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Midterm Exam
Economics 333
Money and Banking
Thursday, October 21st, 2008
Multiple choice 4 points each
1. The Peoples Bank of China increases its required reserve ratio. This increases
the demand for reserves by banks and also increases the reserve to deposit
ratio. If the Peoples Bank has a policy of targeting the inter-bank interest rate,
this results in
a. an increase in the monetary base and an increase in the money
multiplier
b. an increase in the monetary base and a decrease in the money
multiplier
c. a decrease in the monetary base and an increase in the money
multiplier
d. a decrease in the monetary base and a decrease in the money
multiplier.
___________
2. Assume uncovered interest parity is true. Holding the foreign interest rate
constant, an increase in market expectations of the future exchange rate (St+1)
result in
a. an appreciation in the current exchange rate under an interest rate
target and an increase in the domestic interest rate under a fixed
exchange rate.
b. an appreciation in the current exchange rate under an interest rate
target and a decrease in the domestic interest rate under a fixed
exchange rate.
c. a depreciation in the current exchange rate under an interest rate target
and an increase in the domestic interest rate under a fixed exchange
rate.
d. a depreciation in the current exchange rate under an interest rate target
and a decrease in the domestic interest rate under a fixed exchange
rate.
_________

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3. The State Administration of Foreign Exchange in the PRC sees appreciation

pressure on the Renminbi-Dollar rate and decides to engage in a foreign
exchange intervention to alleviate this pressure. They also decide to sterilize
this intervention. They will:
a. buy Renminbi bonds in the domestic market and buy US Treasury bills
and bonds.
b. buy Renminbi bonds in the domestic market and sell US Treasury bills
and bonds
c. sell Renminbi bonds in the domestic market and buy US Treasury bills
and bonds.
d. sell Renminbi bonds in the domestic market and sell US Treasury bills
and bonds.
_________
4. This last month, we saw that rumors led to sudden withdrawals of funds by
individual depositors at the Bank of East Asia. Simultaneously, we see that
banks will face an increased volatility of withdrawals and consumers will see
an increased riskiness of bank deposits. We should expect
a. an increase in the reserve-deposit ratio and an increase in the M2
money multiplier.
b. an increase in the cash-deposit ratio and a decrease in the M2 money
multiplier.
c. a decrease in the reserve-deposit ratio and an increase in the M2 money
multiplier.
d. a decrease in the cash-deposit ratio and a decrease in the M2 money
multiplier.
_________

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5. The Taylor Principle is such that when the central bank faces a 1% rise in the
rate of expected inflation, they should
a. raise the nominal interest rate by either less than or more than 1%
depending on price sensitivity of monetary policy.
b. raise the real interest rate by either less than or more than 1%
depending on price sensitivity of monetary policy
c. reduce the nominal interest rate by either less than or more than 1%
depending on price sensitivity of monetary policy.
d. reduce the real interest rate by either less than or more than 1%
depending on price sensitivity of monetary policy
_________
6. The Federal Reserves bond traders detect downward pressure on the interbank
rate as a result of changes in demand for reserves. They will engage in:
a. repurchase agreements (repos) if they feel the changes in reserve
demand are temporary and outright open market purchases if they feel
the changes are permanent.
b. repurchase agreements (repos) if they feel the changes in reserve
demand are temporary and outright open market sales if they feel the
changes are permanent.
c. matched sale transactions (reverse repos) if they feel the changes in
reserve demand are temporary and outright open market purchases if
they feel the changes are permanent.
d. matched sale transactions (reverse repos) if they feel the changes in
reserve demand are temporary and outright open market sales if they
feel the changes are permanent.
_________
7. The central bank in the USA perceives the expected inflation rate to be falling.
We should expect to see
a. a dynamic open market purchase in the USA and an increase in
Clearing Balances in Hong Kong.
b. a dynamic open market sale in the USA and an increase in Clearing
Balances in Hong Kong.
c. a dynamic open market purchase in the USA and a decrease in
Clearing Balances in Hong Kong.
d. a dynamic open market sale in the USA and a decrease in Clearing
Balances in Hong Kong.
_________

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Short Answer Questions
8. (6 points) Identify a strategy for achieving central bank independence along
each of the following three avenues.
a. Policy Independence

b. Personal Independence

c. Revenue Independence

9. (6 points) Name the interest rate targeted by the central bank of

a. USA
b. European Currency Union
c. Japan
10. (10 points) An economy with a 2.5% long term real interest rate (r = .025) for
1 year and discount bonds and has a permanent 2.5% inflation rate. Calculate:
a. (7 points) The price of a 1 year discount bond with a face value of 100.

b. (3 points) The real return to holding currency.

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Graphing Questions
11. (12 points) During the period 2001-2004, the Bank of Japan engaged in
quantitative easing. As part of doing this, they purchase Japanese stocks from
Japanese banks. Draw a T-account that would show the effect of such a
purpose (of a value of 1 billion) on the balance sheets of Bank of Japan.
Draw the effect of this activity on a model of the Japanese money market rate.
Assets

Liabilities

iIBOR

Reserves

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12. (12 points) Foreign Exchange Market. Diamonds are discovered in Australia.
Foreigners want to buy these diamonds and need Australian dollars to do so.
Assume that this discovery has no particular effect on Australian demand for
foreign goods or assets. Draw two graphs of the Forex market: 1) Demonstrate
the effect on the Australian dollar exchange rate if Australian monetary policy
remains unchanged so the exchange rate is allowed to fluctuate; 2)
Demonstrate the effect on the market if the Reserve Bank of Australia
conducts monetary policy to keep the exchange rate from changing.
A.
Floating Rate
S

FX
B.

Managed Floating

FX

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13. (12 points) The US central bank has the inter-bank interest rate as an operating
target with an inflation targeting interest rate rule. The U.S. government
treasury increases spending which increases economic activity but putting
upward pressure on inflation. Draw two graphs which show the impact of this
fiscal spending on GDP and inflation and another which shows the impact on
the inter-bank market? Remember to consider both the effects on demand for
reserves as well as monetary policy.

Y
Economy

iFF

Interbank Market

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14. (12 points) The central bank has a monetary policy reaction (MPR) function
TGT
that is of the form rt r * b ( t ) where r is the real interest rate, r* is
TGT
the long-term real interest rate, is the inflation rate, and is the
inflation target. Suppose in this economy, the long-term real interest rate rises.
Use two graphs to draw the impact i) on the MPR function; ii) on GDP in the
short run and the long run.

Y
Economy

8
Interbank Market

Reserves