reliable?

Chapter 4

5. How do nominal interest rates, ex-ante real interest rates, and ex-post real interest rates differ? Of the two real rates, which is the most important for understanding economic decisions?

Chapter 12

6. Briefly describe the major functions of Federal Reserve district banks.

7. How do member banks differ from other banks? How did the difference change in 1980?

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

9. Describe the structure of Federal Reserve districts and Federal Reserve banks.

10. Describe the structure and function of the Board of Governors of the Federal Reserve System.

11. How has the power structure of the Federal Reserve System shifted over time?

12. 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.

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

Chapter 13

14. Use t-accounts to show that the Fed can control the monetary base better than it can control either currency or reserves. What does this result tell us?

15. Suppose that a bank has $100,000 in excess reserves that it loans out. Assuming that the required reserve ratio is 20%, use t-accounts to illustrate the multiple deposit creation process. Use this to obtain the simple deposit multiplier.

16. Suppose that the required reserve ratio is 20%, and the monetary base is 1,000. (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.

Chapter 14

17. Explain why the multiplier falls when people hold currency or when banks hold excess reserves.

18. Suppose that the required reserve ratio is 20%, the currency to deposit ratio is .25, the excess reserve to deposit ratio is .05, and the monetary base is 1,000. (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.

19. Explain how and why the money multiplier changes when (a) the required reserve ratio increases, (b) the currency to demand deposit ratio increases, and (c) the excess reserve to demand deposit ratio increases. Who determines each of these quantities?

Chapter 15

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

[Update: Exam ends here, i.e. it covers questions 1-20].

21. Use the supply and demand model for bank reserves to explain and illustrate the effects of (a) an open market operation to buy bonds, (b) a decrease in the discount rate, and (c) an increase in required reserves.

22. Describe the three tools available to the Fed for controlling the money supply. How do defensive and dynamic open-market operations differ? How do primary, seasonal, and secondary credit differ? What are the advantages of open-market operations relative to the other tools?

23. 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 serves to limit the amount the federal funds rate can rise.

Review Questions - Material after Midterm 2

Definitions

Potential or natural rate of output
Aggregate Supply
Deficit
Debt
Debt monetization
Inflation
Cost push inflation
Demand pull inflation
Activist/non-activist
Data lag
Recognition lag
Legislative lag
Implementation lag
Effectiveness lag
Policy ineffectiveness proposition
Rational expectations
Natural rate hypothesis

Essay

1. Explain the Monetarist view of aggregate demand. Explain why Monetarists do not believe that shifts in the IS curve affect aggregate demand.

2. Explain the Keynesian view of aggregate demand.

3. Why does the short-run aggregate supply curve slope upward? What factors cause the aggregate supply curve to shift?

4. Is the economy self-correcting?

5. What causes the SRAS curve to shift? Explain.

6. What causes the LRAS curve to shift, i.e. what factors affect the natural rate of output? Explain.

7. Do Monetarists agree with Friedman's contention that inflation is always and everywhere a monetary phenomenon? Explain using the AD-AS model.

8. Do Keynesians agree with Friedman's contention that inflation is always and everywhere a monetary phenomenon? Explain using the AD-AS model.

9. Explain how the pursuit of a high employment target by policymakers can lead to inflation.

10. Can budget deficits lead to inflation? Explain.

11. Why might governments choose to monetize the debt?

12. 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?

13. Explain and give an example of the Lucas critique. Why is this important?

14. What are the essential differences between the Classical, Keynesian, New Classical, and New Keynesian models?

15. Show that it is possible in a model with expectations (e.g. using the New Classical model) for an increase in the money supply to reduce output if the change in the money supply is smaller than expected.

16. Compare and contrast the effects of an unexpected increase or decrease in the money supply on prices and output in the traditional Keynesian, New Classical, and New Keynesian models.

17. Compare and contrast the effects of an expected increase or decrease in the money supply on prices and output in the traditional Keynesian, New Classical, and New Keynesian models.

18. 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?

Review Questions for Midterm 2

Definitions

Quantity equation
Velocity of money
Equation of exchange
Consumption, disposable income, MPC and MPS
Investment
Government spending
Aggregate demand or expenditures
Autonomous expenditures
Expenditure multiplier
Autonomous money demand
IS curve
LM curve
Policy effectiveness
Crowding out
Short-run and long-run in AD/AS model

Essay

These are from the first set of review questions and cover the material we didn't get to for the first exam:

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

21. Use the supply and demand model for bank reserves to explain and illustrate the effects of (a) an open market operation to buy bonds, (b) a decrease in the discount rate, and (c) an increase in required reserves.

22. Describe the three tools available to the Fed for controlling the money supply. How do defensive and dynamic open-market operations differ? How do primary, seasonal, and secondary credit differ? What are the advantages of open-market operations relative to the other tools?

23. 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 rise.

And here are the rest:

1. Explain the quantity theory of money. Explain the Cambridge approach and illustrate that it leads to the same identity as the quantity theory. What assumptions are imposed to arrive at a theoretical statement?

2. Is velocity a constant in Keynes liquidity preference theory? When actual data is examined, does velocity appear to be a constant? Why is this important?

3. What is the money demand function in the classical model?

4. 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?

5. Show the money demand curve graphically. Show how the money demand curve shifts when income increases.

6. According to Baumol, 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?

7. What did Tobin add to Keynes theory of the speculative demand for money? Why was this development important?

8. Explain Friedman's Modern Quantity Theory of the Demand for Money.

9. What is the 45 degree line diagram? What is the expenditure multiplier?

10. What is the slope of the expenditure function? What factors cause the expenditure function to shift?

11. Derive the IS curve. Explain intuitively why it slopes downward.

12. Derive the LM curve. Explain intuitively why it slopes upward.

13. What factors cause the IS curve to shift? In what direction do they shift the IS curve?

14. What factors cause the LM curve to shift? In what direction do they shift the LM curve?

15. Is the equilibrium in the IS-LM model stable? Explain.

16. Show graphically and explain intuitively how an increase in government spending affects income and the interest rate in the IS-LM model.

