Economics of Money, Banking, and Financial Markets, The, 8E Frederic S. Mishkin Test Bank.pdf (22)

D) $100 times the required reserve ratio.

70) In the simple deposit expansion model, if the Fed purchases $100 worth of bonds from a bank

70) ______

that previously had no excess reserves, deposits in the banking system can potentially increase by A) $10.

B) $100.

C) $100 times the reciprocal of the required reserve ratio.

D) $100 times the required reserve ratio.

71) In the simple deposit expansion model, if the Fed extends a $100 discount loan to a bank that

71) ______

previously had no excess reserves, the bank can now increase its loans by A) $10.

B) $100.

C) $100 times the reciprocal of the required reserve ratio.

D) $100 times the required reserve ratio.

72) In the simple deposit expansion model, if the Fed extends a $100 discount loan to a bank that

72) ______

previously had no excess reserves, deposits in the banking system can potentially increase by A) $10.

B) $100.

C) $100 times the reciprocal of the required reserve ratio.

D) $100 times the required reserve ratio.

73) The formula for the simple deposit multiplier can be expressed as B) C) A) △r=

× △T

△D=

× △R

△R=

× △D

73) ______ D) △R=

× △T

74) In the simple model of multiple deposit creation in which banks do not hold excess reserves,

74) ______

the increase in checkable deposits equals the product of the change in excess reserves and the A) simple deposit expansion multiplier.

B) reciprocal of the simple deposit multiplier.

C) discount rate.

D) reciprocal of the excess reserve ratio.

75) The simple deposit multiplier can be expressed as the ratio of the A) change in deposits divided by the change in reserves in the banking system.

B) change in reserves in the banking system divided by the change in deposits.

C) change in deposits divided by the required reserve ratio.

D) required reserve ratio divided by the change in reserves in the banking system.

75) ______

76) If reserves in the banking system increase by $100, then checkable deposits will increase by

76) ______

$1000 in the simple model of deposit creation when the required reserve ratio is A) 0.20.

B) 0 .10.

C) 0 .05.

D) 0 .01.

77) If reserves in the banking system increase by $100, then checkable deposits will increase by

77) ______

$500 in the simple model of deposit creation when the required reserve ratio is A) 0.01.

B) 0 .10.

C) 0 .20 D) 0 .05.

78) If the required reserve ratio is 10 percent, the simple deposit multiplier is A) 10.0 B) 1 00.0.

C) 5 .0.

For exam and test prep, contact excellentessaywriters@gmail.com D) 2 .5.

78) ______

79) If the required reserve ratio is 15 percent, the simple deposit multiplier is A) 1.5.

B) 6 .67.

C) 1 5.0.

80) If the required reserve ratio is 20 percent, the simple deposit multiplier is A) 2.5.

B) 1 0.0.

C) 4 .0.

81) If the required reserve ratio is 25 percent, the simple deposit multiplier is A) 10.0.

B) 2 .5.

C) 4 .0.

D) 3 .33.

D) 5 .0.

D) 5 .0.

79) ______ 80) ______ 81) ______

82) A simple deposit multiplier equal to one implies a required reserve ratio equal to A) 100 percent.

B) 5 0 percent.

C) 2 5 percent.

D) 0 percent.

82) ______

83) A simple deposit multiplier equal to two implies a required reserve ratio equal to A) 100 percent.

B) 5 0 percent.

C) 2 5 percent.

D) 0 percent.

83) ______

84) A simple deposit multiplier equal to four implies a required reserve ratio equal to A) 100 percent.

B) 5 0 percent.

C) 2 5 percent.

D) 0 percent.

84) ______

85) In the simple deposit expansion model, if the banking system has excess reserves of $75, and

85) ______

the required reserve ratio is 20%, the potential expansion of checkable deposits is A) $37.50.

B) $ 75.

C) $ 375.

D) $ 750.

86) In the simple deposit expansion model, if the required reserve ratio is 20 percent and the Fed increases reserves by $100, checkable deposits can potentially expand by A) $100.

B) $ 250.

C) $ 500.

D) $ 1,000.

87) In the simple deposit expansion model, if the required reserve ratio is 10 percent and the Fed increases reserves by $100, checkable deposits can potentially expand by A) $100.

B) $ 250.

C) $ 500.

86) ______

87) ______

D) $ 1,000.

88) In the simple deposit expansion model, an expansion in checkable deposits of $1,000 when the

88) ______

required reserve ratio is equal to 20 percent implies that the Fed A) purchased $200 in government bonds.

B) s old $500 in government bonds.

C) purchased $500 in government bonds.

D) s old $200 in government bonds.

89) In the simple deposit expansion model, an expansion in checkable deposits of $1,000 when the

89) ______

required reserve ratio is equal to 10 percent implies that the Fed A) sold $1,000 in government bonds.

B) s old $100 in government bonds.

C) purchased $1000 in government bonds.

D) p urchased $100 in government bonds.

90) In the simple deposit expansion model, a decline in checkable deposits of $1,000 when the

90) ______

required reserve ratio is equal to 20 percent implies that the Fed A) sold $200 in government bonds.

B) s old $500 in government bonds.

C) purchased $200 in government bonds.

D) p urchased $500 in government bonds.

91) In the simple deposit expansion model, a decline in checkable deposits of $1,000 when the

91) ______

required reserve ratio is equal to 10 percent implies that the Fed A) sold $1,000 in government bonds.

B) s old $100 in government bonds.

C) purchased $1,000 in government bonds.

D) p urchased $100 in government bonds.

92) In the simple deposit expansion model, a decline in checkable deposits of $500 when the

required

92) reserve ratio is equal to 10 percent implies that the Fed

A) sold $500 in government bonds.

C) purchased $50 in government bonds.

____ __

B) s old $50 in government bonds.

D) p urchased $500 in government bonds.

93) In the simple deposit expansion model, a decline in checkable deposits of $500 when the

93) ______

required reserve ratio is equal to 20 percent implies that the Fed A) sold $250 in government bonds.

B) s old $50 in government bonds.

C) purchased $100 in government bonds.

D) s old $100 in government bonds.

94) If reserves in the banking system increase by $100, then checkable deposits will increase by

94) ______

$400 in the simple model of deposit creation when the required reserve ratio is A) 0.01.

B) 0 .10.

C) 0 .20.

D) 0 .25.

95) If reserves in the banking system increase by $100, then checkable deposits will increase by

95) ______

$667 in the simple model of deposit creation when the required reserve ratio is A) 0.01.

B) 0 .05.

C) 0 .15.

D) 0 .20.

96) If reserves in the banking system increase by $100, then checkable deposits will increase by

96) ______

$100 in the simple model of deposit creation when the required reserve ratio is A) 0.01.

B) 0 .10.

C) 0 .20.

D) 1 .00.

97) If reserves in the banking system increase by $100, then checkable deposits will increase by

97) ______

$2,000 in the simple model of deposit creation when the required reserve ratio is A) 0.01.

B) 0 .05.

C) 0 .10.

D) 0 .20.

98) If reserves in the banking system increase by $200, then checkable deposits will increase by

98) ______

$500 in the simple model of deposit creation when the required reserve ratio is A) 0.04.

B) 0 .25.

C) 0 .40.

D) 0 .50.

99) If a bank has excess reserves of $10,000 and demand deposit liabilities of $80,000, and if the reserve requirement is 20 percent, then the bank has actual reserves of A) $16,000.

B) $ 20,000.

C) $ 26,000.

D) $ 36,000.

100) If a bank has excess reserves of $20,000 and demand deposit liabilities of $80,000, and if the reserve requirement is 20 percent, then the bank has total reserves of A) $16,000.

B) $ 20,000.

C) $ 26,000.

101) _____

D) $ 26,000.

102) If a bank has excess reserves of $15,000 and demand deposit liabilities of $80,000, and if the reserve requirement is 20 percent, then the bank has total reserves of A) $11,000.

B) $ 21,000.

C) $ 31,000.

100) _____

D) $ 36,000.

101) If a bank has excess reserves of $5,000 and demand deposit liabilities of $80,000, and if the reserve requirement is 20 percent, then the bank has actual reserves of A) $11,000.

B) $ 20,000.

C) $ 21,000.

99) ______

102) _____

D) $ 41,000.

103) If a bank has excess reserves of $4,000 and demand deposit liabilities of $100,000, and if the

reserve

requireme 103) nt is 15 percent, then the bank has actual reserves of

A) $17,000.

_____

B) $ 19,000.

C) $ 24,000.

D) $ 29,000.

104) If a bank has excess reserves of $4,000 and demand deposit liabilities of $100,000, and if the reserve requirement is 10 percent, then the bank has actual reserves of A) $14,000.

B) $ 19,000.

C) $ 24,000.

D) $ 29,000.

105) If a bank has excess reserves of $7,000 and demand deposit liabilities of $100,000, and if the reserve requirement is 15 percent, then the bank has actual reserves of A) $17,000.

B) $ 22,000.

C) $ 27,000.

105) _____

D) $ 29,000.

106) If a bank has excess reserves of $7,000 and demand deposit liabilities of $100,000, and if the reserve requirement is 10 percent, then the bank has actual reserves of A) $14,000.

B) $ 17,000.

C) $ 22,000.

104) _____

106) _____

D) $ 27,000.

107) A bank has excess reserves of $6,000 and demand deposit liabilities of $100,000 when the

107) _____

required reserve ratio is 20 percent. If the reserve ratio is raised to 25 percent, the bank's excess reserves will be A) -$5,000.

B) - $1,000.

C) $ 1,000.

D) $ 5,000.

108) A bank has excess reserves of $4,000 and demand deposit liabilities of $100,000 when the

108) _____

required reserve ratio is 20 percent. If the reserve ratio is raised to 25 percent, the bank's excess reserves will be A) -$5,000.

B) - $1,000.

C) $ 1,000.

D) $ 5,000.

109) A bank has excess reserves of $10,000 and demand deposit liabilities of $100,000 when the

109) _____

required reserve ratio is 20 percent. If the reserve ratio is raised to 25 percent, the bank's excess reserves will be A) -$5,000.

B) - $1,000.

C) $ 1,000.

D) $ 5,000.

110) A bank has no excess reserves and demand deposit liabilities of $100,000 when the required

110) _____

reserve ratio is 20 percent. If the reserve ratio is raised to 25 percent, the bank's excess reserves will now be A) -$5,000.

B) - $1,000.

C) $ 1,000.

D) $ 5,000.

111) A bank has excess reserves of $1,000 and demand deposit liabilities of $80,000 when the reserve 111) _____ requirement is 20 percent. If the reserve requirement is lowered to 10 percent, the bank's excess reserves will be A) $1,000.

B) $ 8,000.

C) $ 9,000.

D) $ 17,000.

112) A bank has excess reserves of $1,000 and demand deposit liabilities of $80,000 when the reserve 112) _____ requirement is 25 percent. If the reserve requirement is lowered to 20 percent, the bank's excess reserves will be A) $1,000.

B) $ 5,000.

C) $ 8,000.

D) $ 9,000.

113) Decisions by depositors to increase their holdings of ________, or of banks to hold ________ will 113) _____ result in a smaller expansion of deposits than the simple model predicts.

A) currency; excess reserves B) d eposits; excess reserves C) currency; required reserves D) d eposits; required reserves

114) Decisions by depositors to increase their holdings of ________, or of banks to hold excess

114) _____

reserves will result in a ________ expansion of deposits than the simple model predicts.

A) currency; smaller B) d eposits; larger C) currency; larger D) d eposits; smaller

115) Decisions by ________ about their holdings of currency and by ________ about their holdings of excess reserves affect the money supply.

A) depositors; banks C) banks; depositors

115) _____

B) b orrowers; depositors D) d epositors; borrowers

ESSAY. Write your answer in the space provided or on a separate sheet of paper.

116) Assume that no banks hold excess reserves, and the public holds no currency. If a bank sells a $100 security to the Fed, explain what happens to this bank and two additional steps in the deposit expansion process, assuming a 10% reserve requirement. How much do deposits and loans increase for the banking system when the process is completed?

117) Explain two reasons why the Fed does not have complete control over the level of bank deposits and loans.

Explain how a change in either factor affects the deposit expansion process.

118) Explain why the simple deposit multiplier overstates the true deposit multiplier.

MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question.

119) _____ 119) Which is the most important category of Fed assets?

A) Securities B) G old and SDR certificates C) Discount loans D) C ash items in the process of collection 120) The two most important categories of assets on the Fed's balance sheet are ________ and

120) _____

________ because they earn interest.

A) gold; coins B) cash items in the process of collection; SDR certificate accounts C) discount loans; coins D) securities; discount loans

121) The Fed's holdings of securities consist primarily of ________, but also in the past have

121) _____

included ________.

A) Treasury securities; municipal securities.

B) Treasury securities; bankers' acceptances C) municipal securities; bankers' acceptances.

D) bankers' acceptances; Treasury securities.

122) The volume of loans that the Fed makes to banks is affected by the Fed's setting of the interest rate on these loans, called the A) discount rate.

C) federal funds rate.

122) _____

B) i nterbank rate.

D) p rime rate.

123) Special Drawing Rights (SDRs) are issued to governments by the ________ to settle

intern ation

123) al debts and have replaced ________ in internatio nal transactio ns.

A) International Monetary Fund; gold C) International Monetary Fund; dollars

_____

B) F ederal Reserve System; gold D) F ederal Reserve System; dollars

124) When the Treasury acquires gold or SDRs, it issues certificates to the ________, which are a

124) _____

claim on the gold or SDRs, and in turn is credited with deposit balances at the ________.

A) International Monetary Fund; IMF B) F ederal Reserve System; Fed C) International Monetary Fund; Fed D) F ederal Reserve System; IMF

125) _____ 125) Which of the following are not assets on the Fed's balance sheet?

A) U.S. Treasury deposits B) C ash items in the process of collection C) U.S. Treasury bills D) D iscount loans 126) _____ 126) Which of the following are not assets on the Fed's balance sheet?

A) Deferred availability cash items B) C ash items in the process of collection C) Securities D) D iscount loans 127) Which of the following are not liabilities on the Fed's balance sheet?

A) Bank deposits B) D eferred availability cash items C) Discount loans D) U .S. Treasury deposits

127) _____

128) When the Fed purchases artwork to decorate the conference room at the Federal Reserve Bank

128) _____

of Kansas City, A) the monetary base rises.

B) currency in circulation falls.

C) reserves rise, but the monetary base falls.

D) reserves fall.

129) A Fed purchase of gold, SDRs, a deposit denominated in a foreign currency or any other asset is

129) _____

just an open market ________ of these assets, ________ the monetary base.

A) purchase; raising B) s ale; lowering C) purchase; lowering D) s ale; raising

130) An increase in Treasury deposits at the Fed causes A) the monetary base to increase.

B) the monetary base to decrease.

C) Fed assets to decrease but has no effect on the monetary base.

D) Fed assets to increase but has no effect on the monetary base.

130) _____

131) An increase in U.S. Treasury deposits at the Fed reduces both ________ and the ________.

A) reserves; monetary base B) F ed assets; money multiplier C) Fed assets; monetary base D) F ed liabilities; money multiplier

131) _____

132) U.S. Treasury deposits at the Fed are ________ for the Fed but ________ for the Treasury. Thus

an

incre

ase in U.S. 132) Treasury deposits ________ the monetary base.

