Chapter 17: Monetary Policy Targets and Goals
True/False
4) Raising the reserve requirement led to a worsening of the Great Depression.
7) Open market operation has always been the primary tool of the Fed for
controlling prices.
14) The long term goal of keeping inflation low can conflict with the short term goal
of lowering unemployment.
15) One of the Federal Reserve’s goals is 0% unemployment.
16) By treaty, the primary goal of the ECB is stable prices.
17) A central bank cannot target money supply growth and interest rates at the same
time.
18) A central bank using the Taylor Rule is only concerned about inflation.
19) According to the Taylor Rule, if the output gap falls, the targeted interest rate
should fall as well, ceteris paribus.
20) According to the Taylor Rule, if inflation rises by 2%, then the targeted interest
rate should rise by more than 2%.
23) Policy that tends to make recessions worse and booms inflationary is called procyclical.
25) According to the Taylor Rule, if inflation falls, then the target real interest rate
should rise.
27) One advantage of the Taylor Rule is that it would never require a negative
nominal interest rate target.
28) The natural rate of unemployment is estimated to be less than 4%.
29) The inflation target, stated or implicit, is usually around 2%.
32) Central banks try to use their influence over the money supply to change interest
rates.
33) If central banks decrease interest rates, this is likely to slow the economy.
Multiple Choice
1) The Taylor Rule would be implemented by a central bank using
a) changes in the reserve requirement.
b) discount lending.
c) open market operations.
d) all of the above.
2) The Taylor Rule is used by a central bank that is targeting
a) monetary aggregates.
b) a short term interest rate.
c) bank reserves.
d) none of the above.
3) One reason for the decreased economic volatility starting in the 1980s was
a) better monetary policy.
b) more volatile oil prices.
c) less regulation of the stock market.
d) all of the above.
5) A central bank would increase interest rates to
a) lower inflation.
b) raise employment.
c) stimulate the economy.
d) all of the above.
6) A central bank would lower interest rates to
a) decrease inflation.
b) raise unemployment.
c) stimulate GDP growth.
d) all of the above.
7) A central bank would increase the money supply to
a) lower inflation.
b) lower unemployment.
c) lower GDP growth.
d) none of the above.
8) A central bank would decrease the money supply to
a) lower inflation.
b) lower employment.
c) lower GDP growth.
d) all of the above.
9) According to the Taylor Rule, if the output gap rises by 2% and inflation rises by
1%, then the federal funds rate should rise by
a)
b)
c)
d)
2.0%.
2.5%.
3.0%.
3.5%.
10) According to the Taylor Rule, if the output gap falls by 2% and inflation rises
by 2%, then the federal funds rate should rise by
a) 2.0%.
b) 2.5%.
c) 3.0%.
d) 3.5%.
11) According to the Taylor Rule, if the output gap rises by 1% and inflation rises
by 2%, then the federal funds rate should rise by
a) 2.0%.
b) 2.5%.
c) 3.0%.
d) 3.5%.
12) According to the Taylor Rule, if the output gap rises by 3% and inflation falls
by 1%, then the federal funds rate should
a) fall by 2%.
b) fall by 1%.
c) remain unchanged.
d) rise by 1%.
13) The Taylor Rule is a formula for how the federal funds rate should respond to
changes in the
a) inflation gap.
b) output gap.
c) the equilibrium real federal funds rate.
d) all of the above.
14) According to the Taylor Rule, if the output gap rises by 2% and the inflation gap
rises by 1%, then the real federal funds rate should rise by
a) 1.5%.
b) 2.0%.
c) 2.5%.
d) 3.0%.
15) According to the Taylor Rule, if the output gap falls by 2% and the inflation gap
rises by 1%, then the real federal funds rate should be
a) lowered by 1.0%.
b) lowered by 0.5%.
c) left unchanged.
d) raised by 1.0%.
21) Formally adopting inflation targeting can lead to
a) a short run recession.
b) long run price stability.
c) a loss of independence for the central bank.
d) all of the above.
22) The Federal Reserve began using open market operations in the
a) 1920s.
b) 1930s.
c) 1940s.
d) 1970s.
27) If a central bank is using the Taylor Rule and decides to lower its inflation
target, this will lead to ____ interest rate targets.
a) higher
b) lower
c) unchanged
d) cannot be determined
Short Answer
1) When the Fed was created, what was its primary intended function?
lender of last resort
4) According to their mandates, who is more concerned about inflation, the Fed or
the ECB?
ECB. The Fed is also supposed to maximize employment.
6) What are the two goals that can be in conflict, leading to the time consistency
problem for monetary policymakers?
low inflation and high growth (or low unemployment)
9) If the equilibrium real fed funds rate and the inflation target are 2%, actual
inflation is 4%, and the output gap is 1%, find the federal funds rate recommended
by the Taylor Rule.
7.5%
10) If the equilibrium real fed funds rate is 2%, the inflation gap is 1%, and the
output gap is 2%, find the real federal funds rate recommended by the Taylor Rule.
3.5%
11) If the equilibrium real fed funds rate and the inflation target are 2%, actual
inflation is 3%, and the output gap is –1%, find the real federal funds rate
recommended by the Taylor Rule.
2.0%
12) The equilibrium real fed funds rate is 2%, the inflation target is 2% and the
growth rate of potential output is 3%. If inflation is 8% and output growth is 6%,
find the federal funds rate recommended by the Taylor Rule. (Note: The output gap
is output growth minus potential output growth.)
14.5%
13) The equilibrium real fed funds rate is 2%, the inflation target is 2% and the
growth rate of potential output is 3%. If inflation is –1% and GDP growth is 0%,
find the federal funds rate recommended by the Taylor Rule. What is an additional
problem in this situation? (Note: The output gap is output growth minus potential
output growth.)
The recommended fed funds rate is –2%, but nominal rate can’t fall below
zero (for any sustained period of time).