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.
