Part 13.

Money, Banking, and Monetary Policy (4h 20 mins, MC: 100 mins FRQ: 160 mins)

1. Which function of money best defines $1.25 as the price of a 20 oz. bottle of pop?

(A) Medium of exchange.

(B) Unit of account.
(C) Store of value.
(D)Transfer of ownership.
(E) Fiat money.

2. If a bank has $500 in checking deposits and the bank is required to reserve $50, what is the reserve
ratio? How much does the bank have in excess reserves?

(A) 10 percent, $450 in excess reserves.

(B) 90 percent, $50 in excess reserves.
(C) 90 percent, $450 in excess reserves.
(D) 10 percent, $50 in excess reserves.
(E) 10 percent, $500 in excess reserves.

3. Which is NOT a way that the Fed can affect the money supply?
(A) A change in discount rate.
(B) An open market operation.
(C) A change in reserve ratio.
(D) A change in tax rates.
(E) Buying Treasury securities from commercial banks.

4. If the money supply increases, what happens in the money market? (Assuming money demand is
downward sloping)

(A) The nominal interest rates rises.

(B) The nominal interest rates falls.
(C) The nominal interest rate does not change.
(D)Transaction demand for money falls.
(E) Transaction demand for money rises.

A 5. To move the economy closer to full employment, the central bank decides that the federal funds rate
must be increased. The appropriate open market operation is to ______, which ______ the money supply,
_aggregate demand, and fight ______.

6. Which of the following is a predictable advantage of expansionary monetary policy in a recession?

(A) Decreases aggregate demand so that the price level falls.
(B) Increases aggregate demand, which increases real GDP and increases employment.
(C) Increases unemployment, but low prices negate this effect.
(D) It keeps interest rates high, which attracts foreign investment.
(E) It boosts the value of the dollar in foreign currency markets.

D 7. How would fiscal and monetary policymakers combine spending, tax, and monetary policy to fight a
recessionary gap, while avoiding large budget deficits?

8. Which of the following statements are true?

I. The velocity of money is equal to real GDP divided by the money supply.
II. Dollars earned today have more purchasing power than dollars earned a year from today.
III. The supply of loanable funds consists of investors.

(A) I only
(B) II only
(C) III only
(D) I and II only
(E) I, II, and III

9. A likely cause of falling Treasury bond prices might be

(A) expansionary monetary policy.

(B) contractionary monetary policy.
(C) a depreciating dollar.
(D) fiscal policy designed to reduce the budget deficit.
(E) a decrease in the money demand.

10. When nominal GDP is rising, we would expect money demand to

(A) increase as consumers demand more money as a financial asset, increasing the interest rate.
(B) increase as consumers demand more money for transactions, increasing the interest rate.
(C) decrease as the purchasing power of the dollar is falling, decreasing the interest rate.
(D) decrease as consumers demand more money for transactions, increasing the interest rate.
(E) increase as consumers demand more money as a financial asset, decreasing the interest rate.

11. Households demand more money as an asset when

(A) nominal GDP falls.

(B) the nominal interest rate falls.
(C) bond prices fall.
(D) the supply of money falls.
(E) nominal GDP increases.

E 12. Which of the following represents a combination of contractionary fiscal and expansionary
monetary policy?

13. If current real GDP is $5000, and full employment real GDP is at $4000, which of the following
combinations of policies might have brought the economy to this point?

(A) A decrease in taxes and a lower discount rate.

(B) An increase in government spending and an increase in taxes.
(C) A decrease in taxes and selling bonds in an open market operation.
(D) An increase in government spending and an increase in the discount rate.
(E) A decrease in taxes and a decrease in government spending.

D 14. If a nation is operating at full employment, and the central bank engages in contractionary
monetary policy, the nation can expect the interest rate, the purchases of new homes, and the
unemployment rate to change in which of the following ways?

15. Expansionary monetary policy is designed to

(A) lower the interest rate, increase private investment, increase aggregate demand, and increase domestic
output.
(B) lower the interest rate, increase private investment, increase aggregate demand, and increase the
unemployment rate.
(C) increase the interest rate, increase private investment, increase aggregate demand, and increase
domestic output.
(D) increase the interest rate, decrease private investment, increase aggregate demand, and increase
domestic output.
(E) increase the interest rate, decrease private investment, decrease aggregate demand, and decrease the
price level.

