Question

For Questions 3) True/False Explain Questions:

For each statement, state whether you believe the statement is true or false. Provide a brief explanation of your reasoning.

3) a) If the Federal Reserve commits to money supply growth of 2% per year, then the economy enters recession, it would be time consistent to keep the growth rate at 2%.

b) If households decide to deposit a larger portion of their cash in bank checking accounts, this has no immediate effect on the money supply (M1).

c) If households decide to deposit a larger portion of their cash in bank checking accounts, this has no effect on the money supply (M1) over time.

4) a) The ability of the Federal Reserve to set the federal funds rate is a good example of instrument independence.

b) When setting monetary policy, the Federal Open Market Committee targets short-term interest rates

c) Countries that use inflation targeting attempt to lower inflation expectations.

Answer 1

ANSWER:

3. a.   The general strategy is to increase money supply during periods of recession and reduce money supply during the periods of expansion. When the Federal Reserve Bank increases the money supply, it allows the banks to create new money through loans to private borrowers. As banks compete to make new loans, they will offer loans at lower interest rates. The new lower interest rates attract new borrowers. As a result, the lower interest rates increase investment spending, and aggregate demand increases. Therefore it would be consistent to keep the growth rate at the same percent. Hence the statement is TRUE.

b. M1= cash in circulation plus demand deposits (money held in checking accounts), plus travelers checks, plus other interest-bearing checking accounts.

If the household decide to keep a larger portion of their cash deposit in bank checking account then there is no immediate effect on M1 . The statement is True.

c. However, the household decide to keep a larger portion of their cash deposit in bank checking account over tome, the currency deposit ratio will increase. As a result of money multiplier, the total money supply will increase. Therefore this statement is False.

4.a. In the United States, the federal funds rate is the interest rate at which financial institutions lend reserve balances to other depository institutions. The federal funds target rate is set by the governors of the Federal Reserve, which they enforce by open market operations and adjustments in the interest rate on reserves. Therefore this is a good example of instrument independence. Hence this statement is TRUE.

b. The Federal Open Market committee is the policy making body of the Federal Reserve. While making monetary policy, the Federal Open market committee targets short term interest rate. So this statement is TRUE.

c. In many countries the central bank adopted the inflation targeting technique to control the inflation. Accordingly it predicts a targeted inflation rate and then attempts to steer actual inflation towards targeted inflation rate. Generally the targeted inflation rate will be less than the current inflation rate. Therefore, this statement is TRUE.