Part one.

Don't give incomplete work.

WASHINGTONA top Fed official said Tuesday it is too early to tell whether the coronavirus outbreak will force the central bank to resume rate cuts in the coming months.

Disruptions from the outbreak in China "could spill over to the rest of the global economy," Fed Vice Chairman Richard Clarida said in a speech Tuesday. "But it is still too soon to even speculate about either the size or the persistence of these effects, or whether they will lead to a material change in the outlook."

Markets and global events are giving central bankers a case of dj vu. Last year, the threat of a growth downturn exacerbated by trade uncertainty prompted the Federal Reserve to cut interest rates. Now, the potential for virus-related disruptions that roil supply chains, output and travel is again putting the Fed in a delicate spot.

The coronavirus has led to significant quarantines in China since January, initially focusing attention on how much a hit the global economy might take from idled production in the world's second-largest economy.

Signs that the virus is spreadingother countries across Europe and Asia reported more cases in recent daysled to a deepening rout in global financial markets Tuesday. Stocks fell after hitting highs over the past two months and the yield on the benchmark 10-year U.S. Treasury note closed at a new low.

Mr. Clarida said the Fed doesn't set policy based on day-to-day market movements. Instead the Fed looks at whether broad and sustained changes in stocks, bonds and currencies influence household wealth and business and consumer confidence.

"You have to look at credit availability. You have to look at confidence," he said.

Investors have been placing growing bets on rate cuts later this year in interest-rate futures markets, according to CME Group, with markets expecting the Fed to have cut at least once by June and again by December.

A substantial decline this year in long-term yields means borrowing costs have already grown more favorable. Probabilities for a rate cut at the Fed's next scheduled meeting, on March 17-18, rose to around one in three on Tuesday, up from one in 10 last week, according to futures markets contracts calculated by CME Group.

Mr. Clarida said monetary policy isn't on a preset course and decisions "will proceed on a meeting-by-meeting basis."

Fed Chairman Jerome Powell has said the central bank will want to see evidence that disruptions are persistent and material for the U.S. economy before cutting interest rates.

"There's just great uncertainty around where this virus is going to go and when the full effects are going to be realized, so I'm open minded," Minneapolis Fed President Neel Kashkari said in an interview Monday. "I don't see any urgent need to move until we have more information."

Dallas Fed President Robert Kaplan echoed those sentiments in an interview Tuesday. "We are a number of weeks away from being able to make the judgment" about whether a rate change is needed, he said.

Among the challenges facing the Fed: With its benchmark rate between 1.5% and 1.75%, the central bank has less room to stimulate growth by cutting rates, which are already historically low.

Fed officials have demonstrated a willingness over the past year to ease policy to defuse looming economic threats. An escalation of the U.S. trade war with China beginning last May prompted the Fed to cut rates beginning in July.

"The interconnectedness of our economies means that literally, no man is an island. If one economy starts to struggle, the spillover effects onto others can take hold rapidly," New York Fed President John Williams said in a speech last November, shortly after the Fed called an end to its series of cuts.

A separate issue is that monetary stimulus may not be a neat tool for addressing near-term virus disruptions. "Monetary easing works best when interest rates are relatively high and the economy faces a demand shock. Neither is the case here," said Roberto Perli, an analyst at Cornerstone Macro.

Investors are concerned about the global economy due to the potential for supply-chain disruptions, especially in Asia, and confidence shocks that can't be easily repaired with lower interest rates. Rate cuts are designed to encourage more households and businesses to spend and invest today, rather than wait until tomorrow.

If factories are closed and supply chains are disrupted, lower interest rates may have less immediate effect. "At best, monetary-policy easing should be thought of as something that can facilitate the rebound when the virus is contained, not as something that can prevent growth deterioration now," Mr. Perli said.

Negative rates in Europe and Japan have left central bankers in those countries with less room to counteract a downturn if growth sputters amid virus-related disruptions. "Japan doesn't have the ability to smooth out a coronavirus shock" with monetary policy, said Jason Cummins, an economist at hedge fund Brevan Howard.

The lack of a robust policy response to slowdowns abroad is "the exact kind of potential mechanisms through which the U.S. economy can be affected," said Cleveland Fed President Loretta Mester on Monday. Along those lines, the prospect for slower global growth last year "affected our monetary policy and our assessment of the outlook."

A. Are the markets expecting an increase or decrease in the Fed Funds Rate? List three factors that make Fed consider this action since last year?

B. How will a lower Fed Funds Rate affect the value of dollar relative to other countries, assuming the US inflation rate doesn't change? How will the value of dollar change if other countries' central banks take the same action?

C. What are some of the concerns policy makers may have regarding a further decrease in the Fed Funds Rate at this juncture?

