Economics 470/570 - Monetary Theory and Policy

Practice Problem Set 6

Economics s350k
Summer 2014
Practice Problem Set 6

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. What is the Lucas critique of econometric policy evaluation? Why is it important?

3. What is time consistency?

4. What are the arguments for and against rules over discretion?

5. What is constrained discretion?

6. What is a nominal anchor, and how does it help with credibility?

7. Show that credibility of the Fed helps to stabilize output when (a) there are negative AD shocks.

8. Show that credibility of the Fed helps to stabilize the inflation when there are positive AD shocks.

9. Show that credibility of the Fed helps to stabilize both output and inflation when there are SRAS shocks.

10. Explain why Fed credibility reduces the cost of fighting inflation.

Practice Problem Set 5

Economics s350k
Summer 2014
Practice Problem Set 5

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

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

3. Use the AD-AS and IS-MP diagrams to show that monetary and fiscal policy can change output in the short-run, but not in the long-run. How do inflation and interest rates change in the SR and LR in each case?

4. Use an AD-AS diagram to show how inflation and output adjust in the short-run and long-run in response to an improvement in technology.

5. Use an AD-AS diagram to show how inflation and output adjust in the short-run and long-run in response to an oil price shock.

6. Is the economy self-correcting? Explain.

7. Does stabilizing the inflation rate stabilize the economy? Explain (for AD shocks, SRAS shocks, and LRAS shocks).

8. What is the Phillips curve? How have views about the Phillips curve changed over time?

Practice Problem Set 4

Economics s350k
Summer 2014
Practice Problem Set 4

1. Explain the quantity theory of money. What assumptions are imposed to arrive at a theoretical statement?

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

3. How well does the quantity theory explain inflation in the short-run and long-run?

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 how velocity and money demadn change when people make more visits to the bank each month. How can the optimal number of visits be determined? How does the optimal number change when there is a change in the cost of a visit to the bank, or a change in the interest rate?

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

7. Explain the portfolio theory of money demand and how it relates to the Keynesian model.

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

9. Derive the IS curve graphically and mathematically.

10. What makes the IS curve flatter or steeper?

11. What causes the IS curve to shift?

12. What is the MP curve?

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

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

15. Derive the AD curve.

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

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

Practice Problem Set 3

Economics s350k
Summer 2014
Practice Problem Set 3

1. 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?

2. 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.

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

4. 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.

5. 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?

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

7. 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, (c) an increase in required reserves, and (d) a change in the interest rate paid on reserves.

8. Describe the three traditional tools available to the Fed for controlling the money supply. What tool has the Fed added to its arsenal recently, and why is this important?

9. 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.

Questions added after Wednesday's class:

10. What are the advantages and disadvantages of the Fed's four conventional policy tools?

11. Why did the Fed begin using unconventional policy tools during the Great Recession?

12. Describe the liquidity provisions the Fed put in place during the Great Recession. Did they work?

13. How can quantitative easing provide liquidity to banks? What are the potential channels through which quantitative easing can stimulate the economy?

14. Describe the three rounds of quantitative easing. Did quantitative easing work? Describe operation twist. Why did the Fed adopt this policy?

Practice Problem Set 2

Economics s350k
Summer 2014
Practice Problem Set 2

1.Describe the origins of the Federal Reserve System.

2. Briefly describe the structure and major functions of Federal Reserve district banks.

3. Why is the NY Fed the most important of the district banks?

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

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

6. Describe the structure and function of the Board of Governors of the Federal Reserve System. Why does the chair of the Fed have so much power over monetary policy?

7. 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.

Practice Problem Set 1

Economics s350k
Summer 2014
Practice Problem Set 1

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

2. Suppose that there are 10 individuals, each with $10,000 in savings that they would like to lend, but only if there is little to no chance that they will lose their investment. Suppose there are also 10 different people who want to take out $10,000 loans. (a) Assuming an expected default rate of 10% and an interest rate on loans of 20%, use this example to show how pooling risk through financial intermediation can increase the efficiency of financial markets. (b) Assuming the default rate using financial intermediation is exactly 10%, what is the interest rate at which the return is 0%?

