Aim for FiveMacroeconomics

Short free-response question

Raising interest on reserves

  • Units 3 and 4
  • 5 points
  • About 12 minutes

A shorter question on one or two models, often with data in a table. You might calculate something like an unemployment rate, real GDP or the spending change needed to close a gap, draw a labeled graph (described in words on this site), and explain an effect. On the exam: Questions 2 and 3 of 3 in Section II; each is worth a quarter of the section score, with about 12 minutes suggested for each. A four-function calculator is allowed.

The question

The economy of Halvard is in short-run equilibrium with an inflationary gap. Halvard's banking system has ample reserves, and its central bank wants to close the inflationary gap.

Suggested time: 12 minutes

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Part (a)

1 point

Identify a specific action Halvard's central bank would take with its administered interest rates.

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Part (b)

2 points

Describe a correctly labeled graph of the market for reserves in Halvard, and show the effect of the action identified in part (a) on the policy rate.

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Part (c)

1 point

Based on the change in the policy rate shown in part (b), will private investment spending in Halvard increase, decrease, or remain the same? Explain.

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Part (d)

1 point

Based on the change in investment spending identified in part (c), will Halvard's unemployment rate increase, decrease, or remain the same in the short run? Explain.

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