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

18. Explain why the LM curve is vertical when money demand is unaffected by changes in the interest rate (as in the classical model).

19. Use the IS-LM model to show that monetary policy becomes more effective relative to fiscal policy as money demand becomes less sensitive to the interest rate. Explain the result intuitively.

20. Explain why investment is less sensitive to interest rate changes in recessions as compared to when the economy is operating closer to full employment. Explain why the IS curve is vertical when investment is completely insensitive to changes in the interest rate.

21. Use the IS-LM model to show that fiscal policy becomes more effective relative to monetary policy as investment becomes less sensitive to the interest rate. Explain the result intuitively. What does this imply about the use of monetary and fiscal policy over the business cycle?

Wednesday:

22. Show that the Fed cannot continuously hit both a money supply target and an interest rate target, i.e. that it must choose one or the other.

23. Explain Poole's rules.

24. Do changes in the money supply and government spending affect output in the long-run? Explain using the IS-LM model.

25. Derive the aggregate demand curve from the IS-LM model and explain intuitively why it slopes downward. What factors cause the AD curve to shift? In what direction do they shift the AD curve?

Review Questions for Midterm 1

These are homework/review questions for the first exam. The list is extensive - it covers all the topics we covered in class (some of which we will cover next week). A thorough understanding of these questions is a good study guide for the exam.

Definitions

Medium of exchange/Double coincidence of wants
Unit of account/Multiplicity of prices
Store of value/Liquidity
Liquidity
FOMC
FAC
Discount window
Discount rate
Member bank
Board of Governors
Monetary base
Borrowed and Non-borrowed reserves
Federal funds rate
Asset
Liability
Demand Deposit
Bank Reserves
Reserve Requirement
Required Reserves
Excess Reserves
Currency
Lender of Last Resort
Money multiplier
Dynamic and defensive open-market operations
Primary, secondary, and seasonal credit

Essay

Chapter 3

1. What are the functions of money, i.e. why does money exist? Relative to a barter economy, what problems are overcome by the use of money?

2. To be useful as a medium of exchange, what properties should money have?

3. Describe the evolution of money from barter to fiat money. How did paper money arise?

4. How is money measured? Why is there more than one definition of the money supply? Are data on the money supply reliable?

Chapter 4

5. How do nominal interest rates, ex-ante real interest rates, and ex-post real interest rates differ? Of the two real rates, which is the most important for understanding economic decisions?

Chapter 12

6. Briefly describe the major functions of Federal Reserve district banks.

7. How do member banks differ from other banks? How did the difference change in 1980?

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

9. Describe the structure of Federal Reserve districts and Federal Reserve banks.

10. Describe the structure and function of the Board of Governors of the Federal Reserve System.

11. How has the power structure of the Federal Reserve System shifted over time?

12. 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.

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

Chapter 13

14. Use t-accounts to show that the Fed can control the monetary base better than it can control either currency or reserves. What does this result tell us?

15. Suppose that a bank has $100,000 in excess reserves that it loans out. Assuming that the required reserve ratio is 20%, use t-accounts to illustrate the multiple deposit creation process. Use this to obtain the simple deposit multiplier.

16. Suppose that the required reserve ratio is 20%, and the monetary base is 1,000. (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.

Chapter 14

17. Explain why the multiplier falls when people hold currency or when banks hold excess reserves.

18. Suppose that the required reserve ratio is 20%, the currency to deposit ratio is .25, the excess reserve to deposit ratio is .05, and the monetary base is 1,000. (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.

19. Explain how and why the money multiplier changes when (a) the required reserve ratio increases, (b) the currency to demand deposit ratio increases, and (c) the excess reserve to demand deposit ratio increases. Who determines each of these quantities?

Chapter 15

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

21. Use the supply and demand model for bank reserves to explain and illustrate the effects of (a) an open market operation to buy bonds, (b) a decrease in the discount rate, and (c) an increase in required reserves.

22. Describe the three tools available to the Fed for controlling the money supply. How do defensive and dynamic open-market operations differ? How do primary, seasonal, and secondary credit differ? What are the advantages of open-market operations relative to the other tools?

23. 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 rise.

Review Questions - Material after Midterm 2

Definitions

Potential or natural rate of output
Deficit
Debt
Debt monetization
Inflation
Activist/non-activist
Data lag
Recognition lag
Legislative lag
Implementation lag
Effectiveness lag
Policy ineffectiveness proposition
Rational expectations
Natural rate hypothesis

Essay

1. Explain the Monetarist view of aggregate demand. Explain why Monetarists do not believe that shifts in the IS curve affect aggregate demand.

2. Explain the Keynesian view of aggregate demand.

3. Why does the short-run aggregate supply curve slope upward? What factors cause the aggregate supply curve to shift?

4. Is the economy self-correcting?

5. What causes the SRAS curve to shift? Explain.

6. What causes the LRAS curve to shift, i.e. what factors affect the natural rate of output? Explain.

7. Do Monetarists agree with Friedman's contention that inflation is always and everywhere a monetary phenomenon? Explain using the AD-AS model.

8. Do Keynesians agree with Friedman's contention that inflation is always and everywhere a monetary phenomenon? Explain using the AD-AS model.

9. Explain how the pursuit of a high employment target by policymakers can lead to inflation.

10. Can budget deficits lead to inflation? Explain.

11. Why might governments choose to monetize the debt?

12. 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?

13. Explain and give an example of the Lucas critique. Why is this important?

14. What are the essential differences between the Classical, Keynesian, New Classical, and New Keynesian models?

15. Show that it is possible in a model with expectations (e.g. using the New Classical model) for an increase in the money supply to reduce output if the change in the money supply is smaller than expected.

16. Compare and contrast the effects of an unexpected increase or decrease in the money supply on prices and output in the traditional Keynesian, New Classical, and New Keynesian models.