3. Suppose that there are 10 individuals, each with $10,000 in savings that they would like to lend. Suppose there another person who wants to take out a $100,000 loan. Use this example to show how pooling small deposits through financial intermediation can increase the efficiency of financial markets.

4. Suppose that there are 100 individuals, each with $1,000 in savings that they would like to lend. However, in any given year 20% 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, none of them 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.

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

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

7. 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?

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

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

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

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

12. 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?

Practice Problem Set 4

Economics 470/570 
Winter 2014
Practice Problem Set 4

1. 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.

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

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

5. Explain Friedman's Modern Quantity Theory of the Demand for Money. [Omit -- did not talk about this]

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

7. Derive the IS curve graphically and mathematically.

8. What makes the IS curve flatter or steeper?

9. What causes the IS curve to shift?

10. What is the MP curve?

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

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

13. Derive the AD curve.

14. 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?

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

16. 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.

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

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

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

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

21. Is the economy self-correcting? Explain.

22. 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?

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

Practice Problem Set 3

Economics 470/570 
Winter 2014
Practice Problem Set 3

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, (c) an increase in required reserves, and (d) a change in the interest rate paid on reserves.

3. Describe the three traditional tools available to the Fed for controlling the money supply. What tool has the Fed added to its aresenal recently, and why is this important?

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.

Practice Problem Set 2

Economics 470/570 
Winter 2014
Practice Problem Set 2

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

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

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

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

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

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

7. 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.

8. 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?

9. 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.

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

11. 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.

12. 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?

Practice Problem Set 1

Economics 470/570 
Winter 2014
Practice Problem Set 1

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

2. Suppose that there are 10 individuals, each with $10,000 in savings that they would like to lend, but only if there is little to no chance that they will lose their investment. Suppose there are also 10 different people who want to take out $10,000 loans. (a) Assuming an expected default rate of 10% and an interest rate on loans of 20%, use this example to show how pooling risk through financial intermediation can increase the efficiency of financial markets. (b) Assuming the default rate using financial intermediation is exactly 10%, what is the interest rate at which the return is 0%?

3. Suppose that there are 10 individuals, each with $10,000 in savings that they would like to lend. Suppose there another person who wants to take out a $100,000 loan. Use this example to show how pooling small deposits through financial intermediation can increase the efficiency of financial markets.

4. Suppose that there are 100 individuals, each with $1,000 in savings that they would like to lend. However, in any given year 20% 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, none of them 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.

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

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

7. 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?

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

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

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

11. 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?

Homework 7

Economics 470/570
Monetary Theory and Policy
Homework 7

1. Use the Phillips curve model to explain the SR and LR effects of expected and unexpected changes in the inflation rate..

2. Does stabilizing the inflation rate stabilize the economy? Explain.

3. What problems are encountered in the pursuit of activist policies?

4. Explain how demand pull inflation can occur.

5. What is the Lucas critique of econometric policy evaluation?

6. What are the arguments for and against rules over discretion?

7. Show that credibility of the Fed helps to stabilize the economy when there are negative AD shocks.

Homework 6

Economics 470/570
Monetary Theory and Policy
Homework 6

1. How does the effectiveness of monetary policy change when there is a decrease in the responsiveness of investment to the interest rate? What does this imply about the effectiveness of monetary policy over the business cycle?

2. Derive the SRAS and LRAS curves from  labor supply-labor demand and production function diagrams (alternatively, do it mathematically as we did in class).

3. Use AD-AS and IS-MP diagrams to examine the short-run and long-run effects of an increase in business confidence.

4. Use AD-AS and IS-MP diagrams to examine the short-run and long-run effects of the Fed tightening monetary policy.

5. Use AD-AS and IS-MP diagrams to examine the short-run and long-run effects of a temporary increase in the price of oil. How does the result differ if the change in the price of oil is permanent?

