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CHAPTER FIFTEEN
MONETARY POLICY
CHAPTER OVERVIEW
The objectives and the mechanics of monetary policy are covered in this chapter. It is organized
around seven major topics: (1) the balance sheet of the Federal Reserve Banks; (2) the
techniques of monetary policy; (3) a graphic restatement of monetary policy; (4) the cause-effect
chain of monetary policy; (5) a survey of the advantages and disadvantages of monetary policy;
(6) the dilemma of which targets should be the goal of monetary policy, interest rates, or money
supply; and (7) the impact of monetary policy operating in a world economy. Finally, there is a
brief, but important, synopsis of mainstream theory and policies. The purpose of the concluding
sections is to summarize all the macro theory developed so far and fit the pieces together as an
integrated whole for students.
INSTRUCTIONAL OBJECTIVES
After completing this chapter, students should be able to
1. Identify the goals of monetary policy.
2. List the principal assets and liabilities of the Federal Reserve Banks.
3. Explain how each of the three tools of monetary policy may be used by the Fed to expand
and to contract the money supply.
4. Describe three monetary policies the Fed could use to reduce unemployment.
5. Describe three monetary policies the Fed could use to reduce inflationary pressures in the
economy.
6. Explain the cause-effect relationship between monetary policy and changes in equilibrium
GDP.
7. Demonstrate the money market graphically and show how a change in the money supply
will affect the interest rate.
8. Show the effects of interest rate changes on investment spending.
9. Describe the impact of changes in investment on aggregate demand and equilibrium GDP.
10. Contrast the effects of an easy money policy with the effects of a tight money policy.
11. Identify the federal funds rate, its relation to the prime interest rate, and its importance for
monetary policy.
12. List two strengths and three shortcomings of monetary policy.
13. Describe the arguments for and against “inflation targeting” versus a more discretionary
“artful management” approach to monetary policy.
14. Explain the net export effect of an expansionary and a contractionary monetary policy.
15. Define and identify the terms and concepts at the end of the chapter.