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ECO4223 Exam 2: Questions With Complete
Solutions (100% Correct)
Money and Banking – Exam 2
MODULE I: Central Banking & The Federal Reserve System (Questions 1–10)
Q1: The Federal Open Market Committee (FOMC) consists of how many voting members?
A. 7
B. 12 [CORRECT]
C. 19
D. 5
Correct Answer: B (12)
Rationale: The FOMC has 12 voting members: 7 members of the Board of Governors, the
President of the New York Fed (permanent voting member), and 4 of the remaining 11 regional
bank presidents who rotate on an annual basis. All 12 regional presidents attend meetings and
participate in discussions, but only the designated 12 vote on policy decisions. The 2026 voting
members include Chair Jerome Powell, Vice Chair Philip Jefferson, Vice Chair for Supervision
Michelle Bowman, Governors Michael Barr, Lisa Cook, Stephen Miran, and Christopher Waller,
NY Fed President John Williams, and rotating presidents Beth Hammack (Cleveland), Anna
Paulson (Philadelphia), Lorie Logan (Dallas), and Neel Kashkari (Minneapolis).
Q2: The Federal Reserve's dual mandate established by Congress requires the Fed to pursue:
A. Price stability and maximum employment [CORRECT]
B. Low interest rates and high stock prices
C. Balanced budget and trade surplus
D. Bank profitability and low inflation
Correct Answer: A (Price stability and maximum employment)
Rationale: The Federal Reserve Reform Act of 1977 formally established the dual mandate:
maximum employment and stable prices. The Fed has since adopted a 2% inflation target
(measured by the Personal Consumption Expenditures price index). Unlike the European Central
, 2
Bank (ECB), which has price stability as its primary objective, the Fed gives equal emphasis to
both employment and inflation. As of April 2026, the FOMC statement reaffirms: "The
Committee seeks to achieve maximum employment and inflation at the rate of 2 percent over
the longer run."
Q3: Which of the following is NOT a function of the Federal Reserve?
A. Conducting monetary policy
B. Issuing government bonds (Treasury issues bonds, not Fed) [CORRECT]
C. Acting as lender of last resort
D. Supervising and regulating banks
Correct Answer: B (Issuing government bonds)
Rationale: The U.S. Department of the Treasury issues government bonds to finance
government spending. The Federal Reserve conducts open market operations by buying and
selling existing Treasury securities in the secondary market—it does not issue them. The Fed's
functions include: (1) conducting monetary policy, (2) acting as lender of last resort through the
discount window, (3) supervising and regulating banking institutions (state-chartered member
banks and bank holding companies), (4) providing payment system services (check clearing,
ACH, wire transfers), (5) issuing Federal Reserve notes (currency), and (6) serving as fiscal agent
for the U.S. Treasury.
Q4: As of May 2026, the federal funds rate target range set by the FOMC is:
A. 0%–0.25%
B. 3.50%–3.75% [CORRECT]
C. 5.25%–5.50%
D. 2.25%–2.50%
Correct Answer: B (3.50%–3.75%)
Rationale: The FOMC maintained the target range at 3.50%–3.75% at its April 29, 2026 meeting.
The effective federal funds rate has been trading around 3.63%. The Committee noted that
"inflation is elevated, in part reflecting the recent increase in global energy prices" and that
"developments in the Middle East are contributing to a high level of uncertainty." This rate was
established after three consecutive 25-basis-point cuts in late 2025 (September, October,
December).
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Q5: The concept of "instrument independence" versus "goal independence" refers to:
A. Instrument independence = central bank sets its own goals; Goal independence = central
bank chooses its own policy tools
B. Instrument independence = central bank chooses policy tools to achieve goals set by
government; Goal independence = central bank sets its own policy goals [CORRECT]
C. Both concepts mean the central bank is completely independent from government
D. Neither concept applies to the Federal Reserve
Correct Answer: B
Rationale: Instrument independence means the central bank has autonomy in choosing the
policy tools (interest rates, open market operations, etc.) to achieve its goals. Goal
independence means the central bank sets its own policy objectives (e.g., inflation target,
employment goals). The Federal Reserve has instrument independence but not goal
independence—Congress established the dual mandate (maximum employment and price
stability), but the Fed independently chooses how to achieve these goals. The ECB has both
instrument and goal independence (price stability is its primary goal, defined by the ECB itself as
"below, but close to, 2%").
Q6: Which of the following best describes the political business cycle theory?