A) an asset; a liability; decreases C) a liability; an asset; decreases

_____

B) a liability; an asset; increases D) a n asset; a liability; increases

133) An increase in which of the following leads to a decline in the monetary base?

A) Float B) D iscount loans C) SDRs D) F oreign deposits at the Fed

133) _____

134) Suppose, while cleaning out its closets, a worker at the Federal Reserve bank branch in

134) _____

Memphis discovers a painting of Elvis (medium: acrylic on velvet) that used to grace the walls of the conference room. Suppose further that, at a public auction, the bank sells the painting for $19.95. This sale will cause ________ in the monetary base, everything else held constant.

A) a decrease of more than $19.95 B) a n increase of $19.95 C) an increase of more than $19.95 D) a decrease of $19.95

135) Suppose the Bank of China permanently decreases its purchases of U.S. government bonds and, instead, holds more dollars on deposit at the Federal Reserve. Everything else held constant, a open market ________ would be the appropriate monetary policy action for the Fed to take to offset the expected ________ in the monetary base in the United States.

A) p urchase; decrease C) s ale; increase

B) p urchase; increase D) s ale; decrease

135) _____

1) C 2) D 3) C 4) C 5) B 6) A 7) D 8) D 9) A 10) C 11) D 12) D 13) C 14) D 15) C 16) A 17) B 18) A 19) A 20) A 21) C 22) A 23) A 24) C 25) C 26) C 27) A 28) B 29) D 30) A 31) C 32) B 33) A 34) A 35) A 36) C 37) C 38) C 39) A 40) B 41) B 42) D 43) A 44) C 45) A 46) A 47) A 48) A 49) D 50) D

51) B 52) A 53) A 54) A 55) C 56) D 57) A 58) D 59) B 65) The Fed can increase the monetary base by purchasing government bonds and by extending discount loans. If the 60) person C selling the security chooses to keep the proceeds in currency, bank reserves do not increase. Because the 61) Fed B cannot control the distribution of the monetary base between reserves and currency, it has less control over 62) reserves than the base.

A 66) 63) A D 67) 64) A A 68) D 69) B 70) C 71) B 72) C 73) B 74) A 75) A 76) B 77) C 78) A 79) B 80) D 81) C 82) A 83) B 84) C 85) C 86) C 87) D 88) A 89) D 90) A

99) C 100) D 101) C 102) C 103) B 104) A 105) B 106) B 107) C 108) B 109) D 110) A 111) C 112) B 113) A 114) A 115) A 116) Bank A first changes a security for reserves, and then lends the reserves, creating loans. It receives $100 in reserves from the sale of securities. Since all of these reserve will be excess reserves (there was no change in checkable deposits), the bank will loan out all $100. The $100 will then be deposited into Bank B. This bank now has a change in reserves of $100, of which $90 is excess reserves. Bank B will loan out this $90, which will be deposited into Bank C. Bank C now has an increase in reserves of $90, $81 of which is excess reserves. Bank C will loan out this $81 dollars and the process will continue until there are no more excess reserves in the banking system.

For the banking system, both loans and deposits increase by $1000.

117) The Fed does not completely control the level of bank deposits and loans because banks can hold excess reserves and the public can change its currency holdings. A change in either factor changes the deposit expansion process.

An increase in either excess reserves or currency reduces the amount by which deposits and loans are increased.

118) The simple model ignores the role banks and their customers play in the creation process. The bank's customers can decide to hold currency and the bank can decide to hold excess reserves. Both of these will restrict the banking system's ability to create deposits. Thus, the true multiplier is less than the prediction of the simple deposit multiplier.

119) A 120) D 121) B 122) A 123) A 124) B 125) A 126) A 127) C 128) A 129) A 130) B 131) A 132) C 133) D 134) D 135) A

Exam Name___________________________________ MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question.

1) Models describing the determination of the money supply and the Fed's role in this process

1) _______

normally focus on ________ rather than ________, since Fed actions have a more predictable effect on the former.

A) reserves; high-powered money B) reserves; the monetary base C) the monetary base; reserves D) the monetary base; high-powered money

2) The Fed can exert more precise control over ________ than it can over ________.

A) reserves; high-powered money B) high-powered money; reserves C) high-powered money; the monetary base D) the monetary base; high-powered money

2) _______

3) The ratio that relates the change in the money supply to a given change in the monetary base is

3) _______

called the A) deposit ratio.

C) required reserve ratio.

B) d iscount rate.

D) m oney multiplier.

4) The formula linking the money supply to the monetary base is A) M = m/MB. B) M = m + MB. C) M = m × MB. D) MB = M × m.

E) m = M × MB.

4) _______

5) The variable that reflects the effect on the money supply of changes in factors other than the

5) _______

monetary base is the A) money multiplier.

C) nonborrowed base.

B) r equired reserve ratio.

D) c urrency-checkable deposits ratio.

6) An assumption in the model of the money supply process is that the desired levels of currency

6) _______

and excess reserves A) grow proportionally with high-powered money.

B) grow proportionally with checkable deposits.

C) grow proportionally over time.

D) are given as constants.

7) The total amount of reserves in the banking system is equal to the ________ required reserves and excess reserves.

A) ratio between C) difference between

B) p roduct of D) s um of

8) The total amount of required reserves in the banking system is equal to the ________ the required reserve ratio and checkable deposits.

A) difference between

7) _______

B) r atio between

8) _______

D) p roduct of

C) sum of

9) Since the Federal Reserve sets the required reserve ratio to less than one, one dollar of reserves can support ________ of checkable deposits.

A) less than one dollar C) exactly one dollar

9) _______

B) e xactly twice the amount D) m ore than one dollar

10) The equation that shows the amount of the monetary base needed to support existing levels of

10) ______

checkable deposits, excess reserves, and currency is A) MB = (r × D) - ER - C. B) M B = (r + D) + ER + C.

D) M B = (r × D) + ER + C.

C) MB =

+ ER + C.

11) An increase in the monetary base that goes into ________ is not multiplied, while an increase that goes into ________ is multiplied.

A) currency; deposits C) deposits; currency

B) e xcess reserves; currency D) c urrency; excess reserves

12) An increase in the monetary base that goes into currency is ________, while an increase that goes into deposits is ________.

A) multiplied; not multiplied C) not multiplied; not multiplied

11) ______

12) ______

B) n ot multiplied; multiplied D) m ultiplied; multiplied

13) If the Fed injects reserves into the banking system and they are held as excess reserves, then the 13) ______ money supply A) does not change.

B) increases by only the initial increase in reserves.

C) increases by only one-half the initial increase in reserves.

D) increases by a multiple of the initial increase in reserves.

14) If the Fed injects reserves into the banking system and they are held as excess reserves, then the 14) ______ monetary base ________ and the money supply ________.

A) increases; increases B) i ncreases; remains unchanged C) remains unchanged; remains D) r emains unchanged; increases unchanged

15) The formula that links checkable deposits to the monetary base is A) B) C) D) E)

M=

.

m=

.

M=

.

D=

× MB.

D=

.

16) The formula that links checkable deposits to the money supply is A) M =

15) ______

16) ______

B) .

D = (1 + c) × M

17) The formula for the M1 money multiplier is A) m = [1/(r + e + c)] × MB. C) M = 1/(r + e + c).

C)

D =

× M.

D)

M =

× D.

B) m = (1 + c)/(r + e + c).

D) M = (1 + c)/(r + e + c).

18) If the required reserve ratio is 10 percent, currency in circulation is $400 billion, checkable

17) ______

18) ______

deposits are $800 billion, and excess reserves total $0.8 billion, then the money supply is A) $1200.8.

B) $ 8000.

C) $ 8400.

D) $ 1200.

19) If the required reserve ratio is 10 percent, currency in circulation is $400 billion, checkable

19) ______

deposits are $800 billion, and excess reserves total $0.8 billion, then the M1 money multiplier is A) 0.601.

B) 2 .0.

C) 1 .67.

D) 2 .5.

20) If the required reserve ratio is 10 percent, currency in circulation is $400 billion, checkable

20) ______

deposits are $800 billion, and excess reserves total $0.8 billion, then the currency ratio is A) 0.05.

B) 0 .40.

C) 0 .50.

D) 0 .25.

21) If the required reserve ratio is 10 percent, currency in circulation is $400 billion, checkable

21) ______

deposits are $800 billion, and excess reserves total $0.8 billion, then the excess reserves-checkable deposit ratio is A) 0.01.

B) 0 .001.

C) 0 .05.

D) 0 .10.

22) If the required reserve ratio is 10 percent, currency in circulation is $400 billion, checkable

22) ______

deposits are $800 billion, and excess reserves total $0.8 billion, then the monetary base is A) $480 billion.

B) $ 80.8 billion.

C) $ 480.8 billion. D) $ 80 billion.

23) If the required reserve ratio is 15 percent, currency in circulation is $400 billion, checkable

23) ______

deposits are $800 billion, and excess reserves total $0.8 billion, then the M1 money multiplier is A) 1.67.

B) 2 .3.

C) 0 .651.

D) 2 .5.

24) If the required reserve ratio is 5 percent, currency in circulation is $400 billion, checkable

24) ______

deposits are $800 billion, and excess reserves total $0.8 billion, then the M1 money multiplier is A) 2.72.

B) 2 .3.

C) 0 .551.

D) 2 .5.

25) If the required reserve ratio is 10 percent, currency in circulation is $400 billion, checkable

25) ______

deposits are $1000 billion, and excess reserves total $1 billion, then the money supply is B) $ 10,000.

C) $ 1400. $10,400.

D)A) $ 4000.

26) If the required reserve ratio is 10 percent, currency in circulation is $400 billion, checkable

26) ______

deposits are $1000 billion, and excess reserves total $1 billion, then the M1 money multiplier is A) 2.5.

B) 2 .8.

C) 0 .7.

D) 2 .0.

27) If the required reserve ratio is 10 percent, currency in circulation is $400 billion, checkable deposits are $1000 billion, and excess reserves total $1 billion, then the currency ratio is A) 0.05.

B) 0 .25.

C) 0 .40.

D) 0 .50.

27) ______

28) If the required reserve ratio is 10 percent, currency in circulation is $400 billion, checkable

28) ______

deposits are $1000 billion, and excess reserves total $1 billion, then the excess reserves-checkable deposit ratio is A) 0.05.

B) 0 .10.

C) 0 .001.

D) 0 .01.

29) If the required reserve ratio is 10 percent, currency in circulation is $400 billion, checkable

29) ______

deposits are $1000 billion, and excess reserves total $1 billion, then the monetary base is A) $400 billion.

B) $ 401 billion.

C) $ 500 billion.

D) $ 501 billion.

30) If the required reserve ratio is 15 percent, currency in circulation is $400 billion, checkable

30) ______

deposits are $1000 billion, and excess reserves total $1 billion, then the M1 money multiplier is A) 2.35.

B) 0 .551.

C) 2 .54.

D) 2 .67.

31) If the required reserve ratio is one-third, currency in circulation is $300 billion, and checkable deposits are $900 billion, then the money supply is A) $1800.

B) $ 2700.

C) $ 1200.

D) $ 3000.

32) If the required reserve ratio is one-third, currency in circulation is $300 billion, and checkable deposits are $900 billion, then the M1 money multiplier is A) 2.5.

B) 2 .0.

C) 2 .8.

C) 0 .33.

32) ______

D) 0 .67.

33) If the required reserve ratio is one-third, currency in circulation is $300 billion, and checkable deposits are $900 billion, then the currency ratio is A) 0.67.

B) 0 .375.

31) ______

33) ______

D) 0 .25.

34) If the required reserve ratio is one-third, currency in circulation is $300 billion, and checkable

34) ______

deposits are $900 billion, then the level of excess reserves in the banking system is D) 0 .

A) $300 billion.

B) $ 30 billion.

C) $ 3 billion.

35) If the required reserve ratio is one-third, currency in circulation is $300 billion, and checkable deposits are $900 billion, then the monetary base is A) $333 billion.

B) $ 667 billion.

C) $ 600 billion.

D) $ 300 billion.

36) Everything else held constant, an increase in the required reserve ratio on checkable deposits will cause A) the money supply to fall.

C) the money supply to remain constant.

36) ______

B) t he money supply to rise.

D) c heckable deposits to rise.

37) Everything else held constant, a decrease in the required reserve ratio on checkable deposits will mean A) a decrease in the money supply.

C) an increase in the money supply.

35) ______

37) ______

B) a n increase in discount loans.

D) a decrease in checkable deposits.

38) Everything else hed constant, an increase in the required reserve ratio on checkable deposits

38) ______

causes the M1 money multiplier to _____ and the money supply to _____.

A) increase; increase B) d ecrease; decrease C) decrease; increase D) i ncrease; decrease

39) Everything else held constant, a decrease in the required reserve ratio on checkable deposits causes the M1 money multiplier to _____ and the money supply to _____.

A) increase; decrease B) d ecrease; decrease

39) ______

C) increase; increase

D) d ecrease; increase

40) Assuming initially that r = 10%, c = 40%, and e = 0, an increase in r to 15% causes the M1 money 40) ______ multiplier to _____, everything else held constant.

A) increase from 1.82 to 2 C) decrease from 2 to 1.82

B) d ecrease from 2.8 to 2.55 D) i ncrease from 2.55 to 2.8

41) Assuming initially that r = 10%, c = 40%, and e = 0, a decrease in r to 5% causes the M1 money multiplier to _____, everything else held constant.

A) increase from 2.8 to 3.11 C) decrease from 2.22 to 2

41) ______

B) d ecrease from 3.11 to 2.8 D) i ncrease from 2 to 2.22

42) Everything else held constant, an increase in the currency-checkable deposit ratio will mean A) a decrease in the money supply.

B) an increase in money supply but no change in reserves.

C) an increase in currency in circulation but no change in the money supply.

D) an increase in currency in circulation and an increase in the money supply.

42) ______

43) Everything else held constant, a decrease in the currency-checkable deposit ratio will mean A) a decrease in the money supply.

B) an increase in currency in circulation but no change in the money supply.

C) an increase in money supply.

D) an increase in currency in circulation and an increase in the money supply.

43) ______

44) Everything else held constant, an increase in the currency ratio causes the M1 money multiplier

44) ______

to _____ and the money supply to _____.

A) decrease; increase C) increase; decrease

B) i ncrease; increase D) d ecrease; decrease

45) Everything else held constant, a decrease in the currency ratio causes the M1 money multiplier to _____ and the money supply to _____.

A) decrease; decrease C) increase; decrease

45) ______

B) i ncrease; increase D) d ecrease; increase

46) Assuming initially that r = 10%, c = 40%, and e = 0, an increase in c to 50% causes the M1 money 46) ______ multiplier to _____, everything else held constant.

A) increase from 2.5 to 2.8 C) decrease from 2.8 to 2.33

B) i ncrease from 2.33 to 2.8 D) d ecrease from 2.8 to 2.5

47) Assuming initially that r = 10%, c = 40%, and e = 0, an decrease in c to 30% causes the M1 money 47) ______ multiplier to _____, everything else held constant.