6. Use AD-AS and IS-MP diagrams to examine the short-run and long-run effects of an increase in the capital stock.

Homework 5

Economics 470/570
Fall 2012
Homework 5
Answers posted late Friday (11/9)

Chapter 20, pgs. 512-514

Problems 9, 11, 14, 24, and 25

Chapter 21, pgs. 525-527

Problems 11, 13, 22, and 24

Homework 4

Economics 470/570
Fall 2012
Homework #4
Answers posted late Tuesday (10/23)

1. What is the money demand function in the classical model? How does the money demand function differ under the Cambridge approach? Why is this important?

2. Explain the speculative motive for holding money in Keynes liquidity preference theory and why, in aggregate it is negatively related to the interest rate.

3. Explain why the money demand curve slopes downward. Show how the money demand curve shifts when income increases. How does the money demand curve shift if there is an increase in the riskiness of financial assets? Explain.

[Update: We didn't get to problem 4, so omit this problem]

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

Homework 3

Homework 3
Answers posted 10/19

1. Does the Fed have better control over reserves or the monetary base? Explain.

2. Suppose the Fed sells $1,000 worth of securities to the public. Assuming that the reserve requirement is 25%, use t-accounts to show the resulting multiple deposit contraction (carry the t-accounts out through three steps). Use the simple multiplier formula to calculate the total fall in bank deposits.

3. Derive the money multiplier when C ≠ 0 and ER ≠ 0. Explain why it is smaller than the simple money multiplier.

4. Explain the shape of the reserve demand curve. (b) Explain the shape of the reserve supply curve.

5. Use reserve supply and demand diagrams to show how (a) open market operations, (b) borrowing from the Fed, and (c) changes in reserve requirements impact the federal funds rate.

6. Show graphically how an increase in financial market risk affects the federal funds rate, and how the Fed would respond in order to return the federal funds rate to its target value.

7. Show how the Fed's operating procedure limits the variability in the federal funds rate.

Homework 2

Homework 2
Answers posted 10/11

1. What is meant by the term "fractionally backed currency"? How does fractionally backed currency come about?

2. Briefly, 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?

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

4. How has the power structure of the Fed changed over time?

5. Discuss arguments for and against the independence of the Fed.

Homework 1

Economics 470/570 
Fall 2012
Answers will be posted on Thursday, 10/4

1. Suppose that there are 10 individuals, each with $10,000 in savings that they would like to lend, but only if there is little to no chance that they will lose their investment. Suppose there are also 10 different people who want to take out $10,000 loans. (a) Assuming an expected default rate of 10% and an interest rate on loans of 20%, use this example to show how pooling risk through financial intermediation can increase the efficiency of financial markets. (b) Assuming the default rate using financial intermediation is exactly 10%, what is the interest rate at which the return is 0%?

2. Suppose that there are 10 individuals, each with $10,000 in savings that they would like to lend. Suppose there another person who wants to take out a $100,000 loan. 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 20% 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, none of them 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?

6. You have been put in charge of selecting a new medium of exchange for the economy. Choose something to serve as money, and evaluate it in terms of the properties that a medium of exchange must satisfy in order to be useful.

Homework 6

Economics 470
Fall 2011
Homework 6
Due Thursday 12/1

1. Does monetary policy become more or less effective when consumption is more responsive to changes in the interest rate? Explain.

2. Does fiscal policy become more or less effective when consumption is more responsive to changes in the interest rate? Explain.

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

4. Why does the SRAS slope upward? What causes the SRAS to shift? Why is the LRAS vertical?

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

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

[I may add a few more questions on Tuesday 11/29.]

Homework 5

Economics 470
Fall 2011
Homework 5
Due 11/17

1. Derive the AE curve.

2. What makes the AE curve flatter or steeper?

3. What causes the AE curve to shift?

4. What is the MP curve?

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

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

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

8. 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?

Homework 4

Homework #4
Due Thursday 11/03

1. Explain the shape of the reserve demand curve. (b) Explain the shape of the reserve supply curve.

2. Use reserve supply and demand diagrams to show how (a) open market operations, (b) borrowing from the Fed, and (c) changes in reserve requirements impact the federal funds rate.

