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Chapter 16: Monetary Policy (page 321)
Define Monetary Policy?
Interest Rates changes
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Explain the links between changes in the nation's money supply, the interest rate, investment spending, aggregate demand, real GDP, and the price level.
Refer to the table for Moola below to answer the following questions. What is the equilibrium interest rate in Moola? What is the level of investment at the equilibrium interest rate? Is there either a recessionary output gap (negative GDP gap) or an inflationary output gap (positive GDP gap) at the equilibrium interest rate, and, if either, what is the amount? Given money demand, by how much would the Moola central bank need to change the money supply to close the output gap? What is the expenditure multiplier in Moola?
Money Supply (\() | Money Demand (\)) | Interest Rate (%) | Investment at Interest Rate Shown (\() | Potential Real GDP (\)) | Actual Real GDP at Interest (Rate Shown) ($) |
500 500 500 500 500 | 800 700 600 500 400 | 2 3 4 5 6 | 50 40 30 20 10 | 350 350 350 350 350 | 390 370 350 330 310 |
Does the Taylor Rule put a higher weight on resolving the unemployment gap or the inflation gap? Explain.
What is the basic objective of monetary policy? What are the major strengths of monetary policy? Why is monetary policy easier to conduct than fiscal policy?
In the tables that follow, you will find consolidated balance sheets for the commercial banking system and the 12 Federal Reserve Banks. Use columns 1 through 3 to indicate how the balance sheets will read after each transaction a to c is completed. Do not cumulate your answers; that is, analyze each transaction separately, starting in each case from the numbers provided. All accounts are in billions of dollars.
\( | Consolidated Balance Sheet: All commercial banks | |||
1 | 2 | 3 | ||
Assets Reserve Securities Loans | 33 60 60 150 3 | |||
Liabilities and net worth: Checkable deposits Loans from federal reserve banks |
\) | Consolidated Balance Sheet: The 12 Federal Reserve Banks | |||
1 | 2 | 3 | ||
Assets Securities Loans to commercial banks | 60 03 33 | |||
Liabilities and net worth: Reserves of commercial bank | ||||
Treasury deposits Federal reserve notes | 3 27 |
a. A decline in the discount rate prompts commercial banks to borrow an additional \(1 billion from the Federal Reserve Banks. Show the new balance-sheet numbers in column 1 of each table.
b. The Federal Reserve Banks sell \)3 billion in securities to members of the public, who pay for the bonds with checks. Show the new balance-sheet numbers in column 2 of each table.
c. The Federal Reserve Banks buy $2 billion of securities from commercial banks. Show the new balance-sheet numbers in column 3 of each table.
d. Now review each of the previous three transactions, asking yourself these three questions: (1) What change, if any, took place in the money supply as a direct and immediate result of each transaction? (2) What increase or decrease in the commercial banks' reserves took place in each transaction? (3) Assuming a reserve ratio of 20 percent, what change in the money-creating potential of the commercial banking system occurred as a result of each transaction?
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