D. Why is a wholesale flight out of the dollar unlikely in the immediate future?

E. While some multinational companies consider loosening their ties with China, what factors make leaving the "factory of the world" easier said than done?

Question.

Monetary Policy

1. _________ is the chairperson of the Federal Reserve Board of Governors. (You need to know his full name. You need to be able to spell it correctly.)

2. An increase in the reserve requirement ratio causes the money multiplier to increase.

True

False

3. Think about the loanable funds market. If the Federal Reserve engages in an open market purchase of government, the supply curve ??? and the real interest rate ???.

4. Think about the loanable funds market. If the Federal Reserve engages in an open market sale of government, the supply curve ??? and the real interest rate ??? .

5. When the Federal Reserve engages in an open market sale, this pushes the interest rate ??? and the aggregate demand curve shifts to the ???? .

6. The Federal Reserve is attempting to increase the aggregate demand curve to fight a recession. Which of the following would accomplish their goal? Check all that apply.

Increase the reserve requirement.

Decrease the reserve requirement.

Sell government securities.

Buy government securities.

Increase income tax rates

decrease income tax rates

7. The Federal Reserve is attempting to decrease the aggregate demand curve to fight inflation. Which of the following would accomplish their goal? Check all that apply.

Increase the reserve requirement.

Decrease the reserve requirement.

Sell government securities.

Buy government securities.

increase income tax rates

decrease income tax rates

8. Assume that the bank currently has excess reserves of zero, and the required reserve ratio is 10%.If the Fed buys $150 million, the amount of new loans that the bank can make initially increases by _______ million. Be exact.

9. If the economy is currently operating at potential GDP, an open market purchase of government securities by the Federal Reserve Board will put upward pressure on prices.

True

False

10. Assume that the bank currently has excess reserves of zero, and the required reserve ratio is 20%.If the Fed sells $120 million of government securities to JeffCo Bank, the amount of loans that the bank can make decreases initiallyby _______ million. Be exact.

11. Use the Taylor Rule to find the federal funds rate (FFR).

Assume that the Fed has a target inflation rate of 2% and a target GDP growth rate of 3%. What FFR should they set if the current inflation rate is 2% and GDP is currently growing at 3%?

Answer: _____%

12. Use the Taylor Rule to find the federal funds rate (FFR).

Assume that the Fed has a target inflation rate of 2% and a target GDP growth rate of 3%. What FFR should they set if the current inflation rate is 2% and GDP is currently growing at 1%?

Answer: _____%

13. Use the Taylor Rule to find the federal funds rate (FFR).

Assume that the Fed has a target inflation rate of 2% and a target GDP growth rate of 3%. What FFR should they set if the current inflation rate is 5% and GDP is currently growing at 1%?This is an example of stagflation where the economy experiences inflation with slow growth.

Answer: _____%

14. When the Fed used quantitative easing to combat the Great Recession, they purchased assets from bank balance sheets. What did the Fed think that banks would do in response? Explain why you believe this outcome would occur.

15. What action did the FOMC take at their last meeting?

Section B.

Complete the following.

