I. Multiple Choice (10 questions - 5 points apiece)

Select the best answer to each of the following questions. Place your response to each question in the space provided below. Only answers placed in blanks will receive consideration.

1. ______

2. ______

3. ______

4. ______

5. ______

6. ______

7. ______

8. ______

9. ______

10. ______

1) Concerning the Federal Reserve balance sheet:

A. Federal Reserve Notes and Discount Window loans are liabilities.
B. government securities and Federal Reserve notes are liabilities.
C. Federal funds borrowed and reserve accounts are liabilities.
D. government securities and discount window loans are assets.

2) Assuming a 10% reserve requirement, $2 billion of US Treasury bills purchased by the Fed from U.S. government security dealers results in a:

A. $2 billion increase in the monetary base.
B. $2 billion decrease in the monetary base.
C. $20 billion increase in the monetary base.
D. $20 billion decrease in the monetary base.

3) If the Federal Reserve buys government securities in the open market, all else the same, the supply of curve of money will shift to the:

A. left, and the interest rate will fall.
B. left, and the interest rate will rise.
C. right, and the interest rate will fall.
D. right, and the interest rate will rise.

4) An increase in the quantity of money

A. shifts the goods market aggregate supply curve to the right.
B. shifts the goods market aggregate demand curve to the right.
C. decreases real GDP.
D. decreases the price level.

5) The least frequently used tool of the Federal Reserve is the

A. tax rate on bank profits.
B. required reserve ratio for member banks.
C. buying and selling of government bonds.
D. interest rate charged by the Fed in bank lending.

6) The discount rate refers to the

A. interest rate that banks charge their best customers.
B. interest rate that the Fed charges on loans to commercial banks.
C. interest rate on interbank lending.
D. rate that bank insurers pay on insured deposits.

7) If the price level doubles, the

A. nominal demand for money rises.
B. nominal demand for money falls.
C. real money demand falls.
D. real money demand rises.

8) When interest rates rise, the demand for money falls because

A. people will buy more goods and hold less money.
B. the price level also rises and people reduce their demand for money.
C. people move funds from interest-bearing assets into money.
D. people shift funds from money holdings to interest-bearing assets.

9) Suppose that your cash holdings will buy 4 apples. All else the same, if the price of apples doubles, you will

A. reduce your money holdings because apples now are more expensive.
B. want to buy fewer apples and will double your cash holdings.
C. want to buy more apples and will halve your cash holdings.
D. double your money holdings to keep your real cash balance constant.

10) Which of the following actions best describes the correct sequence of events following an expansionary open market operation?

A. The Fed sells government bonds, which lowers bank reserves, leading to a drop in lending, leading to a reduction in the money supply.
B. The Fed sells government bonds, which raises bank reserves, leading to an increase in lending, leading to an increase in the money supply.
C. The Fed buys government bonds, which lowers bank reserves, leading to an increase in lending, leading to an increase in the money supply.
D. The Fed buys government bonds, which raises bank reserves, leading to an increase in lending, leading to an increase in the money supply.

II. Problem Solving (25 points)

Provide numerical answers to the following questions, using the balance sheets provided below. Partial credit will be given if applicable, so you need to show all work involved in your calculations. Please circle your final answer to each question. If you need more room, use the back side of this page.

Answer the following questions, using the information provided below:

1) The initial level of monetary base.
2) The initial level of the M1 money supply.
3) The excess reserves of the banking system.

Suppose now that Federal Reserve makes an open market purchase of $2000. Calculate
4) The eventual increase in the money supply if the public makes no currency transaction.
5) The eventual increase in the money supply if the public keeps the current currency ratio constant.
 
Federal Reserve Banking System
Foreign Exchange 1000 Reserve Accts. 2000 Reserve Accts 2000 Check. Dep 20000
Loans to bank 600 Currency 8000 Vault Cash 2000 Other Liab. 40000
Govnt Securities 10000 Net Worth 1600 Loans 50000 Borrowed Res. 600
Securities 10600 Net Worth 4000

NOTE: A 20% reserve requirement ratio is in effect for all checkable deposits.

II. Essay (25 Points)

Answer the following question. Use the back of this sheet if necessary. If you need additional space, see me for an additional sheet.

Suppose the Fed wanted to increase aggregate demand in the economy in order to lessen the effects of high unemployment. Explain what specific steps/actions it could take with its various monetary policy tools. Then trace through the effects of these actions in the money market and in the goods market by explaining how interest rates, output, and prices will be affected. Finally, would this policy be helped or hindered by a simultaneous contractionary fiscal policy, and why?