3. Show graphically how an increase in financial market risk affects the federal funds rate, and how the Fed would respond in order to return the federal funds rate to its target value.

4. What is the money demand function in the classical model? How does the money demand function differ under the Cambridge approach? Why is this important?

5. Explain the speculative motive for holding money in Keynes liquidity preference theory and why, in aggregate, it is negatively related to the interest rate.

6. Explain why the money demand curve slopes downward. Show how the money demand curve shifts when income increases. How does the money demand curve shift if there is an increase in the riskiness of financial assets? Explain.

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

Homework 3

Economics 470/570 
Fall 2011
Due: Tuesday, 10/18

1. Discuss arguments for and against the independence of the Fed.

2. What is debt monetization?

3. Does the Fed have better control over reserves or the monetary base? Explain.

Homework 2

Economics 470/570 
Fall 2011
Due: Thursday, 10/13

1. Briefly, 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?

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

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

4. How has the power structure of the Fed changed over time?

Homework 1

Economics 470/570 
Fall 2011
Due: Thursday, 10/6

1. You have been put in charge of selecting a new medium of exchange for the economy. Choose something to serve as money, and evaluate it in terms of the properties that a medium of exchange must satisfy in order to be useful.

2. What is meant by the term "fractionally backed currency"? How does fractionally backed currency come about?

3. Suppose that there are 10 individuals, each with $10,000 in savings that they would like to lend, but only if there is little to no chance that they will lose their investment. Suppose there are also 10 different people who want to take out $10,000 loans. (a) Assuming an expected default rate of 10% and an interest rate on loans of 20%, use this example to show how pooling risk through financial intermediation can increase the efficiency of financial markets. (b) Assuming the default rate using financial intermediation is exactly 10%, what is the interest rate at which the return is 0%?

4. Suppose that there are 10 individuals, each with $10,000 in savings that they would like to lend. Suppose there another person who wants to take out a $100,000 loan. Use this example to explain how pooling small deposits through financial intermediation can increase the efficiency of financial markets.

5. Suppose that there are 100 individuals, each with $1,000 in savings that they would like to lend. However, in any given year 20% 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, none of them 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.

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

Homework #6

Economics 470
Fall 2010
Homework 6
Due Tuesday, November 23

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. Show graphically that monetary and fiscal policy have no long-run effect on output when prices are allowed to vary. Be sure to explain what the graph shows.

3. How would an increase in the riskiness of financial assets shift the AD curve? Use the IS-LM model to derive the result.

4. Why does the SRAS slope upward? Why is the LRAS vertical?

5. Explain debt monetization. Explain why debt monetization can be automatic when the Fed follows an interest rate rule for monetary policy (this can be done graphically). Is this a problem right now?

Homework #5

Economics 470
Fall 2010
Homework 5
Due Tuesday, November 16

1. Explain why (a) investment and the interest rate are inversely related, and (b) net exports and the interest rate are inversely related.

2. (a) Use the 45 degree line diagram to show how the IS curve shifts when there is a decrease in taxes. (b) Show graphically that the IS curve becomes flatter when MPC increases.

3. Derive the LM curve for the case where the economy contains a liquidity trap. Show how the LM curve shifts in this case when there is an increase in the money supply.

4. Does monetary policy become more or less effective when net exports become more responsive to changes in the interest rate? Explain.

Homework #4

Economics 470/570
Fall 2010
Homework #4
Due Thursday, November 4

1. What is the money demand function in the classical model? How does the money demand function differ under the Cambridge approach? Why is this important?

2. Explain the speculative motive for holding money in Keynes liquidity preference theory and why, in aggregate it is negatively related to the interest rate.

3. Explain why the money demand curve slopes downward. Show how the money demand curve shifts when income increases. How does the money demand curve shift if there is an increase in the riskiness of financial assets? Explain.

