Problem 1
What is the basic determinant of \((a)\) the transactions demand and \((b)\) the asset demand for money? Explain how these two demands can be combined graphically to determine total money demand. How is the equilibrium interest rate in the money market determined? Use a graph to show the effect of an increase in the total demand for money on the equilibrium interest rate (no change in money supply). Use your general knowledge of equilibrium prices to explain why the previous interest rate is no longer sustainable.
Problem 2
What is the basic objective of monetary policy? What are the major strengths of monetary policy? Why is monetary policy easier to conduct than fiscal policy?
Problem 3
Distinguish between the federal funds rate and the prime interest rate. Why is one higher than the other? Why do changes in the two rates closely track one another?
Problem 5
Suppose that you are a member of the Board of Governors of the Federal Reserve System. The post- 2008 economy is experiencing a sharp rise in the inflation rate. What change in the federal funds rate would you recommend? How would your recommended change get accomplished? What impact would the actions have on the lending ability of the banking system, the real interest rate, investment spending, aggregate demand, and inflation?
Problem 6
Explain the links between changes in the nation's money supply, the interest rate, investment spending, aggregate demand, real GDP, and the price level.
Problem 7
What do economists mean when they say that monetary policy can exhibit cyclical asymmetry? How does the idea of a liquidity trap relate to cyclical asymmetry? Why is this possibility of a liquidity trap significant to policymakers?
