Monetary Policy Exercise

Part I: The Three Main Tools of Monetary Policy

1. How would the Fed use the three monetary policy tools to pursue an expansionary policy and a contractionary policy?

Monetary Tool Expansionary Policy Contractionary Policy Open Market Operations

Discount Rate

Reserve Requirement________________________________________

2. Circle the correct symbol (⇑ for increase or ⇓ for decrease). What would happen to the money supply and interest rates if the Fed…

a. purchased government securities on the open market? Money Supply ⇑ ⇓ Interest Rates ⇑ ⇓

b. raised the discount rate? Money Supply ⇑ ⇓ Interest Rates ⇑ ⇓

c. lowered the reserve requirement? Money Supply ⇑ ⇓ Interest Rates ⇑ ⇓

3. With an easy money policy (expansionary monetary policy), the equilibrium supply of money(increase/decrease) while interest rates ________________. The (higher/lower) interest rates should cause investment expenditures to __________, this change in investment spending will cause Aggregate Demand to (increase/decrease). Therefore, an easy money policy is consequently appropriate for countering a(an) _______________ gap.

4. If a bank received a deposit of $10,000 when the reserve requirement is 25%,how much… a) will it hold as required reserve? __________ b) will it have in excess reserves? __________ c) is the money multiplier? __________ d) will total deposits in the entire banking system rise? __________ e) new money will be created by the lending activities of the entire banking system? __________
Part II: Graphing Monetary Policy
(How does the Money Supply affect the level of investment, real GDP, and price levels?)

1. Use the diagrams below to illustrate, explain, and predict the effect of a Fed initiated increase in the money supply on the equilibrium interest rate,