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

Homework #2

Homework #2
Due 10/14

1. What is meant by the term "fractionally backed currency"? How does fractionally backed currency come about?

2. Briefly, 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?

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

4. How has the power structure of the Fed changed over time?

5. Discuss arguments for and against the independence of the Fed.

6. Does the Fed have better control over reserves or the monetary base? Explain. [I didn't get to this problem. It will be moved to the next homework.]

 

Homework #1

Economics 470/570 
Fall 2010
Due: Thursday, 10/7

1. Suppose that there are 10 individuals, each with $10,000 in savings that they would like to lend, but only if there is little to no chance that they will lose their investment. Suppose there are also 10 different people who want to take out $10,000 loans. (a) Assuming an expected default rate of 10% and an interest rate on loans of 20%, use this example to show how pooling risk through financial intermediation can increase the efficiency of financial markets. (b) Assuming the default rate using financial intermediation is exactly 10%, what is the interest rate at which the return is 0%?

2. Suppose that there are 10 individuals, each with $10,000 in savings that they would like to lend. Suppose there another person who wants to take out a $100,000 loan. 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 20% 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, none of them 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?

6. You have been put in charge of selecting a new medium of exchange for the economy. Choose something to serve as money, and evaluate it in terms of the properties that a medium of exchange must satisfy in order to be useful. [We will cover this material on Tuesday.]

Homework #6

Economics 470
Fall 2009
Homework 6
Due Tuesday, November 24

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. Show graphically that monetary and fiscal policy have no long-run effect on output when prices are allowed to vary. Be sure to explain what the graph shows.

3. How would an increase in the riskiness of financial assets shift the AD curve? Use the IS-LM model to derive the result.

4. Why does the SRAS slope upward? Why is the LRAS vertical?

5. Explain debt monetization. Explain why debt monetization can be automatic when the Fed follows an interest rate rule for monetary policy (this can be done graphically). Is this a problem right now?

Homework #5

Economics 470
Fall 2009
Homework 5
Due Tuesday, November 17

1. Explain why (a) investment and the interest rate are inversely related, and (b) net exports and the interest rate are inversely related.

2. (a) Use the 45 degree line diagram to show how the IS curve shifts when there is a decrease in taxes. (b) Show graphically that the IS curve becomes flatter when MPC increases.

3. Derive the LM curve for the case where the economy contains a liquidity trap. Show how the LM curve shifts in this case when there is an increase in the money supply.

4. Does monetary policy become more or less effective when net exports become more responsive to changes in the interest rate? Explain.

Homework #4

Economics 470/570
Fall 2009
Homework #4
Due Tuesday, November 3

1. What is the money demand function in the classical model? How does the money demand function differ under the Cambridge approach? Why is this important?

2. Explain the speculative motive for holding money in Keynes liquidity preference theory and why, in aggregate it is negatively related to the interest rate.

3. Explain why the money demand curve slopes downward. Show how the money demand curve shifts when income increases. How does the money demand curve shift if there is an increase in the riskiness of financial assets? Explain.

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

Homework #3

Homework #3
Due Tuesday 10/27 at the end of class.

1. Suppose the Fed sells $1,000 worth of securities to the public. Assuming that the reserve requirement is 25%, use t-accounts to show the resulting multiple deposit contraction (carry the t-accounts out through three steps). Use the simple multiplier formula to calculate the total fall in bank deposits.

2. Derive the money multiplier when C ≠ 0 and ER ≠ 0. Explain why it is smaller than the simple money multiplier.

3. Explain the shape of the reserve demand curve. (b) Explain the shape of the reserve supply curve.

4. Use reserve supply and demand diagrams to show how (a) open market operations, (b) borrowing from the Fed, and (c) changes in reserve requirements impact the federal funds rate.

5. Show graphically how an increase in financial market risk affects the federal funds rate, and how the Fed would respond in order to return the federal funds rate to its target value.

