Download Monetary Policy Worksheet

Monetary Policy Worksheet
This worksheet is almost identical to the Fiscal Policy worksheet. However the tools of Fiscal Policy are different than that
of Monetary Policy. Monetary Policy is controlled by the FED and controls/regulates the banking system of the United
States. It has nothing to do with taxing and spending.
For each of the situations listed below, decide if you would use Easy-Money policy, Tight-Money policy, moral persuasion,
or do nothing.
1. If you use Easy-Money policy (expansionary monetary policy) you are trying to grow the economy and create
more jobs by increasing the money supply. In reality the FED would do this by lowering the reserve requirement,
buying government bonds and securities through open market operations, and/or lowering the discount rate
2. If you use Tight-Money policy (contractionary monetary policy) you are trying to slow the economy down in
order to fight inflation or prevent the economy from over heating and collapsing. The FED would do this by
reducing the money supply. Money can be sucked out of the economy by raising the reserve requirement, selling
government bonds and securities through open market operations, and/or raising the discount rate.
3. Moral persuasion can be used by the Federal Reserve Chairman when he reports to the American people on the state
of the banking system and encourage people and banks to either save more or spend less.
4. Doing nothing = the economy is perfect so we will do nothing.
Questions:
1. Stock prices have declined for the last two weeks.
2. GDP dipped from 3 percent to 1 percent in the last year.
3. The CPI and PPI have risen 3 percent in the last six months.
4. Commercial interest rates are rising, but the FED has not raised rates.
5. The prices of cars have tripled in the last year.
6. GDP is growing steadily, and prices are rising sharply.
7. The United States is experiencing both high inflation and high unemployment.
8. The CPI is up, and housing starts are at a fifteen-year high.
9. We are in a recession. Factory orders are down, and the economy appears to be slumping.
10. Consumers feel worried, inflation is low and spending is sluggish.
11. Unemployment is low and prices are rising steadily.
12. The index of leading economic indicators shows a strong move towards inflation.
13. The FED senses that people are not saving money.
14. Jobless rates are pushing 11 percent while the CPI has fallen from 8 percent to 2 percent growth.
15. We are in a recession but are experiencing high inflation.
16. The money supply appears to be tight, and prices are on the rise.
17. Prices are stable, and the GDP is growing at a 3 percent pace.
Monetary Policy Worksheet
1. If you use Easy-Money policy you are trying to grow the economy and create more jobs by increasing the money supply.
In reality the FED would do this by lowering the reserve requirement, buying government bonds and securities through open
market operations, and/or lowering the discount rate
2. If you use Tight-Money policy you are trying to slow the economy down in order to fight inflation or prevent the
economy from over heating and collapsing. The FED would do this by reducing the money supply. Money can be sucked
out of the economy by raising the reserve requirement, selling government bonds and securities through open market
operations, and/or raising the discount rate.
3. Moral persuasion can be used by the Federal Reserve Chairman when he reports to the American people on the state of
the banking system and encourage people and banks to either save more or spend less.
4. Doing nothing = the economy is perfect so we will do nothing.
Here are the questions and answers:
1. Stock prices have declined for the last two weeks. (A= Do nothing - the stock market is not one of the major
economic indicators. It will rise or fall if the wrong person sneezes! Hah Choooo!!!!)
2. GDP dipped from 3 percent to 1 percent in the last year. (A= Easy-Money Policy - this means the economy is slowing
down and needs a shot in the arm to keep it going.)
3. The CPI and PPI have risen 3 percent in the last six months. (A= Tight-Money Policy - remember that CPI and PPI
are price indexes that are designed to measure inflation. If they are going up it means that inflation is increasing. In one
years time prices might rise 6% at this rate if people continue to spend as much money as they are now. You must suck
money out of the economy in the hopes that prices will come down as people by less. Tight-Money Policy should result in
increasing the amount of interest people must pay when they borrow money. If you have to pay more to borrow money then
you have less money to spend. If people spend less then prices should decrease over time and the CPI and PPI should drop)
4. Commercial interest rates are rising, but the FED has not raised rates. (A= Easy-Money Policy - This situation
applies to our current economic conditions. The banks are afraid to loan out money and as a result interest rates are going
up. The FED can combat this problem by allowing the banks, such as Bank of America or SunTrust, to borrow money from
the Federal Reserve at cheaper rates or lowering the reserve requirement which will allow them to loan out a greater
percentage of their reserve cash. After the FED takes this action it is hoped that the interest rates banks charge their
customers pay for all types of loans and credit cards should be reduced)
5. The prices of cars have tripled in the last year. (A= Do nothing. Most students get this question wrong. The thing you
have to remember is that we only look at the major economic indicators. If the price of cars has tripled as a result of inflation
through out the economy it will show up as an increase in the Consumer Price Index CPI or the Producer Price Index PPI. If
they go up then we worry. If ONLY the price of cars is going up we don't worry at all. After all, the price could be going up
as a result of tougher safety standards or new luxury gadgets that everyone wants.)
