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Demand Management (Demand-side Policies) — Monetary Policy · Paper 1 — Free Economics HL Practice Questions

1FoundationSAQ-SEffects of monetary policy on the economy6 marksPaper 1~9 min

The central bank of Recessionia has purchased government bonds from commercial banks to address falling real GDP and rising unemployment.

(a)

Define the term "monetary policy". [2 marks]

(b)

Explain how the purchase of government bonds by the central bank increases aggregate demand. [2 marks]

(c)

Discuss one reason why this policy may fail to restore full employment in Recessionia. [2 marks]

Solutions

2MasterySAQ-STools of monetary policy (interest rates, reserve requirements)10 marksPaper 1~15 min

Data

Reserve requirement ratio

= \dfrac{\text{required reserves}}{\text{total deposits}}

. Money multiplier

= \dfrac{1}{\text{reserve requirement ratio}}

In Country X, commercial banks currently hold reserves of USD 50 billion at the central bank, while total deposits are USD 500 billion. The central bank increases the reserve requirement from

10\%

12\%

(a)

Calculate the immediate change in the value of reserves commercial banks are required to hold. [2 marks]

(b)

Analyse how this increase in the reserve requirement is likely to affect the money supply and aggregate demand (AD) in Country X. [4 marks]

(c)

Evaluate whether increasing the reserve requirement is an effective tool for reducing inflationary pressure in Country X. [4 marks]

Solutions

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