6. Show how the Fed's operating procedure reduces the variability in the federal funds rate.

Homework #2

Homework #2
Due 10/15 at the end of class

1. What is meant by the term "fractionally backed currency"? How does fractionally backed currency come about?

2. Briefly, 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?

3. How has the power structure of the Fed changed over time?

4. Discuss arguments for and against the independence of the Fed.

5. Does the Fed have better control over reserves or the monetary base? Explain.

6. Suppose the Fed sells $1,000 worth of securities to the public. Assuming that the reserve requirement is 25%, use t-accounts to show the resulting multiple deposit contraction (carry the t-accounts out through three steps). Use the multiplier formula to calculate the total fall in bank deposits.  [This problem has been omitted from this assignment since we didn't get to this material. If you did the problem already, note that it will be on the next homework.]

Homework #1

Economics 470/570
Fall 2009
Due: End of class on Thursday, 10/8

1. Suppose that there are 10 individuals, each with $10,000 in savings that they would like to lend, but only if there is little to no chance that they will lose their investment. Suppose there are also 10 different people who want to take out $10,000 loans. (a) Assuming an expected default rate of 10% and an interest rate on loans of 20%, use this example to show how pooling risk through financial intermediation can increase the efficiency of financial markets. (b) Assuming the default rate using financial intermediation is exactly 10%, what is the interest rate at which the return is 0%?

2. Suppose that there are 10 individuals, each with $10,000 in savings that they would like to lend. Suppose there another person who wants to take out a $100,000 loan. 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 20% 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, none of them 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?

6. You have been put in charge of selecting a new medium of exchange for the economy. Choose something to serve as money, and evaluate it in terms of the properties that a medium of exchange must satisfy in order to be useful.

Homework #7

Economics 470
Fall 2008
Homework 7
Due Thursday, December 4

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. How would an increase in the riskiness of financial assets shift the AD curve? Use the IS-LM model to derive the result.

3. Why does the SRAS slope upward?

4. Explain debt monetization.

Homework #6

Economics 470
Fall 2008
Homework 6
Due Thursday, November 13

1. Explain why (a) investment and the interest rate are inversely related, and (b) net exports and the interest rate are inversely related.

2. (a) Derive the IS curve from the 45 degree line diagram. (b) Use the 45 degree line diagram to show how the IS curve shifts when there is a decrease in taxes.

3. Derive the LM curve for the case where the economy contains a liquidity trap.

Homework #5

Economics 470
Fall 2008
Homework 5
Due Tuesday, November 11

1. What is the money demand function in the classical model? How does the money demand function differ under the Cambridge approach? Why is this important?

2. Explain the speculative motive for holding money in Keynes liquidity preference theory and why, in aggregate it is negatively related to the interest rate.

3. Show the money demand curve graphically and explain why it slopes downward. Show how the money demand curve shifts when income increases. How does the money demand curve shift if there is an increase in the riskiness of financial assets?

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

Homework #4

Economics 470/570
Fall 2008
Homework #4
Due 10/30/2008

1. Suppose the Fed sells $1,000 worth of securities to the public. Assuming that the reserve requirement is 25%, use t-accounts to show the resulting multiple deposit contraction (carry the t-accounts out through three steps). Use the multiplier formula to calculate the total fall in bank deposits.

2. Derive the money multiplier when C ≠ 0 and ER ≠ 0. Explain why it is smaller than the simple money multiplier.

3. Show, using graphs, how (a) open market operations, (b) borrowing from the Fed, and (c) changes in reserve requirements affects the federal funds rate.

4. Show graphically how an increase in financial market risk impacts the federal funds rate, and how the Fed would respond in order to return the federal funds rate to its target value.

Homework #3

Homework #3
Due 10/16 (Thursday) at the end of class

1. (a) Describe the structure and function of the Board of Governors of the Federal Reserve System. (b) Who is on the FOMC? What does the FOMC do?

2. How has the power structure of the Fed changed over time?

3. 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.

Homework #2

Homework #2
Due 10/14 at the end of class
(same due date as homework #1)

1. You have been put in charge of selecting a new medium of exchange for the economy. Choose something to serve as money, and evaluate it in terms of the properties that a medium of exchange must satisfy in order to be useful.

