Second Exam Prep

Course Number: 

For the exam, you should be able to:


1.     Define the Monetary Base and explain why it’s important.

2.     Explain why the Fed rarely changes the required reserve ratio.

3.     Derive the expression for both the simple money multiplier and the complex money multiplier. Define the components, and explain how a change in each will change the value of the multiplier.

4.     Explain, in detail, the process of money creation. Carefully distinguish between the creation powers of the commercial banks and the creation powers of the Fed.

5.     Connect the money creation process to our “money as stuff” and “money as idea” conversation.

6.     Explain how the Fed prevents banks from using discount loans too often.

7.     The economy is a bathtub. The banking system is a bathtub. Explain the metaphors in as much detail as possible.

8.     Explain why the currency ratio might change.

9.     Explain why the excess reserve ratio might change.

10.  Describe the advantages of open market operations over the other tools of monetary policy.

11.  Defend or criticize the following, in as much detail as possible: The Fed has enormous power over the money creation process.

12.  Defend or criticize the following, in as much detail as possible: The Federal Reserve System is a decentralized central bank.

13.  Explain the rationale behind federal regulation of the financial system, including the issues of asymmetric information, adverse selection, and moral hazard.

14.  Give examples of moral hazard and adverse selection, and discuss how regulation might be able to help.

15.  Discuss the different levels of the Money Supply, especially M1 and M2, and tie the definitions to the idea of liquidity.

16.  Explain, using a graph, the market for bank reserves, including the federal funds rate and the supply and demand of reserves.

17.  Discuss the effects on the federal funds rate of changes in open market operations, discount loans, and the required reserve ratio.

18.  Explain the details of discount lending, including adjustment credit, seasonal credit, and extended credit.

19.  Explain the moral hazard problem attached to discount loans.

20.  Distinguish between defensive open market operations and dynamic open market operation.

21.  Discuss, in detail, the major goals of monetary policy (employment, economic growth, price stability), and the secondary goals of monetary policy (interest rate stability, financial market stability, and foreign exchange market stability).


  1. Explain what levels of unemployment, economic growth and inflation are desirable as goals of monetary policy and why?
  2. Explain the difference between a monetary policy *goals* and monetary policy *targets*. What are the intermediary targets?
  3. Explain how the Fed chooses its monetary policy targets.
  4. Explain the “real bills doctrine.”
  5. Defend or criticize the following: in order to stabilize the economy, monetary policy needs fiscal policy, and fiscal policy needs monetary policy. 


***I have no idea why the numbering is weird. And, more importantly, I have no idea how to fix it. So weird it shall remain.