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SN_29: The Federal Reserve System and Monetary Policy True or False

1. A central bank has only one function—controlling the supply of money in a country. 2. The central bank typically serves as the major bank for the central government. 3. The central bank implements monetary and fiscal policy for the government. 4. The 12 member banks of the Federal Reserve System act largely in unison on major monetary policy issues. 5. Banks are not all required to belong to the Fed; but there is currently virtually no difference in the requirements for member and nonmember banks. 6. Historically, the Fed has had limited independence from the executive and legislative branches of government. 7. No member of the Federal Reserve Board will face reappointment by the president who initially made the appointment. 8. The Federal Open Market Committee makes most of the key decisions influencing the direction and size of changes in the money supply. 9. The money supply times velocity equals the price level times real GDP. 10. If individuals are writing lots of checks on their checking accounts and spending currency as fast as they receive it, velocity will tend to be low. 11. Velocity equals nominal GDP divided by the money supply. 12. The magnitude of velocity does not depend on the definition of money that is used. 13. If the money supply increases and the velocity of money does not change, the result will be higher prices (inflation), greater real output of goods and services, or a combination of both. 14. Expanding the money supply, unless counteracted by increased hoarding of currency (leading to a decline in V), will have the same type of impact on aggregate demand as an expansionary fiscal policy. 15. Reducing the money supply, other things being equal, will have a contractionary impact on aggregate demand. 16. The velocity of money is a constant. 17. If velocity changes but moves in a fairly predictable pattern, the connection between money supply and GDP is still fairly predictable. 18. The cause of hyperinflation is excessive money growth. 19. The Fed controls the supply of money, even though privately owned commercial banks actually create and destroy money by making loans. 20. Open market purchases or sales of bonds by the Fed have an ultimate impact on the money supply that is several times the amount of the purchase or sale. 21. If the Fed buys bonds in an open market operation, and the seller deposits the payment in her bank account, the money supply will increase and lead to an increase in the bank’s reserves. 22. With a 10 percent required reserve ratio, a $10,000 cash deposit in a bank would result in an increase in the bank’s excess reserves of $1,000.


or lower the discount rate. 24. The discount rate’s main significance is that changes in the rate signal the Fed’s intentions with respect to monetary policy. it would buy bonds. 28. When interest rates are lower. Currently. The Fed selling government bonds will tend to cause a multiple expansion of bank deposits. 2 . 27. 30. particularly for transactions purposes. but not the demand for money. a $1. 33. The demand for money. An increase in the money supply raises the equilibrium nominal interest rate. where the real value of goods and services is increasing over time.000 bond purchase by the Fed directly creates $1. lower reserve requirements. the quantity of money demanded. If the demand for money increases. An expansionary policy can be thought of as an increase in the money supply or an increase in the interest rate. short-run increase in real GDP if the economy is initially operating at or above full employment. When the price of bonds rises. is greater. 41. An increase in AD brought about through monetary policy can lead to only a temporary. In the long run.000 in additional money to be created through the multiple expansion in bank deposits. 37. Generally. 31. and the Fed wants to keep the interest rate stable. 32. Changes in required reserve ratios are such a potent monetary policy tool that they are frequently used. mainly because member banks do not rely heavily on the Fed for borrowed funds. The discount rate is a relatively unimportant monetary policy tool. 46. and indirectly permits up to $9. At lower interest rates. it will have to increase the money supply.23. Setting the discount rate above the Fed funds target tends to discourage borrowing from the Fed’s discount window. 38. 26. With a 10 percent required reserve ratio. an increase in the supply of money is needed to maintain stable prices. is highly dependent on income levels because the transaction volume varies directly with income. If the Fed raises the discount rate. 34. 29. Focusing on growth in the money supply when the demand for money is changing unpredictably will lead to large fluctuations in the interest rate. in a growing economy. 25. 36. the opportunity cost of holding monetary assets is higher. The Fed cannot control both the money supply and the interest rate at the same time. The Fed buying bonds on the open market is an example of an expansionary monetary policy. 39. If the Fed wanted to increase the money supply. with no long-run effect on output or employment. the interest rate rises. The Fed funds rate target tends to affect interest rates throughout the economy. 42. 40. the money supply will tend to increase.000 in money in the form of bank deposits. A change in the nominal interest rate tends to change the real interest rate by the same amount in the short run because the expected inflation rate is slow to change in the short run. 44. 35. the Fed sets the discount rate below the federal funds target. 43. 45. the real interest rate is determined by the intersection of the saving supply and investment demand curves.