17. Compare and contrast the effects of an expected increase or decrease in the money supply on prices and output in the traditional Keynesian, New Classical, and New Keynesian models.

18. 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?

Review Questions for Midterm 2

Definitions

Quantity equation
Velocity of money
Equation of exchange
Consumption, disposable income, MPC and MPS
Investment
Government spending
Aggregate demand or expenditures
Autonomous expenditures
Expenditure multiplier
Autonomous money demand
IS curve
LM curve
Policy effectiveness
Crowding out
Short-run and long-run in AD/AS model

Essay

1. Explain the quantity theory of money. Explain the Cambridge approach and illustrate that it leads to the same identity as the quantity theory. What assumptions are imposed to arrive at a theoretical statement?

2. Is velocity a constant in Keynes liquidity preference theory? When actual data is examined, does velocity appear to be a constant? Why is this important?

3. What is the money demand function in the classical model?

4. 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?

5. Show the money demand curve graphically. Show how the money demand curve shifts when income increases.

6. According to Baumol, 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?

7. What did Tobin add to Keynes theory of the speculative demand for money? Why was this development important?

8. Explain Friedman's Modern Quantity Theory of the Demand for Money.

9. What is the 45 degree line diagram? What is the expenditure multiplier?

10. What is the slope of the expenditure function? What factors cause the expenditure function to shift?

11. Derive the IS curve. Explain intuitively why it slopes downward.

12. Derive the LM curve. Explain intuitively why it slopes upward.

13. What factors cause the IS curve to shift? In what direction do they shift the IS curve?

14. What factors cause the LM curve to shift? In what direction do they shift the LM curve?

15. Is the equilibrium in the IS-LM model stable? Explain.

16. Show graphically and explain intuitively how an increase in government spending affects income and the interest rate in the IS-LM model.

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

18. Explain why the LM curve is vertical when money demand is unaffected by changes in the interest rate (as in the classical model).

19. Use the IS-LM model to show that monetary policy becomes more effective relative to fiscal policy as money demand becomes less sensitive to the interest rate. Explain the result intuitively.

20. Explain why investment is less sensitive to interest rate changes in recessions as compared to when the economy is operating closer to full employment. Explain why the IS curve is vertical when investment is completely insensitive to changes in the interest rate.

21. Use the IS-LM model to show that fiscal policy becomes more effective relative to monetary policy as investment becomes less sensitive to the interest rate. Explain the result intuitively. What does this imply about the use of monetary and fiscal policy over the business cycle?

22. Show that the Fed cannot continuously hit both a money supply target and an interest rate target, i.e. that it must choose one or the other.

23. Explain Poole's rules.

24. Do changes in the money supply and government spending affect output in the long-run? Explain using the IS-LM model.

25. Derive the aggregate demand curve from the IS-LM model and explain intuitively why it slopes downward. What factors cause the AD curve to shift? In what direction do they shift the AD curve?

Review Questions for Midterm 1

These are homework/review questions for the first exam. The list is extensive - it covers all the topics we covered in class (some of which we will cover next week). Knowing these questions well is a good study guide for the exam.

Definitions

Medium of exchange/Double coincidence of wants
Unit of account/Multiplicity of prices
Store of value/Liquidity
Liquidity
FOMC
FAC
Discount window
Discount rate
Member bank
Board of Governors
Monetary base
Borrowed and Non-borrowed reserves
Federal funds rate
Asset
Liability
Demand Deposit
Bank Reserves
Reserve Requirement
Required Reserves
Excess Reserves
Currency
Lender of Last Resort
Money multiplier
Dynamic and defensive open-market operations
Primary, secondary, and seasonal credit

Essay

1. What are the functions of money, i.e. why does money exist? Relative to a barter economy, what problems are overcome by the use of money?

2. To be useful as a medium of exchange, what properties should money have?

3. Describe the evolution of money from barter to fiat money. How did paper money arise?

4. How is money measured? Why is there more than one definition of the money supply? Are data on the money supply reliable?

5. How do nominal interest rates, ex-ante real interest rates, and ex-post real interest rates differ? Of the two real rates, which is the most important for understanding economic decisions?

6. Briefly describe the major functions of Federal Reserve district banks.

7. How do member banks differ from other banks? How did the difference change in 1980?

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

9. Describe the structure of Federal Reserve districts and Federal Reserve banks.

10. Describe the structure and function of the Board of Governors of the Federal Reserve System.

11. How has the power structure of the Federal Reserve System shifted over time?

12. 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.

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

14. Use t-accounts to show that the Fed can control the monetary base better than it can control either currency or reserves. What does this result tell us?

15. Suppose that a bank has $100,000 in excess reserves that it loans out. Assuming that the required reserve ratio is 20%, use t-accounts to illustrate the multiple deposit creation process. Use this to obtain the simple deposit multiplier.

16. Suppose that the required reserve ratio is 20%, and the monetary base is 1,000. (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.

17. Derive the money multiplier when people hold currency and when banks hold excess reserves. Is the multipliers larger or smaller than the simple money multiplier, i.e. when currency held and excess reserves are both zero? Explain.

18. Suppose that the required reserve ratio is 20%, the currency to deposit ratio is .25, the excess reserve to deposit ratio is .05, and the monetary base is 1,000. (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.

19. Explain how and why the money multiplier changes when (a) the required reserve ratio increases, (b) the currency to demand deposit ratio increases, and (c) the excess reserve to demand deposit ratio increases. Who determines each of these quantities?

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

21. Use the supply and demand model for bank reserves to explain and illustrate the effects of (a) an open market operation to buy bonds, (b) a decrease in the discount rate, and (c) an increase in required reserves.

22. Describe the three tools available to the Fed for controlling the money supply. How do defensive and dynamic open-market operations differ? How do primary, seasonal, and secondary credit differ? What are the advantages of open-market operations relative to the other tools?

23. 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 rise.