A. Politicians manipulate monetary policy to produce economic booms before elections
[CORRECT]
B. Central bankers always raise rates before elections to appear tough on inflation
C. Economic cycles are caused entirely by political instability
D. The Fed coordinates with Congress to set fiscal policy
Correct Answer: A
Rationale: The political business cycle theory (Nordhaus, 1975) suggests that incumbent
politicians have incentives to stimulate the economy before elections to increase their re-
election chances, potentially causing inflationary booms followed by post-election recessions.
This theory provides an argument for central bank independence—if politicians controlled
monetary policy directly, they might manipulate it for electoral gain. An independent central
bank can resist such political pressure and focus on long-term price stability.
Q7: The monetary base (MB) equals:
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A. Currency in circulation only
B. Currency in circulation + Bank reserves (total) [CORRECT]
C. M1 money supply
D. Currency in circulation – Excess reserves
Correct Answer: B
Rationale: The monetary base (also called "high-powered money") consists of currency in
circulation (held by the public) plus total reserves held by banks at the Federal Reserve
(required reserves + excess reserves). The formula is: MB = C + R, where C = currency and R =
reserves. The Fed directly controls the monetary base through open market operations. The
monetary base is smaller than M1 because M1 includes checkable deposits, which are a
multiple of the base created through the banking system's money multiplier process.
Q8: Which central bank has price stability as its sole or primary mandate?
A. Federal Reserve
B. European Central Bank (ECB) [CORRECT]
C. Bank of England
D. People's Bank of China (PBOC)
Correct Answer: B (European Central Bank)
Rationale: The ECB's primary objective, as defined in the Treaty on the Functioning of the
European Union, is to maintain price stability (defined as "below, but close to, 2%" inflation).
While the ECB also considers employment and growth, price stability takes precedence. The
Federal Reserve has a dual mandate (maximum employment and price stability). The Bank of
England has a single inflation target of 2% but also considers growth and employment. The
PBOC has multiple objectives including price stability, economic growth, employment, and
balance of payments.
Q9: On the Federal Reserve's balance sheet, which of the following is a LIABILITY?
A. Treasury securities held by the Fed
B. Mortgage-backed securities (MBS)
C. Currency in circulation (Federal Reserve notes) [CORRECT]
D. Loans to banks through the discount window
Correct Answer: C
ECO4223 Exam 2: Questions With Complete
Solutions (100% Correct)
Money and Banking – Exam 2
MODULE I: Central Banking & The Federal Reserve System (Questions 1–10)
Q1: The Federal Open Market Committee (FOMC) consists of how many voting members?
A. 7
B. 12 [CORRECT]
C. 19
D. 5
Correct Answer: B (12)
Rationale: The FOMC has 12 voting members: 7 members of the Board of Governors, the
President of the New York Fed (permanent voting member), and 4 of the remaining 11 regional
bank presidents who rotate on an annual basis. All 12 regional presidents attend meetings and
participate in discussions, but only the designated 12 vote on policy decisions. The 2026 voting
members include Chair Jerome Powell, Vice Chair Philip Jefferson, Vice Chair for Supervision
Michelle Bowman, Governors Michael Barr, Lisa Cook, Stephen Miran, and Christopher Waller,
NY Fed President John Williams, and rotating presidents Beth Hammack (Cleveland), Anna
Paulson (Philadelphia), Lorie Logan (Dallas), and Neel Kashkari (Minneapolis).
Q2: The Federal Reserve's dual mandate established by Congress requires the Fed to pursue:
A. Price stability and maximum employment [CORRECT]
B. Low interest rates and high stock prices
C. Balanced budget and trade surplus
D. Bank profitability and low inflation
Correct Answer: A (Price stability and maximum employment)
Rationale: The Federal Reserve Reform Act of 1977 formally established the dual mandate:
maximum employment and stable prices. The Fed has since adopted a 2% inflation target
(measured by the Personal Consumption Expenditures price index). Unlike the European Central
, 2
Bank (ECB), which has price stability as its primary objective, the Fed gives equal emphasis to
both employment and inflation. As of April 2026, the FOMC statement reaffirms: "The
Committee seeks to achieve maximum employment and inflation at the rate of 2 percent over
the longer run."
Q3: Which of the following is NOT a function of the Federal Reserve?
