Main Tools
What are the 3 main tools the federal government uses?
1. Open Market Operations
2. Discount Rate
3. Reserve Requirement
This type of monetary policy increases the money supply and is typically used during a recession to stimulate economic growth.
What is expansionary monetary policy?
In the Loanable Funds market, an increase in the expected rate of return on new capital investment will cause which shift, and how does it effect the quantity of loans?
Demand shifts right + quantity increases
If the Federal Reserve purchases $10 million in bonds from the commercial banking system and the reserve requirement is 20%, what is the maximum possible increase in the total Money Supply?
$50 million
What are the effects of a higher discount tate on the following: borrowing and money supply
Increased borrowing and an increase in the money supply
When the Federal Reserve System buys government bonds through open market operations, this happens to the money supply.
What is it increases the money supply?
On a Money Market graph, the Money Supply curve is typically drawn as a vertical line, what does this represent regarding the central bank's relationship with interest rates?
It indicates that the Money Supply is independent of the interest rate and is fixed by the central bank.
According to the Quantity Theory of Money, if the velocity of money and real output are constant, a 5% increase in the money supply will lead to what percentage change in the price level?
MV = PY
5% increase
If lending and the money supply both increased, then what happened to the reserve requirement? (hint: 1/RR)
The reserve requirement decreased
If the Federal Reserve System raises the discount rate, this is the likely effect on bank borrowing and the money supply.
What is borrowing decreases and the money supply decreases?
Explain "Crowding Out", using the Loanable Funds graph.
Government borrowing shifts supply to the left -> raising interest rates -> reducing quantity of private investment
The central bank decreases the required reserve ration from 20% to 10%. By how much does the Money Multiplier change (+/-)?
The multiplier increases by 5
Based on the money market graph, an open market sale by the Federal Reserve would cause which shift, and what happens to the nominal interest rate?
Money supply shifts left; nominal interest rate increases.
If the Federal Reserve System lowers the reserve requirement, explain the effect on banks’ lending ability and the overall money supply.
What is banks can lend more money, increasing the money supply?
Inflation is rising above the target rate. The central bank increases the required reserve ratio. Graph the impact on the Ample Reserve Market. Is this a contractionary or an expansionary move?
Demand for reserves increases. Contractionary.
If a commercial bank charges a nominal interest rate of 8% on a loan and the inflation rate is 3%, what is the real interest rate the bank earns?
5%
Step up and sketch the money market: show how an open market purchase by the Federal Reserve changes equilibrium, clearly labeling the shift and the new nominal interest rate.
Money supply shifts right; nominal interest rate decreases.
To fight inflation, the Federal Reserve System uses all three major tools—open market operations, the discount rate, and reserve requirements. Identify the combination of actions that would correctly implement contractionary monetary policy.
What is selling bonds, raising the discount rate, and increasing the reserve requirement?
To combat high inflation, the central bank increases the Discount Rate and sells bonds via Open Market Operations. Draw two graphs side-by-side: the reserve market and the money market.
Reserves market: Supply shifts left, discount rate increases
Money market: MS shifts left
If the Money Supply grows by 10%, velocity is constant, and the price level increases by 4%, what is the approximate change in real GDP?
%M + %V = %P + %Y
6%