16. Which of the following is a component of the M1 measure of money supply?

(A) Savings deposits

(B) Gold bullion
(C) Cash and coins
(D) 30-year Treasury certificates
(E) 18-month certificates of deposits

17. The fractional reserve banking system’s ability to create money is lessened if

(A) households that borrow redeposit the entire loan amounts back into the banks.
(B) banks hold excess reserves.
(C) banks loan all excess reserves to borrowing customers.
(D) households increase checking deposits in banks.
(E) the Federal Reserve lowers the reserve ratio.

18. If the reserve ratio is 10 percent and a new customer deposits $500, what is the maximum
amount of money created?
(A) $500
(B) $4500
(C) $5000
(D) $50
(E) $5500

19. Suppose today’s headline is that private investment has decreased as a result of an action by the
Federal Reserve. Which of the following choices is the most likely cause?

(A) Selling Treasury securities to commercial banks.

(B) Lowering of the discount rate.
(C) Decreasing the reserve ratio.
(D) Elimination of a corporate tax credit on investment.
(E) A stronger stock market has increased investor optimism.

20. Which of the following is an example of expansionary monetary policy for the Federal Reserve?

(A) Increasing the discount rate.

(B) Increasing the reserve ratio.
(C) Buying Treasury securities from commercial banks.
(D) Lowering income taxes.
(E) Removal of import quotas.

21. If you are estimating your total expenses for school next semester, you are using money primarily as: 

A. a medium of exchange.

B. a store of value
C. a unit of account
D. an economic investment

22. If you place a part of your summer earnings in a savings account, you are using money primarily as
a: 
A. medium of exchange.
B. store of value
C. unit of account
D. standard of value

23. If you write a check on a bank to purchase a used Honda Civic, you are using money primarily as: 

A. a medium of exchange.

B. a store of value
C. a unit of account
D. an economic investment

24 Stock market price quotations best exemplify money serving as a: 

A. store of value.
B. unit of account
C. medium of exchange
D. index of satisfaction

25. Purchasing common stock by writing a check best exemplifies money serving as a: 

A. store of value.
B. unit of account
C. medium of exchange
D. index of satisfaction

26. When economists say that money serves as a medium of exchange, they mean that it is: 

A. a way to keep wealth in a readily spendable form for future use.
B. a means of payment
C. a monetary unit for measuring and comparing the relative values of goods
D. declared as legal tender by the government.

27. When economists say that money serves as a unit of account, they mean that it is: 

A. a way to keep wealth in a readily spendable form for future use.
B. a means of payment
C. a monetary unit for measuring and comparing the relative values of goods
D. declared as legal tender by the government.

28. When economists say that money serves as a store of value, they mean that it is: 

A. a way to keep wealth in a readily spendable form for future use.
B. a means of payment
C. a monetary unit for measuring and comparing the relative values of goods
D. declared as legal tender by the government. 

29. Checkable deposits are classified as money because: 

A. they can be readily used in purchasing goods and paying debts.

B. banks hold currency equal to the value of their checkable deposits.
C. they are ultimately the obligations of the Treasury.
D. they earn interest income for the depositor.
 30. To say that coins are "token money" means that: 

A. their face value is less than their intrinsic value.

B. their face value is greater than their intrinsic value.
C. their face value is equal to their intrinsic value.
D. they are not legal tender.

31. In defining money as M1, economists exclude time deposits because: 

A. the intrinsic value of time deposits is nil.

B. the purchasing power of time deposits is much less stable than that of checkable deposits and
currency.
C. they are not directly or immediately a medium of exchange.
D. they are not recognized by the Federal government as legal tender. 

