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Review Questions
5. Monetary policy in the United States is determined by the Federal Reserve System. The
President appoints the seven members of the Board of Governors of the Federal Reserve System,
including the chairman, but otherwise has no direct influence on monetary policy.
6. Means of controlling the money supply other than open-market operations include:
(1) Reserve requirements. An increase in reserve requirements forces banks to hold more reserves,
increasing the reserve-deposit ratio, thus reducing the money multiplier. With a lower money
multiplier, the money supply is reduced for a given size of the monetary base.
(2) Discount window lending. A reduction in discount window lending, which may be caused by
the Fed increasing the discount rate or by the Fed refusing to lend, causes a reduction in banks’
reserves, decreasing the monetary base. Also, a higher discount rate may lead banks to choose a
higher reserve-deposit ratio, so the money multiplier declines. Both effects reduce the money
supply.
7. Intermediate targets are macroeconomic variables that the Fed cannot directly control, but can
influence fairly predictably, and that are related to the ultimate goals of monetary policy. The
ultimate goals of monetary policy are achieving price stability and promoting stable growth of
aggregate economic activity. Since the Fed can’t control its ultimate goals directly, it influences
its intermediate targets as a method for achieving those goals. The two principal intermediate
targets that the Fed has used in the past are monetary aggregates and short-term interest rates,
such as the Fed funds rate.
8. The three channels of monetary policy transmission are the interest rate channel, the exchange
rate channel, and the credit channel. The interest rate channel arises because tighter monetary
policy raises the real interest rate, which reduces aggregate demand, leading to lower output and
prices. The exchange rate channel comes about as tighter monetary policy raises the real
exchange rate, leading to lower net exports, which reduces aggregate demand and thus reduces
output and prices. The credit channel occurs when tighter monetary policy reduces the supply of
credit, as banks lend less, and the demand for credit, as firms and consumers borrow less. With
less borrowing and lending, consumption and investment decline, so aggregate demand falls,
leading to declines in output and prices.