2. What is meant by the term "fractionally backed currency"? How does fractionally backed currency come about?

3. Briefly, 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?

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

Homework #1

Economics 470/570
Fall 2008
Due: End of class on 10/14

Homework #1

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?

Homework 10

Economics 470/570
Winter 2005
Review Question Set for Week #10

Definitions

Menu costs

Short Answer

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

2. Derive the SRAS and LRAS curves for the New Keynesian model.

Essay

1. 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.

2. 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.

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. Why is the credibility of policymakers important?

 

Homework 9

Economics 470/570
Winter 2005
Review Question Set for Week #9

Definitions

Policy ineffectiveness proposition

Rational expectations

Natural rate hypothesis

Activist/non-activist

Data lag

Recognition lag

Legislative lag

Implementation lag

Effectiveness lag

Short Answer

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

2. How does the New Classical model differ from the traditional Keynesian model?

 

Essay

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? Are there substantial differences for monetary and fiscal policy?

2. Derive the short-run and long-run Phillip's curves from the fixed wage AD-AS model. Explain why the short-run Phillip’s curve shifts when inflationary expectations change.

3. Use the Phillip’s curve to explain why credibility of the monetary authority is important for fighting inflation.

4. Explain why only unexpected changes in policy can affect real output in the short-run and neither expected nor unexpected money can affect real output in the long-run in the New Classical model.

Homework 8

Economics 470/570
Winter 2005
Review Question Set for Week #8

Definitions

Liquidity trap

Monetary shock

SRAS

Full employment

Wealth effect

Real shock

LRAS

Inflationary and recessionary gaps

Short Answer

1. Use the IS-LM model to show that velocity is constant in the classical version of the model, but not in the Keynesian version.

2. 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.

3. Use the IS-LM model to derive the AD curve. Explain intuitively why the AD curve slopes downward.

4. Use IS-LM and AD diagrams to show how the AD curve shifts when there is a shift in either the IS or LM curve due to any factor except changes in price and income.

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

6. Explain why the SRAS curve (assuming fixed wages in the SR) slopes upward. Explain why the curve shifts when the fixed wage is reset.

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

Essay

1. Explain and show graphically using the IS-LM model that wage stickiness can impede the economy’s return to full employment.

2. 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.

3. 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?

4. 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.

5. In the classical version of the IS-LM model, show that (a) fiscal policy is ineffective, and (b) monetary policy is fully effective. In what sense is the result for monetary policy inconsistent with the classical view?

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. Show that the results (a) and (b) also hold in the Keynesian vertical IS version of IS-LM model.

7. Is the private sector inherently stable, i.e. does the economy self correct quickly when there are inflationary or recessionary gaps? Discuss using graphs where appropriate. Is there a role for stabilization policy?

Homework 7

Economics 470/570
Winter 2005
Review Question Set for Week #7

Definitions

IS curve

LM curve

Policy effectiveness

Crowding out

Short Answer

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

2. 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, explain why the LM curve is steeper when money demand is less sensitive to the interest rate.

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

4. Explain why the IS curve is steeper when the sensitivity of investment to the interest rate falls.

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

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

7. Is there any difference between using a tax cut to stimulate output rather than increasing government spending? Explain.

Essay

1. 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.

2. Show graphically and explain intuitively how the slope of the LM curve changes when the responsiveness of money demand to the interest rate (|L_R|) increases.

3. 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.

4. Show graphically and explain intuitively how the slope of the IS curve changes when the responsiveness of investment to the interest rate (|IR|) increases.

5. Consider points above or below the LM curve. Explain why there is excess demand or excess supply at each point and the forces that cause i to change so as to restore equilibrium. Next, consider points above or below the IS curve. Explain why there is excess demand or excess supply at each point and the forces that cause y to change so as to restore equilibrium. Use these results to explain why the IS-LM model is stable.

6. 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.

7. 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.

8. 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.