A) increase from 2.8 to 3.5 C) decrease from 3.25 to 2.8

B) i ncrease from 2.8 to 3.25 D) d ecrease from 3.5 to 2.8

48) Every thing else held constant, a decrease in the excess reserves ratio causes the M1 money

48) ______

multiplier to _____ and the money supply to _____.

A) decrease; decrease B) i ncrease; decrease C) increase; increase D) d ecrease; increase

49) Everything else held constant, an increase in the excess reserves ratio causes the M1 money multiplier to _____ and the money supply to _____.

A) increase; increase B) i ncrease; decrease

49) ______

C) decrease; decrease

D) d ecrease; increase

50) Assuming initially that r = 15%, c = 40%, and e = 5%, a decrease in e to 0% causes the M1 money 50) ______ multiplier to _____, everything else held constant.

A) increase from 2.33 to 2.55 C) decrease from 1.82 to 1.67

B) d ecrease from 2.55 to 2.33 D) i ncrease from 1.67 to 1.82

51) Assuming initially that r = 15%, c = 40%, and e = 5%, an increase in e to 10% causes the M1

51) ______

money multiplier to _____, everything else held constant.

A) increase from 1.54 to 1.67 B) d ecrease from 2.33 to 2.15 C) decrease from 1.67 to 1.54 D) i ncrease from 2.15 to 2.33

52) The excess reserves ratio is _____ related to expected deposit outflows, and is _____ related to the market interest rate.

A) negatively; positively C) negatively; negatively

B) p ositively; positively D) p ositively; negatively

53) The money supply is _____ related to expected deposit outflows, and is _____ related to the market interest rate.

A) negatively; positively C) positively; positively

52) ______

53) ______

B) n egatively; negatively D) p ositively; negatively

54) The money multiplier is A) positively related to holdings of excess reserves.

B) negatively related to the required reserve ratio.

C) negatively related to high-powered money.

D) positively related to the excess reserves ratio.

54) ______

ESSAY. Write your answer in the space provided or on a separate sheet of paper.

55) What factors determine a bank's holdings of excess reserves? How does a change in each factor affect excess reserves, the money multiplier, and the money supply?

56) Explain two developments in recent years that have led to the decreasing importance of reserve requirements in determining the money multiplier and the money supply.

MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question.

57) The Fed does not tightly control the monetary base because it does not completely control 57) ______ A) borrowed reserves.

B) o pen market purchases.

C) the discount rate.

D) o pen market sales.

58) ______ 58) Subtracting borrowed reserves from the monetary base obtains A) the borrowed monetary base.

B) h igh-powered money.

C) reserves.

D) t he nonborrowed monetary base.

59) The relationship between borrowed reserves, the nonborrowed monetary base, and the monetary base is A) MB = MBn - BR.

C) BR = MBn - MB.

59) ______

B) B R = MB - MBn. D) M B = BR - MBn.

60) Recognizing the distinction between borrowed reserves and the nonborrowed monetary base,

the money

supply model is specified as

____ __

60)

A) M = m - (MBn + BR).

C) M = m + (MBn - BR).

B) M = m × (MBn + BR).

D) M = m × (MBn - BR).

61) An increase in the nonborrowed monetary base, everything else held constant, will cause: A) the money supply to rise.

B) n o change in the money supply.

C) demand deposits to fall.

D) t he money supply to fall.

61) ______

62) The money supply is ________ related to the nonborrowed monetary base, and ________

62) ______

related to the level of borrowed reserves.

A) positively; negatively C) negatively; negatively

B) n egatively; not D) p ositively; positively

63) The amount of borrowed reserves is ________ related to the discount rate, and is ________ related to the market interest rate.

A) negatively; positively C) positively; negatively

B) p ositively; positively D) n egatively; negatively

64) A ________ in market interest rates relative to the discount rate will cause discount borrowing to ________.

A) fall; remain unchanged C) fall; increase

63) ______

64) ______

B) r ise; decrease D) r ise; increase

ESSAY. Write your answer in the space provided or on a separate sheet of paper.

65) Explain the complete formula for the M1 money supply, and explain how changes in required reserves, excess reserves, the currency ratio, the nonborrowed base, and borrowed reserves affect the money supply.

MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question.

66) ______ 66) In the model of the money supply process, the Federal Reserve's role in influencing the money supply is represented by A) both the required reserve ratio and the market interest rate.

B) only nonborrowed reserves.

C) the required reserve ratio, nonborrowed reserves, borrowed reserves, and the market interest rate.

D) only borrowed reserves.

67) In the model of the money supply process, the depositor's role in influencing the money supply

67) ______

is represented by A) only the market interest rate.

B) the currency ratio, excess reserve ratio, and the market interest rate.

C) both the currency ratio and excess reserve ratio.

D) only the currency ratio.

68) In the model of the money supply process, the bank's role in influencing the money supply process is represented by A) only the currency ratio.

B) both the excess reserve ratio and the market interest rate.

68) ______

C) only borrowed reserves.

D) only the excess reserve ratio.

69) In the model of the money supply process, borrowers from banks' role in influencing the

69) ______

money supply is represented by A) both the excess reserve ratio and the market interest rate.

B) both borrowed reserves and the market interest rate.

C) only market interest rates.

D) only the currency ratio.

70) All else constant, a rise in market interest rates leads to a A) fall in borrowed reserves and a rise in the money supply.

B) rise in excess reserves and a rise in the money supply.

C) fall in excess reserves and a fall in the money supply.

D) rise in borrowed reserves and a rise in the money supply.

70) ______

71) Over the long run the primary determinant of movements in the money supply is the A) excess reserves ratio.

B) r equired reserve ratio.

C) nonborrowed base.

D) c urrency ratio.

71) ______

72) Over short time periods, changes in the ________ can have a major impact on the money

72) ______

supply.

A) required reserve ratio C) borrowed base

B) c urrency ratio D) e xcess reserve ratio

73) During the bank panics of the Great Depression the currency ratio A) increased sharply.

B) i ncreased slightly.

C) decreased sharply.

D) d ecreased slightly.

73) ______

74) During the bank panics of the Great Depression the excess reserve ratio A) decreased slightly.

B) i ncreased slightly.

C) increased sharply.

D) d ecreased sharply.

74) ______

75) In the early 1930s, the currency ratio rose, as did the level of excess reserves. Money supply

75) ______

analysis predicts that, everything else held constant, the money supply should have A) remain unchanged.

B) r isen.

C) fallen.

D) e ither risen, fallen, or remain unchanged

ESSAY. Write your answer in the space provided or on a separate sheet of paper.

76) The monetary base increased by 20% during the contraction of 1929-1933, but the money supply fell by 25%.

Explain why this occurred. How can the money supply fall when the base increases?

MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question.

77) The equation that represents M2 in the model of the money supply process is 77) ______ A) M2 = C + D + T + MMF B) M 2 = C + D - T + MMF C) M2 = C + D + T - MMF D) M 2 = C + D 78) In the model of the money supply process for M2, the relationship between checkable deposits and the M2 money supply is represented by

78) ______

A)

B) D=

× M2

C) D = (1 + c + t + mm) × M2

D)

M2 =

×D

M2 =

79) The M2 money supply is represented by A) C)

M2 =

× MB

MB =

× M2

79) ______ B) D)

MB =

×

M2 =

×

80) The M2 money multiplier is A) negatively related to high-powered money.

B) positively related to the excess reserves ratio.

C) positively related to the time deposit ratio.

D) positively related to the required reserve ratio.

80) ______

81) Everything else held constant, an increase in the currency ratio will mean ________ in the M2

81) ______

money multiplier and ________ in the M2 money supply.

A) a decrease; a decrease B) a decrease; an increase C) an increase; an increase D) a n increase; a decrease

82) Everything else held constant, a decrease in the currency ratio will mean ________ in the M1

82) ______

money multiplier and ________ in the M2 money multiplier.

A) a decrease; a decrease B) a n increase; a decrease C) an increase; an increase D) a decrease; an increase

83) Everything else held constant, an increase in the required reserve ratio will mean ________ in

83) ______

the M2 money multiplier and ________ in the M2 money supply.

A) a decrease; a decrease B) a n increase; an increase C) an increase; a decrease D) a decrease; an increase

84) Everything else held constant, an increase in the required reserve ratio will result in ________ in M1 and ________ in M2.

A) a decrease; an increase C) an increase; a decrease

84) ______

B) a decrease; a decrease D) a n increase; an increase

85) Everything else held constant, an increase in the time deposit ratio will mean ________ in the

85) ______

M2 money multiplier and ________ in the M2 money supply.

A) a decrease; a decrease B) a n increase; a decrease C) a decrease; an increase D) a n increase; an increase

86) Everything else held constant, an increase in the time deposit ratio will result in ________ in the

86) ______

M1 money multiplier and ________ in the M2 money multiplier.

A) no change; a decrease B) n o change; an increase C) a decrease; a decrease D) a n increase; an increase

87) Everything else held constant, an increase in the money market fund ratio will mean ________ in the M2 money multiplier and ________ in the M2 money supply.

A) an increase; an increase B) a decrease; a decrease

87) ______

C) an increase; a decrease

D) a decrease; an increase

88) Everything else held constant, an increase in the money market fund ratio will result in

88) ______

________ in the M1 money multiplier and ________ in the M2 money multiplier.

A) a decrease; a decrease B) n o change; a decrease C) an increase; an increase D) n o change; an increase

89) Everything else held constant, an increase in the excess reserve ratio will mean ________ in the

89) ______

M2 money multiplier and ________ in the M2 money supply.

A) a decrease; a decrease B) a n increase; a decrease C) a decrease; an increase D) a n increase; an increase

90) Everything else held constant, an increase in the excess reserve ratio will mean ________ in the

90) ______

M1 money multiplier and ________ in the M2 money multiplier.

A) an increase; an increase B) n o change; a decrease C) no change; an increase D) a decrease; a decrease

91) Factors causing an increase in currency holdings include A) an increase in the interest rates paid on checkable deposits.

B) an increase in illegal activity.

C) a decrease in bank panics.

D) an increase in the cost of acquiring currency.

91) ______

92) Part of the increase in currency holdings in the 1960s and 1970s can be attributed to A) the switch from progressive to proportional income taxes.

B) increases in income tax rates.

C) the adoption of regressive taxes.

D) bracket creep due to inflation and progressive income taxes.

92) ______

93) Everything else held constant, an increase in wealth will cause the holdings of checkable

93) ______

deposits to the holdings of currency to ________ and the currency ratio will ________.

A) decrease; increase B) i ncrease; decrease C) increase; increase D) d ecrease; decrease

94) Everything else held constant, an increase in the interest rate paid on checkable deposits will

94) ______

cause ________ in the amount of checkable deposits held relative to currency holdings and ________ in the currency ratio.

A) an increase; a decrease B) a n increase; an increase C) a decrease; an increase D) a decrease; a decrease

95) The increase in the availability of ATM's has caused the cost of acquiring currency to ________

95) ______

which will cause the currency ratio to ________, everything else held constant.

A) decrease; decrease B) d ecrease; increase C) increase; increase D) i ncrease; decrease

96) The steepest increase in the currency ratio since 1892 occurred during A) World War II. B) t he past twenty years.

C) the interwar years.

D) t he Great Depression.

96) ______

97) The factor accounting for the steepest rise in the currency ratio since 1892 is A) an increase in wealth.

B) i llegal activity.

97) ______

C) taxes.

D) b ank panics.

98) The increase in the currency ratio during World War II was due to A) the spread of ATMs. B) a drop in the rate of interest paid on checking deposits.

C) bank panics.

D) high taxes and illegal activities.

98) ______

1) C 2) B 3) D 4) C 5) A 6) B 7) D 8) D 9) D 10) D 11) A 12) B 13) A 14) B 15) D 16) C 17) B 18) D 19) D 20) C 21) B 22) C 23) B 24) A 25) C 26) B 27) C 28) C 29) D 30) C 31) C 32) B 33) C 34) D 35) C 36) A 37) C 38) B 39) C 40) B 41) A 42) A 43) C 44) D 45) B 46) D 47) B 48) C 49) C 50) A

51) B 52) D 53) A 55) An increase in market interest rates reduces excess reserves because banks profit from increased lending. An 54) increase B in expected deposit outflows increases excess reserves. An increase in interest rates reduces excess reserves, increasing the multiplier and the money supply. An increase in expected outflows increases excess reserves, reducing the multiplier and the money supply.

56) The first is the sweep account. Sweep accounts are two accounts tied together, usually a checking account and a money market fund account. At the end of each business day, balances over a certain amount in the checking account are swept into the MMF account. This has led to lower checking account balances and less required reserves, since reserve requirements are only applied to checkable deposit accounts.

The second is the increased availability of ATMs. Banks have found that they need more cash to supply the increased number of ATMs. Hence, this increased vault cash means that banks are holding more excess reserves.

A change in the reserve requirements will not alter banks' behavior, as long as the change is less than the extra vault cash now held by banks.

57) A 58) D 59) B 60) B 61) A 62) D ×( + BR). The formula indicates that the money supply is the product of the 63) The formula is M = A multiplier times the base. Increases in any of the multiplier components, required reserves, r; excess reserves, e; or 64) the currency ratio, c; reduce the multiplier and the money supply. Increases in the nonborrowed base and D borrowed reserves both increase the base and the money supply.

66) C 65) 67) B 68) B 69) C 70) D 71) C 72) B 73) A 74) C banking crisis caused the public to fear for the safety of their deposits, increasing both the currency ratio and 76) The 75) bank C holdings of excess reserves in anticipation of deposit outflows. Both of these changes reduce the money multiplier and the money supply. In this case, the fall in the multiplier due to increases of currency and excess reserves more than offset the increase in the base, causing the money supply to fall.

77) A 78) A 79) A 80) C 81) A 82) C 83)

84) B 85) D 86) B 87) A 88) D 89) A 90) D 91) B 92) D 93) B 94) A 95) B 96) D 97) D 98) D

Exam Name___________________________________ MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question.

1) The Fed uses three policy tools to manipulate the money supply: ________, which affect

1) _______

reserves and the monetary base; changes in ________, which affect the monetary base; and changes in ________, which affect the money multiplier.

A) borrowed reserves; open market operations; margin requirements B) borrowed reserves; open market operations; reserve requirements C) open market operations; borrowed reserves; reserve requirements D) open market operations; borrowed reserves; margin requirements

2) The Fed uses three policy tools to manipulate the money supply: open market operations,

2) _______

which affect the ________; changes in borrowed reserves, which affect the ________; and changes in reserve requirements, which affect the ________.

A) monetary base; monetary base; money multiplier B) money multiplier; money multiplier; monetary base C) money multiplier; monetary base; monetary base D) monetary base; money multiplier; monetary base

3) The interest rate charged on overnight loans of reserves between banks is the A) discount rate.

B) f ederal funds rate.

C) Treasury bill rate.

D) p rime rate.

3) _______

4) The primary indicator of the Fed's stance on monetary policy is A) the federal funds rate.

B) t he growth rate of M2.

C) the growth rate of the monetary base.

D) t he discount rate.

4) _______

5) The quantity of reserves demanded equals A) total reserves minus excess reserves.

B) required reserves plus excess reserves.

C) required reserves plus borrowed reserves.

D) excess reserves plus borrowed reserves.

5) _______

6) The quantity of reserves demanded rises when the A) federal funds rate rises.

B) f ederal funds rate falls.

