Monetary Policy Worksheet

You are the Fed Chairman. For each of the situations listed below, decide if you would use Easy-Money policy, Tight-
Money policy, moral persuasion, or do nothing. 

1. If you use Expansionary Monetary Policy (Easy) you are trying to grow the economy and create more jobs
by increasing the money supply.  In reality the FED would do this by lowering the reserve requirement, buying
government bonds and securities through open market operations, and/or lowering the discount rate
2. If you use Contractionary Monetary Policy (Tight) you are trying to slow the economy down in order to
fight inflation or prevent the economy from over heating and collapsing.  The FED would do this by reducing
the money supply.  Money can be sucked out of the economy by raising the reserve requirement, selling
government bonds and securities through open market operations, and/or raising the discount rate.
3. Moral persuasion can be used by the Federal Reserve Chairman when he reports to the American people on
the state of the banking system and encourage people and banks to either save more or spend less. 
4. Doing nothing = the economy is perfect so we will do nothing.

1.  Stock prices have declined for the last two weeks.   

2.  GDP dipped from 3 percent to 1 percent in the last year. 

3.  The CPI and PPI have risen 3 percent in the last six months. 

4.  Commercial interest rates are rising, but the FED has not raised rates. 

5.  The prices of cars have tripled in the last year. 

6.  GDP is growing steadily, and prices are rising sharply. 

7.  The United States is experiencing both high inflation and high unemployment.

8.  The CPI is up, and housing starts are at a fifteen-year high. 

9.  We are in a recession.  Factory orders are down, and the economy appears to be slumping. 

10.  Consumers feel worried, inflation is low and spending is sluggish. 

11.  Unemployment is low and prices are rising steadily. 

12.  The index of leading economic indicators shows a strong move towards inflation. 

13.  The FED senses that people are not saving money. 

14.  Jobless rates are pushing 11 percent while the CPI has fallen from 8 percent to 2 percent growth. 

15.  We are in a recession but are experiencing high inflation. 

16.  The money supply appears to be tight, and prices are on the rise. 

17.  Prices are stable, and the GDP is growing at a 3 percent pace. 
 Key - Monetary Policy Worksheet
1. Stock prices have declined for the last two weeks.
Do nothing - the stock market is not one of the major economic indicators

2. GDP dipped from 3 percent to 1 percent in the last year.

Expansionary Monetary Policy - this means the economy is slowing down and needs a shot in the arm to keep it going.)

3. The CPI and PPI have risen 3 percent in the last six months. 
Contractionary Monetary Policy - remember that CPI and PPI are price indexes that are designed to measure inflation.  If
they are going up it means that inflation is increasing.  In one years time prices might rise 6% at this rate if people continue
to spend as much money as they are now.  You must suck money out of the economy in the hopes that prices will come
down as people buy less.  Tight-Money Policy should result in increasing the amount of interest people must pay when they
borrow money.  If you have to pay more to borrow money then you have less money to spend.  If people spend less then
prices should decrease over time and the CPI and PPI should drop)

4. Commercial interest rates are rising, but the FED has not raised rates. 
Expansionary Monetary Policy - The banks are afraid to loan out money and as a result interest rates are going up.  The FED
can combat this problem by allowing the banks to borrow money from the Federal Reserve at cheaper rates or lowering the
reserve requirement which will allow them to loan out a greater percentage of their reserve cash.  After the FED takes this
action the interest rates banks charge their customers pay for all types of loans and credit cards should be reduced.

5. The prices of cars have tripled in the last year. 

Do nothing.  Remember, we only look at the major economic indicators.  If the price of cars has tripled as a result of
inflation through out the economy it will show up as an increase in the Consumer Price Index CPI or the Producer Price
Index PPI.  If they go up then we worry.  If ONLY the price of cars is going up we don't worry at all.  After all, the price
could be going up as a result of tougher safety standards or new luxury gadgets that everyone wants.

