Whitman CollegeEcon 407Exam 2November 8, 1994Write all answers in your blue book. Show all of your work.1. (a) (2pts) List the assumptions of the pure expectations theory of the term structure of interest rates. Suppose these assumptions hold for parts (b) and (c).(b) (20pts) Use the yield curve for government Treasury debt below to forecast the nominal annual interest rate on a one-year Treasury bill that will be issued two years fromnow. Explain your work as thoroughly as possible.(c) (8pts) Suppose that all individuals believe that the inflation rate will be three percent per year through the next two years. They believe that as a result of the 1996 presidential elections, the inflation rate will rise to four percent per year starting in November of 1996. Use the yield curve below to forecast the real annual interest rate on the one-year Treasury bill issued two years from now. Explain your work.2. (15pts) During the banking panics of the early 1930's, the president of Baker Boyer Bank stopped a run on his bank by dividing the bank's cash reserves among several of hisfriends who then prominently displayed this cash, calling out that they wanted to make deposits as they cut through the lines of depositors anxious to make withdrawals. Reassured, depositors left without asking to withdraw their money. Suppose that you readan editorial claiming that, since the Baker Boyer run was stopped before federal deposit insurance existed, this example shows that deposit insurance is unnecessary. Write a counter editorial in which you argue that, regardless of the Baker Boyer example, deposit insurance plays an important role in the U.S. banking system.3. (20pts) Suppose the Federal Reserve desires a small decrease in the money supply. Discuss the advantages and disadvantages of each of the Federal Reserve tools for controlling the money supply in this case.4. (10pts) Write a brief newspaper article for the Walla Walla Union Bulletin in which you explain how the Federal Reserve creates money, and why no one but the FederalReserve has the ability to create money.5. (25pts) Claim: If the Federal Reserve runs a monetary policy targeting real interest rates, then the Fed runs a procyclical monetary policy, i.e. the Fed decreases the money supply in recessions and increases the money supply in expansions.With reference to a Keynesian money supply and money demand diagram (with real money balances on the x-axis and the real interest rate on the y-axis) prove the above claim either true or false. Explain your