C) discount rate rises.

D) d iscount rate falls.

6) _______

7) The opportunity cost of holding excess reserves is A) the Treasury bill rate.

C) the federal funds rate.

7) _______

B) t he prime rate.

D) t he discount rate.

8) The quantity of reserves supplied equals A) total reserves minus required reserves.

B) nonborrowed reserves minus borrowed reserves.

C) required reserves plus borrowed reserves.

D) nonborrowed reserves plus borrowed reserves.

8) _______

9) In the market for reserves, when the federal funds interest rate is below the discount rate, the

9) _______

supply curve of reserves is

A) positively sloped.

C) horizontal.

B) n egatively sloped.

D) v ertical.

10) When the federal funds rate equals the discount rate A) the supply curve of reserves is vertical.

B) the demand curve for reserves is vertical.

C) the demand curve for reserves is horizontal.

D) the supply curve of reserves is horizontal.

10) ______

11) In the market for reserves, an open market ________ the supply of reserves, raising the federal

11) ______

funds interest rate, everything else held constant.

A) purchase decreases C) sale decreases

B) p urchase increases D) s ale increases

12) In the market for reserves, an open market purchase ________ the ________ of reserves which

12) ______

causes the federal funds rate to fall, everything else held constant.

A) decreases; demand B) i ncreases; supply C) decreases; supply D) i ncreases; demand

13) Suppose on any given day there is an excess demand of reserves in the federal funds market. If

13) ______

the Federal Reserve wishes to keep the federal funds rate at its current level, then the appropriate action for the Federal Reserve to take is a ________ open market ________, everything else held constant.

A) defensive; sale B) d ynamic; sale C) dynamic; purchase D) d efensive; purchase

14) In the market for reserves, an open market purchase ________ the supply of reserves and causes 14) ______ the federal funds interest rate to ________, everything else held constant.

A) increases; fall B) d ecreases; rise C) i ncreases; rise

D) d ecreases; fall

15) Suppose on any given day the prevailing equilibrium federal funds rate is above the Federal

15) ______

Reserve's federal funds target rate. If the Federal Reserve wishes for the federal funds rate to be at their target level, then the appropriate action for the Federal Reserve to take is a ________ open market ________, everything else held constant.

A) dynamic; purchase B) d efensive; sale C) dynamic; sale D) d efensive; purchase

16) In the market for reserves, an open market sale ________ the supply of reserves causing the

16) ______

federal funds rate to ________, everything else held constant.

A) increases; decrease B) d ecreases; decrease C) increases; increase D) d ecreases; increase

17) Suppose on any given day there is an excess supply of reserves in the federal funds market. If

17) ______

the Federal Reserve wishes to keep the federal funds rate at its current level, then the appropriate action for the Federal Reserve to take is a ________ open market ________, everything else held constant.

A) dynamic; sale B) d efensive; purchase C) defensive; sale D) d ynamic; purchase

18) Suppose on any given day the prevailing equilibrium federal funds rate is below the Federal Reserve's federal funds target rate. If the Federal Reserve wishes for the federal funds rate to be at their target level, then the appropriate action for the Federal Reserve to take is a ________

opeket n ______ mar__,

everythin 18) g else held constant.

A) defensive; sale C) defensive; purchase

____ __

B) d ynamic; purchase D) d ynamic; sale

19) In the market for reserves, an open market sale ________ the ________ of reserves, causing the 19) ______ federal funds rate to increase, everything else held constant.

A) increases; demand B) i ncreases; supply C) decreases; demand D) d ecreases; supply

20) In the market for reserves, a lower discount rate A) lengthens the vertical section of the supply curve of reserves.

B) decreases the supply of reserves.

C) shortens the vertical section of the supply curve of reserves.

D) increases the supply of reserves.

20) ______

21) Everything else held constant, in the market for reserves, when the federal funds rate is 3%,

21) ______

lowering the discount rate from 5% to 4% A) has no effect on the federal funds rate.

B) lowers the federal funds rate.

C) raises the federal funds rate D) has an indeterminate effect on the federal funds rate.

22) Everything else held constant, in the market for reserves, when the federal funds rate is 5%,

22) ______

lowering the discount rate from 5% to 4% A) lowers the federal funds rate.

B) has no effect on the federal funds rate.

C) raises the federal funds rate.

D) has an indeterminate effect on the federal funds rate.

23) Everything else held constant, in the market for reserves, when the federal funds rate is 3%,

23) ______

raising the discount rate from 5% to 6% A) has an indeterminate effect on the federal funds rate.

B) has no effect on the federal funds rate.

C) lowers the federal funds rate.

D) raises the federal funds rate.

24) Everything else held constant, in the market for reserves, when the federal funds rate equals the

24) ______

discount rate, lowering the discount rate A) increases the federal funds rate.

B) has no effect on the federal funds rate.

C) lowers the federal funds rate.

D) has an indeterminate effect of the federal funds rate.

25) Everything else held constant, in the market for reserves, when the demand for federal funds intersects the reserve supply curve along the horizontal section, increasing the discount rate A) has an indeterminate effect of the federal funds rate.

B) has no effect on the federal funds rate.

C) increases the federal funds rate.

D) lowers the federal funds rate.

25) ______

26) Everything else held constant, in the market for reserves, when the demand for federal funds

26) ______

intersects the reserve supply curve on the vertical section, increasing the discount rate A) has an indeterminate effect on the federal funds rate.

B) has no effect on the federal funds rate.

C) lowers the federal funds rate.

D) increases the federal funds rate.

27) Everything else held constant, in the market for reserves, increases in the discount rate affect

27) ______

the federal funds rate A) when the funds rate equals the discount rate.

B) when the demand for federal funds equals zero.

C) when the funds rate is below the discount rate.

D) when the demand for federal funds intersects the vertical section of the reserve supply curve.

28) ______ 28) The Federal Reserve usually keeps the discount rate A) equal to zero.

B) e qual to the target federal funds rate.

C) above the target federal funds rate.

D) b elow the target federal funds rate.

29) Everything else held constant, the vertical section of the supply curve of reserves is shortened when the A) federal funds rate rises.

C) discount rate increases.

B) d iscount rate decreases.

D) f ederal funds rate falls.

30) Everything else held constant, the vertical section of the supply curve of reserves is lengthened when the A) federal funds rate rises.

C) discount rate increases.

29) ______

30) ______

B) d iscount rate decreases.

D) f ederal funds rate falls.

31) In the market for reserves, an increase in the reserve requirement ________ the demand for

31) ______

reserves, ________ the federal funds rate, everything else held constant.

A) increases; lowering B) d ecreases; lowering C) decreases; raising D) i ncreases; raising

32) In the market for reserves, a ________ in the reserve requirement ________ the demand for

32) ______

reserves, raising the federal funds interest rate, everything else held constant.

A) rise; increases B) d ecline; increases C) decline; decreases D) r ise; decreases

33) In the market for reserves, a ________ in the reserve requirement increases the demand for

33) ______

reserves, ________ the federal funds interest rate, everything else held constant.

A) rise; raising B) r ise; lowering C) decline; raising D) d ecline; lowering

34) In the market for reserves, an increase in the reserve requirement ________ the demand of

34) ______

reserves and causes the federal funds interest rate to ________, everything else held constant.

A) decreases; fall B) d ecreases; rise C) i ncreases; rise D) i ncreases; fall

35) In the market for reserves, an increase in the reserve requirement ________ the ________ for reserves and causes the federal funds interest rate to rise, everything else held constant.

A) increases; supply B) d ecreases; supply C) increases; demand D) d ecreases; demand

35) ______

36) In the market for reserves, a ________ in the reserve requirement ________ the demand for

36) ______

37) In the market for reserves, a ________ in the reserve requirement decreases the demand for

37) ______

reserves, lowering the federal funds interest rate, everything else held constant.

A) decline; decreases B) d ecline; increases C) rise; decreases D) r ise; increases

reserves, ________ the federal funds interest rate, everything else held constant.

A) rise; lowering B) d ecline; raising C) rise; raising D) d ecline; lowering

38) In the market for reserves, a decline in the reserve requirement ________ the ________ curve of 38) ______ reserves and causes the federal funds interest rate to fall, everything else held constant.

A) decreases; supply B) i ncreases; supply C) increases; demand D) d ecreases; demand

39) In the market for reserves, a decline in the reserve requirement ________ the demand of

39) ______

reserves, ________ the federal funds rate, everything else held constant.

A) decreases; lowering B) i ncreases; raising C) decreases; raising D) i ncreases; lowering

40) Suppose, at a given federal funds rate, there is an excess demand for reserves in the federal

40) ______

funds market. If the Fed wants the federal funds rate to stay at that level, then it should undertake an open market ________ of bonds, everything else held constant. If the Fed does nothing, however, the federal funds rate will ________.

A) purchase; increase B) s ale; decrease C) purchase; decrease D) s ale; increase

41) Suppose, at a given federal funds rate, there is an excess supply of reserves in the federal funds

41) ______

market. If the Fed wants the federal funds rate to stay at that level, then it should undertake an open market ________ of bonds, everything else held constant. If the Fed does nothing, however, the federal funds rate will ________.

A) sale; ecrease B) s ale; increase C) purchase; ncrease D) p urchase; decrease

ESSAY. Write your answer in the space provided or on a separate sheet of paper.

42) Explain the Fed's three tools of monetary policy and how each is used to change the money supply. Does each tool affect the monetary base or the money multiplier?

43) State whether the following statement is true or false AND explain why: "A decrease in the discount rate will always cause a decrease in the federal reserve funds rate."

MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question.

44) ______ 44) ________ are the most important monetary policy tool because they are the primary determinant of changes in the ________, the main source of fluctuations in the money supply.

A) Open market operations; money multiplier B) Changes in reserve requirements; monetary base C) Changes in reserve requirements; money multiplier D) Open market operations; monetary base

45) Open market purchases raise the ________ thereby raising the ________.

45) ______

A) money multiplier; monetary base C) money multiplier; money supply

B) m onetary base; money multiplier D) m onetary base; money supply

46) Open market purchases ________ reserves and the monetary base thereby ________ the money 46) ______ supply.

A) raise; lowering C) lower; raising

B) l ower; lowering D) r aise; raising

47) Open market sales shrink ________ thereby lowering ________.

A) the money base; the money multiplier B) the money multiplier; the money supply C) reserves and the monetary base; the money supply D) the money multiplier; reserves and the monetary base

47) ______

48) Open market sales ________ reserves and the monetary base thereby ________ the money

48) ______

supply.

A) lower; raising C) raise; raising

49) The two types of open market operations are A) dynamic and defensive.

C) active and passive.

B) r aise; lowering D) l ower; lowering B) o ffensive and defensive.

D) d ynamic and reactionary.

50) There are two types of open market operations: ________ open market operations are intended

49) ______

50) ______

to change the level of reserves and the monetary base, and ________ open market operations are intended to offset movements in other factors that affect the monetary base.

A) dynamic; static B) d efensive; dynamic C) dynamic; defensive D) d efensive; static

51) Open market operations intended to offset movements in noncontrollable factors (such as float)

51) ______

that affect reserves and the monetary base are called A) offensive open market operations.

B) d efensive open market operations.

C) dynamic open market operations.

D) r eactionary open market operations.

52) When the Federal Reserve engages in a repurchase agreement to offset a withdrawal of

52) ______

Treasury funds from the Federal Reserve, the open market operation is said to be A) dynamic.

B) o ffensive.

C) r eactionary.

D) d efensive.

53) The Federal Open Market Committee makes the Fed's decisions on the purchase or sale of

53) ______

government securities, but these purchases or sales are executed by the Federal Reserve Bank of A) New York.

B) S an Francisco. C) B oston.

D) C hicago.

54) The actual execution of open market operations is done at A) the Federal Reserve Bank of New York.

B) the Federal Reserve Bank of Boston.

C) the Board of Governors in Washington, D.C. D) the Federal Reserve Bank of Philadelphia.

54) ______

55) If float is predicted to decrease because of unseasonably good weather, the manager of the

55) ______

trading desk at the Federal Reserve Bank of New York will likely conduct a ________ open market ________ of securities.

A) d efensive; purchase

B) d ynamic; purchase

C) defensive; sale

D) d ynamic; sale

56) When bad storms slow the check-clearing process, float tends to ________ causing the Fed to initiate defensive open market ________.

A) decrease; purchases C) decrease; sales

B) i ncrease; purchases D) i ncrease; sales

57) When good weather speeds the check-clearing process, float tends to ________ causing the Fed to initiate defensive open market ________.

A) decrease; sales C) increase; purchases

58) ______

B) d ecrease; defensive; sales D) i ncrease; defensive; sales

59) When good weather speeds the check-clearing process, float tends to ________ causing the Fed to initiate ________ open market ________.

A) decrease; defensive; purchases C) increase; dynamic; purchases

57) ______

B) d ecrease; purchases D) i ncrease; sales

58) When bad storms slow the check-clearing process, float tends to ________ causing the Fed to initiate ________ open market ________.

A) increase; dynamic; purchases C) decrease; dynamic; purchases

56) ______

59) ______

B) d ecrease; defensive; sales D) d ecrease; dynamic; sales

60) If float is predicted to increase because of bad weather, the manager of the trading desk at the

60) ______

New York Fed bank will likely conduct ________ open market operations to ________ reserves.

A) dynamic; inject B) d efensive; inject C) defensive; drain D) d ynamic; drain

61) If float is predicted to decrease because of good weather, the manager of the trading desk at the

61) ______

New York Fed bank will likely conduct ________ open market operations to ________ reserves.

A) defensive; drain B) d ynamic; inject C) defensive; inject D) d ynamic; drain

62) If Treasury deposits at the Fed are predicted to increase, the manager of the trading desk at the

62) ______

New York Fed bank will likely conduct ________ open market operations to ________ reserves.

A) dynamic; inject B) d efensive; inject C) defensive; drain D) d ynamic; drain

63) If Treasury deposits at the Fed are predicted to ________, the manager of the trading desk at the 63) ______ New York Fed bank will likely conduct ________ open market operations to ________ reserves.

A) increase; defensive; inject B) i ncrease; dynamic; inject C) decrease; dynamic; drain D) d ecrease; defensive; drain

64) If Treasury deposits at the Fed are predicted to fall, the manager of the trading desk at the New

64) ______

York Fed bank will likely conduct ________ open market operations to ________ reserves.

A) dynamic; drain B) d efensive; drain C) dynamic; inject D) d efensive; inject

65) If Treasury deposits at the Fed are predicted to ________, the manager of the trading desk at the 65) ______ New York Fed bank will likely conduct ________ open market operations to ________ reserves.

A) rise; dynamic; inject B) f all; dynamic; drain C) rise; defensive; drain D) f all; defensive; drain

66) If the Fed expects currency holdings to rise, it conducts open market ________ to offset the expected ________ in reserves.

A) purchases; increase C) sales; increase

B) s ales; decrease D) p urchases; decrease

67) If the Fed expects currency holdings to fall, it conducts open market ________ to offset the expected ________ in reserves.

A) sales; decrease C) purchases; decrease

66) ______

67) ______

B) p urchases; increase D) s ales; increase

68) If the banking system has a large amount of reserves, many banks will have excess reserves to

68) ______

lend and the federal funds rate will probably ________; if the level of reserves is low, few banks will have excess reserves to lend and the federal funds rate will probably ________.

