Download Chapter 16 Practice Problems 1. What are the Federal Reserve`s

Chapter 16 Practice Problems
1.
What are the Federal Reserve’s goals? How are Fed officials held accountable for
meeting them?
The goals of the Federal Reserve, as set by Congress are to “maintain long run growth of the
monetary and credit aggregates commensurate with the economy's long run potential to increase
production, so as to promote effectively the goals of maximum employment, stable prices, and
moderate long-term interest rates." The Fed’s officials release large amounts of information in
order to maintain accountability. After each of the meetings of the FOMC, the target interest rate
is released immediately, along with a brief statement. Minutes and transcripts of the meetings
are also eventually made public. Members of the FOMC give public speeches and the chair
reports to Congress and twice a year.
2.
While the chair of the Federal Reserve Board has only one of 12 votes on the FOMC, he
is never in the minority. What gives him the power to control the committee?
The Chair controls the staff of the Board of Governors that produces the material distributed to
the Committee members prior to the meeting; he controls the agenda of the meeting; he controls
when people speak; and he is the first to make a policy recommendation.
3.
Why might eliminating the Fed’s independence lead to a more pronounced political
business cycle?
The political business cycle occurs when sitting members of the government manipulate
economic policy to increase their chance of re-election. For instance, a sitting president may
attempt to increase spending during the year leading up to his re-election. The increase in
spending may stimulate the economy, raise real GDP, decrease unemployment, and increase his
chances of re-election. Since the Fed is not elected, there is less reason to believe they act this
way (although many still claim that the Fed does try to please sitting politicians and hence there
may still be a monetary political business cycle). If monetary policy were under control of
politicians, then they would have one more tool to induce a political business cycle. Indeed, the
impacts of monetary policy are likely to be felt more quickly than fiscal policy so politicians may
find it easier to manipulate monetary policy than fiscal policy.
4.
The Fed promotes secrecy by not releasing the minutes of the FOMC meetings to
Congress or the public immediately. Discuss the pros and cons of this policy.
The argument for not releasing the FOMC directives immediately is that it keeps Congress off
the Fed’s back, thus enabling the Fed to pursue an independent monetary policy that is less
subject to inflation and political business cycles. The argument for releasing the directive
immediately is that it would make the Fed more accountable.
5.
Suppose the Fed buys $1 million of bonds from the First National Bank. If the First
National Bank and all other banks use the resulting increase in reserves to purchase securities
only and do not make loans, what will happen to checkable deposits?
The $1 million purchase of bonds increases reserves in the banking system by $1 million, and the
total increase in checking accounts by $10 million (assuming the simple money multiplier and a
10% required reserve ratio). The fact that banks buy securities rater than make loans with their
excess reserves makes no difference in the multiple deposit creation process.