Homework 6

Economics 470/570
Winter 2005
Review Question Set for Week #6

Definitions

Consumption, disposable income, MPC and MPS

Investment

Government spending

Aggregate demand or expenditures

Autonomous expenditures

Expenditure multiplier

Transactions, precautionary, and speculative demand for money

Liquidity preference

Autonomous money demand

Short Answer

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

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

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

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

Essay

1. 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?

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

3. Explain intuitively and use a money demand – money supply diagram to show how the interest rate changes if (a) the nominal money supply increases, (b) the price level increases, (c) real income increases, and (d) an increase in autonomous money demand.

4. 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?

Homework 2 Update

Economics 470/570
Winter 2005
Review Question Set for Week #2

[ADDS PAGE NUMBERS FROM MISHKIN’S TEXT]

Definitions

FOMC [341]

FAC [345]

Discount window [359]

Discount rate [359]

Member bank [340]

Federal Funds rate [393]

Short Answer

1. What are the three types of financial intermediaries? What types of firms are in each category? [34-37]

2. Briefly describe the major functions of Federal Reserve district banks. [339]

3. Who is on the FOMC? What does the FOMC do? [341-344]

Essay

1. What are the reasons for regulating financial markets? Discuss the types of regulations that have been imposed on financial markets. [37-40]

2. Describe the structure of Federal Reserve districts and Federal Reserve banks. [336-340]

3. Describe the structure and function of the Board of Governors of the Federal Reserve System. [340-341]

4. How has the power structure of the Federal Reserve System shifted over time? [344-346]

5. 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 part of the question next class). [346-349, 352-354]

 

Homework 1 Update

Economics 470/570
Winter 2005
Review Question Set for Week #1

[ADDS PAGE NUMBERS FROM MISHKIN'S TEXT]

Definitions

Medium of exchange/Double coincidence of wants [45-47]

Unit of account/Multiplicity of prices [45-47]

Store of value/Liquidity [45-47]

Financial intermediary [29]

Direct and indirect finance [23-25]

Liquidity [47]

Short Answer

1. How is money measured? Why is there more than one definition of the money supply? [51-55]

2. How do bonds and equities differ? Which is more risky? [25-26]

3. How do bond and equity markets differ? How do primary and secondary markets differ? How do money and capital markets differ? [25-28]

4. Explain how secondary markets determine the price of new securities and why they make new securities easier to sell. How do over-the-counter markets and organized exchanges differ? [26-27]

5. List and briefly describe the various money market instruments.

http://wps.aw.com/wps/media/objects/744/761962/appendixes/ch02appendix.pdf

6. List and briefly describe the various capital market instruments.

http://wps.aw.com/wps/media/objects/744/761962/appendixes/ch02appendix.pdf

Essay

1. Why study of money? Why study banking? Why study financial markets? [3-13]

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? [45-48]

3. Describe the main function of financial markets. Explain how direct finance and indirect finance differ. Among households, government, business, and the foreign sector, who are the biggest borrowers/lenders? [29-32 plus class notes]

4. 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.

5. How do financial intermediaries reduce default risk, transactions costs, and matching costs? [29-32 plus class notes for both 4 and 5]

Homework 5

Economics 470/570
Winter 2005
Review Question Set for Week #5

Definitions

Monetary aggregate

Velocity of money

Output gap

Short Answer

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

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

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

4. What is meant be the phrase “money is a veil” in the classical model? What is the role of money in the classical model?

5. What is the difference between real and nominal money? Do changes in nominal money also change real money in the classical model? Explain.

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

7. 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?

Essay

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

2. 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?

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

4. 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?

5. What is the money demand function in the classical model? What factors determine velocity? How do these factors affect money demand?

Homework 4

Economics 470/570
Winter 2005
Review Question Set for Week #4

Definitions

Monetary Base

Borrowed and Non-borrowed reserves

Operating targets

Intermediate targets

Monetary Policy Goals

Defensive and Dynamic Open Market Operations

Primary, Secondary, and Seasonal Credit

Short Answer

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.

Essay

1. 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?

2. 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?

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 rise.

4. 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?

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