Chapter 10, Monetary Policy and the Economy Video Solutions, Microeconomics

Problem 1

Using Figures 10-5 through 10-7, work through each of the following:
a. As in 2007-2008, the Federal Reserve is concerned about a decline in housing prices that is reducing investment. What steps might the Fed take to stimulate the economy? What will be the impact on bank reserves? What will be the impact on interest rates? What will be the impact on investment (other things held constant)?
b. As in 1979, the Fed is concerned about rising inflation and wishes to reduce output. Answer the same questions as in a.

Majid Borumand

Numerade Educator

04:37

Problem 2

Suppose you are the chair of the Fed's Board of Governors at a time when the economy is heading into a recession and you are called to testify before a congressional committee. Write your explanation to an interrogating senator outlining what monetary steps you would take to prevent the recession.

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Numerade Educator

02:34

Problem 3

Consider the balance sheet of the Fed in Table 10-1. Construct a corresponding balance sheet for banks (like the one in Table 9-3 in the previous chapter)
assuming that reserve requirements are 10 percent on checking accounts and zero on everything else.
a. Construct a new set of balance sheets, assuming that the Fed sells $$\$ 1$$ billion worth of government securities through open-market operations.
b. Construct another set of balance sheets, assuming that the Fed increases reserve requirements from 10 to 20 percent.
c. Assume that banks borrow $$\$ 1$$ billion worth of reserves from the Fed. How will this action change the balance sheets?

Majid Borumand

Numerade Educator

02:34

Problem 4

Assume that commercial banks have $$\$ 100$$ billion of checking deposits and $$\$ 4$$ billion of vault cash. Further assume that reserve requirements are 10 percent of checking deposits. Lastly, assume that the public holds $$\$ 200$$billion of currency, which is always fixed. Centralbank assets include only government securities.
a. Construct the balance sheets for the central bank and the banking system. Make sure you include banks' deposits with the central bank.
b. Now assume that the central bank decides to engage in an open-market operation, selling $$\$ 1$$ billion worth of government securities to the public. Show the new balance sheets. What has happened to $M_1$ ?
c. Finally, using the graphical apparatus of the monetary transmission mechanism, show the qualitative impact of the policy on interest rates, investment, andou tput.

Majid Borumand

Numerade Educator

03:21

Problem 5

In his memoirs, Alan Greenspan wrote, "I regret to say that Federal Reserve independence is not set in stone. FOMC discretion is granted by statute and can be withdrawn by statute." (The Age of Turbulence, p. $478 \mathrm{f}$.) Explain why the independence of a central bank might affect the way in which monetary policy is conducted. If a central bank is not independent, how might its monetary policies change in response to electoral pressures? Would you recommend that a new country have an independent central bank? Explain.

Majid Borumand

Numerade Educator

Problem 6

One of the nightmares of central bankers is the liquidity trap. This occurs when nominal interest rates approach or even equal zero. Once the interest rate has declined to zero, monetary expansion is ineffective because interest rates on securities cannot go below zero.
a. Explain why the nominal interest rate on government bonds cannot be negative.
b. A liquidity trap is particularly serious when a country simultaneously experiences falling prices, also called deflation. For example, in the early 2000 s, consumer prices in Japan were falling at 2 percent
per year. What were Japanese real interest rates during this period if the nominal interest rate was 0 ? What was the lowest real interest rate that the Bank of Japan could have produced during this period?
c. Explain on the basis of $\mathbf{b}$ why the liquidity trap poses such a serious problem for monetary policy during periods of deflation and depression.

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Problem 7

After the reunification of Germany in 1990, payments to rebuild the East led to a major expansion of aggregate demand in Germany. The German central bank responded by slowing money growth and raising German real interest rates. Trace through why this German monetary tightening would be expected to lead to a depreciation of the dollar. Explain why such a depreciation would stimulate economic activity in the United States. Also explain why European countries that had pegged their currencies to the German mark would find themselves plunged into recessions as German interest rates rose and pulled other European rates up with them.

Md.Daniyal Arshad

Numerade Educator

03:10

Problem 8

In December 2007, the Federal Open Market Committee made the following statement: "The Federal Open Market Committee seeks monetary and financial conditions that will foster price stability and promote sustainable growth in output. To further its long-run objectives, the Committee [will reduce] the federal funds rate [from $4 \frac{1}{2}$ percent to] $4 \frac{1}{4}$ percent." Your assignment is to explain the macroeconomic rationale behind this monetary expansion. It will help to review the minutes of the FOMC meeting at www.federalreserve. gov/monetarypolicy/files/fomcminutes20071211.pdf.

Majid Borumand

Numerade Educator