Monetary Policy Example

I. 1. Given $120 million in assets, $120 million in liabilities, $6 million in total legal reserves, and a full compliance with the reserve requirement set by the Federal Reserve, the required reserve ratio is 5%. 2. a. When the value of the US dollar depreciates relative to foreign currencies, ceteris paribus, there will be an increase in the net export of the United States because a depreciation of the local currency will make export products of the United States appear cheaper to foreign countries.

Since quantity demanded of a product and the price at which such product is being offered are negatively related, there will be an increase in the demand for US exports, and ultimately an increase in the net exports. 2. b. Given the National Income Accounts Identity: GDP = Consumption + Investment + Government Expenditure + Net Exports, depreciation of the US dollar will positively affect the United States GDP in the short-run since such depreciation will cause an increase in the net exports item in the national income account.

2. c. Being the arm of the government concerned with the implementation of monetary policy, the Fed can prevent depreciation from affecting the GDP by increasing the interest rate. This policy will result in a fall in investment, and thus, will offset the increase in GDP propelled by the local currency depreciation. II. 1. Based on the report, the disturbances in the performance of the United States economy were primarily because of “..

substantial strains in financial markets in the United States and abroad, the intensifying downturn in the housing market, and higher prices for crude oil and some other commodities…[and] rising delinquencies on subprime mortgages.. ” (February 2008 Monetary Policy Report, part 2. ). There is a general risk-averse attitude among investors and this contributed to the periods of economic slowdown in the country.

2. Taking cognizance of the current economic situation, that is, the increase in inflation rate and the tight credit conditions in the financial market, the Federal Reserve seeks to “help promote moderate growth over time and mitigate the risks to economic activity” (February 2008 Monetary Policy Report, part 3. ). In line with this, The Federal Reserve lowered target for federal funds rate to 3 % to address the conditions in the financial market as part of its policy easing. In addition, it seeks to monitor developments in inflation since it inflation is a significant and indispensable consideration in the economic projections on which appropriate monetary policies will be based.

Reference: The Federal Reserve Board. (Feb 2008) Monetary Policy Report to Congress. Accessed May 15, 2008 from http://www. federalreserve. gov/boarddocs/hh/2008/february/fullreport. htm.