A) fall; fall B) r ise; fall C) f all; rise D) r ise; rise

69) The Federal Reserve will engage in a repurchase agreement when it wants to ________ reserves ________ in the banking system.

A) decrease; temporarily C) increase; temporarily

69) ______

B) i ncrease; permanently D) d ecrease; permanently

70) ______ 70) If the Fed wants to temporarily inject reserves into the banking system, it will engage in A) reverse repurchase agreement.

B) a n open market sale.

C) a repurchase agreement.

D) a matched sale-purchase transaction.

71) The Fed can offset the effects of an increase in float by engaging in A) a matched sale-purchase transaction.

B) a n open market purchase.

C) an interest rate swap.

D) a repurchase agreement.

71) ______

72) The Federal Reserve will engage in a matched sale-purchase transaction when it wants to

72) ______

________ reserves ________ in the banking system.

A) decrease; temporarily B) i ncrease; temporarily C) increase; permanently D) d ecrease; permanently

ESSAY. Write your answer in the space provided or on a separate sheet of paper.

73) Explain dynamic and defensive open market operations. What is the purpose of each type? Describe two situations when defensive open market operations are used. How are defensive open market operations typically conducted?

MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question.

74) ______ 74) Discount policy affects the money supply by affecting the volume of ________ and the ________.

A) excess reserves; money multiplier C) borrowed reserves; monetary base

B) b orrowed reserves; money multiplier D) e xcess reserves; monetary base

75) The discount rate is A) the price banks pay the Fed for government securities.

B) the interest rate that banks charge their most preferred customers.

C) the interest rate the Fed charges on loans to banks.

D) the price the Fed pays for government securities.

75) ______

76) The most common type of discount lending that the Fed extends to banks is called

76) ______

B) p rimary credit.

D) i nstallment credit.

A) secondary credit.

C) seasonal credit.

77) The most common type of discount lending, ________ credit loans, are intended to help healthy

77) ______

banks with short-term liquidity problems that often result from temporary deposit outflows.

A) seasonal B) s econdary C) p rimary D) t emporary

78) ______

78) When the Fed acts as a lender of last resort, the type of lending it provides is A) secondary credit.

B) p rimary credit.

C) installment credit.

D) s easonal credit.

79) The Fed's discount lending is of three types: ________ is the most common category; ________ is 79) ______ given to a limited number of banks in vacation and agricultural areas; ________ is given to banks that have experienced severe liquidity problems.

A) primary credit; seasonal credit; secondary credit B) seasonal credit; secondary credit; primary credit C) secondary credit; seasonal credit; primary credit D) seasonal credit; primary credit; secondary credit

80) The discount rate is ________ kept ________ the federal funds rate.

A) always; below B) t ypically; below C) typically; above D) t ypically; equal to

80) ______

81) The discount rate refers to the interest rate on A) secondary credit.

C) primary credit.

81) ______

B) f ederal funds.

D) s easonal credit.

82) The interest rate on secondary credit is set ________ basis points ________ the primary credit rate.

A) 100; above

B) 5 0; below

C) 5 0; above

82) ______

D) 1 00; below

83) The interest rate for primary credit is set ________ basis points ________ the federal funds rate.

A) 100; below B) 5 0; above C) 5 0; below D) 1 00; above

83) ______

84) The interest rate on seasonal credit equals A) the primary credit rate.

B) an average of the federal funds rate and rates on certificates of deposits.

C) the federal funds rate.

D) the secondary credit rate.

84) ______

85) The Fed is considering eliminating A) its lender of last resort function.

C) secondary credit lending.

85) ______

B) s easonal credit lending.

D) p rimary credit lending.

86) ______ 86) At its inception, the Federal Reserve was intended to be A) the Treasury's banker.

B) a lender-of-last-resort.

C) the issuer of government debt.

D) a regulator of bank holding companies.

87) Much of the credit for prevention of a financial market meltdown after "Black Monday" (October 19, 1987) must be given to the Federal Reserve System and its chairman A) Alan Blinder.

B) A lan Greenspan.

87) ______

C) Arthur Burns.

D) P aul Volker.

88) A financial panic was averted in October 1987 following "Black Monday" when the Fed

88) ______

announced that A) it would provide discount loans to any bank that would make loans to the security industry.

B) it was lowering the discount rate.

C) it was raising the discount rate.

D) it stood ready to purchase common stocks to prevent a further slide in stock prices.

89) The Fed's lender-of-last-resort function A) has proven to be ineffective.

B) is no longer necessary due to FDIC insurance.

C) creates a moral hazard problem.

D) cannot prevent runs by large depositors.

89) ______

90) The most important advantage of discount policy is that the Fed can use it to A) punish banks that have deficient reserves.

B) perform its role as lender of last resort.

C) control the money supply.

D) precisely control the monetary base.

90) ______

91) ______ 91) An increase in ________ reduces the money supply since it causes the ________ to fall.

A) margin requirements; money multiplier B) r eserve requirements; money multiplier C) reserve requirements; monetary base D) m argin requirements; monetary base 92) ______ 92) A decrease in ________ increases the money supply since it causes the ________ to rise.

A) reserve requirements; monetary base B) m argin requirements; monetary base C) margin requirements; money multiplier D) r eserve requirements; money multiplier 93) The Federal Reserve has had the authority to vary reserve requirements since the A) 1920's.

B) 1 930's.

C) 1 940's.

D) 1 950's.

93) ______

94) Since 1980, ________ are subject to reserve requirements.

A) all depository institutions B) only nationally chartered depository institutions C) only commercial banks D) only the member institutions of the Federal Reserve

94) ______

95) Funds held in ________ are subject to reserve requirements.

A) all time deposits B) all checkable and time deposits C) all checkable deposits D) all checkable, time, and money market fund deposits

95) ______

96) The policy tool of changing reserve requirements is A) no longer used.

B) the preferred tool from the bank's perspective.

C) still used, even with its disadvantanges.

D) the most widely used.

96) ______

97) In the channel-corridor system A) the overnight rate always equals the Lombard rate.

B) reserve requirements are essential for monetary control.

C) monetary control can be exercised with no required reserves.

D) control of the overnight interest rate is impossible.

97) ______

98) The European System of Central Banks signals the stance of its monetary policy by setting a

98) ______

target for the A) lombard rate.

C) federal funds rate.

B) r eserve rate.

D) o vernight cash rate.

99) When the European System of Central Banks uses main refinancing operations, it is similar to the Federal Reserve using A) dynamic open market operations.

C) discount policy.

B) r eserve requirements.

D) d efensive open market operations.

100) When the European System of Central Banks uses long-term refinancing operations, it is similar to the Federal Reserve using A) discount policy.

C) dynamic open market operations.

A) marginal lending rate.

C) deposit facility rate.

100) _____

B) d efensive open market operations.

D) r eserve requirements.

101) The equivalent to the Federal Reserve's discount rate in the European System of Central Banks is the

99) ______

101) _____

B) l ombard rate.

D) f ederal funds rate.

102) The Federal Reserve ________ pay interest on reserves held on deposit. The European System

102) _____

of Central Banks ________ pay interest on reserves held on deposit.

A) does; does not B) d oes not; does C) does; does D) d oes not; does not

103) Since the European Central Bank ________ interest on reserves, banks have a ________ cost of complying with reserve requirements when compared to banks complying with the reserve requirements of the Federal Reserve.

A) d oes not pay; lower C) p ays; higher

B) d oes not pay; higher D) p ays; lower

103) _____

1) C 2) A 3) B 4) A 5) B 6) B 7) C 8) D 9) D 10) D 11) C 12) B 13) D 14) A 15) A 16) D 17) C 18) D 19) D 20) C 21) A 22) A 23) B 24) C 25) C 26) B 27) A 28) C 29) B 30) C 31) D 32) A 33) A 34) C 35) C 36) A 37) D 38) D 39) A 40) A 41) A 42) The three tools are open market operations, the purchase and sale of government securities; discount policy, controlling the price and quantity of discount loans to banks; and reserve requirements, setting the percentage of deposits that banks must hold in reserve. Open market operations and the discount rate affect the monetary base, and reserve requirements affect the money multiplier.

43) False. Since the discount rate is set above the federal funds rate, a decrease in the discount rate will only cause a decrease in the federal funds rate if the discount rate is decreased below the original federal funds rate level. If the decrease in the discount rate is such that the new rate is still above the federal funds rate, then the federal funds rate does not change, everything else held constant.

44) D

45) D 46) D 47) C 48) D 49) A 50) C 51) B 52) D 53) A 54) A 55) A 56) D 57) B 58) D 59) A 60) C 61) C 62) B 73) 63) Dynamic OMOs are used to permanently change the monetary base and money supply. Defensive operations are A used to offset temporary changes in the monetary base and/or money supply. Defensive operations are used to float, shifts in Treasury balances into or out of the Fed, and temporary changes in currency. Defensive 64) offset B 65) purchases are typically conducted by using repurchase agreements, while reverse repos or matched sale-purchase D transactions are used to conduct defensive open market sales.

74) 66) C 75) D C 76) 67) B 77) D C 78) 68) C A 69) C 79) 70) C A 71) 80) A C 81) 72) C 82) A C 83) D 84) B 85) B 86) B 87) B 88) A 89) C 90) B 91) B

92) D 93) B 94) A 95) C 96) A 97) C 98) D 99) D 100) C 101) A 102) B 103) D

Exam Name___________________________________ MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question.

1) The most common definition that central bankers use for price stability is A) an inflation rate of zero percent.

B) h igh and stable inflation.

C) low and stable inflation.

D) l ow and stable deflation.

1) _______

2) Price stability is desirable because A) everyone is better off when prices are stable.

B) price stability increases the profitability of the Fed. C) it guarantees full employment.

D) inflation creates uncertainty, making it difficult to plan for the future.

2) _______

3) Inflation results in A) ease of comparing prices over time.

B) lower nominal interest rates.

C) difficulty interpreting relative price movements.

D) ease of planning for the future.

3) _______

4) Economists believe that countries recently suffering hyperinflation have experienced A) reduced prices.

B) r educed growth.

C) increased growth.

D) l ower interest rates.

4) _______

5) A nominal variable, such as the inflation rate or the money supply, which ties down the price

5) _______

level to achieve price stability is called ________ anchor.

A) an intermediate B) a real C) a nominal D) a n operating

6) A central feature of monetary policy strategies in all countries is the use of a nominal variable

6) _______

that monetary policymakers use as an intermediate target to achieve an ultimate goal such as price stability. Such a variable is called a nominal A) tether.

B) a nchor.

C) g uideline.

D) b enchmark.

7) A central feature of monetary policy strategies in all countries is the use of a nominal anchor,

7) _______

which is a nominal variable that monetary policymakers use as an A) intermediate target to achieve an ultimate goal such as price stability.

B) intermediate target, such as the federal funds interest rate.

C) operating target to achieve an ultimate goal such as exchange rate stability.

D) operating target, such as the federal funds interest rate.

8) A nominal anchor promotes price stability by A) keeping inflation expectations low.

C) stabilizing interest rates.

B) k eeping economic growth low.

D) o utlawing inflation.

9) Monetary policy is considered time-inconsistent because A) policymakers are tempted to pursue discretionary policy that is more expansionary in the short run.

B) policymakers are tempted to pursue discretionary policy that is more contractionary in the short run.

8) _______

9) _______

C) of the lag times associated with the recognition of a potential economic problem and the implementation of monetary policy.

D) of the lag times associated with the implementation of monetary policy and its effect on the economy.

10) The time-inconsistency problem with monetary policy tells us that, if policymakers use

10) ______

discretionary policy, there is a higher probability that the ________ will be higher, compared to policy makers following a behavior rule.

A) inflation rate B) i nterest rate C) unemployment rate D) f oreign exchange rate

11) The theory that monetary policy conducted on a discretionary, day-by-day basis leads to poor long-run outcomes is referred to as the A) time-inconsistency problem.

C) moral hazard problem.

11) ______

B) a dverse selection problem.

D) n ominal-anchor problem.

12) The ________ problem of discretionary policy arises because economic behavior is influenced

12) ______

by what firms and people expect the monetary authorities to do in the future.

A) time-inconsistency B) m oral hazard C) nominal-anchor D) r ational-expectation

13) If the central bank pursues a monetary policy that is more expansionary than what firms and

13) ______

people expect, then the central bank must be trying to A) constrain prices.

B) b oost prices in the short run.

C) boost output in the short run.

D) c onstrain output in the short run.

14) The time-inconsistency problem in monetary policy can occur when the central bank conducts policy

A) on a discretionary, day-by-day basis.

C) using a flexible, discretionary rule.

14) ______

B) u sing a strict and inflexible rule.

D) u sing a nominal anchor.

ESSAY. Write your answer in the space provided or on a separate sheet of paper.

15) Explain the time-inconsistency problem. What is the likely outcome of discretionary policy? What are the solutions to the time-inconsistency problem?

MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question.

16) ______ 16) Even if the Fed could completely control the money supply, monetary policy would have critics because A) it is required to keep Treasury security prices high.

B) the Fed's primary goal is exchange rate stability, causing it to ignore domestic economic conditions.

C) the Fed's goals do not include high employment, making labor unions a critic of the Fed. D) the Fed is asked to achieve many goals, some of which are incompatible with others.

17) High unemployment is undesirable because it A) reduces idle resources.

C) results in a loss of output.

B) a lways increases inflation.

D) a lways increases interest rates.

18) When workers voluntarily leave work while they look for better jobs, the resulting unemployment is called A) underemployment.

B) s tructural unemployment.

17) ______

18) ______

C) cyclical unemployment.

D) f rictional unemployment.

19) Unemployment resulting from a mismatch of workers' skills and job requirements is called A) seasonal unemployment.

B) f rictional unemployment.

C) structural unemployment.

D) c yclical unemployment.

19) ______

20) The goal for high employment should seek a level of unemployment at which the demand for

20) ______

labor equals the supply of labor. Economists call this level of unemployment the A) Keynesian rate level of unemployment.

B) n atural rate level of unemployment.

C) structural level of unemployment.

D) f rictional level of unemployment.

21) Supply-side economic policies seek to A) increase consumption expenditures by increasing taxes.

B) increase federal government expenditures.

C) raise interest rates through contractionary monetary policy.

D) increase saving and investment using tax incentives.

21) ______

22) The Federal Reserve System was created to A) lower the unemployment rate.

C) promote financial market stability.

22) ______

B) p romote rapid economic growth.

D) m ake it easier to finance budget deficits.

23) Having interest rate stability A) leads to problems in financial markets.

B) allows for less uncertainty about future planning.

C) leads to demands to curtail the Fed's power.

D) guarantees full employment.

23) ______

24) Which set of goals can, at times, conflict in the short run?

A) High employment and price level stability.

B) High employment and economic growth.

C) Exchange rate stability and financial market stability.

D) Interest rate stability and financial market stability.

24) ______

25) The primary goal of the European Central Bank is A) exchange rate stability.

C) interest rate stability.

25) ______

B) h igh employment.

D) p rice stability.

26) The mandate for the monetary policy goals that has been given to the European Central Bank is an example of a ________ mandate.

