Partial Credit, End of Chapter 4.11

partial credit, End of Chapter 4.
11
Using the Taylor rule, calculate the target for the federal funds rate for July 2010 using the following information:
Equilibrium real federal funds rate 2
%
Target inflation rate 2%
Current inflation rate 0.9
%
Output gap minus
8
%
The target for the federal funds rate for July 2010 is
negative 1.65
%.
(Enter
your response rounded to two decimal places and include a minus sign if
necessary.)
In your calculations, the inflation gap is negative if the current inflation rate is below the target inflation rate. How
does the targeted federal funds rate calculated using the Taylor rule compare to the actual federal funds rate of 0% to
0.25%?
A.
This Taylor rule federal funds rate target
is higher than
the Fed's actual target range.
B.
is lower than
Your answer is correct.
C.
fits within
In a column in the Wall Street

Journal,
two economists at the Council on Foreign Relations argue:
"Simply put, the Fed must choose between managing the level of reserves and managing rates. It cannot do both."
Source: Benn Steil and Paul Swartz, "Bye-Bye to the Fed-Funds Rate," Wall Street
Journal,
August 19, 2010.
Do you agree?
A.
Agree. In the federal funds market, the federal funds rate is the "price" and reserves are the "quantity". Only one of
these variables can be controlled at any one time.
B.
Disagree. The Fed can simultaneously manage more than one variable since it possesses more than one policy tool.
John Taylor has argued that: "Considerable empirical work supports the view that interest rates were too low for too
long in 2003-2005 and were a major factor in the housing boom and bust that resulted."
Source: John Taylor, First Principles: Five Keys to Restoring America's Prosperity, New York: W.W. Norton &
Company, 2012, p. 133.
When comparing the actual target federal funds rate and the federal funds rate suggeted by the Taylor rule during the
2003-2005 period, the Taylor rule federal funds rate
was greater than
the actual target federal funds rate, thus indicating that interest rates
were too low
during the 2003-2005 period.
The interest rates during the
2003dash
2005
period may have contributed to the housing boom and bust by:
(Select
all that
apply)
A.
allowing Fannie Mae and Freddie Mac to bundle large amount of loans into mortgage-backed securites.
B.
keeping the demand for mortgage loans above the equilibrium level causing the prices to become inflated.
C.
creating a situation where financial institutions made too many loans because of the high demand for mortgages.
D.
setting interest rates at a level that caused the public to save a higher percentage of their income in mortgage loans.
[Related to the Chapter

Opener]
In a letter to a member of Congress, Fed Chairman Ben Bernanke made the following statement. The monetary
accommodation provided by the Federal Reserve has substantially helped the U.S. economy by easing financial
conditions. ... The easing in financial conditions has promoted economic activity through a variety of channels,
including reducing the cost of capital, boosting the aggregate wealth of U.S. households, and improving the
competitiveness of U.S. businesses in the global marketplace.
Source: Letter from Ben S. Bernanke to Representative Darrell E. Issa, August 22, 2012.
When Bernanke uses the terminology
monetary accommodation
,
he is referring to the Fed's use of monetary policy to ease the money supply and financial interest rates.
When Bernanke uses the terminology
easing financial conditions
,
he is referring to the loans and stability being created from monetary policy movements.
Which of the following is NOT a way in which easing financial conditions promotes economic activity?
A.
As the money supply increases and interest rates decrease, U.S. businesses expand operations because of lower
investment costs and that makes them more competitive globally.
B.
As interest rates fall and the money supply increases, households are encouraged to save more, leading to larger
investment portfolios and wealth.
C.
The reduction in interest rates causes the cost of borrowing funds to decrease. This reduces the cost of capital and
encourages additional investment expenditures from firms.
D.
The stimulation of the economy from monetary accommodation raises the amount of employment and income for
households leading to increases in overall wealth.
What advantages do open market operations have over other policy tools?
(Check
all that
apply.)
A.
They are inexpensive.
B.
Open market operations are easy to implement.
C.
They are under the complete control of the Fed.
D.
They are flexibiible.
What is the aim of monetary policy?

Monetary policy aims to
A.
keep the level of inflation at zero.
B.
advance the economic well-being of the country's citizens.
C.
encourage a financial crisis.
D.
determine the correct allocation of social benefits among citizens.
What is meant by economic well-being?
Economic well-being is typically determined by the
A.
institutional framework that defines the deliberate incentive structure of a society.
B.
stock of human knowledge particularly as applied to the human command over nature.
C.
quantity and quality of goods and services that individuals can enjoy.
D.
cost of goods and services that individuals can enjoy.
Describe the role of targeting in the monetary policies of the

Bank of England
.
A.
The Bank
has not adopted a formal inflation target comma but does emphasize price stability
.
B.
The Bank
uses inflation targeting
.
This is the correct answer.
C.
The Bank
uses inflation targeting and focuses on the exchange value of the national currency
.
Your answer is not correct.
D.
The Bank
has an inflation target and attaches a significant role to the monetary aggregate Upper M 3
What trade-offs does the Fed face, particularly in the short run, in attempting to reach its goals?
A.
In attempting to reach high economic growth, the Fed would pursue contractionary monetary policy, but this policy
could cause higher unemployment.
B.
In attempting to reach high economic growth or high employment, the Fed would pursue expansionary monetary
policy, but this policy could cause higher inflation.
C.
In attempting to reach high employment, the Fed would pursue expansionary monetary policy, but this policy could
cause lower economic growth.
D.
In attempting to reach high economic growth, the Fed would pursue expansionary monetary policy, but this policy
could cause higher unemployment.
partial credit, End of Chapter 2.1
What are the Fed's traditional monetary policy tools?

