Part -1:

1. The Fed faces a recessionary gap. How would you expect it to respond? Explain step by step how its policy change is likely to affect the economy.

2. The Fed decides to take a contractionary policy action. Under what circumstances would this type of policy action be most appropriate? What would you expect to happen to the nominal interest rate, The real interest rate, and the money supply?

3. What effect does an open-market purchase of bonds by the Fed have on nominal interest rates? Discuss in terms of

(a) The effect of the purchase on bond prices.

(b) The effect of the purchase on the supply of money.

4. The Federal Reserve System was created by the Fed Reserve Act, Passed by Congress in 1913, and began operations in 1914. Like all central banks, the Fed is a government agency. Which of the following statements about the Fed is false?

A. The Fed has the power to supervise and regulate banks.
B. the Fed's goals are to promote economic growth, maintain low inflation, and watch over a smooth operation of financial markets.
C. the Fed is the "Lender of last resort."
D. the Fed is allowed to make a profit like commercial banks.

Part -2:

1. What two variables are related by the aggregate demand (AD) curve? Explain why changes in the inflation rate affect the components of planned spending and cause the AD curve to slope downward.

2. State how and why each of the following affects and AD curve:

a. An increase in government purchases.
b. A tax increase.
c. An increase in planned investment spending by firms caused by optimism about the future.
d. A decrease in the Fed's inflation target.

3. Discus the relationship between output gaps and inflation. How is this relationship captured in the AS curve?

Part -3:

1. Explain how and why each of the following events affects the AD curve.
a. An increase in consumer confidence leads to higher consumption spending.
b. The government reduces income taxes.

2. Explain how and why each of the following events affects the AS Curve.
a. Fed raises its target rate of inflation.
b. Oil prices drop sharply.

3. Suppose the economy is initially in long-run equilibrium. Now, Due to a decline in house price, consumers reduce their consumption spending.
a. explain how the decline in consumer spending affects the AD curve.
b. explain how your answer to part a affects the economy's short-run equilibrium. Use an AD-AS diagram to illustrate your answer?

4.True or False: The economy's self-correcting tendency makes active use of stabilization policy unnecessary. Explain in one to three paragraphs.

Part -5:

1. Suppose there is an increase in taxes. What is the short-run effect on output, inflation, and the real interest rate, assuming any supply-side effects are minimal? What will be the effect in the long run if the Fed chooses to adjust its target real interest rate to the new long-run real interest rate at which saving equals investment?

2. How does the adoption of a tighter monetary policy, like that conducted by Volcker Fed in the early 1980's affect output, inflation, and the real interest rate in the short run? In the Long run?

3. What factors determine a central bank's independence? What are the benefits of having an independent central bank?