A) secondary B) p rimary

C) d ual

D) h ierarchical

27) The mandate for the monetary policy goals that has been given to the Federal Reserve System is an example of a ________ mandate.

A) secondary B) p rimary

C) h ierarchical

27) ______

D) d ual

28) Either a dual or hierarchial mandate is acceptable as long as ________ is the primary goal in the ________.

A) price stability; long run B) reducing business-cycle fluctuations; long run C) price stability; short run

26) ______

28) ______

D) reducing business-cycle fluctuations; short run 29) Under monetary targeting, a central bank announces an annual growth rate target for ________.

A) the monetary base B) a monetary aggregate C) a reserve aggregate D) G DP

29) ______

30) During the years 1979 to 1982, the Federal Reserve's announced policy was monetary targeting.

30) ______

During this time period the Federal Reserve A) hit about half of their monetary targets.

B) did not hit any of their monetary targets because they were unrealistic.

C) hit all of their monetary targets.

D) did not hit any of their monetary targets because it is believed that controlling the money supply was not the intent of the Federal Reserve.

31) Compared to the United States, Japan's experience with monetary targeting performed A) worse with regard to the inflation rate, but better with regard to output fluctuations.

B) better with regard to the inflation rate, but worse with regard to output fluctuations.

C) better with regard to the inflation rate and output fluctuations.

D) worse with regard to the inflation rate and output fluctuations.

31) ______

32) One of the factors that contributed to the success German policymakers had using a monetary

32) ______

targeting type policy was that A) they used a rigid target for the money growth rate.

B) they rarely communicated the intentions of policy to the public in order to keep the public from panicking.

C) they implemented policy so their inflation rate goal was met in the short run.

D) the money target was flexible to allow the Bundesbank to concentrate on other goals as needed.

33) Which of the following is an advantage to money targeting?

A) There is an immediate signal on the achievement of the target.

B) It implies lack of transparency.

C) It does not rely on a stable money-inflation relationship.

D) It implies smaller output fluctuations.

33) ______

34) Which of the following is a disadvantage to monetary targeting?

A) There is a delayed signal about the achievement of a target.

B) It implies larger ouput fluctuations.

C) It relies on a stable money-inflation relationship.

D) It implies a lack of transparency.

34) ______

35) If the relationship between the monetary aggregate and the goal variable is weak, then A) monetary aggregate targeting is superior to exchange-rate targeting.

B) inflation targeting is superior to exchange-rate targeting.

C) monetary aggregate targeting is superior to inflation targeting.

D) monetary aggregate targeting will not work.

35) ______

36) The monetary policy strategy that provides an immediate signal on target achievement is A) inflation targeting.

B) t he implicit nominal anchor.

C) monetary targeting.

D) e xchange-rate targeting.

36) ______

37) The monetary policy strategy that relies on a stable money-income relationship is A) the implicit nominal anchor.

B) e xchange-rate targeting.

C) monetary targeting.

D) i nflation targeting.

37) ______

38) The type of monetary policy that is used in Canada, New Zealand, and the United Kingdom is A) monetary targeting.

B) interest-rate targeting.

C) targeting with an implicit nominal anchor.

D) inflation targeting.

38) ______

39) Which of the following is not an element of inflation targeting?

A) An information-inclusive approach in which only monetary aggregates are used in

39) ______

making decisions about monetary policy

B) Increased accountability of the central bank for attaining its inflation objectives C) An institutional commitment to price stability as the primary long-run goal D) A public announcement of medium-term numerical targets for inflation 40) The first country to adopt inflation targeting was A) Canada.

C) the United Kingdom.

B) A ustralia.

D) N ew Zealand.

41) In both New Zealand and Canada, what has happened to the unemployment rate since the

40) ______

41) ______

countries adopted inflation targeting?

A) The unemployment rate increased sharply.

B) The unemployment rate declined sharply immediately after the inflation targets were adopted.

C) The unemployment rate has declined substantially after a sharp increase.

D) The unemployment rate remained constant.

42) Which of the following is not an advantage of inflation targeting?

A) Inflation targeting does not rely on a stable money-inflation relationship.

B) There is an immediate signal on the achievement of the target.

C) Inflation targeting reduces the effects of inflation shocks.

D) There is simplicity and clarity of the target.

42) ______

43) Which of the following is not a disadvantage to inflation targeting?

A) Inflation targets could impose a rigid rule on policymakers.

B) There is potential for larger output fluctuations.

C) There is a lack of transparency.

D) There is a delayed signal about achievement of the target.

43) ______

44) The decision by inflation targeters to choose inflation targets ________ zero reflects the concern

44) ______

of monetary policymakers that particularly ________ inflation can have substantial negative effects on real economic activity.

A) above; high B) a bove; low C) b elow; high D) b elow; low

45) Inflation targets can increase the central bank's flexibility in responding to declines in aggregate spending. Declines in aggregate ________ that cause the inflation rate to fall below the floor of the target range will automatically stimulate the central bank to ________ monetary policy without fearing that this action will trigger a rise in inflation expectations.

A) s upply; tighten

B) d emand: tighten

45) ______

C) demand; loosen

D) supply; loosen

ESSAY. Write your answer in the space provided or on a separate sheet of paper.

46) Explain what inflation targeting is. What are the advantages and disadvantages of this type of monetary policy strategy?

MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question.

47) ______ 47) The type of monetary policy regime that the Federal Reserve has been following in recent years can best be described as A) policy with an implicit nominal anchor.

C) monetary targeting.

B) i nflation targeting.

D) e xchange-rate targeting.

48) Estimates suggest that, in the United States economy, it takes just over ________ for monetary

48) ______

policy to affect output and just over ________ for monetary policy to affect the inflation rate.

A) 1 year; 2 years B) 2 years; 1 year C) 6 months; 1 year D) 1 year; 6 months

49) Which of the following is an advantage of using an implicit nominal anchor for monetary

49) ______

policy?

A) It is simplistic and has clarity.

B) There is increased accountability of central bankers.

C) It does not rely on the money-inflation relationship.

D) There is an immediate signal if the target has been achieved.

50) Which of the following is not a disadvantage of using an implicit nominal anchor for monetary

50) ______

policy?

A) It relies on a stable money-inflation relationship.

B) There is low transparency of policy.

C) There is low accountability for central bankers.

D) This type of policy relies on the policy-makers in charge.

51) When compared to the Fed's ________ anchor approach, ________ targeting can make the

51) ______

institutional framework for the conduct of monetary policy more consistent with democratic principles.

A) nominal; inflation B) i mplicit; inflation C) implicit; monetary D) n ominal; monetary

52) The monetary policy strategy that suffers a lack of transparency is A) inflation targeting.

B) e xchange-rate targeting.

C) monetary targeting.

D) t he implicit nominal anchor.

52) ______

53) The monetary policy strategy that provides the least accountability is A) monetary targeting.

B) e xchange-rate targeting.

C) the implicit nominal anchor.

D) i nflation targeting.

53) ______

ESSAY. Write your answer in the space provided or on a separate sheet of paper.

54) Explain the type of monetary policy strategy that the Federal Reserve has used in recent years. What are the advantages and disadvantages to this type of strategy?

MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question.

55) Which of the following is not an operating instrument?

A) Discount rate B) N onborrowed reserves C) Federal funds interest rate D) M onetary base

55) ______

56) Which of the following is a potential operating instrument for the central bank?

A) The discount rate B) N ominal GDP C) The M1 money supply D) T he monetary base

56) ______

57) Due to the lack of timely data for the price level and economic growth, the Fed's strategy A) uses an intermediate target, such as an interest rate.

B) targets the price of gold, since it is closely related to economic activity.

C) targets the exchange rate, since the Fed can control this variable.

D) stabilizes the consumer price index, since the Fed can control the CPI.

57) ______

58) If the central bank targets a monetary aggregate, it is likely to lose control over the interest rate

58) ______

because A) of fluctuations in the business cycle.

B) of fluctuations in the demand for reserves.

C) of fluctuations in the consumption function.

D) bond values will tend to remain stable.

59) If the Fed pursues a strategy of targeting an interest rate when fluctuations in money demand

59) ______

are prevalent, A) fluctuations of nonborrowed reserves will be large.

B) the Fed will probably quickly abandon this policy, as it did in the 1950s.

C) the Fed will probably quickly abandon this policy, as it did in the 1960s.

D) fluctuations of nonborrowed reserves will be small.

60) Fluctuations in the demand for reserves cause the Fed to lose control over a monetary aggregate if the Fed targets A) the monetary base.

C) a monetary aggregate.

60) ______

B) a n interest rate.

D) n ominal GDP.

61) Interest rates are difficult to measure because A) data on them are not available in a timely manner.

B) they cannot be controlled by the Fed. C) real interest rates depend on the hard-to-determine expected inflation rate.

D) they fluctuate too often to be accurate.

61) ______

62) ______ 62) Which of the following criteria need not be satisfied for choosing an intermediate target?

A) The variable must be transportable.

B) T he variable must be measurable.

C) The variable must be controllable.

D) T he variable must be predictable.

63) ______ 63) Which of the following is not a requirement in selecting an intermediate target?

A) Measurability B) F lexibility C) P redictability D) C ontrollability 64) When it comes to choosing an policy instrument, both the ________ rate and ________ aggregates are measured accurately and are available daily with almost no delay.

A) three-month T-bill; reserve B) f ederal funds; reserve C) three-month T-bill; monetary D) f ederal funds; monetary

64) ______

65) If the desired intermediate target is an interest rate, then the preferred policy instrument will be a(n) ________ variable like the ________.

A) interest rate; three-month T-bill rate C) monetary aggregate; nonborrowed base

65) ______

B) i nterest rate; federal funds rate D) m onetary aggregate; monetary base

66) If the desired intermediate target is a monetary aggregate, then the preferred policy instrument

66) ______

will be a(n) ________ variable like the ________.

A) interest rate; three-month T-bill rate B) reserve aggregate; monetary base C) interest rate; federal funds rate D) reserve aggregate; narrow money supply M1

67) If the desired intermediate target is a monetary aggregate, which of the following would be the most preferred policy instrument?

A) The monetary base C) The 90-day T-bill rate

67) ______

B) T he 180-day T-bill rate D) T he federal funds rate

68) If the desired intermediate target is an interest rate, the preferred policy instrument would be A) the discount rate.

B) borrowed reserves.

C) nonborrowed reserves.

D) the monetary base.

E) the federal funds rate.

68) ______

ESSAY. Write your answer in the space provided or on a separate sheet of paper.

69) Explain and demonstrate graphically how targeting nonborrowed reserves can result in federal funds rate instability.

70) Explain and demonstrate graphically how targeting the federal funds rate can result in fluctuations in nonborrowed reserves.

MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question.

71) ______ 71) According to the Taylor rule, the Fed should raise the federal funds interest rate when inflation ________ the Fed's inflation target or when real GDP ________ the Fed's output target.

A) drops below; drops below B) d rops below; rises above C) rises above; drops below D) r ises above; rises above

72) Using Taylor's rule, when the equilibrium real federal funds rate is 3 percent, the positive

72) ______

output gap is 2 percent, the target inflation rate is 1 percent, and the actual inflation rate is 2 percent, the nominal federal funds rate target should be A) 5 percent.

B) 5 .5 percent.

C) 6 percent.

D) 6 .5 percent.

73) Using Taylor's rule, when the equilibrium real federal funds rate is 2 percent, there is no output

73) ______

gap, the actual inflation rate is zero, and the target inflation rate is 2 percent, the nominal federal funds rate should be A) 0 percent.

B) 1 percent.

C) 2 percent.

D) 3 percent.

74) The rate of inflation tends to remain constant when A) the unemployment rate equals the NAIRU. B) the unemployment rate increases faster than the NAIRU increases.

74) ______

C) the unemployment rate is below the NAIRU. D) the unemployment rate is above the NAIRU. 75) The rate of inflation increases when A) the unemployment rate increases faster than the NAIRU increases.

B) the unemployment rate equals the NAIRU. C) the unemployment rate is less than the NAIRU. D) the unemployment rate exceeds the NAIRU.

75) ______

ESSAY. Write your answer in the space provided or on a separate sheet of paper.

76) Explain the Taylor rule, including the formula for setting the federal funds rate target, and the components of the formula. If the Fed were to use this rule, how many goals would it use to set monetary policy?

MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question.

77) ______ 77) In its earliest years, the Federal Reserve's guiding principle for the conduct of monetary policy was known as the A) real bills doctrine.

C) free reserves doctrine.

B) q uantity theory of money.

D) l iberal liquidity doctrine.

78) The guiding principle for the conduct of monetary policy that held that as long as loans were

78) ______

being made for "productive" purposes, then providing reserves to the banking system to make these loans would not be inflationary became known as the A) efficient liquidity doctrine.

B) r eal bills doctrine.

C) free reserves doctrine.

D) B enjamin Strong doctrine.

79) The real bills doctrine was the guiding principle for the conduct of monetary policy during the A) 1910s.

B) 1 940s.

C) 1 950s.

D) 1 960s.

79) ______

80) The Fed accidentally discovered open market operations in the early A) 1920s.

B) 1 910s.

C) 1 900s.

80) ______

D) 1 890s.

81) The Fed accidentally discovered open market operations when A) it came to the rescue of failing banks in the early 1930s, and found that its purchases of

81) ______

bank loans injected reserves into the banking system.

B) it reinterpreted a key provision of the Federal Reserve Act. C) it purchased securities for income following the 1920-1921 recession.

D) it attempted to slow inflation in 1919 by selling securities and found that its sales drained reserves from the banking system.

82) The Fed's mistakes of the early 1930s were compounded by its decision to A) lower reserve requirements in 1936-1937.

B) lower the monetary base in 1936-1937.

C) raise reserve requirements in 1936-1937.

D) raise the monetary base in 1936-1937.

82) ______

83) During World War II, whenever interest rates would ________ and the price of bonds would

83) ______

begin to ________, the Fed would make open market purchases.

A) fall; rise B) r ise; rise C) f all; fall

D) r ise; fall

84) During World War II, whenever interest rates would rise and the price of bonds would begin to fall, the Fed would

84) ______

A) lower reserve requirements.

B) make open market purchases of government securities.

C) make open market sales of government securities.

D) raise reserve requirements.

85) During World War II, the Fed in effect relinquished its control of monetary policy through its

85) ______

policy of A) continually lowering reserve requirements.

B) pegging interest rates.

C) continually raising reserve requirements.

D) targeting free reserves.

86) The Fed was committed to keeping interest rates low to assist Treasury financing of budget

86) ______

deficits A) throughout the entire existence of the Fed. B) only during World War I. C) during World War I and World War II. D) during the Great Depression.

87) The Fed-Treasury Accord of March 1951 provided the Fed greater freedom to A) let unemployment increase.

B) l et exchange rates increase.

C) let inflation accelerate.

D) l et interest rates increase.

87) ______

88) During the 1950s, the Fed targeted A) M2.

C) the monetary base.

88) ______

89) During the 1950s, Fed monetary policy targeted A) discount loans.

C) the monetary base.

B) m oney market conditions.

D) M 1.

B) i nterest rates.

D) t he exchange rate.

90) Targeting interest rates can be procyclical because A) an increase in income increases interest rates, causing the Fed to buy bonds, increasing

89) ______

90) ______

the monetary base and money supply, leading to further increases in income.