32. A bank owns a 10-story office building. In the bank's balance sheet, this would be an example of: 

A. An asset
B. A liability
C. Capital stock
D. A checkable deposit

33. A bank has $2 million in checkable deposits. In the bank's balance sheet, this would be an example
of: 

A. An asset
B. A liability
C. Net worth
D. Capital stock

34. A checkable deposit at a commercial bank is a(n): 

A. Liability to the depositor and an asset to the bank

B. Liability to both the depositor and the bank
C. Asset to the depositor and a liability to the bank
D. Asset to both the depositor and the bank

35. When cash is deposited in a checkable-deposit account in a commercial bank: 

A. The money supply increases

B. The money supply decreases
C. The composition of the money supply changes
D. The composition of the money supply does not change

36. Legal reserve requirements: 

A. Give commercial banks more legal control over the money supply
B. Limit "windfall" profits in the commercial banking system
C. Permit the Federal Reserve System to control the lending capacity of banks
D. Provide the FDIC with the power to protect deposits at commercial banks

37. A commercial bank's required reserves can be calculated by: 

A. Dividing its excess reserves by its required reserves

B. Dividing its required reserves by its excess reserves
C. Multiplying its checkable-deposit liabilities by the reserve ratio
D. Multiplying its checkable-deposit liabilities by its excess reserves

38. A commercial bank has actual reserves of $50,000 and checkable deposits of $200,000, and the
required reserve ratio is 20%. The excess reserves of the bank are: 

A. $10,000
B. $20,000
C. $40,000
D. $50,000

39. A bank is in the position to make loans when required reserves: 

A. Equal actual reserves

B. Equal excess reserves
C. Are less than actual reserves
D. Are greater than actual reserves

40. An individual deposits $12,000 in a commercial bank. The bank is required to hold 10 percent of all
deposits on reserve at the regional Federal Reserve Bank. The deposit increases the loan capacity of the
bank by: 

A. $11,000
B. $10,800
C. $9,600
D. $6,000

41. Assume that the required reserve ratio is 25 percent. If a commercial bank has $2 million cash in its
vault, $1 million in short-term government securities, $3 million on deposit at a Federal Reserve Bank,
and $6 million in checkable deposits, its total reserves equal: 

A. $3 million
B. $4 million
C. $5 million
D. $8 million

42. A bank has excess reserves of $5,000 and deposit liabilities of $50,000 when the required reserve ratio
is 20 percent. If the reserve ratio is raised to 25 percent, this bank can lend a maximum of: 

A. $1,000
B. $1,500
C. $2,000
D. $2,500

43. When a check is cleared against a bank, it will lose: 

A. Cash and securities

B. Checkable deposits and reserves
C. Reserves and capital stock
D. Loans and demand deposits

44. The primary reason commercial banks must keep required reserves on deposit at Federal Reserve
Banks is to: 
A. Add to the liquidity of the commercial bank
B. Allow the Fed to control the amount of bank lending
C. Protect the deposits in the commercial bank against losses
D. Provide the means by which checks drawn on a commercial bank and deposited in other commercial
banks can be collected

45. A depositor places $5,000 in cash in a commercial bank, and the reserve ratio is 20 percent; the bank
sends the $5,000 to the Federal Reserve Bank. As a result, the reserves and excess reserves of the bank
have been increased, respectively, by: 

A. $5,000 and $1,000

B. $5,000 and $4,000
C. $5,000 and $5,000
D. $4,000 and $4,000

46. Henry Trudeau deposits $2,000 in currency in the First Street Bank. Later that same day Jane Harris
negotiates a loan for $5,400 at the same bank. After these transactions, the supply of money has: 

A. Increased by $2,100
B. Increased by $3,300
C. Increased by $5,400
D. Decreased by $3,300

47. Which of the following is correct? 

A. When borrowers repay bank loans, the money supply is increased

B. When borrowers take out bank loans, the money supply is decreased
C. A single commercial bank can legally lend an amount greater than its excess reserves
D. The actual reserves of a commercial bank equal its excess reserves plus its required reserves

48. Other things being equal, an expansion of commercial bank lending: 

A. Changes the composition, but not the size, of the money supply
B. Is desirable during a period of demand-pull inflation
C. Reduces the money supply
D. Increases the money supply

