Practice Free Response

1
Practice Free Response
On Monetary Policy
Answers to Questions 1 2
2
a) 100 r.r.
b) 10 r.r.
First Generation Bank
First Generation Bank
Assets
Liabilities
Assets
Liabilities
Required Reserves
Required Reserves
5,000 Demand Deposits
5,000 Demand Deposits
500
5,000
4,500
Excess Reserves
-----------------------------------------------
-----------------------------------------------
Total
5,000
5,000
5,000
5,000
Total

1. MS ? 5,000 (Fed has new money)
2. 5,000
3. 5,000

1. 4,500
2. MS ? 50,000 (4,500 X 10 5K)
3. 5,000
4. 50,000

3
(c) If banks keep some of the deposit as excess
reserves, how will this influence the change in
the money supply that was determined in part
(b)(ii)? Explain.
If the banks hold some of the excess reserves gt
increase in the money supply would be less than
50,000 gt banks lend less money gt less money
creation

d) When the Federal Reserve purchases bonds in
the open market what happens to the price of
bonds?
The price of bonds would rise. When bond
prices ? gt interest rate ?

(inverse relationship)
4
a) One point for a correctly labeled graph of the
short-run Phillips curve (SRPC). One point for
showing a vertical long-run Phillips curve (LRPC)
and the point A to the right of the LRPC on the
SRPC.
5

1. U.S. economy in a recession
2. Govt raises taxes gt AD shifts left gt real
   GDP falls gt bigger recession

6
Question d
ii)

• Buying Bonds in Open Market Operations injects
• money into the banking system increasing money
• supply and lowering nominal interest rates
• (federal funds rate)

Nominal Interest Rate
---------
i1
MD
Q1
Qty of
iii) Lower interest rates gt more Investment (I)
Consumption (C) gt AD will shift
right gt real GDP ? Price Level ?
iv) Monetarists believe money is neutral gt an
increase in MS Will have no effect on real GDP.
Only nominal GDP would rise
7
Question e

1. SRAS shifts right as the expected price level
   falls

ii) The natural rate of unemployment is
unchanged.