Review Questions - Material after Midterm 2

Definitions

Potential or natural rate of output
Short-run and long-run in AD/AS model
Deficit
Debt
Debt monetization
Inflation
Activist/non-activist
Data lag
Recognition lag
Legislative lag
Implementation lag
Effectiveness lag
Policy ineffectiveness proposition
Rational expectations
Natural rate hypothesis

Essay

1. Show that the Fed cannot continuously hit both a money supply target and an interest rate target, i.e. that it must choose one or the other.

2. Explain Poole's rules.

3. Do changes in the money supply and government spending affect output in the long-run? Explain using the IS-LM model.

4. Derive the aggregate demand curve from the IS-LM model and explain intuitively why it slopes downward. What factors cause the AD curve to shift? In what direction do they shift the AD curve?

5. Explain the Monetarist view of aggregate demand. Explain why Monetarists do not believe that shifts in the IS curve affect aggregate demand.

6. Explain the Keynesian view of aggregate demand.

7. Why does the short-run aggregate supply curve slope upward? What factors cause the aggregate supply curve to shift?

8. Is the economy self-correcting?

9. What causes the SRAS curve to shift? Explain.

10. What causes the LRAS curve to shift, i.e. what factors affect the natural rate of output? Explain.

11. Do Monetarists agree with Friedman's contention that inflation is always and everywhere a monetary phenomenon? Explain using the AD-AS model.

12. Do Keynesians agree with Friedman's contention that inflation is always and everywhere a monetary phenomenon? Explain using the AD-AS model.

13. Explain how the pursuit of a high employment target by policymakers can lead to inflation.

14. Can budget deficits lead to inflation? Explain.

15. Why might governments choose to monetize the debt?

16. 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?

[8/16/06 - omit this question] 17. Explain and give an example of the Lucas critique. Why is this important?

18. What are the essential differences between the Classical, Keynesian, New Classical, and New Keynesian models?

19. Show that it is possible in a model with expectations (e.g. using the New Classical model) for an increase in the money supply to reduce output if the change in the money supply is smaller than expected.

20. Compare and contrast the effects of an unexpected increase or decrease in the money supply on prices and output in the traditional Keynesian, New Classical, and New Keynesian models.

21. Compare and contrast the effects of an expected increase or decrease in the money supply on prices and output in the traditional Keynesian, New Classical, and New Keynesian models.

[8/16/06 - omit this question] 22. 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?

Review Questions - Midterm 2

Definitions

Quantity equation
Velocity of money
Equation of exchange
Consumption, disposable income, MPC and MPS
Investment
Government spending
Aggregate demand or expenditures
Autonomous expenditures
Expenditure multiplier
Autonomous money demand
IS curve
LM curve
Policy effectiveness
Crowding out

Essay

1. Explain the quantity theory of money. Explain the Cambridge approach and illustrate that it leads to the same identity as the quantity theory. What assumptions are imposed to arrive at a theoretical statement?

2. Is velocity a constant in Keynes liquidity preference theory? When actual data is examined, does velocity appear to be a constant? Why is this important?

3. What is the money demand function in the classical model?

4. 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?

5. Show the money demand curve graphically. Show how the money demand curve shifts when income increases.

6. According to Baumol, 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?

7. What did Tobin add to Keynes theory of the speculative demand for money? Why was this development important?

8. Explain Friedman's Modern Quantity Theory of the Demand for Money.

9. What is the 45 degree line diagram? What is the expenditure multiplier?

10. What is the slope of the expenditure function? What factors cause the expenditure function to shift?

11. Derive the IS curve. Explain intuitively why it slopes downward.

12. Derive the LM curve. Explain intuitively why it slopes upward.

13. What factors cause the IS curve to shift? In what direction do they shift the IS curve?

14. What factors cause the LM curve to shift? In what direction do they shift the LM curve?

15. Show graphically and explain intuitively how an increase in government spending affects income and the interest rate in the IS-LM model.

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

17. Explain why the LM curve is vertical when money demand is unaffected by changes in the interest rate (as in the classical model).

18. Use the IS-LM model to show that monetary policy becomes more effective relative to fiscal policy as money demand becomes less sensitive to the interest rate. Explain the result intuitively.

19. Explain why investment is less sensitive to interest rate changes in recessions as compared to when the economy is operating closer to full employment. Explain why the IS curve is vertical when investment is completely insensitive to changes in the interest rate. 

20. Use the IS-LM model to show that fiscal policy becomes more effective relative to monetary policy as investment becomes less sensitive to the interest rate. Explain the result intuitively. What does this imply about the use of monetary and fiscal policy over the business cycle?

Review Questions - Midterm 1

Definitions

Medium of exchange/Double coincidence of wants
Unit of account/Multiplicity of prices
Store of value/Liquidity
Liquidity
FOMC
FAC
Discount window
Discount rate
Member bank
Board of Governors
Monetary base
Borrowed and Non-borrowed reserves
Federal funds rate
Asset
Liability
Demand Deposit
Bank Reserves
Reserve Requirement
Required Reserves
Excess Reserves
Currency
Lender of Last Resort
Money multiplier
Dynamic and defensive open-market operations
Primary, secondary, and seasonal credit

Essay

1. How is money measured? Why is there more than one definition of the money supply?

2. What are the functions of money, i.e. why does money exist? Relative to a barter economy, what problems are overcome by the use of money?

3. Describe the evolution of money from barter to fiat money.

4. How do nominal interest rates, ex-ante real interest rates, and ex-post real interest rates differ?

5. Briefly describe the major functions of Federal Reserve district banks.

6. How do member banks differ from other banks? How did the difference change in 1980?

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

8. Describe the structure of Federal Reserve districts and Federal Reserve banks.

9. Describe the structure and function of the Board of Governors of the Federal Reserve System.

10. How has the power structure of the Federal Reserve System shifted over time?

11. 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.

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

13. Why is a demand deposit an asset for an individual, but a liability of the bank?

14. Use t-accounts to show that the Fed can control the monetary base better than it can control either currency or reserves. What does this result tell us?