they could not be certain of how to best promote stable economic growth. If the Fed raises bank reserve requirements. 58. they decrease the supply of money. and so on. if the SRAS is relatively steep over the relevant range. When the Fed is trying to constrain monetary expansion. Banks maintaining excess reserves hinder attempts by the Fed to induce monetary expansion. The Fed occasionally works to partly offset or even neutralize the effects of fiscal policies that it views as inappropriate. The Fed buying bonds on the open market will lead to an appreciation of the dollar. A macroeconomic problem arises if the federal government’s fiscal decision makers differ with the Fed’s monetary decision makers on policy objectives or targets. sell secondary reserves. the Fed could cause a recession. 55. it can provide banks with excess reserves. Economic advisers. 51. 61. Even if economists could provide completely accurate economic forecasts of what will happen if macroeconomic policies are unchanged. Most of the effects of a given monetary policy will be on prices rather than RGDP in the short run. For government policymakers to be sure of doing more good than harm. The Fed can precisely control the short-run real interest rates through its monetary policy instruments. 59. but the banks themselves must take the steps necessary to increase or decrease the supply of money. in trying to allow for greater economic growth without creating inflationary pressures. banks will call in loans that are due for collection. and in the process of contracting loans. If the Fed pursues a contractionary monetary policy when the economy is at full employment. 60. it often has difficulty in getting banks to make appropriate responses. The Fed may be able to predict the impact of its monetary policies on loans by member banks. and/or raises the discount rate. can forecast what the economy will do in the future with reasonable accuracy. The Fed can change the environment in which banks act. 48. 57. 63. 53. sells bonds. Given the difficulties of timing stabilization policy. 49. but the actions of global and nonbanking institutions can serve to offset at least in part. but it cannot force the banks to make loans. If the “new” economy increases productivity. must estimate how much faster productivity is increasing and whether those increases are temporary or permanent. 64. When the Federal Reserve wants to induce monetary expansion. 62. 54. 50. the impact of monetary policies adopted by the Fed on the money and loanable funds markets. thereby creating new money. the Fed. and an increase in RGDP in the short run. to obtain the necessary reserves. 3 . they need far more accurate and timely information than experts can give them. using sophisticated econometric models. 52. 56. The FOMC of the Federal Reserve is unable to act quickly in emergencies.47. 65. The length and variability of the impact lag before the effects of monetary policy on output and employment are felt longer and are more variable than for fiscal policy. an increase in net exports. an expansionary monetary policy intended to reduce the severity of a recession may instead add inflationary pressures to an economy that is already overheating.

b.5. 400. b. If nominal GDP is $3. The monetary policies generated by the Federal Reserve System a. 5. e. automatically becomes poorer. then a. 4. monetary policy will always offset fiscal policy. c. If the velocity of money (V) and real output (Q) were increasing at approximately the same rate. 4. b. M x Q = P x V. 4 . receives reserves that can be used to make additional loans. The Fed is institutionally independent. c. none of the above 6. c. Velocity would be expected to decrease. Q x M = P x V. 8. 2. d. are sometimes inconsistent with fiscal policies. d. When the Fed purchases government bonds from a commercial bank. b. both a and b would be true. b. loses its ability to make loans. regulating the supply of money.200 billion and M1 is $800 billion. raising or lowering taxes. d. none of the above. increasing or reducing government spending. c. 7. inflation would be closely related to the long-run rate of monetary expansion. b. monetary policy cannot be changed once it has been determined. Velocity would be expected to remain the same. c. b.Multiple Choice 1. must be consistent with fiscal policies that are formatted in Congress. The most important role of the Federal Reserve System is a. d. must be ratified by Congress. 0. 8. If people expect increasing inflation. d. c. Velocity would be expected to increase. M x P = V x Q. it would be impossible for monetary authorities to control inflation. The equation of exchange can be written as a. A major advantage of this is that a. d. monetary policy will always be coordinated with fiscal policy. monetary acceleration would not lead to inflation. b. c. must be approved by the president. M x V = P x Q. then velocity is a. 2. what would be the expected reaction of velocity in the equation of exchange? a. c. loses equity in the Fed. d. d. the bank a. monetary policy is subject to regular ratification by congressional votes. e. 3. monetary policy is not subject to control by politicians.