49. A commercial bank has no excess reserves until a depositor places $5000 in cash in the bank. The
bank then adds the $5000 to its reserves by sending it to the Federal Reserve Bank. The commercial bank
then lends $4000 to a borrower. As a consequence of these transactions the size of the money supply has: 

A. Not been affected

B. Increased by $4000
C. Increased by $5000
D. Decreased by $5000

50. A commercial bank has excess reserves of $10,000 and a required reserve ratio of 20%; it grants a loan
of $13,000 to a borrower. If the borrower writes a check for $13,000 that is deposited in another
commercial bank, the first bank will be short of reserves, after the check has been cleared, in the amount
of: 

A. $2,000
B. $3,000
C. $10,000
D. $12,000

51. A commercial bank buys a $50,000 government security from a securities dealer. The bank gives the
dealer an increase in its checkable deposits of $50,000. The money supply has: 

A. Not been affected

B. Decreased by $50,000
C. Increased by $50,000
D. Increased by $50,000 multiplied by the reciprocal of the required reserve ratio

 Answer the next question(s) on the basis of the following figures for a single commercial bank which you
are to arrange on the balance sheet. All figures are in thousands of dollars

   

52. Refer to the above data. This bank has liabilities and net worth of: 

A. $400 million
B. $440 million
C. $550 million
D. $580 million

53. Refer to the above data. This bank has assets of: 

A. $340 million
B. $440 million
C. $520 million
D. $580 million

54. Refer to the above data. If the required reserve ratio is 10 percent, the bank has excess reserves of: 

A. $28,000
B. $22,000
C. $18,000
D. $16,000

55. Refer to the above data. If the reserve ratio is 10 percent and a check for $10,000 is drawn and cleared
in favor of another bank, it can be concluded that excess reserves will be: 

A. $8,000
B. $12,000
C. $13,000
D. $18,000

56. When commercial banks and thrift institutions make loans, they: 

A. Buy government securities from the Federal Reserve

B. Sell government securities to the Federal Reserve
C. Monetize the credit extended to borrowers
D. Decrease their balance-sheet liabilities

57. A fractional reserve system requires banks to keep a fraction of demand deposits in

A. government securities
B. loans to customers
C. vault cash or deposits at a Federal Reserve bank
D. collateral assets, such as home mortgages
E. savings accounts or time deposits

58. Banks create money in the US monetary system by

A. printing it
B. making loans
C. selling government securities
D. increasing interest rates
E. increasing the reserve requirement

59. If a customer deposits $2,000 and the bank is allowed to loan $1,200 of the deposit, the reserve
requirement is

A. 40%
B. 6%
C. 167%
D. 60%
E. 8%

60. Assume the reserve requirement is 15% and a bank initially has no excess reserve. If a customer
deposits $1,000, how much of that deposit can be loaned?

A. $15
B. $150
C. $7,000
D. $850
E. $1,015

61. When a customer deposits $200 cash into his checking account at the bank, the money supply

A. increases by $200
B. decreases by $200 times the multiplier
C. decreases by $200
D. increases by $200 times the multiplier
E. doesn’t change

62. The balance sheet below shows the current financial status of Horvath National Bank. If the reserve
requirement is 20% and the bank doesn’t sell any securities, by how much could it increase loans?
Assets Liabilities + Net Worth
Total reserve $35,000 Demand deposits $100,000
Loans $10,000
Securities $55,000
A. $0 B.$10,000 C.$70,000 D. $25,000 E. $15,000

63. Assume a bank has no excess reserves and the reserve requirement is 20%.If a customer deposits
$20,000 in currency into his checking account, what is the maximum amount by which banks will increase
the money supply through multiple-deposit expansion in the banking system?

