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Monetary Policy Flashcards

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  1. Which of the following best describes the 'Taylor Rule' in the context of monetary policy?

    Answer: A formula guiding how the central bank should set interest rates based on inflation and output gaps

    The Taylor Rule recommends adjusting the federal funds rate in response to deviations of inflation from target and output from potential.

  2. If a central bank is described as 'independent,' this most directly means:

    Answer: It sets monetary policy free from direct political control by the government

    Central bank independence means monetary policy decisions are insulated from short-term political pressures, supporting credibility.

  3. How does an increase in the money supply affect the aggregate demand curve in the short run?

    Answer: AD shifts right due to lower interest rates stimulating spending

    More money lowers interest rates, boosting investment and consumption, which shifts the AD curve to the right.

  4. In the long run, most economists agree that an increase in the money supply primarily leads to:

    Answer: A proportional rise in the price level with no lasting change in real output

    Money is neutral in the long run — prices adjust fully, so only the price level rises while real variables return to their natural rates.

  5. Which of the following is an example of the Fed using forward guidance as a monetary policy tool?

    Answer: Publicly committing to keep rates near zero for an extended period to influence expectations

    Forward guidance shapes market expectations about future policy, influencing long-term rates and economic decisions today.

  6. The demand for money is primarily driven by which two motives in macroeconomic theory?

    Answer: Transactions demand and asset (speculative) demand

    People hold money to conduct everyday transactions and as a store of value or speculative asset, forming the two main components of money demand.

  7. If the Federal Reserve raises the reserve requirement from 10% to 20%, what happens to the money multiplier and the money supply?

    Answer: Multiplier falls and money supply contracts

    A higher reserve requirement means banks keep more funds in reserve, reducing the multiplier (from 10 to 5) and shrinking the money supply.