15. Suppose that a bank has $100,000 in excess reserves. Assuming that the required reserve ratio is 20%, use t-accounts to illustrate the multiple deposit creation process. Use this to obtain the simple deposit multiplier.

16. Suppose that the required reserve ratio is 20%, and the monetary base is 1,000. (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.

17. Derive the money multiplier when people hold currency and when banks hold excess reserves. Is the multipliers larger or smaller than the simple money multiplier, i.e. when currency held and excess reserves are both zero? Explain.

18. Suppose that the required reserve ratio is 20%, the currency to deposit ratio is .25, the excess reserve to deposit ratio is .05, and the monetary base is 1,000. (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.

19. Explain how and why the money multiplier changes when (a) the required reserve ratio increases, (b) the currency to demand deposit ratio increases, and (c) the excess reserve to demand deposit ratio increases. Who determines each of these quantities?

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

21. Use the supply and demand model for bank reserves to explain and illustrate the effects of (a) an open market operation to buy bonds, (b) a decrease in the discount rate, and (c) an increase in required reserves.

22. Describe the three tools available to the Fed for controlling the money supply. How do defensive and dynamic open-market operations differ? How do primary, seasonal, and secondary credit differ? What are the advantages of open-market operations relative to the other tools?

23. 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 rise.

Review Questions Through Week 9

Economics 470/570
Winter 2006
Review Questions Through Week 9
[pdf file.]

Definitions

Consumption, disposable income, MPC and MPS
Investment
Government spending
Aggregate demand or expenditures
Autonomous expenditures
Expenditure multiplier
Autonomous money demand
IS curve
LM curve
Policy effectiveness
Crowding out

Essay

1. Show graphically using a money demand – money supply diagram and explain intuitively how the interest rate changes if (a) the nominal money supply increases, (b) the price level increases, (c) real income increases, and (d) autonomous money demand increases.

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

3. Explain why the LM curve is vertical when money demand is unaffected by changes in the interest rate (as in the classical model). More generally, show graphically and explain intuitively how the slope of the LM curve changes when the responsiveness of money demand to the interest rate (|L_i|) increases.

4. What factors cause the LM curve to shift? In what direction do they shift the LM curve? Show the shifts graphically using money demand - money supply and LM curve diagrams.

5. Explain why setting income equal to expenditures is equivalent to setting saving equal to investment.

6. What does the 45 degree line diagram show? Show the equilibrium on the 45 degree line diagram and explain how the economy moves to equilibrium if output differs from its equilibrium value. How will the equilibrium level of output change if there is a change in autonomous consumption, investment, government spending, or taxes? Explain. How will income change if the interest rate falls?

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

8. Explain why investment is negatively related to the interest rate.

9. Derive the IS curve graphically and explain intuitively why the IS curve slopes downward.

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

11. What factors cause the IS curve to shift? In what direction do they shift the IS curve? Show the shifts graphically using 45 degree line and IS curve diagrams.

12. Show graphically and explain intuitively how an increase in (a) the money supply, and (b) government spending affects income and the interest rate in the IS-LM model.

13. 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.

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

Review for Midterm 2

Economics 470/570
Winter 2006
Review Questions
[pdf file.]

Definitions

Monetary Base
Borrowed and Non-borrowed reserves
Operating and intermediate targets
Monetary Policy Goals
Defensive and Dynamic Open Market Operations
Primary, Secondary, and Seasonal Credit
Monetary aggregate
Velocity of money
Output gap
Potential output
Natural rate of output
Explain Poole's rules.
Liquidity preference

Essay

1. Derive the deposit and money multipliers when people hold currency and when banks hold excess reserves. Are the multipliers larger or smaller than the simple multiplier, i.e. when currency held and excess reserves are both zero? Explain.

2. Suppose that the required reserve ratio is 20%, the currency to deposit ratio is .25, the excess reserve to deposit ratio is .05, and the monetary base is 1,000. (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.

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

5. Show that the Fed cannot simultaneously control bank reserves and the federal funds rate and therefore cannot adopt both as operating targets.

6. Explain how and why the money multiplier changes when (a) the required reserve ratio increases, (b) the currency to demand deposit ratio increases, and (c) the excess reserve to demand deposit ratio increases. Who determines each of these quantities?

7. 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 rise.

8. Describe the three tools available to the Fed for controlling the money supply. How do defensive and dynamic open-market operations differ? How do primary, seasonal, and secondary credit differ? What are the advantages and disadvantages of each tool?

9. What are the tools, operating targets, intermediate targets, and goals of Federal Reserve Policy? How are they related?

10. Show that if the Fed controls either the federal funds rate or bank reserves, then the variance of the other variable increases.

11. Can the Fed control bank reserves exactly? Explain. Why is this important?

12. Explain the reasons for the Fed’s decision to adopt an interest rate target rather than a monetary aggregate target.

13. Explain Poole's rules.

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

15. What is the role of money in the classical model?

16. Represent the classical model using an AD-AS diagram and show that changes in money, government spending, and taxes do not affect real output. What is the AD curve in the classical model?

17. 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?

18. Explain classical interest theory. Be sure to explain why the investment function slopes downward and the saving function slopes upward.

19. Explain the quantity theory of money. Explain the Cambridge approach and illustrate that it leads to the same identity as the quantity theory. What assumptions are imposed to arrive at a theoretical statement?

20. What is the money demand function in the classical model?

21. 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?

22. According to Baumol, 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?

Review for Final

UPDATE: PDF File of This Entire Post

Economics 470/570
Winter 2006
Review Questions - Midterm 1
[pdf file]

Definitions

Medium of exchange/Double coincidence of wants
Unit of account/Multiplicity of prices
Store of value/Liquidity
Financial intermediary
Direct and indirect finance
Liquidity
FOMC
FAC
Discount window
Discount rate
Member bank
Federal Funds rate

Essay

1. How is money measured? Why is there more than one definition of the money supply?

2. What are the functions of money, i.e. why does money exist? Relative to a barter economy, what problems are overcome by the use of money?