B) an increase in the monetary base increases the money supply, causing the Fed to buy

bonds, increasing the monetary base and money supply, leading to further increases in income.

C) an increase in income increases the monetary base and money supply, causing the Fed to buy bonds to increase interest rates and income.

D) an increase in interest rates increases income, causing the Fed to buy bonds, increasing the monetary base and money supply, leading to further increases in income.

91) High inflation can spiral out of control when A) expected inflation increases nominal interest rates, causing the Fed to sell bonds, increasing the money supply and further increasing inflation.

B) expected inflation decreases nominal interest rates, causing the Fed to buy bonds, increasing the money supply and further increasing inflation.

C) expected inflation increases nominal interest rates, causing the Fed to buy bonds, increasing the money supply and further increasing inflation.

D) expected inflation decreases nominal interest rates, causing the Fed to sell bonds, increasing the money supply and further increasing inflation.

91) ______

92) In practice, the Fed's policy of targeting money market conditions in the 1960s proved to be A) procyclical, destabilizing the economy.

B) countercyclical, destabilizing the economy.

C) procyclical, helping to stabilize the economy.

D) countercyclical, helping to stabilize the economy.

92) ______

93) In practice, the Fed's policy of targeting ________ in the 1960s proved to be ________,

93) ______

destabilizing the economy.

A) monetary aggregates; countercyclical B) money market conditions; procyclical C) money market conditions; countercyclical D) monetary aggregates; procyclical

94) Although the Fed professed employment of a monetary aggregate targeting strategy during the 1970s, its behavior suggests that it emphasized A) price-index targeting.

C) interest-rate targeting.

B) f ree-reserve targeting.

D) a real-bills doctrine.

95) Although the Fed professed employment of ________ targeting during the 1970s, its behavior suggests that it emphasized ________ targeting.

A) free-reserve; interest-rate C) interest-rate; monetary aggregate

94) ______

95) ______

B) m onetary aggregate; interest-rate D) f ree reserve; monetary aggregate

96) The Fed's use of the federal funds rate as an operating target in the 1970s resulted in A) procyclical monetary policy.

B) too rapid growth in M1 throughout the decade.

C) too slow growth in M1 throughout the decade.

D) countercyclical monetary policy.

96) ______

97) The Fed's use of the ________ as an operating target in the 1970s resulted in ________ monetary 97) ______ policy.

A) M1 money supply; procyclical C) federal funds rate; countercyclical

B) f ederal funds rate; procyclical D) M 1 money supply; countercyclical

98) In the 1970s, the Fed selected an interest rate as an operating target rather than a reserve

98) ______

aggregate primarily because it A) was still very concerned with achieving interest rate stability.

B) was committed to targeting free reserves.

C) was committed to the real bills doctrine.

D) had no interest in targeting a monetary aggregate, as evidenced by its unwillingness to target a reserve aggregate.

99) The Fed operating procedures employed between 1979 and 1982 resulted in ________ swings in 99) ______ the federal funds rate and ________ swings in the M1 growth rate.

A) increased; increased B) d ecreased; increased C) decreased; decreased D) i ncreased; decreased

100) The fluctuations in both money supply growth and the federal funds rate during 1979-1982 suggest that the Fed A) never intended to target monetary aggregates.

B) had shifted to borrowed reserves as an operating target.

C) had shifted to total reserves as an operating target.

100) _____

D) had shifted to the monetary base as an operating target.

101) The Fed's failure to exercise effective control over the money supply during the 1979-1982

101) _____

period A) stems from the Treasury-Federal Reserve Accord.

B) occurred despite evidence of a strong link between open market operations and the money supply.

C) resulted because forces outside of its control removed the link between open market operations and the money supply.

D) proves that such control is not possible.

102) Large fluctuations in money supply growth and smaller fluctuations in the federal funds rate

102) _____

between October 1982 and the early 1990s indicate that the Fed had shifted to ________ as an operating target.

A) borrowed reserves B) r equired reserves C) excess reserves D) n onborrowed reserves

103) The strengthening of the dollar between 1980 and 1985 contributed to a ________ in American

103) _____

competitiveness, putting pressure on the Fed to pursue a more ________ monetary policy.

A) increase; contractionary B) d ecrease; expansionary C) increase; expansionary D) d ecrease; contractionary

104) A borrowed reserves target is ________ because increases in income ________ interest rates and 104) _____ discount loans, causing the Fed to ________ the monetary base, everything else held constant.

A) countercyclical; reduce; reduce B) p rocyclical; reduce; reduce C) procyclical; increase; increase D) c ountercyclical; increase; increase

105) Fed policy since the early 1990s indicates that it is pursuing a policy of targeting the A) monetary base.

B) m oney supply.

C) exchange rate.

D) f ederal funds interest rate.

105) _____

106) Since the early 1990s, the Fed has conducted monetary policy by setting a target for the A) level of borrowed reserves.

B) i nflation rate.

C) federal funds rate.

D) m onetary base.

106) _____

107) The Fed can engage in preemptive strikes against a rise in inflation by ________ the federal

107) _____

funds interest rate; it can act preemptively against negative demand shocks by ________ the federal funds interest rate.

A) raising; raising B) l owering; lowering C) lowering; raising D) r aising; lowering

108) International policy coordination refers to A) central banks in major nations pursuing only domestic objectives.

B) central banks adopting policies in pursuit of joint objectives.

C) central banks all adopting identical policies.

D) central banks in major nations acting without regard to the global consequences of their policies.

108) _____

1) C 2) D 3) C 4) B 5) C 6) B 7) A 8) A 9) A 10) A 11) A 12) A 13) C 14) A 15) With policy discretion, policymakers have an incentive to attempt to increase output by pursuing expansionary

policies once expectations are set. The problem is that this policy results not in higher output, but in higher actual and expected inflation. The solution is to adopt a rule to constrain discretion. Nominal anchors can provide the necessary constraint on discretionary behavior.

16) D 17) C 18) D 19) C 20) B 21) D 22) C 23) B 24) A 25) D 26) D 27) D 28) A 29) B 30) D 31) C 32) D 33) A 34) C 35) 46) D There are five main elements to inflation targeting: 1. a public announcement of a medium-term target for the rate; 2. a commitment to price stability as the primary long-term goal of policy; 3. many variables are 36) inflation C 37) C 38) D

used increased transparency about policy strategy with the public; 5. the central bank has increased accountability for in attaining policy goals. makin g The advantages of inflation targeting include: 1. the simplicity and clarity of a numerical target for the inflation decisirate; 2. does not rely on a stable money-inflation relationship; 3. there is increased accountability of the central ons bank; 4. reduces the effects of inflationary shocks. about policy The disadvantages of inflation targeting include: 1. there is a delayed signal about the achievement of the target; 2. movesit could lead to a rigid rule where the only focus is the inflation rate (has not happened in practice); 3. if sole focus ; 4.

is the inflation rate, larger output fluctuations can occur (has not happened in practice).

47) A 48) A 49) C 50) A 51) B Federal Reserve doesn't use an explicit nominal anchor such as a monetary aggregate or the inflation rate. Its 54) The 52) strategy revolves around using an implict nominal anchor in the form of an overriding concern to control inflation in the D long run. This involves forward-looking behavior and "pre-emptive strikes" by policy actions to prevent inflation. This 53) forward-looking C behavior is necessary because of the long time lags between monetary policy action and its impact on inflation.

The advantages of this policy strategy include: 1. it doesn't rely on a stable money-inflation relationship; 2. the demonstrated success it had in the United States.

The disadvantages of this policy strategy include: 1. there is a lack of transparency; 2. its success depends on the individuals in charge of policy; 3. there is low accountability of the central bank.

55) A 56) D 57) A 58) B 59) A 60) B 61) C 62) A 63) B 64) B 69) See figure below.

65) B 66) B 67) A 68) E

When nonborrowed reserves are held constant, increases in the demand for reserves result in the federal funds rate increasing and decreases in the demand for nonborrowed reserves result in the federal funds rate declining.

Since fluctuations in demand do not cause monetary policy actions, the result is the federal funds rate will fluctuate (assuming the equilibrium federal funds rate is below the discount rate).

70) See figure below.

With a federal funds rate target, fluctuations in demand for reserves require similar changes in the nonborrowed reserves to keep the federal funds rate constant.

71) D 72) D 73) B 74) 76) The Taylor rule specifies that the target federal fund rates should be set to equal the equilibrium real federal funds A rate, plus the rate of inflation (for the Fisher effect), plus one-half times the output gap, plus one-half times the 75) inflation C gap. The formula is Federal funds rate target = equilibrium real federal funds rate + inflation rate + (output gap) + (inflation gap) The output gap is the percentage deviation of real GDP from potential full-employment real GDP. The inflation gap is the difference between actual inflation and the central bank's target rate of inflation. The equilibrium real federal funds rate is the real rate consistent with full employment in the long run. The inflation rate is the actual rate of inflation. The Taylor rule sets the federal funds rate recognizing the goals of low inflation and full employment (or equilibrium long-run economic growth).

77) A 78) B 79) A 80) A 81) C

82) C 83) D 84) B 85) B 86) C 87) D 88) B 89) B 90) A 91) C 92) A 93) B 94) C 95) B 96) A 97) B 98) A 99) A 100) A 101) B 102) A 103) B 104) C 105) D 106) C 107) D 108) B

Exam Name___________________________________ MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question.

1) The exchange rate is A) the change in the value of money over time.

B) the price of one currency relative to gold.

C) the price of one currency relative to another.

D) the value of a currency relative to inflation.

1) _______

2) Exchange rates are determined in A) the money market.

C) the foreign exchange market.

2) _______

B) t he capital market.

D) t he stock market.

3) Although foreign exchange market trades are said to involve the buying and selling of

3) _______

currencies, most trades involve the buying and selling of A) gold.

B) bank deposits denominated in different currencies.

C) ECUs. D) SDRs.

4) The immediate (two-day) exchange of one currency for another is a A) exchange transaction.

B) s pot transaction.

C) forward transaction.

D) m oney transaction.

4) _______

5) An agreement to exchange dollar bank deposits for euro bank deposits in one month is a A) future transaction.

B) f orward transaction.

C) deposit transaction.

D) s pot transaction.

5) _______

6) Today 1 euro can be purchased for $1.10. This is the A) financial exchange rate.

B) s pot exchange rate.

C) forward exchange rate.

D) f ixed exchange rate.

6) _______

7) In an agreement to exchange dollars for euros in three months at a price of $0.90 per euro, the

7) _______

price is the A) spot exchange rate.

C) money exchange rate.

B) f ixed exchange rate.

D) f orward exchange rate.

8) When the value of the British pound changes from $1.25 to $1.50, the pound has ________ and the U.S. dollar has ________.

A) appreciated; appreciated C) depreciated; depreciated

B) d epreciated; appreciated D) a ppreciated; depreciated

9) When the value of the British pound changes from $1.50 to $1.25, then the pound has ________ and the U.S. dollar has ________.

A) depreciated; depreciated C) depreciated; appreciated

9) _______

B) a ppreciated; appreciated D) a ppreciated; depreciated

10) When the value of the dollar changes from £0.5 to £0.75, then the British pound has ________ and the U.S. dollar has ________.

8) _______

10) ______

A) appreciated; appreciated C) appreciated; depreciated

B) d epreciated; depreciated D) d epreciated; appreciated

11) When the value of the dollar changes from £0.75 to £0.5, then the British pound has ________ and the U.S. dollar has ________.

A) appreciated; appreciated C) depreciated; depreciated

11) ______

B) d epreciated; appreciated D) a ppreciated; depreciated

12) When the exchange rate for the Mexican peso changes from 9 pesos to the U.S. dollar to 10

12) ______

pesos to the U.S. dollar, then the Mexican peso has ________ and the U.S. dollar has ________.

A) depreciated; depreciated B) a ppreciated; appreciated C) depreciated; appreciated D) a ppreciated; depreciated

13) When the exchange rate for the Mexican peso changes from 10 pesos to the U.S dollar to 9 pesos 13) ______ to the U.S. dollar, then the Mexican peso has ________ and the U.S. dollar has ________.

A) depreciated; depreciated B) a ppreciated; depreciated C) depreciated; appreciated D) a ppreciated; appreciated

14) On April 7, 2006, one U.S. dollar traded on the foreign exchange market for about 0.83 euros.

Therefore, one euro would have purchased about ________ U.S. dollars.

A) 0.83 B) 1 .00 C) 1 .20

14) ______

D) 1 .83

15) On April 7, 2006, one U.S. dollar traded on the foreign exchange market for about 44.5 Indian

15) ______

rupees. Thus, one Indian rupee would have purchased about ________ U.S. dollars.

A) 0.02 B) 1 .20 C) 7 .00 D) 4 4.5

16) On April 7, 2006, one U.S. dollar traded on the foreign exchange market for about 1.30 Swiss

16) ______

francs. Therefore, one Swiss franc would have purchased about ________ U.S. dollars.

A) 0.30 B) 0 .77 C) 1 .30 D) 3 .10

17) On April 7, 2006, one U.S. dollar traded on the foreign exchange market for about 2.86

17) ______

Romanian new lei. Therefore, one Romanian new lei would have purchased about ________ U.S. dollars.

A) 0.35 B) 1 .86 C) 2 .86 D) 3 .35

18) If the U.S. dollar appreciates from 1.25 Swiss franc per U.S. dollar to 1.5 francs per dollar, then

18) ______

the franc depreciates from ________ U.S. dollars per franc to ________ U.S. dollars per franc.

A) 0.67; 0.80 B) 0 .50; 0.33 C) 0 .33; 0.50 D) 0 .80; 0.67

19) If the British pound appreciates from $0.50 per pound to $0.75 per pound, the U.S. dollar depreciates from ________ per dollar to ________ per dollar.

A) £2; £1.33 B) £ 2; £1.5 C) £ 2; £2.5

D) £ 2; £1.25

20) If the Japanese yen appreciates from $0.01 per yen to $0.02 per yen, the U.S. dollar depreciates from ________ per dollar to ________ per dollar.

A) 5¥; 10¥ B) 1 0¥; 5¥

C) 5 0¥; 100¥

20) ______

D) 1 00¥; 50¥

21) If the dollar appreciates from 1.5 Brazilian reals per dollar to 2.0 reals per dollar, the real depreciates from ________ per real to ________ per real.

A) $0.50; $0.67 B) $0.50; $0.75 C) $0.75; $0.50

19) ______

21) ______

D) $0.33; $0.50 E) $0.67; $0.50 22) When the exchange rate for the British pound changes from $1.80 per pound to $1.60 per

22) ______

pound, then, holding everything else constant, the pound has ________ and ________ expensive.

A) depreciated; American wheat sold in Britain becomes more B) depreciated; American wheat sold in Britain becomes less C) appreciated; British cars sold in the United States become less D) appreciated; British cars sold in the United States become more

23) If the dollar depreciates relative to the Swiss franc A) Swiss chocolate will become more expensive in the United States.

B) Swiss computers will become cheaper in the United States.

C) American computers will become more expensive in Switzerland.

D) Swiss chocolate will become cheaper in the United States.

23) ______

24) Everything else held constant, when a country's currency appreciates, the country's goods

24) ______

abroad become ________ expensive and foreign goods in that country become ________ expensive.