A. $4,000
B. $20,000
C. $40,000
D. $100,000
E. $80,000

64. If members of the public choose to hold money in currency rather than depositing it into banks, the
growth of the money supply will be

A. less than the potential growth of the money supply

B. infinite
C. unaffected, because currency is only a different form of M1
D. determined by the marginal propensity to consume
E. determined by the reserve requirement

65. Which event could lead to a recessionary phase of business cycle?

A. an increase in worker productivity;

B. firms investing in new technology;
C. an increase in consumer confidence;
D. a supply shock that reduces the costs of production for firms
E. a reduction in the money supply

66. Which of the following factors would cause demand-pull inflation?

A. an increase in the cost of raw materials for firms

B. an increase in the money supply;
C. a significant decrease in the supply of energy products
D. a serious crop failure
E. a reduction in imports allowed into the country

67. Fractional reserve system requires banks to keep a fraction of demand deposits in

A. government securities
B. loans to customers
C. vault cash or deposits at a Federal Reserve bank
D. collateral assets, such as home mortgages
E. savings account or time deposits

68. Banks create money in U.S. monetary system by

A. printing it
B. making loans
C. selling government securities
D. increasing interest rates
E. increasing the reserve requirement
69. If a customer deposits $2,000 and the bank is allowed to loan $1,200 of the deposit, the reserve
requirement is

A. 40 %; B. 6 %; C. 167%; D. 60%; E. 8%

70. When a customer deposits $200 cash into his checking account at the bank, money supply

A. increase by $200
B. decrease by $200 times the multiplier
C. decreases by $200
D. increases by $200 times the multiplier
E. doesn’t change

71. The federal funds rate is the

A. the interest rate banks charge each other for short-term loans
B. total money supply in the U.S
C. rate of growth of the money supply
D. percentage of deposits banks must hold in cash
E. ratio of loans to deposits

72. Assume a bank has no excess reserves and the reserve requirement is 20 percent. If a customer
deposits $20,000 in currency into his checking account, what is the maximum amount by which banks will
increase the money supply through multiple-deposit expansion in the banking system

A. $4,000; B. $20,000; C. $40,000; D. $100,000; E. $80,000

73. If members of the public choose to hold money in currency rather than depositing it into banks, the
growth of the money supply will be

A. less than the potential growth of the money supply

B. infinite
C. unaffected, because currency is only a different form of M1
D. determined by the marginal propensity to consume
E. determined by the reserve requirement

74. In the money market

A. the demand for money consists of asset and transactions demand

B. the supply of money is horizontal
C. the interest rate is determined by the demand for money
D. Congress determines the money supply
E. Congress and the Fed jointly determine an appropriate interest rate

75. The Federal Reserve increases the money supply when it

A. buy bonds
B. increases the reserve requirements
C. lower taxes
D. increases the discount rate
E. increases government spending

76. The interest rate the Fed charges commercial banks for loans is the

A. reserve requirement
B. real interest rate
C. prime rate
D. discount rate
E. federal funds rate

77. The most commonly used tool of monetary policy is

A. the reserve requirement

B. the discount rate
C. open market operations
D. tax rates
E. government spending

78. If the Federal Reserve sells bonds on the open market,

A. money supply and interest rate both increase

B. money supply decreases and interest rate increases
C. money supply increases and interest rate doesn’t change
D. money supply and interest rate both decrease
E. money supply increases and interest rate decreases

79. Expansionary monetary policy is most appropriate when

A. the unemployment rate is low; B. the inflation rate is high

C. real GDP is falling; D. money supply is high
E. interest rate is low

80. Which of the following policies would be appropriate to resolve recession

A. increasing the federal funds rate

B. the Fed selling bonds to a commercial bank
C. increasing discount rate
D. raising the prime rate
E. lowering the reserve requirement

81. If the Federal Reserve increases the money supply, how will interest rate, capital investment and AD
be affected

Interest rate Investment AD

A. Increase Increase Increase
B. Decrease Decrease Decrease
C. Increase Decrease Increase
D. Decrease Increase Increase
E. Increase Decrease Decrease

82. Which of the following policies would be inappropriate if the Federal Reserve is trying to reduce the
inflation rate

A. selling bonds on the open market

B. increasing the discount rate
C. reducing federal funds rate
D. increasing the reserve requirement
E. reducing money supply
83. How will Fed’s purchase of bonds likely affect real output, employment and price level
Real output Employment Price level
A. Decrease Decrease Decrease
B. Increase Increase Decrease
C. Decrease Decrease Increase
D. Increase Decrease Decrease
E. Increase Increase Increase

