1. For each of the following shocks, describe how monetary policy makers would respond (if at all)
to stabilize economic activity. Assume the economy starts at a long run equilibrium.
a. Consumers reduce autonomous consumption.
No Policy Change
1) Explain the process of open market purchase from a Bank by $200 million on Banking
systems T-accounts, FEDs T-accounts, monetary base and money supply.
1. Fed buys 200 m of bonds from bank
2. Bank cashes check with Fed or cashes it in for cu
1. Explain the Keynesian theory of money demand. What motives did Keynes think
determined money demand? What are the two reasons why Keynes thought velocity
could not be treated as a constant?
(Liquidity Preference Theory) Three Motives:
1) Explain the effect of open market purchase on federal fund rate and equilibrium reserve using
diagram (use both cases).
Open Market Purchase will cause the IFF and equilibrium to fall. (Ex. Pg 359 and notes)
Open Market Sail will cause the
1. What is the present value of the cash flow of $600 after two years with rate of interest 8%?
600/ (1.08)^2 = $514.40
2. Suppose you buy a bond with $27 and get $216 after three years. What is the rate of interest on this
1. Describe the relationship of inflation, real rate of interest and FEDs monetary policy to draw the
monetary policy curve.
Because the government is constantly trying to stabilize inflation, they follow the Taylor Principle
where they raise n
1. Draw AD curve. Explain why the slope of AD curve is negative.
AGGREGATE DEMAND: consumption expenditure + planned investment spending +
government purchases + net exports (C+I+G+NX).
It is downward sloping because if Inflation rises, the gov
1. Suppose, FED sells 100 Euro in the foreign exchange market. How does it affect the FEDs Taccount? How does it affect the foreign exchange rate (Discuss both sterilized and unsterilized
foreign exchange intervention) and money supply?
1. If public expects the FED to pursue a policy that is likely to raise short term interest rates
permanently to 12% but the FED does not go through with this policy change, what will happen
to long run interest rates? Explain your answer.
1. Derive the equation of IS curve step by step. Draw the IS curve and discuss why it has a negative
slope using the equation of IS curve.
Equation for IS curve:
Y=(C+I+df+NE+G-mpc x T)/(1-mpc)
2. Explain how could you relate t