6. GDP is growing steadily, and prices are rising sharply. (A = Tight-Money Policy - the key to this question is the term
"prices." The question does not say the price of one product or service it just says "prices" in general. This is a code word
for an increase in CPI/PPI and the inflation rate. You must put the breaks on inflation by sucking money out of the
economy. Yes.....this will hurt GDP and cause some people to lose their jobs but it must be done or the economy could suffer
a major crash later on.)
7. The United States is experiencing both high inflation and high unemployment. (A= Tight-Money Policy.
AAAHHGG!!!! This is the nightmare scenario!!!! In this situation you must assume that the high inflation has caused the
high levels of unemployment. Therefore you must reduce the amount of money available consumers by using the tools of
Tight-Money policy to destroy the inflation. Doing this will probably mean that people will hate you because they will think
they need more money to survive the inflation. In reality if you used Easy-Money Policy you would only make inflation
worse and the economy would spiral into a larger recession or depression. The good news is that unlike politicians you are
appointed by the president and your board members are only appointed every 14 years. That makes you immune to most
public opinion concerns and allows you to do the right thing without fear of being thrown out of your job by the public.
Chances are in the next 14 years the economy will improve!)
8. The CPI is up, and housing starts are at a fifteen-year high. (A= Tight-Money Policy. The CPI going up is a sign of
inflation. Housing starts, meaning new home construction, at a fifteen year high is a sign that the economy is growing to fast
and may be over heating. If it over heats inflation will get worse and the economy will crash. So we need to decrease the
money supply to slow the economy down a little bit.
9. We are in a recession. Factory orders are down, and the economy appears to be slumping. (A= Easy-Money Policy
- A recession means two quarters of negative growth in GDP. Use this policy to increase the money supply and allow the
banks to loan more money and the bank customers to spend more money on credit. When people spend more money more
aggregate demand increases. Greater demand = a need for more jobs. More jobs= more money and a growing economy!)
10. Consumers feel worried, inflation is low and spending is sluggish. (A= Moral Persuasion - In this situation you don't
have any hard numbers or economic indicators saying that the economy is in bad shape. All you have is polling data showing
that consumers are scared that the economy is going to go down in the future and they are not spending as much money. This
is a time when a popular and trusted Federal Reserve Chairman can make a difference by reassuring people that things are
going to be okay and they just need to relax and take their families out to dinner or go buy a plasma TV. I WOULD LOVE
TO HAVE A PLASMA TV!!!! Sometimes that's all it takes to keep the nations economy on the right track! YES....even if
YOU have never heard of them...business leaders and adults will listen to a Federa Reserve Chairman who has a proven track
record of guiding the economy out of trouble!)
11. Unemployment is low and prices are rising steadily. (A= Tight-Money Policy - this is a very similar situation to
question #8. Please see #8 for an explanation.)
12. The index of leading economic indicators shows a strong move towards inflation. (A= Tight-Money Policy - leading
economic indicators is code language for the Consumer Price Index,CPI, and the Producer Price Index, PPI. We need to take
money out of the economy on the assumption that this is demand-pull inflation. Demand-pull inflation is caused by people
having so much money to spend that producers can not keep up with demand. As a result prices rise for all products.
If you take enough money out of the economy the inflation should go away.)
13. The FED senses that people are not saving money. (A=Moral Persuasion - Get on TV and tell the people they need to
save more money. "Good evening my fellow Americans. I want you to save more money! Trust me, you will be glad you
did!)
14. Jobless rates are pushing 11 percent while the CPI has fallen from 8 percent to 2 percent growth. (A= EasyMoney Policy - In this situation we are recovering from a period of high inflation that has caused large scale unemployment.
Now that the inflation is gone we can allow the banks to loan more money out to customers to encourage job growth and try
to get the unemployment rate back down to 5%)
15. We are in a recession but are experiencing high inflation. (A= Tight-Money Policy - See question #7 for an
explanation.)
16. The money supply appears to be tight, and prices are on the rise. (A= Tight-Money Policy - the money supply may
be tight but we are going to have to suck more money out to kill the inflation. THE INFLATION MUST DIE!!! AT ALL
COST!!!! See #7 for further explanation!)
17. Prices are stable, and the GDP is growing at a 3 percent pace. (A= Do nothing. If its not broke don't fix it! If you
are the Chairman of the Federal Reserve this is a good time to go on holiday because no one will be screaming for you to
help them today. Put on your sun glasses and go to the beach!!!)