Economics 470/570 - Monetary Theory and Policy

Final Exam Fall 2010

Final and solution.

Final Exam Winter 2007

Final and Solution.

Final Exam Fall 2006

Final and Solution

Final Exam

Economics 470/570
Winter 2005
Final Exam

Part I - Definitions. Define each of the following (2 points each, 12 points total).

1. Liquidity

2. Discount window and Discount rate

3. Velocity of money

4. Policy effectiveness

5. Monetary shock and Real shock

6. Natural rate hypothesis

Part II - Short Answer. Answer FOUR of the following questions (7 points each, 28 points total).

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

2. What is the difference between real and nominal interest rates? How do the ex-ante and ex-post real interest rates differ?

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

4. Use the fixed wage AD-AS model to show the SR and LR adjustment to AD shocks.

5. How does the New Keynesian model differ from the traditional Keynesian and New Classical models?

Part III – Essays and problems. Answer FOUR of the following questions (15 points each, 60 points total)

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. 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

3. 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?

4. 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.

5. 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.

Final Exam

Economics 470/570
Spring 2004
Final Exam

Part I - Definitions. Define EACH of the following (4 points each, 40 points total).

1. Crowding out

2. Speculative demand for money

3. Potential output

4. Rational expectations

5. Debt monetization

6. Direct and indirect finance

7. Excess reserves

8. Policy ineffectiveness proposition

9. Recognition lag

10. Short-run and long-run in AD/AS model

Part II - Short Answer. Answer FOUR of the following questions (15 points each, 60 points total).

1. Is the economy self-correcting? Explain.

2. Derive the aggregate demand curve from the IS-LM model and explain intuitively why it slopes downward. What makes the AD curve steeper or flatter?

3. Using T-accounts show that the Fed can increase the monetary base by (a) an open market purchase of government bonds from banks, or (b) an open market purchase of government bonds from an individual.

4. 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.

5. Explain the shape of the supply curve for reserves.

Part III – Essays and problems. Answer FIVE of the following questions (20 points each, 100 points total)

1. 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?

2. Describe the structure and function of the Board of Governors of the Federal Reserve System. How has the power structure of the Federal Reserve System shifted over time?

3. Can budget deficits lead to inflation? Explain. Why might governments choose to monetize the debt?

4. (a) Explain intuitively how the money multiplier changes when (i) the required reserve ratio increases, (ii) the currency to deposit ratio increases, and (iii) the excess reserve to deposit ratio increases. What factors determine the quantity of excess reserves held by banks? (b) Explain how the money supply changes when discount loans increase. What might cause discount loans to change?

5. 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.

6. (a) Compare and contrast the effects of an unexpected increase in the money supply on prices and output in the New Classical and New Keynesian models. (b) Compare and contrast the effects of an expected increase in the money supply on prices and output in the New Classical and New Keynesian models.

Final Exam

Economics 470/570
Summer 2003
Final Exam

Answer AT LEAST ONE QUESTION FROM SECTION I and FIVE QUESTIONS OVERALL (25 points each).

Section I (answer at least one of these questions):

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

2. (a) Describe the quantity theory approach to money demand. (b) Describe the Cambridge approach to money demand. How does the Cambridge theory differ from the quantity theory?

Section II (answer four of the following questions if you answered one question in section I or three of the following questions if you answered two questions in section I):

3. 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.

4. Explain how the pursuit of a high employment target by policymakers can lead to inflation. Be sure to cover both cost push and demand pull inflation in your answer.

5. Explain why the IS curve is steeper when the sensitivity of investment to the interest rate falls. Use the IS-LM model to examine how the relative effectiveness of fiscal policy changes as investment becomes less sensitive to the interest rate. Explain the result intuitively.

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

7. (a) 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. Why doesn't the Fed target output directly? (b) Explain Poole's rules.

Final Exam

Economics 470/570
Winter 2003
Dr. Thoma
Final Exam

Answer EIGHT of the following questions (25 points each).

1.  What is the Fisher equation?  Explain the difference between the ex-ante real interest rate and the ex-post real interest rate.

2.  Derive the short-run and long-run Phillip's curves from the AD-AS model.  Use the Phillips Curve to examine the role of credibility in fighting inflation.  Why might a government be willing to give up its credibility?

3.  Explain why the IS curve is steeper when the sensitivity of investment to the interest rate falls.  When is investment more sensitive to changes in the interest rate, at full employment or in a recession?  Explain.  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.

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

5.  Derive the short-run and long-run supply curves under the assumption that the wage is fixed in the short-run.  Show how the short-run AS curve shifts when the fixed wage increases.

6.  Explain how the pursuit of a high employment target by policymakers can lead to inflation.  Can budget deficits lead to inflation?  Explain. 

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

8.  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?

9.  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.  Explain Poole's rules.

Final Exam

Economics 470/570
Summer 2000
Final Exam

I. Short Answer.

Answer FIVE of the following six questions. Each question is worth 5 points.