84. Which combination of fiscal and monetary policy actions would be most effective in reducing
inflationary gap

A. increasing taxes and decreasing the reserve requirement

B. decreasing government spending and the Fed selling bonds
C. decreasing taxes and increasing the discount rate
D. increasing government spending and decreasing the discount rate
E. increasing taxes and the Fed buying bonds

85. The M1 definition of money includes which of the following

I. currency; II. demand deposits; III. savings accounts and small time deposits

A. I only; B. II only; C. III only; D. I and II only; E. I, II and III

86. When money is used as a standard of value, a person is

A. earning more money than before; B. purchasing a necessity

C. making a financial transaction
D. making price comparisons among products
E. writing a check for groceries

87. In the United States, the dollar is

A. backed by silver
B. backed by gold and silver
C. commodity-backed money
D. commodity money
E. fiat money

88. Which of the following is the best example of using money as a store of value

A. A customer pays in advance for $10 worth of gasoline at a gas station

B. A babysitter puts her earnings in a drawer while she saves to buy a bicycle
C. Travelers buy meals on board an airline flight
D. Foreign visitors to U.S convert their currency to dollars at the airport
E. You use $1 bills to purchase soda from a vending machine

89. If the interest rate is 10%, the present value of $1 paid to you one year from now is

A. $0; B.$0.89; C. $0.91; D. $1; E. more than $1

90. Which of the following is NOT a role of the Federal Reserve System

A. controlling bank reserves

B. printing currency
C. carrying out monetary policy
D. supervising and regulating banks
E. holding reserves for commercial banks

91.
I. the aggregate price level II. real GDP III. the interest rate

A. I only; B. II only; C. III only; D. I and II only; E. I, II and III

92. Which of the following monetary and fiscal policy combinations would definitely cause a
decrease in aggregate demand in the short run?

Discount Government Open Market

Rate Spending Operations
(A) Decrease Decrease Buy bonds
(B) Decrease Increase Buy bonds
(C) Decrease Increase Sell bonds
(D) Increase Decrease Sell bonds
(E) Increase Decrease Buy bonds

93. When the unemployment rate is 10 percent and the CPI is rising at 2 percent, the federal government
cuts taxes and increases government spending. If the Federal Reserve buys bonds on the open market,
interest rates, investment, real gross domestic product (GDP) and the price level are most likely to change
in which of the following ways?

Interest Real Price

Rates Investment
(A) Decrease Decrease
(B) Decrease Increase
(C) Increase Decrease
(D) Increase Decrease
(E) Increase Increase
GDP Level
Increase Increase
Increase Increase
Decrease Decrease
Increase Increase
Increase Increase

94. “Sales of durable goods last month were surprisingly high. Recent price increases have pushed the CPI
to more than a 7 percent increase for the past year. On average, the producer price index has gained 1
percent each month during the last year. Wage rates have increased throughout the economy, but
productivity gains are minimal. The unemployment rate, however, is steady at 6 percent”. Which of the
following changes in the tax rate, government spending and the federal funds rate are most appropriate
given the state of the economy?

Tax Rate Government Spending Federal Funds Rate

(A) Increase Increase Increase
(B) Increase Decrease Increase
(C) Increase Decrease Decrease
(D) Decrease Increase Decrease
(E) Decrease Decrease Decrease

Free-Response Questions:

1.(2006)
 2. Jack deposits his money at Bank 1, while Maria deposits her money at Bank 2. Balance sheets for each
bank are listed below.

(a) What will the banks’ balance sheets look like when Jack writes a $50,000 check to Maria and the
check clears?

(b) The reserve ratio is 20%. What are each bank’s excess reserves after the check clears in (a)?

(c)How many additional loans can each bank make when Jack writes Maria another check for $100,000?

3. Suppose that Continental Bank has the simplified balance sheet shown below and that the reserve ratio is
20 percent:

a. What is the maximum amount of new loans that this bank can make? Show in column 1 how the
bank’s balance sheet will appear after the bank has lent this additional amount.

b. By how much has the supply of money changed? Explain.

c. How will the bank’s balance sheet appear after checks drawn for the entire amount of the new
loans have been cleared against this bank? Show this new balance sheet in column 2.

d. Answer questions a, b, and c on the assumption that the reserve ratio is 15 %.