23 . Is the Phillips curve a myth? Intertemporal tradeoff between inflation and unemployment After the World War II, empirical economists noticed that, in many advanced economies, as unemployment fell, inflation tended to rise, and vice vers The inverse relationship between unemployment and inflation, was depicted as the Phillips curve, after William Phillips of the London School of Economics. In the 1950s and 1960s, the Phillips curve convinced many policy makers that they could use the relationship to pick acceptable levels of unemployment and inflation for the economy. They adjusted taxes, public expenditures, and interest rates to choose a desirable spot on the Phillips curve. However, theories based on the Phillips curve failed to explain stagflation of the 1970s, when many countries experienced high levels of both inflation and unemployment. Many economists began questioning the validity of the Phillips curve. Edmund Phelps of Columbia University suggested that the perceived tradeoff between unemployment and inflation was only temporary, and in the long run, the tradeoff disappears. Does this mean that the relationship revealed in the post-World War II data was invalid, and the Phillips curve itself is flawed? Read the following article, and then answer the subsequent questions. IS THE PHILLIPS CURVE A MYTHT BY THE APLIA CONTENT TEAM Phelps's research, which was conducted in the 1960s and 1970s and earned him a Nobel Prize in Economics in 2006, suggests that there will always be some frictional unemployment as workers move between jobs because of layoffs and quitting. In a world with no surprises, unemployment should return to a specific rate-the natural rate of unemployment-that is determined by turnover in the labor market. An unexpected increase in the rate of inflation might push the unemployment rate below this natural level, but the effect, he reasoned, should be temporary. For policy makers, Phelps's insights offered both good news and bad news. The bad news is that any fiscal or monetary program can keep unemployment below the natural rate only so long as it keeps generating a sequence of unexpected increases in the inflation rate. The good news is that since unemployment tends toward its natural rate, regardless of the inflation rate, policy makers can achieve permanently lower inflation without permanently higher unemployment. In a 2008 speech, economist Frederic Mishkin of Columbia University emphasized that the central bank has a dual goal of achieving price stability and maximum sustainable employment. The short-run Phillips curve is not a myth. It is not vertical, and it does imply that expansionary monetary policy that raises inflation can lower unemployment. The long-run Phillips curve, however, is vertical because the economy gravitates to a natural rate of unemployment and is independent of the inflation rate. Therefore, in the long run, any central bank's strategy to keep unemployment below the natural rate would only lead to higher inflation, which would lower economic activity in the long run. In practice, in the short run, a negative shock to aggregate demand that caused by households cutting spending leads to a decline in actual output relative to its potential.' Future inflation will fall below levels consisted with price stability, and the central bank should pursue an expansionary policy to keep inflation from falling. An expansionary policy will then result in an increase in demand that boosts output back towards its potential, and will return inflation to a level consistent with price stability, Stabilizing output thus stabilizes inflation and vice versa. Conversely, a negative supply shock, for example, an increase in the price of energy, drives inflation and output in opposite directions. In this case, because a contractionary monetary policy put in place to reduce inflation can lead to lower output, the goal of stabilizing inflation might conflict with the goal of stabilizing economic activity.According to Phelps, if unemployment falls below the equilibrium level, inflation tends to and then consumer expectations of inflation . Which of the following describes the outcome?. No lower unemployment, but higher inflation O Lower unemployment and no higher inflation Lower unemployment and lower inflation O Lower unemployment and higher inflation According to the article, a negative shock to aggregate demand causes in future inflation and In actual output relative to its potential. which of the following would be an appropriate policy response in order to stabilice prices? O An expansionary monetary policy to keep inflation from falling Q An expansionary fiscal policy to keep inflation from rising A contractionary fiscal policy to keep inflation from falling C A contractionary fiscal policy to keep inflation from rising Grade It Now Save & Continue Continue without savingUltimately, the relationship broke down in the early 19705. Phelps was critical about the statistical nature of the Phillips curve, which was not grounded in economic theories of decisions made by people or companies, nor was it related to any notion of stability in the labor market. He stressed that inflation depends not only on the levels of unemployment, but also on how quickly companies and households expect prices and wages to rise. For any level of unemployment, if people and companies expect inflation to rise, they will demand higher wages and set higher prices, so the expectations will become a self-fulfilling prophecy. Phelps's model became known as the "expectations-augmented Phillips curve" and the work has had profound consequences for economic policy: expectations of price increases tend to go up when unemployment is below an "equilibrium rate,"which can differ between countries, depending on institutions and the strength of the labor market. If unemployment falls below this equilibrium level, inflation tends to rise (as in the standard Phillips curve model), but then expectations of price increases, results in no lower unemployment, but only higher inflation. The disastrous rise in inflation in the early 1970s was partly a result of policy makers not understanding that the equilibrium unemployment rate had risen as the oil crisis hit and productivity growth fell, so they kept loosening monetary and fiscal policy to lower unemployment below this level. The consequence was ever-higher inflation. Eventually, monetary policy makers accepted the role of expectations, First, expectations of future policy actions and accompanying economic conditions play a crucial role in determining the effects of current policy actions on the economy. Second, monetary policy is most effective when the central bank is firmly committed, through its actions and statements, to a "nominal anchor" - such as to keeping inflation low and stable. A strong commitment to stabilizing inflation helps anchor inflation expectations so that a central bank will not have to worry that expansionary policy to counter a negative demand shock will lead to a sharp rise in expected inflation-a so-called inflation scare. The level of output that the economy can produce at the maximum sustainable level of employment. Sources: Chris Giles, "Phelps Wins Nobel for Exploding Economic Myths." Financial Times of London, Now ber 10, 2005; Frederic S. Mixtion, "Does Stabilizing Inflation Contribute to Scablli mic Activity?" Board of Governors of the Federal Reserve, February 25, 2008, https://www.federalreserve.gowewsevents/speech/mishkin20080225s.htm. According to Phelps, if unemployment falls below the equilibrium level, inflation tends to , and then consumer expectations of inflation .Which of the following describes the outcome? No lower unemployment, but higher inflation O Lower unemployment and no higher inflation Lower unemployment and lower inflation Lower unemployment and higher inflation According to the article, a negative shock to aggregate demand causes in future inflation and in actual output Type here to search O