1. Explain the Fed's three tools of monetary policy and how each is used to change the money supply. Does each tool affect the monetary base or the money multiplier?

Answer) There are three tools for the monetary policy that are bank rates, reverses, and open market operations. Each tool can change the money supply as when reserves increase supply goes towards decrease. Increase in the open market operations regulates the money supply in the most effective manner as government and federal make policies for money supply according to the open market operations requirements and outcomes. While increase or decrease in the bank rates as the discount rate and interest rates also affect the decision towards the money supply. Reserve has the direct impact on the money multiplier. But discount rate and open market operations have the influence on the monetary base.

2.      Explain inflation targeting. What are the advantages and disadvantages of this type of monetary policy strategy?

Answer) Following are the five elements of inflation targeting:

-          Medium term target’s public announcement for the rate of inflation

-          The price stability commitment as the policy's long-term primary goal

-          Use of various variables in decision making regarding policy moves

-          Transparency increase about the strategy of policy with the public

-          Accountability increase by the central bank for attaining the policy goals.

The inflation targeting advantages include the clarity and simplicity of the numerical inflation rate target; there is increased central bank accountability; reduces the inflationary shocks’ effects.

The inflation targeting’s disadvantages: there is the delayed signal about the target’s achievement; the rigid rule could be led where the only and major focus is the inflation rate; if the inflation rate is the sole focus, larger fluctuations in output can occur.

3.      Explain and demonstrate graphically how targeting the federal funds rate can result in fluctuations in non-borrowed reserves.

Answer) When non-borrowed reserves are constant, demand for reserve increase will cause the increase in federal funds rate while a decrease in the non-borrowed reserve demand will cause the decrease in federal funds rate. Since demand fluctuation does not cause the actions of monetary policy, this will cause the fluctuations in the federal funds rate. It can be seen in the following figures as well.

Figure 1:

Figure 2:

4.      Explain the Taylor rule, including the formula for setting the federal funds rate target, and the components of the formula. If the Fed were to use this rule, how many goals would it use to set monetary policy?

Answer) The Taylor rule has specified that the target rate of federal funds should be equal to the equilibrium of real federal fund rate plus on half time an output gap, plus the inflation rate for a Fisher effect, plus one-half times the gap of inflation. Following formula explains the Taylor rule:

 Target of federal funds rate = equilibrium real federal fund rate + ½ (output gap) + inflation rate + ½ inflation gap

The output gap represents the real GDP’s percentage deviation from the potential full-employment real GDP. The inflation gap represents the difference between the target rate of inflation of the central bank and the actual inflation. The equilibrium real federal fund rate represents the real rate that is consistent with the full level of employment in the long run. The federal funds rate is set by the Taylor rule recognizing the goals of full employment and low inflation or long-run economic growth equilibrium.

5.      Make the case for and against an independent Federal Reserve?

Answer) Case for the independent Federal monetary policy.  Moreover, money supply control is that it cannot are inexperienced.

the state to by some autonomous is not accountable.  The freedom of not used wisely by the Fed may encourage the own self-interest priority of the public.

6.      Extra Credit

Outline and summarize the assigned reading: “Understanding the Persistence of Poverty.” 2006 Annual Report, Federal Reserve Bank of Cleveland.

Summary

In this reading, the issue and persistence of poverty are highlighted that with one of the most productive and wealthiest nations around the globe, millions of the citizens are still living in poverty. The poverty rate in the United States has remained among the highest as compare of other developed companies as well as stalled for the previous 30 years. This reading has discussed the issues of people living in poverty that they tend to earn less money, acquire fewer job skills, and experience worse health as well as financial issues than the people who are comparatively better off. Moreover, this reading has highlighted the gaps created by the poverty that how it saps the strengths of people and communities. The research function of this reading is among the various areas of bank contributing to advance the leadership’s strategic objective in deed and thought external focus, and operational excellence in 2006. The reading has discussed the ongoing research efforts of the bank to better understand the role played by innovation, education, and human capital in driving the economic growth for the long term.