10.7: Exercises for Chapter 10

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EXERCISE 10.1

Explain carefully why a central bank does not operate to make a profit but a commercial bank does. What is the central bank's operating objective? What unique power does a central bank have that allows it to pursue its operating objective?

EXERCISE 10.2

Explain carefully why a central bank's power to conduct monetary policy is based on its unique position as supplier of the monetary base.

EXERCISE 10.3

Why would a change in the monetary base cause a change in the money supply?

Suppose a central bank buys $10 million on the open market. What effect does this have on the monetary base and the reserve position of the commercial banks?
If the banks hold reserves equal to 2.5 percent of their deposit liabilities, and the public holds a constant amount of cash, calculate the effect of this open-market transaction on:
1. The money supply.
2. The banks' reserve balances.

EXERCISE 10.4

Suppose the central bank decides to use its power to set interest rates. Use a money market diagram to show and explain what happens to the real money supply if real output increases and the central bank maintains a constant interest rate.

EXERCISE 10.5

In terms of a monetary policy rule

What is the Bank of Canada's monetary policy target?
What monetary policy instrument does the Bank use to pursue this target?
What do the Bank's procedures for implementing policy mean for its control over money supply?

EXERCISE 10.6

Use a diagram to show circumstances in the market for overnight funds that might lead the Bank of Canada to make an SRA. Why would the Bank use an SRA in this case rather than an open market operation?

EXERCISE 10.7

Suppose a central bank decides to conduct monetary policy according to a rule for interest rates.

How does it choose the basic setting for the interest rate within the rule?
How would it respond to a rise in the output gap (Y–Y_P)?
How would the bank react to an inflation rate higher than its target inflation rate?
Why would the bank decide to change the basic setting of its interest rate?