Question

1.

Inflation targeting allows monetary policy to focus on inflation and inflation forecasts except during times of severe recession.

A. True B. False

2.The Taylor rule predicted a federal funds rate which was ________ that set when Paul Volcker was chairman of the Fed, and a rate which was ________ that set when Arthur Burns chaired the Fed.

• A. less than; greater than
• B. greater than; less than
• C. less than; equal to
• D. greater than; equal to

3.

Your income will increase if the Federal Reserve buys a Treasury bill from you and pays you with a check from the Fed.

A. True B. False

4.

Despite saving Lehman Brothers from failing, the Fed and the Treasury decided to allow Bear Stearns to go bankrupt, which it did in September, 2008.

A. True B. False

5.

The Fed can directly lower the inflation rate.

A. True B. False

Answer 1

1) True
The Central Bank aims to maintain the price stability in the short to medium terms by targeting the inflation. This ensures some sort of assurance as higher inflation affects the people. The central bank through its monetary policy tools such as reserve requirements, repo rate and open market operations alters the money supply which affects the inflation. In the recessionary times the policy is to stimulate the consumption and that means there will be a higher level of money supply and inflation.

2) Option A
Taylor rules recommends the nominal interest rate in the economy considering the output gap and spread in the inflation against the target inflation. Paul Volcker has been credited with bringing the inflation down but the data indicates that he has set the Fed funds rate far higher than Taylor Rule suggests. Similarly, in the time of Arthur Burns, the fed funds rate should have been set higher but it was actually lower.

3) False
The purchase of the treasury by Fed will not increase income as it is an economic transaction and asset has been exchanged with another asset. It will increase money supply in the economy.

4) False
The Fed has not intervened in the market in early period and allowed Bear Stearns as well Lehman Brothers to collapse. These investment banks have been involved in the financial instruments such CDOs which were too complicated and highly inflated.

5) False
The Fed can not directly decrease the inflation rate because it is a function of money supply in the market. The Fed can alter the money supply and in this case reduce it to lower the inflation.