Chapter 13 - Monetary Policy
MONETARY POLICY PROBLEM SET
NAME: _______________________________________ DATE: ____ / ____ / ____
Give the best answer to each of the following questions.
1. Suppose the current money supply is $4,000. For each of the following situations, determine
the following: the money multiplier, the monetary base, and the amount by which the Fed
must change the reserve requirement to achieve the stated desired change in the money
supply. Assume that banks hold no excess reserves and individuals hold no currency.
a. The reserve requirement is 0.2. The Fed wants to decrease the money supply by $800.
b. The reserve requirement is 0.5. The Fed wants to increase the money supply by $1,000.
2. Suppose the current money supply is $10,000. For each of the following situations, determine
the following: the monetary base, and what open market operation the Fed would have to
take to achieve the stated desired change in the money supply. Assume that banks hold no
excess reserves and individuals hold no currency.
a. The reserve requirement is 0.1. The Fed wants to decrease the money supply by $800.
b. The reserve requirement is 0.5. The Fed wants to increase the money supply by $1,000.
3. Suppose the current money supply is $8,000. For each of the following situations, determine
the following: the money multiplier, the monetary base, and the change in the discount rate
necessary to achieve the stated desired change in the money supply. Assume that for every 1
percentage-point decline in the discount rate, banks borrow an additional $50. Assume that
banks hold no excess reserves and individuals hold no currency.
a. The reserve requirement is 0.1. The Fed wants to increase the money supply by $600.
b. The reserve requirement is 0.5. The Fed wants to increase the money supply by $400.
Chapter 13 - Monetary Policy
4. Use the Taylor Rule to predict the Fed’s target for the Federal funds rate in the following
situations:
a. Inflation is 3%, which is 1% above the target; output growth is 4%, which is 1% above
potential.
b. Inflation is 2%, which is the target rate; output growth is 4%, which is 1% above
potential.
c. Inflation is 1%, which is 1% below the target; output growth is 2%, which is 1% below
potential.
5. Explain the effect of expansionary monetary policy in the short run in the AS/AD model. Be
sure to explain why the curve(s) shift. How would your answer differ under the structural
stagnation hypothesis?
6. Using the concepts of supply and demand, explain the effect of an open market sale of bonds
by the Fed on the price of a bond. What happens to the interest rate associated with that
bond?
7. Given each of the following situations, state whether the yield curve is inverted, standard, or
flat:
a. The yield on 1-year bonds is 4.0%, and the yield on 30-year bonds is 3.8%.
b. The yield on 10-year bonds is 6.1%, and the yield on 20-year bonds is 9.9%.
c. The yield on 3-year bonds is 3.9%, and the yield on 10-year bonds is 4.1%.
d. The yield on 15-year bonds is 4.0%, and the yield on 20-year bonds is 3.3%.
Chapter 13 - Monetary Policy
Answers to the Problem Set
The following are the correct answers to the problem set that follows on the next two
pages, along with the learning objective associated with each question. The problem set
is designed to be photocopied directly from this book and distributed for student use.
1. (LO1, LO2, LO3)
a. Multiplier is 5. Monetary base is $800. Increase reserve requirement to 0.25.
b. Multiplier is 2. Monetary base is $2,000. Decrease reserve requirement to 0.4.
2. (LO1, LO2, LO3)
a. Multiplier is 10. Monetary base is $1,000. Sell $80 in bonds.
b. Multiplier is 2. Monetary base is $5,000. Buy $500 in bonds.
3. (LO1, LO2, LO3)
a. Multiplier is 10. Monetary base is $800. Reduce the discount rate by 1.2
percentage points.
b. Multiplier is 2. Monetary base is $4,000. Reduce the discount rate by 4
percentage points.
4.
(LO2, LO3, LO4)
a. 6 percent; b. 4.5 percent; c. 2 percent
5. (LO1, LO2)
Expansionary monetary policy reduces interest rates, which increases investment.
The AD curve shifts to the right by an amount equal to the multiplier times the
initial increase in investment expenditures. In the short run, the economy moves
up along the SAS curve; output and the price level both increase. In the structural
stagnation model, the decrease in interest rates drives up asset prices and
increases a country's trade deficit.
6. (LO1, LO2, LO3)
The supply curve for bonds shifts to the right by the amount of the sale. This
moves the equilibrium down along the demand curve, and the price of bonds
falls. Because bond prices and interest rates are inversely related, the interest rate
associated with the bonds rises.
7. (LO4)
a. Inverted; b. Standard; c. Standard; d. Inverted