Economics 470/570 Part I - Definitions. Define each of the following (3 points each, 18 points
total).
Winter 2005 (worth 1 point)
Midterm #1
1. Direct and indirect finance
2. Federal Funds rate
3. Bank Reserves
4. Monetary Base
5. Defensive and Dynamic Open Market Operations
6. Output gap
Part II - Short Answer. Answer THREE of the following questions (9 points each, 27 points total).
1. Who is on the FOMC? What does the FOMC do?
2. Write down the government budget constraint and explain each term.
3. (a) Explain why the demand curve for reserves slopes downward. (b) Explain the shape of the supply curve for reserves.
4. What is the Taylor rule? How is it used? How well does it predict Fed policy?
Part III – Essays and problems. Answer THREE of the following questions (18
points each, 54 points total)
1. How independent is the Fed? What factors contribute to independence? What factors work against independence? Discuss arguments for and against the independence of the Fed.
2. Show the t-accounts and the balance sheet for the following series of transactions. (i) Open a bank with 5 million dollars, put 2 million into buildings and equipment. (ii) Put 1 million of the cash into T-bills. (iii) Deposit .5 million into regional Fed bank. (iv) Collect 1.5 million in deposits from other banks. (v) Let the required reserve ratio be 10% and show what happens if the bank loans out all excess reserves.
3. What is meant by the phrase lender of last resort? Why is this important? Explain and show graphically how the Fed uses discount rate policy to act as a lender of last resort and how this limits the amount the federal funds rate can increase.
4. (a) State Say’s law. What is the significance of this in terms of government stabilization policy? Explain why Malthus does not believe in Say’s law. How does classical interest theory answer address Malthus’ criticism of Say’s law? (b) Explain why the investment function slopes downward and the saving function slopes upward.
