Question

1. If the federal reserve pursues a contractionary monetary policy, output and the price level will change in which of the following ways in the short run?

A) Output – Increase; Price Level - Increase

B) Output - Increase; Price Level - No change

C) Output - Increase; Price Level - Decrease

D) Output - Decrease; Price Level - Decrease

E) Output - Decrease; Price Level - Increase

2. To counteract a recession, the Federal Reserve should

		buy securities on the open market and raise the reserve requirement
		buy securities on the open market and lower the reserve requirement
		buy securities on the open market and raise the discount rate
		sell securities on the open market and raise the discount rate
		raise the reserve requirement and lower the discount rate

3. Suppose the required reserve ratio is 20 percent and a single bank with no excess reserves receives a $100 deposit from a new customer. The bank now has excess reserves equal to

		$20
		$80
		$100
		$400
		$500

4. The purchase of securities on the open market by the Federal Reserve will
      
A) increase the supply of money
      
B) increase the interest rate
      
C) increase the discount rate
      
D) decrease the number of Federal Reserve notes in circulation
      
E) decrease the reserve requirement

Answer 1

Question 1

Contractionary monetary policy leads to decrease in the money supply.

When the money supply decreases, interest rates rises.

This leads to increase in cost of borrowing for businesses and households.

This lead to fall in investment spending and consumption spending. Due to this, there is decrease in aggregate demand.

Given the aggregate supply, decrease in aggregate demand leads to fall in output and price level.

So,

In short-run, output decreases and price level decreases.

Hence, the correct answer is the option (D).

Question 2

To counteract recession, Fed has to induce aggregate demand.

To increase aggregate demand, Fed pursues expansionary monetary policy.

Expansionary monetary policy includes buying of securities in the open market and lower the reserve requirement.

Hence, the correct answer is the option (2).

Question 3

New deposit = $100

Required reserve ratio = 20% or 0.20

Required reserves = $100 * 0.20 = $20

Excess reserves = New deposit - Required reserves = $100 - $20 = $80

The bank now has excess reserves equal to $80.

Hence, the correct answer is the option (2).

Question 4

The purchase of securities on the open market by the Federal Reserve leads to increase in reserves with banks.

This increase in reserves make the banks to lend more leading to an increase in the money supply.

Hence, the correct answer is the option (A).