and the money supply tends to grow. and the money supply tends to fall. The flatter the SRAS curve. the banking system has fewer reserves. recession. Reducing reserve requirements.S. and the money supply tends to grow.9. the harder it is for monetary policy to change real GDP in the short run. d. c. The money supply will tend to increase. decreasing interest rates or decreasing the supply of money. increase the dollar volume of loans made by the banking system. 12. decrease the money supply and lower interest rates d. the easier it is for fiscal policy to change real GDP in the short run. increase aggregate demand. the banking system has more reserves. increase the money supply and increase interest rates c. e. Not enough data are given to answer. the Fed can choose between a. 16. d. c. d. do all of the above. decrease the money supply and increase interest rates 15. d. other things being equal. When money demand increases. c. increase the money supply. b. b. decreasing interest rates or increasing the supply of money. If the Fed sells a U. stagflation. b. c. a. Contractionary monetary policy will tend to have what effect? a. If the Fed lowers the discount rate. and investment spending rises. increase the money supply and lower interest rates b. and investment spending falls. increasing interest rates or increasing the supply of money. what will be the effect on the money supply? a. c. do a and b. real interest rates fall. and the money supply tends to fall. the banking system has more reserves. government bond from a member of the public. The money supply will tend to decrease. When the money supply increases. d. d. other things being equal. inflation. c. The money supply will not change nor influence an expansion or contraction process. d. e. but not c. real interest rates fall. unemployment. real interest rates rise. Both b and d are true. b. 10. increasing interest rates or decreasing the supply of money. the easier it is for monetary policy to change real GDP in the short run. If velocity is relatively stable and the central bank persistently increases the money supply faster than the rate of real output. and investment spending rises. real interest rates rise. b. a. 13. c. 5 . 11. b. a. the result will be a. the harder it is for fiscal policy to change real GDP in the short run. and investment spending falls. 14. the banking system has fewer reserves. b. would tend to a.

a reduction in reserve requirements d. c. Starting from an initial long-run equilibrium. $200 million increase in the money supply. b. sell. the steeper is LRAS. increase d. c. d.S. the flatter is LRAS. All of the above are true. sell. In a recession. d. If the reserve requirement is 20 percent and all banks keep zero excess reserves. real output in the long run. appropriate monetary policy would tend to be for the Fed to _______________ bonds to _______________ AD. real output in the short run. a. the flatter is SRAS. decrease 19. buy. c. a reduction in taxes. $100 million decrease in the money supply. 21. the steeper is SRAS. holding taxes constant c.17. increase b. $500 million increase in the money supply. An unanticipated shift to a more expansionary monetary policy will temporarily stimulate real output and employment. but not in the long run. Which one of the following would be the most appropriate stabilization policy if the economy is operating beyond its long-run potential capacity? a. Suppose the Fed purchases $100 million of U. holding government purchases constant 22. 18. b. 6 . Once decision makers come to anticipate the inflationary side effects. the total impact of this action on the money supply will be a a. b. c. prices and unemployment in the long run. d. real output in both the long run and short run. an unanticipated shift to more expansionary monetary policy would tend to increase a. 20. an increase in the discount rate b. but not the short run. expansionary monetary policy will fail to stimulate either real output or employment. b. an increase in government purchases. d. $100 million increase in the money supply. decrease c. buy. The effects of a given expansionary monetary policy on RGDP in the short run will be greater. Which of the following is true? a. a. The primary long-run effect of persistent growth of the money supply at a rapid rate will be inflation. bonds from the public.

a commercial bank purchasing U. An important limitation of monetary policy is that a. an increase in reserve requirements d. it is conducted by people in Congress who are under pressure to get reelected every two years. Which of the following would tend to reduce the price level? a. a commercial bank using excess reserves to extend a loan to a customer b. ---------.S. an increase in the discount rate e. it must be conducted through the commercial banking system. government bonds by the Fed 24. and the Fed cannot always make banks do what it wants them to do. a purchase of U. when the Fed tries to buy bonds.23.END ---------- 7 . it is often unable to find a seller. b. it is often unable to find a buyer. c. d.S. bonds from an individual as an investment c. when the Fed tries to sell bonds.