6. GDP is growing steadily, and prices are rising sharply. 

Contractionary Monetary Policy -  the key to this question is the term "prices."  The question does not say the price of one
product or service it just says "prices" in general.  This is a code word for an increase in CPI/PPI and the inflation rate.  You
must put the breaks on inflation by sucking money out of the economy.  Yes.....this will hurt GDP and cause some people to
lose their jobs but it must be done or the economy could suffer a major crash later on.

7. The United States is experiencing both high inflation and high unemployment. 
Contractionary Monetary Policy - This is the nightmare scenario!!!!  In this situation you must assume that the high inflation
has caused the high levels of unemployment.  Therefore you must reduce the amount of money available consumers by
using the tools of Tight-Money policy to destroy the inflation.  Doing this will probably mean that people will hate you
because they will think they need more money to survive the inflation.  In reality if you used Easy-Money Policy you would
only make inflation worse and the economy would spiral into a larger recession or depression.  The good news is that unlike
politicians you are appointed by the president and your board members are only appointed every 14 years.  That makes you
immune to most public opinion concerns and allows you to do the right thing without fear of being thrown out of your job
by the public.  Chances are in the next 14 years the economy will improve!

8. The CPI is up, and housing starts are at a fifteen-year high. 

Contractionary Monetary Policy - The CPI going up is a sign of inflation.  Housing starts, (new home construction), at a
fifteen-year high is a sign that the economy is growing to fast and may be over heating.  If it over heats inflation will get
worse and the economy will crash.  So, we need to decrease the money supply to slow the economy down a little bit.

9. We are in a recession.  Factory orders are down, and the economy appears to be slumping. 
Expansionary Monetary Policy -  A recession means two quarters of negative growth in GDP.  Use this policy to increase
the money supply and allow the banks to loan more money and the bank customers to spend more money on credit.  When
people spend more money more aggregate demand increases.  Greater demand = a need for more jobs.  More jobs= more
money and a growing economy!

10. Consumers feel worried, inflation is low and spending is sluggish.

Moral Persuasion -  In this situation you don't have any hard numbers or economic indicators saying that the economy is in
bad shape.  All you have is polling data showing that consumers are scared that the economy is going to go down in the
future and they are not spending as much money.  This is a time when a popular and trusted Federal Reserve Chairman can
make a difference by reassuring people that things are going to be okay and they just need to relax and take their families out
to dinner or go buy a new TV. 

11. Unemployment is low and prices are rising steadily. 

Contractionary Monetary Policy -  this is a very similar situation to question #8.  Please see #8 for an explanation.

12. The index of leading economic indicators shows a strong move towards inflation. 
Contractionary Monetary Policy - We need to take money out of the economy on the assumption that this is demand-pull
inflation.  Demand-pull inflation is caused by people having so much money to spend that producers can’t keep up
with demand and prices rise.  If you take enough money out of the economy the inflation should go away.

13. The FED senses that people are not saving money. 
Moral Persuasion -  Get on TV and tell the people they need to save more money.  "Good evening my fellow Americans.  I
want you to save more money!  Trust me, you will be glad you did!

14. Jobless rates are pushing 11 percent while the CPI has fallen from 8 percent to 2 percent growth.
Expansionary Monetary Policy -  In this situation we are recovering from a period of high inflation that has caused large
scale unemployment.  Now that the inflation is gone we can allow the banks to loan more money out to customers to
encourage job growth and try to get the unemployment rate back down to 5%

15. We are in a recession but are experiencing high inflation. 

Contractionary Monetary Policy - See question #7 for an explanation.

16. The money supply appears to be tight, and prices are on the rise.
Contractionary Money Policy - the money supply may be tight but we are going to have to suck more money out to kill the
inflation.  THE INFLATION MUST DIE!!!  AT ALL COST!!!!   See #7 for further explanation!

17. Prices are stable, and the GDP is growing at a 3 percent pace. 
Do nothing.  If its not broke don't fix it!  If you are the Chairman of the Federal Reserve this is a good time to go on holiday
because no one will be screaming for you to help them today.  Put on your sun glasses and go to the beach!!!