Download Answer Key--Fiscal and Monetary Policy Practice

Fiscal and Monetary Policy Practice Problems
1.
Name _________________________
What is the Fed (Federal Reserve Board)’s main tool for controlling interest rates and the money supply in the economy? Explain.
Open Market Operations (buying/selling of Treasuries). Such Open Market Operations can be used to increase or decrease the money
supply, the amount of money in the economy, which in turn affects short-term interest rates. Taking money out of the economy makes
money scarcer and leads to higher interest rates. Putting money into the economy makes money less scarce, causing interest rates to fall.
2.
What are the two tools of Fiscal Policy? How do they work?
Of course, Fiscal Policy refers to actions by CONGRESS. Taxes and Government Spending are the two things Congress controls. If
Congress wants to speed up the circular flow with expansionary policy it can cut taxes and/or increase government spending. To slow
down the economy, it can raise taxes and/or decrease government spending.
Interpret the following statistics and use this information to answer the questions below:
2001
2002
2003
Unemployment Rate
6%
4%
3%
CPI (Inflation Rate)
5%
7%
10%
GDP Growth Rate
+7%
+9%
+10%
3. What is the economic problem facing this economy? What type of monetary policy and what specific tools could be used to correct
this problem?
The circular flow is moving too fast, which is leading to high INFLATION. The FED is in charge of monetary policy and it could use
“loose” monetary policy by first raising the discount rate (minor tool) and then selling treasury bonds through Open Market Operations
(major tool) which will decrease the supply of money and lead to higher interest rates. This in turn will deter people from borrowing and
spending and will reduce Aggregate Demand.
4. What kind of fiscal policy and what specific tools could be used to correct this economy?
Fiscal policy = Congress, so Congress would use contractionary policy and the tools that would be used would be a) raising taxes and b)
cutting government spending
Interpret the following statistics use this information to answer the question below:
Unemployment Rate
CPI (Inflation Rate)
GDP Growth Rate
2000
4%
5%
+7%
2001
6%
3%
+4%
2002
9%
2%
+3%
5. What is the economic problem facing this economy? What types of monetary policy and what specific tools could be used to correct
this problem?
Economic growth is slowing down and, most alarmingly, the unemployment rate is skyrocketing. The Fed could use “tight” monetary
policy by raising the discount rate and buying treasury bonds (thus increasing the money supply which would then lead to lower interest
rates).
6. What type of fiscal policy and what specific tools could be used to correct this economy?
Congress could use expansionary fiscal policy by cutting taxes and increasing government spending.
NAME:
_______________________________________________________
Economic Problem #1:
Unemployment is at 3.9%. The GDP grew at a rate of 5.5% last quarter and inflation is at 9%. As a member of Congress you must, formulate a policy
that will address this problem.
A.
Draw the Aggregate Demand Curve and the Aggregate Supply Curve that reflects the state of this economy.

Label each axis of your graph.
B.
Explain in writing (minimum three sentences) what type of policy you will use AND the specific policy tools (actions) you will use.
Be sure to explain the specific effects you expect from the actions you propose.
C.
Illustrate the change graphically and label any new curves.
Economic Problem #2
Unemployment is at 12.7%. The Gross Domestic Product grew at a rate of 0.1% last quarter and inflation is at 0.3%. As a member of the Federal
Reserve Board of Governors what policy would you implement in this economy?
A.
Draw the Aggregate Demand Curve and the Aggregate Supply Curve that reflects the state of the economy described above.

Label each axis of your graph.
B.
Draw the Money Market graph (Money Demand Curve & Money Supply Curve)
Label each axis of your graph.
C.
Discuss in writing (minimum three sentences) what type of policy the Fed would use and the two specific steps the Fed would take to solve this
economic problem. In your answer, be sure to explain the SPECIFIC actions the Fed would need to take to implement this policy, and explain
how its actions would ultimately affect Aggregate Demand.
D.
Illustrate graphically the changes that the Fed’s actions would have on the two graphs.