6.2.4 Practice_ Apply Concepts of Monetary Policy

docx

School

Case Western Reserve University *

*We aren’t endorsed by this school

Course

102

Subject

Economics

Date

Jan 9, 2024

Type

docx

Pages

Uploaded by buttercream10

AP Macroeconomics Page 1 of 5 Assignment: Apply Concepts of Monetary Policy User Name: ______ Instructor: _______ Date: ______ (print clearly) 1. The two tasks with which the Fed is charged are promoting the health of the banking industry and promoting the overall health of the economy. Various regulations allow the Fed to achieve the first of these tasks. Three tools allow it to achieve the second. A. List and briefly describe the three policy tools the Fed can use to promote the overall health of the economy. (3 points) The first policy tool Fed can use is the required reserve ratio, which is the percent of total deposits a bank must hold in reserve. The second policy tool is the discount rate, which is the interest rate the Fed charges on overnight loans. Banks may borrow from the Fed if they're short at the end of the day and need to borrow to meet their required reserves. The third is open market operations, which are purchases and sales of Treasury securities. Treasury securities are government bonds that are bought and sold in the "secondhand" market. B. How should the Fed adjust each of the three policy tools if it wants to conduct expansionary monetary policy? Contractionary monetary policy? (6 points) To pursue an expansionary monetary policy and increase the money supply, the Fed would decrease the required reserve ratio. A low discount rate makes borrowing less costly, so a bank is more likely to loan out all it's excess reserves, therefore, a small discount rate is an expansionary monetary policy. To increase the money supply, the Fed buys bonds, and this injects money into the economy, and the money supply grows, conducting an expansionary monetary policy. C. Explain why the required reserve ratio is rarely used to conduct expansionary monetary policy. Specifically state how it would be used, and why that's usually not a great idea. (4 points) The required reserve ratio is rarely used to conduct expansionary monetary policy because the required reserve ratio is changed only rarely, since a stable required reserve ratio helps to maintain a stable banking system. If the required reserve ratio decreased in order for it to be expansionary, it would increase the size of the money multiplier. This would result in banks being less secure since they would have fewer reserves and in times of recession, borrowers would be more likely to default on their loans. 2. The most important tool the Fed uses to conduct monetary policy is open market operations (OMOs), a tool controlled by the Federal Open Market Committee (FOMC). A. Explain what OMOs are. (2 points) Open market operations are sales and purchases of treasury bonds by the Fed. This tool is used constantly and continuously, with the Fed engaging in high volumes of T-bond transactions every day. This is the major tool of monetary policy . _____________ Copyright © 2021 Apex Learning. See Terms of Use for further information. AP Macroeconomics Page 2 of 5 Assignment: Apply Concepts of Monetary Policy User Name: ______ Instructor: _______ Date: ______ (print clearly)

B. Explain how OMOs affect the money supply. (4 points) Open market operations are sales and purchases of treasury bonds by the Fed. When bonds are bought, the money supply increases; when bonds are sold, the money supply decreases. When the Fed purchases bonds, they go into the Fed and then money comes out, which increases the money supply, shifting the money supply curve to the right. When the Fed sells bonds, they go into circulation and money goes into the Federal Reserve, shifting the money supply curve to the left, which decreases the money supply. C. What type of OMO is consistent with expansionary policy? With contractionary policy? (2 points) An expansionary policy would be buying bonds because demand for bonds increases and the demand curve shifts to the right. A contractionary policy would be selling bonds because it results in an increase in supply of bonds which shifts the supply curve to the left and lowers both investment and aggregate demand. D. Show the effects of OMOs on graphs of money and bond markets to establish the relationship between interest rates and bond prices. Then provide a detailed written explanation of how the sale and purchase of bonds affects interest rates. (6 points) _____________ Copyright © 2021 Apex Learning. See Terms of Use for further information. AP Macroeconomics Page 3 of 5 Assignment: Apply Concepts of Monetary Policy User Name: ______ Instructor: _______ Date: ______ (print clearly) 3. Perhaps the most frequently reported detail of Fed policy is the target set for the federal funds rate. Although this isn’t a tool of the Fed, it is a good goal for the Fed to work toward because it’s easy to observe and conveys good information about the state of the economy.

