6. An evaluation of monetary policies taken by the Central Banks.

Discuss actions taken by the

Fed and describe the effect of these policies on the economy in both the long-run and the short
run using the theories and models we learned. Evaluate whether these policies were successful
in combatting the recession.
The monetary policy is the set of operations to which, the monetary authorities resort to affect
the amount of money in circulation in order to support the achievement of primary goals such as
price stability or full employment. With the fiscal policy, the policy of price and income, and the
currency policy, the monetary policy constitutes one of the four forms of macroeconomic
intervention in the economy. Usually, Central Banks have as a primary goal the price stability,
while to the Federal Bank is also assigned the achievement of the goal concerning the full
employment.
In order to monitor the achievement of the primary goals, central banks generally resort to
intermediate goals, by which they can achieve their primary goals. For example, to promote
growth in income and employment (primary goal), they can act on the amount of money in
circulation and on the structure of interest rates (intermediate goals). In the short run, a change in
money market interest rates induced by the central bank launches a number of mechanisms and
actions that will affect operators, and consequently will affect developments in economic
variables such as products or prices. In the long term, after the economy has absorbed all the
necessary adjustments, a change in the quantity of money, if all other conditions are the same,
will change the overall price level, but do not permanently affect real variables, such as product
and unemployment.
The tasks of the Federal Reserve do not differ from those of the Central Banks, and can be
divided into four main areas:

1. Establishing the national monetary policy by influencing the amount of money in circulation
and credit conditions of the economy in order to pursuit a maximum employment, stable prices
and moderate long-term interest rates.
2. Supervising and regulate banking institutions to ensure the security and stability of the
banking system, and to protect consumer rights.
3. Maintaining the stability of the financial system and containing systemic risk that may arise in
financial markets.
4. Providing treasury services to depositor institutions, the US government, and foreign official
institutions including the supervision of the national payment system.
The Fed controls the money supply indirectly using a variety of instruments. These instruments
can be classified into two broad groups: those that influence the monetary base and those that
influence the reservedeposit ratio and thereby the money multiplier.
To influence the monetary base, the FED recurs to the open-market operations, which are the
purchases and sales of government bonds by the Fed. When the Fed buys bonds from the public,
the dollars it pays for the bonds increase the monetary base and thereby increase the money
supply When the Fed sells bonds to the public, the dollars it receives reduce the monetary base
and thus decrease the money supply.
As our model of the money supply shows, the money multiplier is the link between the monetary
base and the money supply. The money multiplier depends on the reservedeposit ratio, which in
turn is influenced by various Fed policy instruments.
While in the short run, the monetary policy affects both the level and the composition of the
production, in the medium and long run the policy monetary is neutral, since it does not have real
effects. The monetary policy has effects in the long run only if the inflation rate varies.

These various instruments give the Fed substantial power to influence the money supply.
Nonetheless, the Fed cannot control the money supply perfectly. Bank discretion in conducting
business can cause the money supply to change in ways the Fed did not anticipate.
7. An evaluation of Fiscal policies taken by the government: Discuss the actions taken by the
government and describe the effect of these policies on the economy in both the long-run and the
short-run using the theories and models we learned. Evaluate whether these policies were
successful in combatting the recession. You will probably want to discuss the national debt.
When the government changes its spending or the level of taxes, it affects the demand for the
economys output of goods and services and alters national saving, investment, and the
equilibrium interest rate.
If the government decides to increase its purchases by an amount *G, the immediate impact is to
increase the demand for goods and services by *G. But because total out- put is fixed by the
factors of production, the increase in government purchases must be met by a decrease in some
other category of demand. Disposable income Y T is unchanged, so consumption C is
unchanged as well. Therefore, the increase in government purchases must be met by an equal
decrease in investment.
To induce investment to fall, the interest rate must rise. Hence, the increase in government
purchases causes the interest rate to increase and investment to decrease. Government purchases
are said to crowd out investment.
If the government decides to decrease taxes by *T, The immediate impact of the tax cut is to
raise disposable income and thus to raise consumption. Disposable income rises by *T, and
consumption rises by an amount equal to *T times the marginal propensity to consume MPC.
The higher the MPC, the greater the impact of the tax cut on consumption.

Because the economys output is fixed by the factors of production, and the government fixes the
level of government purchases, the increase in consumption must be met by a decrease in
investment. For investment to fall, the interest rate must rise. Hence, a reduction in taxes, like an
increase in government purchases, crowds out investment and raises the interest rate.