3. Describe the evolution of money from barter to fiat money.

4. Describe the main function of financial markets. Explain how direct finance and indirect finance differ.

5. How do financial intermediaries, through their ability to pool resources promote more efficient use of financial resources? Be sure to cover risk pooling, the pooling of small investors, and pooling over time in your answer.

6. How do financial intermediaries reduce default risk, transactions costs, and matching costs?

7. Briefly describe the major functions of Federal Reserve district banks.

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

9. Describe the structure of Federal Reserve districts and Federal Reserve banks.

10. Describe the structure and function of the Board of Governors of the Federal Reserve System.

11. How has the power structure of the Federal Reserve System shifted over time?

12. 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 (we will discuss this question next class).

Economics 470/570
Winter 2006
Review Questions - Midterm 2
[pdf file.]

Definitions

Monetary Base
Borrowed and Non-borrowed reserves
Operating and intermediate targets
Monetary Policy Goals
Defensive and Dynamic Open Market Operations
Primary, Secondary, and Seasonal Credit
Monetary aggregate
Velocity of money
Output gap
Potential output
Natural rate of output
Explain Poole's rules.
Liquidity preference

Essay

1. Derive the deposit and money multipliers when people hold currency and when banks hold excess reserves. Are the multipliers larger or smaller than the simple multiplier, i.e. when currency held and excess reserves are both zero? Explain.

2. Suppose that the required reserve ratio is 20%, the currency to deposit ratio is .25, the excess reserve to deposit ratio is .05, and the monetary base is 1,000. (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.

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

5. Show that the Fed cannot simultaneously control bank reserves and the federal funds rate and therefore cannot adopt both as operating targets.

6. Explain how and why the money multiplier changes when (a) the required reserve ratio increases, (b) the currency to demand deposit ratio increases, and (c) the excess reserve to demand deposit ratio increases. Who determines each of these quantities?

7. 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 rise.

8. Describe the three tools available to the Fed for controlling the money supply. How do defensive and dynamic open-market operations differ? How do primary, seasonal, and secondary credit differ? What are the advantages and disadvantages of each tool?

9. What are the tools, operating targets, intermediate targets, and goals of Federal Reserve Policy? How are they related?

10. Show that if the Fed controls either the federal funds rate or bank reserves, then the variance of the other variable increases.

11. Can the Fed control bank reserves exactly? Explain. Why is this important?

12. Explain the reasons for the Fed’s decision to adopt an interest rate target rather than a monetary aggregate target.

13. Explain Poole's rules.

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

15. What is the role of money in the classical model?

16. Represent the classical model using an AD-AS diagram and show that changes in money, government spending, and taxes do not affect real output. What is the AD curve in the classical model?

17. 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?

18. Explain classical interest theory. Be sure to explain why the investment function slopes downward and the saving function slopes upward.

19. Explain the quantity theory of money. Explain the Cambridge approach and illustrate that it leads to the same identity as the quantity theory. What assumptions are imposed to arrive at a theoretical statement?

20. What is the money demand function in the classical model?

21. 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?

22. According to Baumol, 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?

Economics 470/570
Winter 2006
Review Questions Through Week 9
[pdf file.]

Definitions

Consumption, disposable income, MPC and MPS
Investment
Government spending
Aggregate demand or expenditures
Autonomous expenditures
Expenditure multiplier
Autonomous money demand
IS curve
LM curve
Policy effectiveness
Crowding out

Essay

1. Show graphically using a money demand – money supply diagram and explain intuitively how the interest rate changes if (a) the nominal money supply increases, (b) the price level increases, (c) real income increases, and (d) autonomous money demand increases.

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

3. Explain why the LM curve is vertical when money demand is unaffected by changes in the interest rate (as in the classical model). More generally, show graphically and explain intuitively how the slope of the LM curve changes when the responsiveness of money demand to the interest rate (|L_i|) increases.

4. What factors cause the LM curve to shift? In what direction do they shift the LM curve? Show the shifts graphically using money demand - money supply and LM curve diagrams.

5. Explain why setting income equal to expenditures is equivalent to setting saving equal to investment.

6. What does the 45 degree line diagram show? Show the equilibrium on the 45 degree line diagram and explain how the economy moves to equilibrium if output differs from its equilibrium value. How will the equilibrium level of output change if there is a change in autonomous consumption, investment, government spending, or taxes? Explain. How will income change if the interest rate falls?

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

8. Explain why investment is negatively related to the interest rate.

9. Derive the IS curve graphically and explain intuitively why the IS curve slopes downward.

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

11. What factors cause the IS curve to shift? In what direction do they shift the IS curve? Show the shifts graphically using 45 degree line and IS curve diagrams.

12. Show graphically and explain intuitively how an increase in (a) the money supply, and (b) government spending affects income and the interest rate in the IS-LM model.

13. 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.

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

Economics 470/570
Winter 2006
Review Questions for Week 10
[pdf file.]

Definitions

Liquidity trap
Monetary shock
SRAS
Full employment
Wealth effect
Real shock
LRAS
Taylor rule
MP curve

Essay

1. Use the IS-LM model to show and explain how price adjustments return the economy to full employment when output differs from its full employment level.

2. Use the AD-AS model to show the SR and LR adjustment to AD shocks in the presence of frictions such as rigid wages.

3. 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.

4. 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?

5. Explain and show graphically using the IS-LM model that when investment is highly insensitive to changes in interest rates, the automatic adjustment mechanism that returns the economy to full employment can break down.

6. In the Keynesian liquidity trap version of the IS-LM model, show that, when the economy is in the liquidity trap, (a) monetary policy is ineffective, and (b) fiscal policy is fully effective.

7. What is the Taylor rule? What are the issues involved in its implementation?

8. Explain why the MP curve slopes upward.

9. Use the IS-MP model to examine the effects of an increase in government spending on output, the real interest rate, consumption, and investment.

