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Chapter 16: Q10. (page 347)
True or False: In the United States, monetary policy has two key advantages over fiscal policy: (1) isolation from political pressure and (2) speed and flexibility.
The given statement is true.
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Use commercial bank and Federal Reserve Bank balance sheets to demonstrate the effect of each of the following transactions on commercial bank reserves:
a. Federal Reserve Banks purchase securities from banks.
b. Commercial banks borrow from Federal Reserve Banks at the discount rate.
c. The Fed reduces the reserve ratio.
d. Commercial banks increase their reserves after the Fed increases the interest rate that it pays on reserves.
In 1980, the U.S. inflation rate was 13.5 percent, and the unemployment rate reached 7.8 percent. Suppose that the target rate of inflation was 3 percent back then and the full employment rate of unemployment was 6 percent at that time. What value does the Taylor Rule predict for the Fed鈥檚 target interest rate? Would you be surprised to learn that the Fed鈥檚 targeted interest rate (the federal funds rate) reached 18.9 percent in December 1980?
Refer to Table 16.2 and assume that the Fed鈥檚 reserve ratio is 10 percent and the economy is in a severe recession. Also, suppose that the commercial banks are hoarding all excess reserves (not lending them out) because they fear loan defaults. Finally, suppose that the Fed is highly concerned that the banks will suddenly lend out these excess reserves and possibly contribute to inflation once the economy begins to recover and confidence returns. By how many percentage points does the Fed need to increase the reserve ratio to eliminate one-third of the excess reserves? What is the size of the monetary multiplier before and after the change in the reserve ratio? By how much would banks鈥� lending potential decline as a result of the increase in the reserve ratio?
(1) Reserve Ratio, % | (2) Checkable Deposits, \( | (3) Actual Reserves, \) | (4) Required Reserves, \( | (5) Excess Reserve, \) (3-4) | (6) Money-Creating Potential of Single Bank, \(=5 | (7) Money-Creating Potential of Banking System, \) |
10 20 25 30 | 20,000 20,000 20,000 20,000 | 5,000 5,000 5,000 5,000 | 2,000 4,000 5,000 6,000 | 3,000 1,000 0 -1,000 | 3,000 1,000 0 -1,000 | 30,000 5,000 0 -3,333 |
Explain the links between changes in the nation's money supply, the interest rate, investment spending, aggregate demand, real GDP, and the price level.
Suppose that actual inflation is 3 percentage points, the Fed鈥檚 inflation target is 2 percentage points, and unemployment is 1 percent below the Fed鈥檚 unemployment target. According to the Taylor rule, what value will the Fed want to set for its targeted interest rate?
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