Money Banking Practice Questions and Answers

1.
What are the benefits of using a nominal anchor for the

conduct of monetary policy?
2. What incentives arise for a central bank to fall into the

time-inconsistency trap of pursuing overly expansion-
ary monetary policy? Because short-term gains such as output growth and decline in
unemployment. Also pressure by politicians
3. Why would it be problematic for a central bank to have
a primary goal of maximizing economic growth? Economic growth is strongly related to the decline
in unemployment because businesses will invest more and more in equipment if they see effective
use of human resources and need for equipment. So, having economic growth should not be
primary goal as we can reach that goal with reducing unemployment (alongside controlling prices)
which is called dual mandate. Also having eonomic growth as a primary goal would cause prices to
rise and inflation
4. “Since financial crises can impart severe damage to the
economy, a central bank’s primary goal should be to
ensure stability in financial markets.” Is this statement
true, false, or uncertain? Explain.
Uncertain. It is important but as financial crises are rare, only focusing on financial markets can cost
us neglecting other important problems such as unemployment, price stability and etc.
5. “A central bank with a dual mandate will achieve lower
unemployment in the long run than a central bank
with a hierarchical mandate in which price stability
takes precedence.” Is this statement true, false, or
uncertain? Explain.
False. Because unemployment can be prevented in the short run, not long run. Purpose of dual
mandate is to maintain price stability in the long run, but also focusing on reduction in
unemployment in the short run. There is no long-run trade-off between inflation and unemployment
6. Why is a public announcement of numerical inflation
rate objectives important to the success of an inflation-
targeting central bank?
- Transparency to the public and taking accountability of central bank. Otherwise (no public
announcement) Market participants and the public would have expectations about inflation, which
would drive price up
- Reducing pressure by politicians, which in turn reduces falling in the trap of time-inconsistency
7.Why does inflation targeting help reduce the time-

inconsistency of discretionary policy?
- Transparency to the public and taking accountability of central bank. Otherwise (no public
announcement)
- Reducing pressure by politicians, which in turn reduces falling in the trap of time-inconsistency
8. What methods have inflation-targeting central banks
used to increase communication with the public and
increase the transparency of monetary policy making?
Well-designed brochures, public info campaigns
9. Why might inflation targeting increase support for the
independence of the central bank to conduct monetary
policy?
Because pressure from politicians will decline as they take accountability
10. “Because inflation targeting focuses on achieving the
inflation target, it will lead to excessive output fluctua-
tions.” Is this statement true, false, or uncertain? Explain.
Uncertain. It might be, but not certain. a sole focus on inflation may lead to monetary policy that is
too tight when inflation is above target and thus may result in larger output fluctuations.
Inflation targeting does not, however, require a sole focus on inflation—in fact, experi-
ence has shown that inflation targeters display substantial concern about output fluctua-
tions. All the inflation targeters have set their inflation targets above zero. 3 For example,
currently, New Zealand, Canada, the United Kingdom, and Sweden set the midpoint of
their inflation target at 2%, while Australia has its midpoints at 2.5%
11. What are the key advantages and disadvantages of
the monetary strategy used at the Federal Reserve
under Alan Greenspan and Ben Bernanke in which the
nominal anchor is only implicit?
12. “The zero-lower-bound on short-term interest rates

is not a problem, since the central bank can just use
quantitative easing to lower intermediate and longer-
term interest rates instead.” Is this statement true, false,
or uncertain? Explain.
13. If higher inflation is bad, then why might it be advan-
tageous to have a higher inflation target, rather than a
lower target closer to zero?
14. Why aren’t most central banks more proactive at trying

to use monetary policy to eliminate asset-price bubbles?
15. Why would it be better to lean against credit-driven bub-
bles and clean after other types of asset bubbles crash?
16. According to the Greenspan Doctrine, under what
conditions might a central bank respond to a perceived
stock market bubble? As long as policymakers respond in a timely fashion, by easing monetary
policy aggressively after an asset bubble bursts, the harmful effects of a bursting bubble can be
kept at a manageable level. Indeed, the Greenspan Fed acted exactly in this way after
the stock market crash of 1987 and the bursting of the tech bubble in the stock market
in 2000. Aggressive easing after the stock market bubbles burst in 1987 and 2000 was
highly successful
17. Classify each of the following as either a policy instru-
ment or an intermediate target, and explain why.
Aggressive easing after burst of bubble
18. “If the demand for reserves did not fluctuate, the Fed
could pursue both a reserves target and an interest-rate
target at the same time.” Is this statement true, false, or
uncertain? Explain.
19. What procedures can the Fed use to control the federal
funds rate? Why does control of this interest rate imply
that the Fed will lose control of nonborrowed reserves?
20. Compare the monetary base to M1 on the grounds of
controllability and measurability. Which do you prefer
as an intermediate target? Why?
21. “Interest rates can be measured more accurately and
quickly than reserve aggregates; hence an interest
rate is preferred to the reserve aggregates as a policy
instrument.” Do you agree or disagree? Explain your
answer.
22. How can bank behavior and the Fed’s behavior cause
money supply growth to be procyclical (rising in
booms and falling in recessions)?
23. What does the Taylor rule imply that policymakers
should do to the fed funds rate under the following
scenarios?
a. Unemployment rises due to a recession.
b. #An oil price shock causes the inflation rate to rise by
1% and output to fall by 1%.
c. #The economy experiences prolonged increases in
productivity growth while actual output growth is
unchanged.
d. #Potential output declines while actual output
remains unchanged.
e. #The Fed revises its (implicit) inflation target down.

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What are the benefits and drawbacks of using an implicit nominal anchor for monetary policy?

What factors could cause money supply growth to be procyclical?

1.

What are the benefits of using a nominal anchor for the

2. What incentives arise for a central bank to fall into the

7.Why does inflation targeting help reduce the time-

12. “The zero-lower-bound on short-term interest rates

14. Why aren’t most central banks more proactive at trying

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