10. Use the IS-MP model to examine the effects of tighter monetary policy on output, the real interest rate, consumption, and investment.

11. Use the IS-MP model to examine the effects of a fall in consumer confidence on output, the real interest rate, consumption, and investment.

12. Explain why the SRAS curve shifts upward when output exceeds the natural rate and downward when output is below the natural rate.

13. Derive the AD curve from the IS-MP diagram and explain why it slopes downward.

14. Use the IS-MP and AD-AS diagrams to examine the impact and long-run effects of an increase in government spending or a decrease in taxes on output, inflation, the real interest rate, consumption, and investment.

15. Use the IS-MP and AD-AS diagrams to examine the impact and long-run effects of tighter monetary policy on output, inflation, the real interest rate, consumption, and investment.

Review Questions

Economics 470/570
Winter 2006
Review Questions
[pdf file.]

Definitions

Monetary Base
Borrowed and Non-borrowed reserves
Operating and intermediate targets
Monetary Policy Goals
Defensive and Dynamic Open Market Operations
Primary, Secondary, and Seasonal Credit
Monetary aggregate
Velocity of money
Output gap

Essay

1. Derive the deposit and money multipliers when people hold currency and when banks hold excess reserves. Are the multipliers larger or smaller than the simple multiplier, i.e. when currency held and excess reserves are both zero? Explain.

2. Suppose that the required reserve ratio is 20%, the currency to deposit ratio is .25, the excess reserve to deposit ratio is .05, and the monetary base is 1,000. (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.

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

5. Show that the Fed cannot simultaneously control bank reserves and the federal funds rate and therefore cannot adopt both as operating targets.

6. Explain how and why the money multiplier changes when (a) the required reserve ratio increases, (b) the currency to demand deposit ratio increases, and (c) the excess reserve to demand deposit ratio increases. Who determines each of these quantities?

7. 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 rise.

8. Describe the three tools available to the Fed for controlling the money supply. How do defensive and dynamic open-market operations differ? How do primary, seasonal, and secondary credit differ? What are the advantages and disadvantages of each tool?

9. What are the tools, operating targets, intermediate targets, and goals of Federal Reserve Policy? How are they related?

10. Show that if the Fed controls either the federal funds rate or bank reserves, then the variance of the other variable increases.

11. Can the Fed control bank reserves exactly? Explain. Why is this important?

12. Explain the reasons for the Fed’s decision to adopt an interest rate target rather than a monetary aggregate target.

Review Questions for Exam

Economics 470/570
Winter 2006
Review Questions for Exam
[PDF FILE]

Definitions

Medium of exchange/Double coincidence of wants
Unit of account/Multiplicity of prices
Store of value/Liquidity
Financial intermediary
Direct and indirect finance
Liquidity
FOMC
FAC
Discount window
Discount rate
Member bank
Federal Funds rate
Asset
Liability
Demand Deposit
Bank Reserves
Reserve Requirement
Required Reserves
Excess Reserves

Essay

1. How is money measured? Why is there more than one definition of the money supply?

2. What are the functions of money, i.e. why does money exist? Relative to a barter economy, what problems are overcome by the use of money?

3. Describe the evolution of money from barter to fiat money.

4. Describe the main function of financial markets. Explain how direct finance and indirect finance differ.

5. How do financial intermediaries, through their ability to pool resources promote more efficient use of financial resources? Be sure to cover risk pooling, the pooling of small investors, and pooling over time in your answer.

6. How do financial intermediaries reduce default risk, transactions costs, and matching costs?

7. Briefly describe the major functions of Federal Reserve district banks.

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

9. Describe the structure of Federal Reserve districts and Federal Reserve banks.

10. Describe the structure and function of the Board of Governors of the Federal Reserve System.

11. How has the power structure of the Federal Reserve System shifted over time?

12. 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.

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

14. Why is a demand deposit an asset for an individual, but a liability of the bank?

15. Show the t-accounts and the balance sheet for the following series of transactions. 

(i) Open a bank with 10 million dollars, put 3 million into buildings and equipment.

(ii) Put 2 million of the cash into T-bills.

(iii) Deposit 1.5 million into regional Fed bank.

(iv) Collect 4 million in deposits from other banks.

(v) Let the required reserve ratio be 20% and show what happens if the bank loans out all excess reserves.

16. Suppose that a bank has $100,000 in excess reserves. Assuming that the required reserve ratio is 20%, use t-accounts to illustrate the multiple deposit creation process. Use this to obtain the simple deposit multiplier. Why are the deposit multiplier and the money multiplier the same when there is no currency and when banks loan out all excess reserves?

17. Suppose that the required reserve ratio is 20%, and the monetary base is 1,000. (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. [Update: This question had a mistake in it - we hadn't covered excess reserves and currency as part of the multiplier yet. It's been fixed.]

Review Questions

Economics 470/570
Winter 2006
Review Questions - Midterm 1
[pdf file]

Definitions

Medium of exchange/Double coincidence of wants
Unit of account/Multiplicity of prices
Store of value/Liquidity
Financial intermediary
Direct and indirect finance
Liquidity
FOMC
FAC
Discount window
Discount rate
Member bank
Federal Funds rate

Essay

1. How is money measured? Why is there more than one definition of the money supply?

2. What are the functions of money, i.e. why does money exist? Relative to a barter economy, what problems are overcome by the use of money?

3. Describe the evolution of money from barter to fiat money.

4. Describe the main function of financial markets. Explain how direct finance and indirect finance differ.

5. How do financial intermediaries, through their ability to pool resources promote more efficient use of financial resources? Be sure to cover risk pooling, the pooling of small investors, and pooling over time in your answer.

6. How do financial intermediaries reduce default risk, transactions costs, and matching costs?

7. Briefly describe the major functions of Federal Reserve district banks.

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

9. Describe the structure of Federal Reserve districts and Federal Reserve banks.

10. Describe the structure and function of the Board of Governors of the Federal Reserve System.

11. How has the power structure of the Federal Reserve System shifted over time?

12. 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 (we will discuss this question next class).