(Check
all that
apply.)
A.
Reserve requirements.
B.
Interest on reserve balances.
C.
Open market operations.
D.
Discount policy.
E.
Term deposit facility.
What
do reserve requirements
imply?
A.
Regulation requiring banks to hold a fraction of checkable deposits as vault cash or deposits with the Fed
.
This is the correct answer.
B.
Paying interest on banks' required reserve and excess reserve deposits.
C.
Setting the discount rate and the terms of discount lending
.
D.
The purchase or sale of securities comma typically U.S. Treasury securities comma in financial markets
.
Which of the Fed's traditional monetary policy tools is the most important?
A.
Reserve requirements.
B.
Discount policy.
C.
Open market operations.
D.
They are equally important.
If you owned a firm that did business internationally, why would excess fluctuations in the foreign exchange value
of the dollar make planning for business and financial transactions more difficult?
(Check
all that
apply.)
A.
They make it difficult to know the cost of domestic intermediate goods.
B.
They make it difficult to know the cost of imported intermediate goods.
C.
They make it difficult to know the dollar value of foreign assets.
D.
They make it difficult to know the cost of your products abroad.
Explain the effect on the demand for reserves or the supply of reserves of the following Fed policy action:
Upper A decrease in the required reserve ratio
.
A.
This would
increase the supply of reserves
.
B.
This would
lower the interest rate at which the demand curve becomes horizontal
.
C.
This would
raise the interest rate at which the demand curve becomes horizontal
.
D.
This would
decrease the demand for reserves
.
correct, End of Chapter 1.6
A columnist in the Wall Street Journal has argued in favor of changing the Fed's dual mandate to a single mandate
of price stability: "When an economy gets weak enough, extraordinary easing measures can be justified as the
necessary battle against potentially highly damaging deflation rather than to reduce unemployment."
Source: Neal Lipschutz, "Should Fed Chairman Have a Single Term, Single Mandate?" Wall Street
Journal,
September 27, 2012.
Deflation would be "potentially highly damaging" because of all of the following EXCEPT?
A.
It would further reduce demand and output below the natural rate and could have extreme recessionary impacts.
B.
It would increase the cost of labor for firms in real terms, making it more costly for firms to produce.
C.
It would raise the costs of paying back loans, making it more difficult for debtors to spend.
D.
It would make prices fall, so goods would become less expensive.
The term "extraordinary easing measures" refers to
A.
the Fed using general open market operations to increase reserves.
B.
the Fed selling government securitites to banks and financial institutions.
C.
the Fed using all possible methods to engage in quantative easing.
D.
All of the above.
"Extraordinary easing measures" would end deflation by greatly
increasing
aggregate demand and thus pushing prices
upward
.
Which of the following is NOT a supportive argument that the Fed's dual mandate should be replaced with a single
mandate of price stability?
A.
Having a dual-mandate can lead to problematic policies and central bank created bubbles as the unemployment goal
often is counter to the price stability goal.
B.
Monetary policy has been shown to be effective at affecting inflation in both the short-run and the long-run, while
estimation on the effectiveness monetary policy impacts on employment and output have been mixed.
C.
Countries in which the central bank has one primary goal of price stability have been shown to have lower and more
consistently stable inflation than countries that do not have the one goal of price stability.
D.
Monetary policy can sometimes be used to stimulate the economy quickly in times of large decreases in demand
which can reduce unemployment in the economy.
The following appeared in a feature in the New York Times that provides an overview of the Federal Reserve
System:
"The federal funds rate is set by the Fed's Open Market Committee, composed of the chairman, the six other
governors, and five of the 12 regional bank presidents, on a rotating basis."
Source: "Federal Reserve System," New York
Times,
August 27, 2010.
Do you agree that the federal funds rate is set by the FOMC?
A.
Disagree. The federal funds rate is actually determined by the demand for and supply of reserves. The FOMC only
sets a target for the federal funds rate.
B.
Agree. The FOMC first announces a target for the federal funds rate, then sets the rate at its target.
Achieving the goal of price stability with low and steady inflation allows the Fed to achieve other goals, such as
stable interest rates and stable foreign exchange rates. If the Fed fails to achieve low and steady inflation, why will it
be hard to achieve stable interest rates?
A.
Because low inflation leads to tremendous increases of nominal interest rates.
B.
Because the real interest rate includes an inflation premium.
C.
Because high inflation leads to tremendous decreases of nominal interest rates.
D.
Because the nominal interest rate includes an inflation premium.

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partial credit, End of Chapter 4.

In a column in the Wall Street

[Related to the Chapter

What is the aim of monetary policy?

Describe the role of targeting in the monetary policies of the

partial credit, End of Chapter 2.1

What are the Fed's traditional monetary policy tools?

correct, End of Chapter 3.9

correct, End of Chapter 1.8

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