Questions and Problems

Check Your Understanding

1. Question

   Why is it important for the Federal Reserve Board to be independent of the executive branch of the federal government?

   Prob 24 1. Why is it important for the Federal Reserve Board to be independent of the executive branch of the federal government?

2. Question

   When the interest rate falls, why do people desire higher money balances?

   Prob 24 2. When the interest rate falls, why do people desire higher money balances?

3. Question

   Describe how open market operations alter the supply of money.

   Prob 24 3. Describe how open market operations alter the supply of money.

4. Question

   What does the equation of exchange, M × V = P × Q, help to explain?

   Prob 24 4. What does the equation of exchange, M × V = P × Q, help to explain?

5. Question

   How is the impact of expansionary monetary policy different when the economy is considerably below full employment than when it is at full employment?

   Prob 24 5. How is the impact of expansionary monetary policy different when the economy is considerably below full employment than when it is at full employment?

6. Question

   How do sticky wages and prices make monetary policy effective in the short run?

   Prob 24 6. How do sticky wages and prices make monetary policy effective in the short run?

Apply the Concepts

7. Question

   Suppose a rise in consumer confidence causes aggregate demand to increase, resulting in a short-run equilibrium that is above full employment output. What type of monetary policy might the Fed use to reduce inflationary pressures and to bring the economy back to full employment?

   Prob 24 7. Suppose a rise in consumer confidence causes aggregate demand to increase, resulting in a short-run equilibrium that is above full employment output. What type of monetary policy might the Fed use to reduce inflationary pressures and to bring the economy back to full employment?

8. Question

   It seems that each time the Fed raises interest rates, the stock market has an awful few days. Why do higher interest rates have such an impact on the stock market?

   Prob 24 8. It seems that each time the Fed raises interest rates, the stock market has an awful few days. Why do higher interest rates have such an impact on the stock market?

9. Question

   If the Fed persistently pursues an easy money policy, what is the likely outcome?

   Prob 24 9. If the Fed persistently pursues an easy money policy, what is the likely outcome?

10. Question

    When NASA scientists were operating the Mars rovers to get them to drive across the Martian landscape and collect and analyze rocks and crevices, the scientists complained that the 20-minute delay between when they issued a command and when the rovers responded made their job more challenging. Isn’t this somewhat similar to what monetary policymakers face? How is it different?

    Prob 24 10. When NASA scientists were operating the Mars rovers to get them to drive across the Martian landscape and collect and analyze rocks and crevices, the scientists complained that the 20-minute delay between when they issued a command and when the rovers responded made their job more challenging. Isn’t this somewhat similar to what monetary policymakers face? How is it different?

11. Question

    Suppose another spike in energy prices causes a negative supply shock to occur. What type of monetary policy should the Fed use if the goal is to maintain price stability in the economy? What are the consequences of doing so?

    Prob 24 11. Suppose another spike in energy prices causes a negative supply shock to occur. What type of monetary policy should the Fed use if the goal is to maintain price stability in the economy? What are the consequences of doing so?

12. Question

    Explain how the housing bubble at the beginning of the 21st century led to the Taylor rule target exceeding the actual federal funds rate. Could increasing the federal funds rate during this time have helped to reduce the severity of the last recession?

    Prob 24 12. Explain how the housing bubble at the beginning of the 21st century led to the Taylor rule target exceeding the actual federal funds rate. Could increasing the federal funds rate during this time have helped to reduce the severity of the last recession?

In the News

13. Question

    There are two forces that cause the economy to grow. One is real, the other is an illusion. The real force—entrepreneurial innovation and creativity—comes naturally as long as government policies do not drive it away. The artificial force is easy money. An increased supply of money, by creating an illusion of wealth, can increase spending in the short run, but this eventually turns into inflation. Printing money cannot possibly create wealth; if it could, counterfeiting would be legal.3
    Does this quote illustrate the short-run versus the long-run aspects of monetary policy? Why or why not?

    Prob 24 13. There are two forces that cause the economy to grow. One is real, the other is an illusion. The real force—entrepreneurial innovation and creativity—comes naturally as long as government policies do not drive it away. The artificial force is easy money. An increased supply of money, by creating an illusion of wealth, can increase spending in the short run, but this eventually turns into inflation. Printing money cannot possibly create wealth; if it could, counterfeiting would be legal.3 Does this quote illustrate the short-run versus the long-run aspects of monetary policy? Why or why not?

14. Question

    The Economist commented on the Greek debt crisis in an aptly titled article on February 11, 2012, “Brinkmanship in Athens,” as Greece led the European economy to the edge as a battle brewed between Greek political leaders attempting to satisfy its citizens’ demands and the European Central Bank, which held the much needed rescue funds but demanded major fiscal reforms in return. Using an AD/AS model, explain how a major monetary stimulus from the European Central Bank would affect Greece’s economy. Next, explain what the required austerity measures (i.e., budget cuts) might do to the economy. Do these measures conflict with each other? Explain.

    Prob 24 14. The Economist commented on the Greek debt crisis in an aptly titled article on February 11, 2012, “Brinkmanship in Athens,” as Greece led the European economy to the edge as a battle brewed between Greek political leaders attempting to satisfy its citizens’ demands and the European Central Bank, which held the much needed rescue funds but demanded major fiscal reforms in return. Using an AD/AS model, explain how a major monetary stimulus from the European Central Bank would affect Greece’s economy. Next, explain what the required austerity measures (i.e., budget cuts) might do to the economy. Do these measures conflict with each other? Explain.

Solving Problems

15. Question

    Why are supply shocks so much harder than demand shocks for monetary policy to adjust to? Use the grid below to show your answer to this question.
    

    
    
    
    

    Prob 24 15. Why are supply shocks so much harder than demand shocks for monetary policy to adjust to? Use the grid below to show your answer to this question.

16. Question

    In 2012, the U.S. inflation rate was 2.1% and output was 4.8% below its long-run potential output due to the slow recovery of the economy. Assuming that the inflation target is 2%, what would be the federal funds target rate if the FOMC used the Taylor rule? How does this compare to the actual federal funds rate of 0.1%?

    Prob 24 16. In 2012, the U.S. inflation rate was 2.1% and output was 4.8% below its long-run potential output due to the slow recovery of the economy. Assuming that the inflation target is 2%, what would be the federal funds target rate if the FOMC used the Taylor rule? How does this compare to the actual federal funds rate of 0.1%?

17. Question

    According to By the Numbers, what were the approximate interest rates for the following types of loans in September 2013: federal funds rate, discount rate, prime rate, 30-year mortgage rate? Why aren’t these interest rates all the same?

    Prob 24 17. According to By the Numbers, what were the approximate interest rates for the following types of loans in September 2013: federal funds rate, discount rate, prime rate, 30-year mortgage rate? Why aren’t these interest rates all the same?

18. Question

    According to By the Numbers, in what region outside of the United States is the largest percentage of U.S. $100 bills in circulation held? Why is the answer not China, which holds the most U.S. debt?

    Prob 24 18. According to By the Numbers, in what region outside of the United States is the largest percentage of U.S. $100 bills in circulation held? Why is the answer not China, which holds the most U.S. debt?