Critical Thinking Questions

9 . Why might the velocity of money change unexpectedly? 10 . Explain how to use the IORB to lower interest rates. 11 . Explain how to use the IORB to raise interest rates.

Review Questions

12 . How is a central bank different from a typical commercial bank? 13 . List the three traditional tools that a central bank has for controlling the money supply. 14 . How is bank regulation linked to the conduct of monetary policy? 15 . What is a bank run? 16 . In a program of deposit insurance as it is operated in the United States, what is being insured and who pays the insurance premiums? 17 . In government programs of bank supervision, what is being supervised? 18 . What is the lender of last resort? 19 . Name and briefly describe the responsibilities of each of the following agencies: FDIC, NCUA, and OCC. 20 . Explain how to use an open market operation to expand the money supply. 21 . Explain how to use the reserve requirement to expand the money supply. 22 . Explain how to use the discount rate to expand the money supply. 23 . How do the expansionary and contractionary monetary policy affect the quantity of money? 24 . How do tight and loose monetary policy affect interest rates? 25 . How do expansionary, tight, contractionary, and loose monetary policy affect aggregate demand? 26 . Which kind of monetary policy would you expect in response to high inflation: expansionary or contractionary? Why? 27 . Explain how to use quantitative easing to stimulate aggregate demand. 28 . Which kind of monetary policy would you expect in response to recession: expansionary or contractionary? Why? 29 . How might each of the following factors complicate the implementation of monetary policy: long and variable lags, excess reserves, and movements in velocity? 30 . Define the velocity of the money supply. 31 . What is the basic quantity equation of money? 32 . How does a monetary policy of inflation target work?

Critical Thinking Questions

33 . Why do presidents typically reappoint Chairs of the Federal Reserve Board even when they were originally appointed by a president of a different political party? 34 . In what ways might monetary policy be superior to fiscal policy? In what ways might it be inferior? 35 . The term “moral hazard” describes increases in risky behavior resulting from efforts to make that behavior safer. How does the concept of moral hazard apply to deposit insurance and other bank regulations? 36 . Explain what would happen if banks were notified they had to increase their required reserves by one percentage point from, say, 9% to10% of deposits. What would their options be to come up with the cash? 37 . A well-known economic model called the Phillips Curve (discussed in The Keynesian Perspective chapter) describes the short run tradeoff typically observed between inflation and unemployment. Based on the discussion of expansionary and contractionary monetary policy, explain why one of these variables usually falls when the other rises. 38 . How does rule-based monetary policy differ from discretionary monetary policy (that is, monetary policy not based on a rule)? What are some of the arguments for each? 39 . Is it preferable for central banks to primarily target inflation or unemployment? Why? 40 . If for some reason the IORB increased and momentarily stayed above the FFR, why would the FFR ultimately increase as well? Explain this process in detail.

Problems

41 . Suppose the Fed conducts an open market purchase by buying $10 million in Treasury bonds from Acme Bank. Sketch out the balance sheet changes that will occur as Acme converts the bond sale proceeds to new loans. The initial Acme bank balance sheet contains the following information: Assets – reserves 30, bonds 50, and loans 50; Liabilities – deposits 100 and equity 30. 42 . Suppose the Fed conducts an open market sale by selling $10 million in Treasury bonds to Acme Bank. Sketch out the balance sheet changes that will occur as Acme restores its required reserves (10% of deposits) by reducing its loans. The initial balance sheet for Acme Bank contains the following information: Assets – reserves 30, bonds 50, and loans 250; Liabilities – deposits 300 and equity 30. 43 . All other things being equal, by how much will nominal GDP expand if the central bank increases the money supply by $100 billion, and the velocity of money is 3? (Use this information as necessary to answer the following 4 questions.) 44 . Suppose now that economists expect the velocity of money to increase by 50% as a result of the monetary stimulus. What will be the total increase in nominal GDP? 45 . If GDP is 1,500 and the money supply is 400, what is velocity? 46 . If GDP now rises to 1,600, but the money supply does not change, how has velocity changed? 47 . If GDP now falls back to 1,500 and the money supply falls to 350, what is velocity?