4. Suppose the simplified consolidated balance sheet shown below is for the entire commercial banking
system. All figures are in billions. The reserve ratio is 25 percent.

a. What amount of excess reserves does the commercial banking system have? What is the maximum amount
the banking system might lend? Show in column 1 how the consolidated balance sheet would look after this
amount has been lent. What is the monetary multiplier?

b. Answer the questions in part A assuming that the reserve ratio is 20 percent. Explain the resulting
difference in the lending ability of the commercial banking system.

5. Sandy receives a graduation gift of $1000 in $100 bills from her grandmother. Sandy deposits the $1000
into her checking account at the First Federal Bank

(a) What’s the initial impact of Sandy’s deposit on the money supply? Explain

(b) If the reserve requirement is 20 percent, calculate the following:

(i) the maximum amount First Federal Bank can loan from the initial deposit. Explain how you calculated
this amount
(ii) the maximum potential increase in the total money supply as a result of the deposit. Explain how you
calculated this amount.

(b) Identify two reasons why the money supply might not grow to its maximum potential.

(c) If the reserve requirement were 100 percent, what would be the maximum potential increase in the
money supply as a result of Sandy’s deposit? Explain

(e) If the reserve requirement were 0 percent, explain the following:

(i) maximal potential increase in the money supply as a result of Sandy’s deposit
(ii) the effect on the purchasing power of the dollar

6. In recent years, Fed has made targeting the federal funds rate a main focus of monetary policy.

(a) Define the federal funds rate.

(b) If the Fed wants to lower the federal funds rate, what open market operation would be
appropriate?

(c) Assume that the open market operation that you indicated in part (b) is equal to $10 million. If the
required reserve ratio is 0.2, calculate the maximum change in loans throughout the banking system.
 (d) Indicate the effect of the open market operation that you indicated in part (b) on the nominal
interest rate.

(e) Assume that the Federal Reserve’s action results in some inflation. What would be the impact of
the open market operation on the real rate of interest? Explain.

7. Assume that the United States economy is currently in equilibrium at the full-employment level of
real gross domestic product.
a. Draw a correctly labeled graph of aggregate demand and aggregate supply showing each of the
following in the United States. (i) Output level; (ii) price level

b. Japan is major importer of United States products. Assume that the Japanese economy goes into a
recession. (i) Explain the impact of the Japanese recession on US equilibrium output and price level.
(ii) Show these effects on your graph in part (a).

c. Assume that the Fed takes action to curb the effects of the Japanese recession on the United States
economy. (i)What open market operation would be the Fed undertake? (ii)Use a correctly labeled
graph of the money market to show how the Federal Reserve policy action will affect the nominal
interest rate. (iii) Explain how the change in the nominal interest rate in part (c) (ii) will affect AD,
price level and real output in US.

d. Define real interest rate.

e. Indicate the effect of the open-market operation you identified in part (c) (i) on the real interest rate in
US.

8. Assume that Australia and New Zealand are trading partners. Australia’s economy is currently in
recession.

(a)Now assume that Australia begins to recover from its recession. Using a correctly labeled graph of
aggregate demand and aggregate supply for New Zealand, show how the impact of Australia’s rising
income on each of the following in the short run.:
(i) Aggregate demand in New Zealand. Explain. (ii) Output in New Zealand.
(b) Using a correctly labeled graph of the money market for New Zealand, show the effect of output
change in part (a) (ii) on the following:
(i) Demand for money. Explain. (ii) the nominal interest rate.
(c)Assume that the price level in New Zealand rises. Given your answer to part (b)(ii), explain what will
happen to real interest rate.

(d) Although recovering, Australia remains in recession and its government takes no action. Indicate
whether each of the following curves will shift to the left, shift to the right or remain unchanged in the
long run in Australia:
(i)Aggregate supply; (ii) Aggregate demand.