A. Conducting monetary policy
B. Issuing government bonds (Treasury issues bonds, not Fed) [CORRECT]
C. Acting as lender of last resort
D. Supervising and regulating banks
Correct Answer: B (Issuing government bonds)
Rationale: The U.S. Department of the Treasury issues government bonds to finance
government spending. The Federal Reserve conducts open market operations by buying and
selling existing Treasury securities in the secondary market—it does not issue them. The Fed's
functions include: (1) conducting monetary policy, (2) acting as lender of last resort through the
discount window, (3) supervising and regulating banking institutions (state-chartered member
banks and bank holding companies), (4) providing payment system services (check clearing,
ACH, wire transfers), (5) issuing Federal Reserve notes (currency), and (6) serving as fiscal agent
for the U.S. Treasury.
Q4: As of May 2026, the federal funds rate target range set by the FOMC is:
A. 0%–0.25%
B. 3.50%–3.75% [CORRECT]
C. 5.25%–5.50%
D. 2.25%–2.50%
Correct Answer: B (3.50%–3.75%)
Rationale: The FOMC maintained the target range at 3.50%–3.75% at its April 29, 2026 meeting.
The effective federal funds rate has been trading around 3.63%. The Committee noted that
"inflation is elevated, in part reflecting the recent increase in global energy prices" and that
"developments in the Middle East are contributing to a high level of uncertainty." This rate was
established after three consecutive 25-basis-point cuts in late 2025 (September, October,
December).
, 3
Q5: The concept of "instrument independence" versus "goal independence" refers to:
A. Instrument independence = central bank sets its own goals; Goal independence = central
bank chooses its own policy tools
B. Instrument independence = central bank chooses policy tools to achieve goals set by
government; Goal independence = central bank sets its own policy goals [CORRECT]
C. Both concepts mean the central bank is completely independent from government
D. Neither concept applies to the Federal Reserve
Correct Answer: B
Rationale: Instrument independence means the central bank has autonomy in choosing the
policy tools (interest rates, open market operations, etc.) to achieve its goals. Goal
independence means the central bank sets its own policy objectives (e.g., inflation target,
employment goals). The Federal Reserve has instrument independence but not goal
independence—Congress established the dual mandate (maximum employment and price
stability), but the Fed independently chooses how to achieve these goals. The ECB has both
instrument and goal independence (price stability is its primary goal, defined by the ECB itself as
"below, but close to, 2%").
Q6: Which of the following best describes the political business cycle theory?
A. Politicians manipulate monetary policy to produce economic booms before elections
[CORRECT]
B. Central bankers always raise rates before elections to appear tough on inflation
C. Economic cycles are caused entirely by political instability
D. The Fed coordinates with Congress to set fiscal policy
Correct Answer: A
Rationale: The political business cycle theory (Nordhaus, 1975) suggests that incumbent
politicians have incentives to stimulate the economy before elections to increase their re-
election chances, potentially causing inflationary booms followed by post-election recessions.
This theory provides an argument for central bank independence—if politicians controlled
monetary policy directly, they might manipulate it for electoral gain. An independent central
bank can resist such political pressure and focus on long-term price stability.
Q7: The monetary base (MB) equals:
, 4
A. Currency in circulation only
B. Currency in circulation + Bank reserves (total) [CORRECT]
C. M1 money supply
D. Currency in circulation – Excess reserves
Correct Answer: B
Rationale: The monetary base (also called "high-powered money") consists of currency in
circulation (held by the public) plus total reserves held by banks at the Federal Reserve
(required reserves + excess reserves). The formula is: MB = C + R, where C = currency and R =
reserves. The Fed directly controls the monetary base through open market operations. The
monetary base is smaller than M1 because M1 includes checkable deposits, which are a
multiple of the base created through the banking system's money multiplier process.
Q8: Which central bank has price stability as its sole or primary mandate?
A. Federal Reserve
B. European Central Bank (ECB) [CORRECT]
C. Bank of England
D. People's Bank of China (PBOC)
Correct Answer: B (European Central Bank)
Rationale: The ECB's primary objective, as defined in the Treaty on the Functioning of the
European Union, is to maintain price stability (defined as "below, but close to, 2%" inflation).
While the ECB also considers employment and growth, price stability takes precedence. The
Federal Reserve has a dual mandate (maximum employment and price stability). The Bank of
England has a single inflation target of 2% but also considers growth and employment. The
PBOC has multiple objectives including price stability, economic growth, employment, and
balance of payments.
Q9: On the Federal Reserve's balance sheet, which of the following is a LIABILITY?
A. Treasury securities held by the Fed
B. Mortgage-backed securities (MBS)
C. Currency in circulation (Federal Reserve notes) [CORRECT]
D. Loans to banks through the discount window
Correct Answer: C