1. Discuss two properties that money must satisfy in order to be useful as a medium of exchange.

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

3. What is debt monetization?

4. Explain the policy ineffectiveness proposition.

5. What factors affect the natural rate of output?

6. What is the credit view of the transmission mechanism?

II. Essay Questions.

Answer ALL of the following questions. Each question is worth 15 points.

1. Examine the effects of anti-inflation policies on inflation and output in the traditional Keynesian, New Classical, and New Keynesian models.

2. 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 tell us about the use of monetary policy in recessions?

3. Do Monetarists and Keynesians believe that inflation is always and everywhere a monetary phenomena? Explain.

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

5. Explain the Lucas critique of econometric policy evaluation.

Final Exam

Economics 470/570
Summer 1999
Final Exam

I. Short Answer.

Answer FIVE of the following six questions. Each question is worth 5 points.

1. Explain the difference between direct and indirect finance.

2. Explain the Monetarist view of aggregate demand.

3. What is the definition of the natural rate of output?

4. What is the federal funds rate?

5. What is the government budget constraint?

6. What is meant by the term crowding out?

II. Essay Questions.

Answer FIVE of the following six questions. Each question is worth 15 points.

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

2. Derive the short-run and long-run Phillip's curves from the AD-AS model.

3. Show that the pursuit of an interest rate target by the Fed results in monetization of the debt. What are the consequences of pursuing an interest rate target if the government consistently runs a budget deficit?

4. Derive the LM curve for the classical model. Use the IS-LM model to examine the relative effectiveness of monetary and fiscal policy in the classical model. Give an intuitive explanation of the result.

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. Examine the effects of anticipated and unanticipated changes in the money supply in the New Classical model. What is the policy ineffectiveness proposition? What assumptions are required to obtain the policy ineffectiveness proposition?

Final Exam

Economics 470/570
Summer 1998
Final Exam

I. Short Answer. Answer FIVE of the following six questions. Each question is worth 5 points.

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

2. Compare rational and adaptive expectations.

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

4. What is the Lucas Supply Curve?

5. What is the government budget constraint?

6. What are real business cycle models?

II. Essay Questions. Answer FIVE of the following six questions. Each question is worth 15 points.

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

2. Explain why the IS curve is vertical when investment is unaffected by changes in the interest rate. 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.

3. Derive the short-run and long-run supply curves under the assumption that price expectations are fixed in the short-run. Show how the short-run AS curve shifts when price expectations increase.

4. Explain how the pursuit of a high employment target by policy makers can lead to inflation. Can budget deficits lead to inflation? Explain.

5. Compare the effects of anticipated and unanticipated changes in the money supply on output and prices in the New Keynesian and New Classical models. What difficulties are encountered in pursuing stabilization policies in the New Keynesian model?

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

Final Exam

Economics 470/570
Summer 1997
Final Exam

I. Short Answer. Answer FIVE of the following six questions. Each question is worth 5 points.

1. What is the natural rate hypothesis?

2. What is the credit view of the transmission mechanism?

3. What is the speculative demand for money?

4. Explain the multiple deposit creation process.

5. What are real business cycle models?

6. What is stabilization policy?

II. Essay Questions. Answer FIVE of the following six questions. Each question is worth 15 points.

1. Explain how the pursuit of a high employment target by policy makers can lead to inflation. Can budget deficits lead to inflation? Explain.

2. Derive the money multiplier when the public is allowed to hold currency and banks are allowed to hold excess reserves. Explain how the money multiplier changes when the required reserve ratio increases.

3. Examine the effects of anticipated and unanticipated changes in the money supply in the New Classical model. What is the policy ineffectiveness proposition? What assumptions are required to obtain the policy ineffectiveness proposition?

4. Explain why the IS curve is vertical when investment is unaffected by changes in the interest rate. 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.

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. Derive the short-run and long-run supply curves under the assumption that wages are fixed in the short-run. Show how the short-run AS curve shifts if the fixed wage is higher. Is policy effective in this model?

Final Exam

Economics 470/570
Summer 1996
Final Exam

I. Short Answer.

Answer FIVE of the following six questions. Each question is worth 5 points.

1. What is the natural rate of unemployment?

2. Define and explain the velocity of money.

3. What is the Lucas supply curve?

4. What are adaptive expectations?

5. What is debt monetization?

6. What is the policy ineffectiveness proposition?

II. Essay Questions.

Answer FIVE of the following six questions. Each question is worth 15 points.

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

2. Derive the short-run and long-run supply curves under the assumption that price expectations are fixed in the short-run. Show how the short-run AS curve shifts when price expectations increase.

3. Do Monetarists and Keynesians agree with Friedman's contention that inflation is always and everywhere a monetary phenomena? Explain.

4. Examine the effects of anti-inflation policies on output and prices in the traditional, New Classical, and New Keynesian models.

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

6. Explain the Monetarist and Keynesian views of aggregate demand. Explain why Monetarists do not believe that shifts in the IS curve affect aggregate demand.