Economics 470/570
Winter 2006
Review Questions - Midterm 2
[pdf file.]

Definitions

Monetary Base
Borrowed and Non-borrowed reserves
Operating and intermediate targets
Monetary Policy Goals
Defensive and Dynamic Open Market Operations
Primary, Secondary, and Seasonal Credit
Monetary aggregate
Velocity of money
Output gap
Potential output
Natural rate of output
Explain Poole's rules.
Liquidity preference

Essay

1. Derive the deposit and money multipliers when people hold currency and when banks hold excess reserves. Are the multipliers larger or smaller than the simple multiplier, i.e. when currency held and excess reserves are both zero? Explain.

2. Suppose that the required reserve ratio is 20%, the currency to deposit ratio is .25, the excess reserve to deposit ratio is .05, and the monetary base is 1,000. (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.

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

5. Show that the Fed cannot simultaneously control bank reserves and the federal funds rate and therefore cannot adopt both as operating targets.

6. Explain how and why the money multiplier changes when (a) the required reserve ratio increases, (b) the currency to demand deposit ratio increases, and (c) the excess reserve to demand deposit ratio increases. Who determines each of these quantities?

7. 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 rise.

8. Describe the three tools available to the Fed for controlling the money supply. How do defensive and dynamic open-market operations differ? How do primary, seasonal, and secondary credit differ? What are the advantages and disadvantages of each tool?

9. What are the tools, operating targets, intermediate targets, and goals of Federal Reserve Policy? How are they related?

10. Show that if the Fed controls either the federal funds rate or bank reserves, then the variance of the other variable increases.

11. Can the Fed control bank reserves exactly? Explain. Why is this important?

12. Explain the reasons for the Fed’s decision to adopt an interest rate target rather than a monetary aggregate target.

13. Explain Poole's rules.

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

15. What is the role of money in the classical model?

16. Represent the classical model using an AD-AS diagram and show that changes in money, government spending, and taxes do not affect real output. What is the AD curve in the classical model?

17. 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?

18. Explain classical interest theory. Be sure to explain why the investment function slopes downward and the saving function slopes upward.

19. Explain the quantity theory of money. Explain the Cambridge approach and illustrate that it leads to the same identity as the quantity theory. What assumptions are imposed to arrive at a theoretical statement?

20. What is the money demand function in the classical model?

21. 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?

22. According to Baumol, 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?

Economics 470/570
Winter 2006
Review Questions Through Week 9
[pdf file.]

Definitions

Consumption, disposable income, MPC and MPS
Investment
Government spending
Aggregate demand or expenditures
Autonomous expenditures
Expenditure multiplier
Autonomous money demand
IS curve
LM curve
Policy effectiveness
Crowding out

Essay

1. Show graphically using a money demand – money supply diagram and explain intuitively how the interest rate changes if (a) the nominal money supply increases, (b) the price level increases, (c) real income increases, and (d) autonomous money demand increases.

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

3. Explain why the LM curve is vertical when money demand is unaffected by changes in the interest rate (as in the classical model). More generally, show graphically and explain intuitively how the slope of the LM curve changes when the responsiveness of money demand to the interest rate (|L_i|) increases.

4. What factors cause the LM curve to shift? In what direction do they shift the LM curve? Show the shifts graphically using money demand - money supply and LM curve diagrams.

5. Explain why setting income equal to expenditures is equivalent to setting saving equal to investment.

6. What does the 45 degree line diagram show? Show the equilibrium on the 45 degree line diagram and explain how the economy moves to equilibrium if output differs from its equilibrium value. How will the equilibrium level of output change if there is a change in autonomous consumption, investment, government spending, or taxes? Explain. How will income change if the interest rate falls?

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

8. Explain why investment is negatively related to the interest rate.

9. Derive the IS curve graphically and explain intuitively why the IS curve slopes downward.

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

11. What factors cause the IS curve to shift? In what direction do they shift the IS curve? Show the shifts graphically using 45 degree line and IS curve diagrams.

12. Show graphically and explain intuitively how an increase in (a) the money supply, and (b) government spending affects income and the interest rate in the IS-LM model.

13. 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.

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

Economics 470/570
Winter 2006
Review Questions for Week 10
[pdf file.]

Definitions

Liquidity trap
Monetary shock
SRAS
Full employment
Wealth effect
Real shock
LRAS
Taylor rule
MP curve

Essay

1. Use the IS-LM model to show and explain how price adjustments return the economy to full employment when output differs from its full employment level.

2. Use the AD-AS model to show the SR and LR adjustment to AD shocks in the presence of frictions such as rigid wages.

3. 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.

4. 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?

5. Explain and show graphically using the IS-LM model that when investment is highly insensitive to changes in interest rates, the automatic adjustment mechanism that returns the economy to full employment can break down.

6. In the Keynesian liquidity trap version of the IS-LM model, show that, when the economy is in the liquidity trap, (a) monetary policy is ineffective, and (b) fiscal policy is fully effective.

7. What is the Taylor rule? What are the issues involved in its implementation?

8. Explain why the MP curve slopes upward.

9. Use the IS-MP model to examine the effects of an increase in government spending on output, the real interest rate, consumption, and investment.

10. Use the IS-MP model to examine the effects of tighter monetary policy on output, the real interest rate, consumption, and investment.

11. Use the IS-MP model to examine the effects of a fall in consumer confidence on output, the real interest rate, consumption, and investment.

12. Explain why the SRAS curve shifts upward when output exceeds the natural rate and downward when output is below the natural rate.

13. Derive the AD curve from the IS-MP diagram and explain why it slopes downward.

14. Use the IS-MP and AD-AS diagrams to examine the impact and long-run effects of an increase in government spending or a decrease in taxes on output, inflation, the real interest rate, consumption, and investment.

15. Use the IS-MP and AD-AS diagrams to examine the impact and long-run effects of tighter monetary policy on output, inflation, the real interest rate, consumption, and investment.