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Study Tips—Exam II
Money and Banking (Econ. 402)
Spring 2009, Washington University
Mr. Vaughan
“Fair Game” Material:
 Barro, chapters 6-11 and supporting lecture (excluding chapter 9, pp. 210-228)
 Friedman and Schwartz (F&S), chapters 7.6-10
 No WSJ Alerts
Exam Format:
Exam II will have three components, each worth roughly one-third of total points: (a) one essay taken
verbatim from the list of F&S questions over chapters 7.6-10 (see below), (b), the textbook/lecture essay
on page 2 of this study sheet verbatim (see below), and (c) roughly 20 objective questions (multiplechoice or true/false) covering all reading and lecture (see below)
F&S Essay Questions:
1. (Chapter 7.6-7.7) According to F&S, what alternative policies – if implemented at specific times
from 1930-33 – would have arrested the economic contraction? Why would these policies have
worked? Why were such policies not pursued (i.e., why was monetary policy so inept)?
2. (Chapter 8) In chapter one, F&S assert “[m]ajor changes in both the banking structure and the
monetary system resulted from the Great Contraction. In banking, the major change was the
enactment of federal deposit insurance in 1934. This probably succeeded, where the Federal Reserve
Act failed, in rendering it impossible for a loss of public confidence to produce a widespread banking
panic involving severe downward pressure on the stock of money; if so, it is of greatest importance
for the subsequent monetary history of the United States (p. 11).” Write an essay making this case.
NOTE: “Making the case” means explaining what the Fed was created to do (in re “an elastic
currency”), what it could have done in the 1930s (in general terms), how (in principal) the FDIC
produces the same outcome, and how successful the FDIC has been. [Hint: Think about the
number of bank failures and stability of the money multiplier since 1934.]
3. Chapter (9) What was the Fed’s excuse for not stemming the 1929-1933 contraction and preventing
the banking panic? How did the Fed’s structure and powers change with the Banking Act of 1935?
Why are these changes ironic? Did the Fed use its new powers wisely in the late 1930s? Explain.
4. Chapter (9) Discuss the economic recovery of 1933-1937. What is notable about the recovery (two
features)? What explains the “incompleteness” of the recovery? Specifically, what happened to (a)
money, (b) velocity, (c) prices (implicit NNP deflator), and (d) real output (NNP in constant prices)?
What accounted arithmetically for the overall change in the money stock? What explains movement
in the money-stock determinant(s)? What role (if any) did explicit Federal Reserve measures play in
“monetary ease” during this period? What role did bank lending play in the recovery?
NOTE: The goal of this question is to get you to think about the role specific policies played in
the 1933-37 recovery and what (if any) lessons might apply to the current economic situation.
5. (Chapter 9) F&S use the Fed’s doubling of reserve requirements in the late 1930s to help make their
case that the money plays an independent causal role in economic fluctuations. Exactly what did the
Fed do, why did the Fed do it, what effect did the policy action have on the money stock, and what
effect did the policy action have on the real economy? Why is this particular action so important to
making the case that money can be causal (i.e. why does this episode serve as a persuasive “natural
experiment”)?
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6. (Chapter 10) Write an essay describing/explaining the behavior of the money supply and the price
level between 1939 and 1948. What role did the Fed’s support of bond prices play in the behavior of
money and prices? Who really conducted monetary policy – the Treasury of the Fed? Explain. How
did the World War II experience differ from the World War I experience? What special factors kept
monetization of the deficit in World War II from producing a larger inflation rate?
Lecture/Textbook: This question will appear verbatim on your exam.
1. Consider the complete Barro (equilibrium) model of the business cycle. Assume the central bank
partially accommodates changes in money demand (i.e., the money-supply curve is positively sloped
in the money market, when the price level in on the vertical axis and money is on the horizontal axis.
Also, assume the labor-supply curve is positively sloped (i.e., the substitution effects of a change in
real wages outweigh the income effects). Suppose shocks to the economy take the form of longlasting but not permanent technology shocks.
a)
Trace the impact (words/graphs) of a negative technology shock on the following variables: real
GDP, real consumption, real net investment, real wages, employment/hours works, real rental
price of capital, capacity utilization, interest rate, money stock, and the price level.
b)
What impact does the shock have on aggregate economic welfare? Is stabilization policy
welfare-improving? Explain.
c)
Assess the empirical success of the model (from Barro’s perspective). The model is far from
realistic in that does not include many real-world institutions. Why does this lack of realism not
bother Barro? What does this empirical success imply about the need for stabilization policy?
d)
Critically evaluate the equilibrium model from a theoretical and empirical perspective.
2. Objective Questions: These will be multiple-choice or true/false questions that involve working
with the Barro model. A specific shock will be identified and you will be asked to work through it.
The questions will cover all reading and lecture in the sense you will have to integrate all you have
learned.
For example (as above), assume the central bank partially accommodates changes in money demand
(i.e., the money-supply curve is positively sloped in the money market, when the price level in on the
vertical axis and money is on the horizontal axis. Also, assume the labor-supply curve is positively
sloped (i.e., the substitution effects of a change in real wages outweigh the income effects).
Trace the impact (words/graphs) of each of the following shocks on: real GDP, real consumption, real
net investment, real wages, employment/hours works, real rental price of capital, capacity utilization,
interest rate, money stock, and the price level.
a) Increase/decrease in the money supply (or rate of monetary growth).
b) Permanent (temporary) technology shock.
c) Permanent increase (decrease) in taste for saving out of current income
d) Permanent increase (decrease) in taste for working (from a given allocation of time)
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