1) List the 3 functions of money: 4) The Federal Reserve is the bank of the USA. It is considered from the Government and has 2 primary goals:

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1 AP ECONOMICS---Ippolito 2017 Study Guide for Monetary Policy (unit #4) Name: Due Friday December 8 th Multiple Choice Test (25 questions, 100 pts) 1) List the 3 functions of money: 2) What is liquidity? 3) List everything which is included in M2: 4) The Federal Reserve is the bank of the USA. It is considered from the Government and has 2 primary goals: Goal #1: Goal #2: 5) The Federal Reserve has 3 tools used to conduct monetary policy: Each tool is designed to change the money supply (MS) which, in turn, changes short term. 6) Assume the required reserve ratio is 20% and a bank holds no excess reserves Joe deposits $10,000 into Bank 1 Fill in the balance sheets below for each of the 3 banks which shows the effect of Joe s deposit BANK 1 BANK 2 BANK 3 Total Total Total Total Total Total *Assuming banks hold no excess reserves => answer the following: 7) Calculate the total increase in bank deposits caused by Joe s deposit (in the entire banking system) 8) Calculate the total increase in money supply caused by Joe s deposit 9) Calculate the total increase in required reserves caused by Joe s deposit (in the entire banking system) 10) During expansionary monetary policy state the appropriate actions on the following 3 tools of monetary policy: (specific action needed) Impact on Money Supply Reserve Requirement or Discount Rate or Open Market Operations or 11) Which is the most impactful tool of monetary policy in the real world which attempts to lower/target the Federal Funds Interest Rate. (currently 1.0%)

2 12) Assume the economy is in a inflationary gap and the current federal funds rate is 2.0% Draw the current market equilibrium on both graphs below & use appropriate labels on each graph AD/AS Graph Money Market Graph 13) The type of monetary policy called for in this situation: also called tight policy 3 steps of the monetary policy needed: Modify both graphs for the end result of this policy End Result: Effect on: Unemployment R-GDP Price Level: bank reserves MS This policy allows the Fed to achieve their goal of but it hurts their goal of 14) Explain why money supply (MS) is a vertical line in the Money Market graph? (right hand graph above) 15) When the Federal Reserve creates money supply, how does it impact Government debt? 16) What does the money demand (MD) represent in the money market graph and mention one event that would cause it to shift to the right. 17) The Loanable Funds market is very different from the Money Market graph. Supply curve in loanable funds represents: Demand curve in loanable funds represents: The loanable funds market allocates savings to business who need to borrow money for. The money market is impacted not by savings but by the quantity of created by the.

3 18) Liquidity Traps: In economics, when interest rates approach ZERO % it is known as a liquidity trap. That is if short term interest rates are already at zero, monetary policy becomes ineffective at stimulating Aggregate Demand since interest rates cannot go any lower. The Federal Reserve kept the federal funds rate at approximately zero percent between 2008 and December The Fed has raised the federal funds rate 4 times since then by 0.25% each time, so the current federal funds is 1.0% 19) Because the federal funds rate was already at 0.0%, the Federal Reserve used a policy known as quantitative easing between 2009 and 2015 to attempt to lower LONG term interest rates. However, remember in AP Econ the Fed only controls term interest rates. So in AP Econ there would be no such thing possible as quantitative easing. 20) Equation of Exchange is MV = PY M= V = P = Y = 21) The quantity theory of money (equation of exchange) is a separate theory outside of traditional monetary policy. Explain why this theory considers monetary policy to be ineffective in creating higher economic growth. Specifically, explain the impact of higher MS on all the variables in the equation of exchange. 22) Explain what the classical dichotomy is in terms of economic analysis. Why is it important Hint: see page of your textbook

4 Note: correct answers are in Bold 23. If the reserve ratio is 10 percent and a bank receives a new deposit of $4000, it will lead to a. an increase in required reserves of $400. b. an increase in excess reserves of $3,600 c. an increase in required reserves of $4,000 d. an increase in excess reserves of $4,000 e. Both A & B draw a fully labeled T-Account for your explanation 24. Under what circumstances would increasing the money supply be most effective in increasing real GDP? Interest Rates Unemployment Rate Business Optimism a. High Full Employment High b. High Above Full High c. Low Above Full High d. Low Full Employment Low e. Low Almost at Full Low Hint: what are animal spirits? (Keynes used this term) 25. If Joey puts $100,000 of cash into the local bank and the reserve requirement is 20%, then money supply will eventually increase by how much due to this deposit: a. $500,000 b. $400,000 c. $300,000 d. $100,000 e. none listed Show math in your explanation

5 26. If the Federal Reserve buys $20,000 of bonds from a bank and Joe puts $20,000 in the bank, explain the impact on bank deposits and money supply in the entire banking system. (Assume 10% r.r. & banks hold no excess reserves) a. Both bank deposits and money supply rise $40,000 b. Bank deposits rise by $40,000 money supply rise $36,000 c. Both bank deposits and money supply rise $400,000 d. Bank deposits rise by $400,000 money supply rise $360,000 e. None listed are true 27. According to the Quantity Theory of Money, an increase in money supply of 20% will lead to: a. Nominal GDP increasing 20% b. Real GDP increasing 20% c. Velocity falling by 20% d. Real GDP falling e. Both A & B are true TOTAL SCORE /30 PTS Excellent Work Very Good Work Good Work Try Harder