A. Explain what the federal funds rate is. (3 points) When the bank borrows funds from other banks. The market for loans from bank to bank is called the federal funds market, and the interest rate is the federal funds rate. This is the rate banks charge each other on overnight loans to meet their required reserves. B. Would an increase in the federal funds rate be expansionary or contractionary? (2 points) An increase in the federal funds rate would be contractionary because it helps the Fed to meet their reserve requirements. C. What might the Fed do if the federal funds rate is higher than the target rate? How would it use its tools to achieve this target? (3 points) If the federal funds rate is higher than the target rate, The Federal Reserve would employ a contractionary policy. Increasing the required reserve rate, increasing the discount rate, or selling bonds, will result in a smaller money supply. 4. One of the tasks with which the Fed is charged is maintaining the health of the economy. The Fed achieves this through monetary policy, changing the money supply. A. Describe the steps through which changes in the money supply affect RGDP. Hint: Consider the effect of the slope of the relevant curve in each of the questions below: (6 points) A decrease in money supply would decrease RGDP because the interest rate increases, causing investment to drop since less firms will want to invest during high interest rates. This causes aggregate demand to decrease which means a lower price level and a lower level of RGDP. An increase in money supply would increase RGDP because the interest rate decreases, causing investment to increase since firms will want to invest more since interest rates are low. This causes aggregate demand to increase which results in a higher price level and a higher level of RGDP. _____________ Copyright © 2021 Apex Learning. See Terms of Use for further information. AP Macroeconomics Page 4 of 5 Assignment: Apply Concepts of Monetary Policy User Name: ______ Instructor: _______ Date: ______ (print clearly) B. Explain why monetary policy may fail to affect RGDP due to the characteristics of: I. The money market (3 points) A flat money demand curve represents an elastic demand, suggesting that people are very sensitive to interest rates when they're determining how much cash to hold. A flat money

Your preview ends here

Eager to read complete document? Join bartleby learn and gain access to the full version

Access to all documents
Unlimited textbook solutions
24/7 expert homework help

demand leads to a small change in interest rates for either an increase or decrease in the money supply, causing the monetary policy to be not so effective. II. Investment demand (3 points) A steep investment demand curve will cause the monetary policy to be less effective, since firms are less sensitive to interest rates while making investment decisions. This is because a small change in interest rates will not lead to a relatively big change in investment decisions. III. Aggregate supply (3 points) If the Fed employs an expansionary monetary policy when there is a supply shock, then RGDP will not be affected. Or if it uses a contractionary monetary policy to combat inflation, then the RGDP will also not be affected. 5. The equation of exchange is an identity that relates the money supply, velocity, the price level, and real output. An identity is something that is true by definition. A. One group of economists, the monetarists, look at the equation of exchange and say that the Fed should simply increase the money supply by an annual rate equal to the long-run growth rate of the economy. Explain the effect that such a policy is likely to have on inflation. (5 points) Since monetarists believe that an increase in money supply will have no impact on real variables such as output, employment, and rate of interest in the long run and will have an impact in the short run. But they also stated that there will be an impact on the price level in the long run. Monetarists believe the Fed should choose a steady rate for increases in the money supply, since they argue that if the Fed does more than that, it will cause increases in inflation, and if it does less, it'll cause disinflation _____________ Copyright © 2021 Apex Learning. See Terms of Use for further information. AP Macroeconomics Page 5 of 5 Assignment: Apply Concepts of Monetary Policy User Name: ______ Instructor: _______ Date: ______ (print clearly) B. Another group of economists, those who hold to the quantity theory of money, believe that V is predictable and otherwise unchangeable and that Q is steady. Is their view of the economy consistent with the Keynesian view, the classical view, or neither? Explain. (5 points) Their view of the economy is consistent with the classical view because this group of economists believe that the increase in money supply will lead to a proportional increase in price level for both the short run and the long run, and no impact on the real variables. Where the classical view believes that money only influences nominal variables and real variables.

6.2.4 Practice_ Apply Concepts of Monetary Policy

Related Documents