Write an 8-page essay on the following questions.
Short Essay Question I (20%, 1-2 pages)
How do economists define money? Explain. What are the three functions of money? Explain each. Explain the evolution of money from the 19th century to modern times. How can a rapid inflation degrade the ability of money to carry out its three functions? Explain.
Short Essay Question II (20%, 1-2 pages)
What are the principal uses of funds (assets) and sources of funds (liabilities) of banks? Explain each. What are the two potential problems inherent in our banking system? Explain each. What is a bank run? Explain. How can a bank run turn into a financial panic? Explain. How can the Federal Reserve prevent banking panics? Explain. How can a bank become insolvent? Explain. How can policy makers deal with banks/financial institutions that become insolvent? Explain.
Long Essay Question (60%, 4-6 pages)
What are the three instruments of monetary control? Explain. Why does the Federal Reserve prefer to use open market operations? Explain. How can the Federal Reserve use its open market operations to expand or contract the nation’s money and credit supply? Explain in some detail. Describe the workings of the Federal Open market Committee which controls monetary policy. Give a detailed account of how monetary policy works to change interest rates, aggregate demand, and the macroeconomy.
A. Conventional Monetary Policy, a Run-of-the-Mill Recession, a Depression Induced by a Financial Crisis
Use the diagram below, your knowledge of conventional monetary policy, a run-of-the-mill (an ordinary recession) recession, and depressions induced by financial crises to answer this part.
What is the natural interest rate Before the Financial Crisis? Explain. What would cause a Run-of-the-Mill Recession? Explain. How would the Federal Reserve use conventional monetary policy in a run-of-the-mill recession to achieve its policy goals by moving output back to potential? Explain. How could a financial crisis cause a Depression Induced by a Financial Crisis? In your answer to this part, explain how a financial crisis might cause both a large shift to the left of the IS Curve and change the slope of the IS Curve. Why would it be impossible to use conventional monetary policy in a Depression Induced by a Financial Crisis to return output to potential? Explain. Is reducing the interest rate to zero a mistake? Explain. What would happen if the Federal Reserve refused to reduce the interest rate when the IS curve collapses? Explain. Why might fiscal policy work to move output back to potential? Explain. What unconventional monetary policies might the Federal Reserve resort to for the purpose of returning output to potential? Explain.
B. The Coronavirus Crisis
Use the diagram below, your knowledge of the economic impact of the coronavirus crisis, and of the debate surrounding the economic impact of “opening up” the economy to answer this part.
Why might the IS Curve collapse due to the Coronavirus Crisis? Explain. If after the Coronavirus Crisis starts, the Fed leaves the interest rate at 3%, approximately how much does output and employment fall? If the Fed cuts the interest rate to zero in response to the Coronavirus Crisis, what is output and employment? Why might the Fed’s zero interest rate policy be ineffective? Explain. If we shut down non-essential output, what is output and employment? Explain. If we allow some non-essential businesses to open, shifting the Blue Line (the Government Constraint) to 19 trillion dollars, without convincing households and businesses that the health-threat of the virus is gone, what will happen to output and employment? Explain. Suppose we allow some non-essential businesses to open, shifting the Blue Line (the Government Constraint) to 19 trillion dollars, without convincing households and businesses that the health-threat of the virus is gone, and cut taxes to households and businesses, what is likely to happen to output and employment? Explain. Is there likely to be a way to return to high levels of output and employment without convincing households and businesses that the health threat is gone? Defend your answer.
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