A) more; more B) m ore; less C) l ess; less D) l ess; more

25) Everything else held constant, when a country's currency depreciates, its goods abroad become

25) ______

________ expensive while foreign goods in that country become ________ expensive.

A) less; less B) m ore; more C) m ore; less D) l ess; more

26) According to the law of one price, if the price of Colombian coffee is 100 Colombian pesos per

26) ______

pound and the price of Brazilian coffee is 4 Brazilian reals per pound, then the exchange rate between the Colombian peso and the Brazilian reals is: A) 100 pesos per real.

B) 0 .4 pesos per real.

C) 40 pesos per real.

D) 2 5 pesos per real.

27) The starting point for understanding how exchange rates are determined is a simple idea called

27) ______

________, which states: if two countries produce an identical good, the price of the good should be the same throughout the world no matter which country produces it.

A) arbitrage B) p urchasing power parity C) Gresham's law D) t he law of one price

28) The ________ states that exchange rates between any two currencies will adjust to reflect changes in the price levels of the two countries.

A) quantity theory of money C) theory of money neutrality

B) t heory of purchasing power parity D) l aw of one price

29) The theory of PPP suggests that if one country's price level rises relative to another's, its currency should A) float.

C) depreciate.

29) ______

B) a ppreciate.

D) d o none of the above.

30) The theory of PPP suggests that if one country's price level falls relative to another's, its currency should A) appreciate.

C) float.

28) ______

B) d epreciate.

D) d o none of the above.

30) ______

31) The theory of PPP suggests that if one country's price level rises relative to another's, its currency should A) depreciate in the long run.

C) appreciate in the long run.

B) a ppreciate in the short run. D) d epreciate in the short run.

32) The theory of PPP suggests that if one country's price level falls relative to another's, its currency should A) appreciate in the short run.

C) depreciate in the long run.

31) ______

32) ______

B) a ppreciate in the long run.

D) d epreciate in the short run.

33) The theory of purchasing power parity cannot fully explain exchange rate movements because A) some goods are not traded between countries.

B) monetary policy differs across countries.

C) fiscal policy differs across countries.

D) all goods are identical even if produced in different countries.

33) ______

34) The theory of purchasing power parity states that exchange rates between any two currencies

34) ______

will adjust to reflect changes in A) the trade balances of the two countries.

B) the current account balances of the two countries.

C) the price levels of the two countries.

D) fiscal policies of the two countries.

35) In the long run, a rise in a country's price level (relative to the foreign price level) causes its

35) ______

currency to ________, while a fall in the country's relative price level causes its currency to ________.

A) depreciate; appreciate B) a ppreciate; appreciate C) depreciate; depreciate D) a ppreciate; depreciate

36) If the 2005 inflation rate in Canada is 4 percent, and the inflation rate in Mexico is 2 percent,

36) ______

then the theory of purchasing power parity predicts that, during 2005, the value of the Canadian dollar in terms of Mexican pesos will A) rise by 6 percent.

B) f all by 2 percent.

C) fall by 6 percent.

D) r ise by 2 percent.

37) Assume that the following are the predicted inflation rates in these countries for the year: 2%

37) ______

for the United States, 3% for Canada; 4% for Mexico, and 5% for Brazil. According to the purchasing power parity and everything else held constant, which of the following would we expect to happen?

A) The Brazilian real will depreciate against the U.S. dollar.

B) The U.S. dollar will depreciate against the Canadian dollar.

C) The Canadian dollar will depreciate against the Mexican peso.

D) The Mexican peso will depreciate against the Brazilian real.

38) According to the purchasing power parity theory, a rise in the United States price level of 5 percent, and a rise in the Mexican price level of 6 percent cause A) the dollar to depreciate 1 percent relative to the peso.

B) the dollar to appreciate 1 percent relative to the peso.

C) the dollar to depreciate 5 percent relative to the peso.

D) the dollar to appreciate 5 percent relative to the peso.

38) ______

39) Higher tariffs and quotas cause a country's currency to ________ in the ________ run, everything else held constant.

A) appreciate; short C) depreciate; short

39) ______

B) d epreciate; long D) a ppreciate; long

40) Lower tariffs and quotas cause a country's currency to ________ in the ________ run, everything 40) ______ else held constant.

A) appreciate; short C) appreciate; long

B) d epreciate; long D) d epreciate; short

41) Anything that increases the demand for foreign goods relative to domestic goods tends to

41) ______

________ the domestic currency because domestic goods will only continue to sell well if the value of the domestic currency is ________, everything else held constant.

A) depreciate; lower B) d epreciate; higher C) appreciate; higher D) a ppreciate; lower

42) Everything else held constant, increased demand for a country's ________ causes its currency to 42) ______ appreciate in the long run, while increased demand for ________ causes its currency to depreciate.

A) exports; imports B) e xports; exports C) imports; imports D) i mports; exports

43) Everything else held constant, increased demand for a country's exports causes its currency to

43) ______

________ in the long run, while increased demand for imports causes its currency to ________ A) appreciate; depreciate B) d epreciate; appreciate C) depreciate; depreciate D) a ppreciate; appreciate

44) Everything else held constant, if a factor increases the demand for ________ goods relative to

44) ______

________ goods, the domestic currency will appreciate.

A) domestic; domestic B) d omestic; foreign C) foreign; foreign D) f oreign; domestic

45) Everything else held constant, if a factor decreases the demand for ________ goods relative to

45) ______

________ goods, the domestic currency will depreciate.

A) foreign; foreign B) d omestic; foreign C) foreign; domestic D) d omestic; domestic

46) An increase in productivity in a country will cause its currency to ________ because it can

46) ______

produce goods at a ________ price, everything else held constant.

A) depreciate; lower B) a ppreciate; higher C) depreciate; higher D) a ppreciate; lower

47) If, in retaliation for "unfair" trade practices, Congress imposes a 30 percent tariff on Japanese DVD recorders, but at the same time, U.S. demand for Japanese goods increases, then, in the long run, ________, everything else held constant A) the Japanese yen should depreciate relative to the U.S. dollar B) there is no effect on the Japanese yen relative to the U.S. dollar C) the Japanese yen could appreciate, depreciate or remain constant relative to the U.S. dollar D) the Japanese yen should appreciate relative to the U.S. dollar

48)

47) ______

____ __

If the U.S. 48) Congress imposes a quota on imports of Japanese cars due to claims of "unfair" trade practices, and Japanese demand for American exports increases at the same time, then, in the long run ________, everythin g else held constant.

A) there will be no effect on the Japanese yen relative to the U.S. dollar B) the Japanese yen will either appreciate, depreciate or remain constant against the U.S. dollar

C) the Japanese yen will depreciate relative to the U.S. dollar D) the Japanese yen will appreciate relative to the U.S. dollar 49) If the inflation rate in the United States is higher than that in Mexico and productivity is

49) ______

growing at a slower rate in the United States than in Mexico, then, in the long run, ________, everything else held constant.

A) the Mexican peso will depreciate relative to the U.S. dollar B) there will be no effect on the Mexican peso relative to the U.S. dollar C) the Mexican peso will either appreciate, depreciate, or remain constant relative to the U.S. dollar D) the Mexican peso will appreciate relative to the U.S. dollar

50) If the Brazilian demand for American exports rises at the same time that U.S. productivity rises

50) ______

relative to Brazilian productivity, then, in the long run, ________, everything else held constant.

A) the Brazilian real will appreciate relative to the U.S. dollar B) the Brazilian real will depreciate relative to the U.S. dollar C) there is no effect on the Brazilian real relative to the U.S. dollar D) the Brazilian real will either appreciate, depreciate, or remain constant relative to the U.S. dollar

ESSAY. Write your answer in the space provided or on a separate sheet of paper.

51) Explain the law of one price and the theory of purchasing power parity. Why doesn't purchasing power

parity

explain all exchange rate movements? What factors determine long-run exchange rates?

MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question.

52) ______ 52) The theory of asset demand suggests that the most important factor affecting the demand for domestic and foreign assets is A) the expected return on these assets relative to one another.

B) the liquidity of these assets relative to one another.

C) the riskiness of these assets relative to one another.

D) the level of trade and capital flows.

53) The ________ suggests that the most important factor affecting the demand for domestic and

53) ______

foreign assets is the expected return on domestic assets relative to foreign assets.

A) theory of foreign capital mobility B) t heory of asset demand C) law of one price D) i nterest parity condition

54) The theory of asset demand suggests that the most important factor affecting the demand for

54) ______

domestic and foreign assets is the ________ on these assets relative to one another.

A) interest rate B) e xpected return C) risk D) l iquidity

55) The condition that states that the domestic interest rate equals the foreign interest rate minus

55) ______

the expected appreciation of the domestic currency is called A) the purchasing power parity condition.

B) m oney neutrality.

C) the interest parity condition.

D) t he theory of foreign capital mobility.

56) As the relative expected return on dollar assets increases, foreigners will want to hold more

56) ______

________ assets and less ________ assets, everything else held constant.

A) foreign; foreign B) d ollar; dollar C) dollar; foreign D) f oreign; dollar

57) When Americans or foreigners expect the return on ________ assets to be high relative to the

57) ______

return on ________ assets, there is a higher demand for dollar assets and a correspondingly lower demand for foreign assets.

A) foreign; dollar B) d ollar; foreign C) dollar; dollar D) f oreign; foreign

58) When Americans or foreigners expect the return on ________ assets to be high relative to the

58) ______

return on ________ assets, there is a ________ demand for dollar assets, everything else held constant.

A) dollar; foreign; higher B) f oreign; dollar; constant C) dollar; foreign; constant D) f oreign; dollar; higher

59) When Americans or foreigners expect the return on dollar assets to be high relative to the

59) ______

return on foreign assets, there is a ________ demand for dollar assets and a correspondingly ________ demand for ________ foreign assets.

A) lower; higher B) h igher; lower C) l ower; lower D) h igher; higher

60) If the interest rate is 7 percent on euro-denominated assets and 5 percent on dollar-denominated assets, and if the dollar is expected to appreciate at a 4 percent rate, for Francois the Frenchman the expected rate of return on dollar-denominated assets is

A) 1 1 percent.

60) ______

B) 9 percent.

C) 5 percent.

D) 3 percent.

E) 1 percent.

61) If the interest rate is 7 percent on euro-denominated assets and 5 percent on

61) ______

dollar-denominated assets, and if the dollar is expected to appreciate at a 4 percent rate, the expected return on ________-denominated assets in ________ percent.

A) euro; dollars is 3 B) e uro; dollars is 1 C) dollar; euros is 1 D) d ollar; euros is 3

62) If the interest rate on euro-denominated assets is 13 percent and it is 15 percent on

62) ______

peso-denominated assets, and if the euro is expected to appreciate at a 4 percent rate, for Manuel the Mexican the expected rate of return on euro-denominated assets is A) 11 percent.

B) 1 3 percent.

C) 1 7 percent.

D) 1 9 percent.

63) If the interest rate on euro-denominated assets is 13 percent and it is 15 percent on

63) ______

peso-denominated assets, and if the euro is expected to appreciate at a 4 percent rate, for Francois the Frenchman the expected rate of return on peso-denominated assets is A) 11 percent.

B) 1 5 percent.

C) 1 7 percent.

D) 1 9 percent.

64) With a 10 percent interest rate on dollar deposits, and an expected appreciation of 7 percent

64) ______

over the coming year, the expected return on dollar deposits in terms of the foreign currency is A) 3 percent.

B) 1 0 percent.

C) 1 3.5 percent.

D) 1 7 percent.

65) With a 10 percent interest rate on dollar deposits, and an expected appreciation of 7 percent

65) ______

over the coming year, the expected return on dollar deposits in terms of the dollar is A) 3 percent.

B) 1 0 percent.

C) 1 3.5 percent.

D) 1 7 percent.

66) The expected return on dollar deposits in terms of foreign currency can be written as the

66) ______

________ of the interest rate on dollar deposits and the expected appreciation of the dollar.

A) difference B) p roduct C) r atio D) s um

67) In a world with few impediments to capital mobility, the domestic interest rate equals the sum

67) ______

of the foreign interest rate and the expected depreciation of the domestic currency, a situation known as the A) foreign asset parity condition.

B) i nterest parity condition.

C) purchasing power parity condition.

D) e xchange rate parity condition.

68) According to the interest parity condition, if the domestic interest rate is 12 percent and the

68) ______

foreign interest rate is 10 percent, then the expected ________ of the foreign currency must be ________ percent.

A) depreciation; 2 B) a ppreciation; 2 C) a ppreciation; 4 D) d epreciation; 4

69) According to the interest parity condition, if the domestic interest rate is 10 percent and the

69) ______

foreign interest rate is 12 percent, then the expected ________ of the foreign currency must be ________ percent.

A) appreciation; 4 B) a ppreciation; 2 C) d epreciation; 4 D) d epreciation; 2

70) Everything else held constant, when the current value of the domestic currency increases, the ________ domestic assets ________.

A) demand for; increases

B) d emand for; decreases

70) ______

C) quantity demanded of; increases

D) q uantity demanded of; decreases

71) Everything else held constant, when the current value of the domestic exchange rate increases, the ________ of domestic assets ________.

A) supply; decreases C) quantity supplied; does not change

71) ______

B) q uantity supplied; increases D) s upply; increases

ESSAY. Write your answer in the space provided or on a separate sheet of paper.

72) Explain the interest parity condition. What key assumption underlies this condition? What factors affect the returns on domestic and foreign assets?

MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question.

73) An increase in the domestic interest rate causes the demand for domestic assets to ________ and 73) ______ the domestic currency to ________, everything else held constant.

A) decrease; depreciate B) i ncrease; appreciate C) increase; depreciate D) d ecrease; appreciate

74) An increase in the domestic interest rate causes the demand for domestic assets to shift to the

74) ______

________ and the domestic currency to ________, everything else held constant.

A) right; appreciate B) r ight; depreciate C) left; depreciate D) l eft; appreciate

75) A decrease in the domestic interest rate causes the demand for domestic assets to ________ and 75) ______ the domestic currency to ________, everything else held constant.

A) increase; appreciate B) d ecrease; depreciate C) increase; depreciate D) d ecrease; appreciate

76) A decrease in the domestic interest rate causes the demand for domestic assets to shift to the

76) ______

________ and the domestic currency to ________, everything else held constant.

A) left; appreciate B) l eft; depreciate C) right; depreciate D) r ight; appreciate

77) ________ in the domestic interest rate causes the demand for domestic assets to increase and the 77) ______ domestic currency to ________, everything else held constant.

A) A decrease; appreciate B) A decrease; depreciate C) An increase; appreciate D) A n increase; depreciate

78) ________ in the domestic interest rate causes the demand for domestic assets to shift to the right 78) ______ and the domestic currency to ________, everything else held constant.

A) An increase; appreciate B) A decrease; appreciate C) An increase; depreciate D) A decrease; depreciate

79) ________ in the domestic interest rate causes the demand for domestic assets to decrease and

79) ______

the domestic currency to ________, everything else held constant.

A) A decrease; appreciate B) A n increase; depreciate C) An increase; appreciate D) A decrease; depreciate

80) ________ in the domestic interest rate causes the demand for domestic assets to shift to the left and the domestic currency to ________, everything else held constant.

A) An increase; appreciate B) A decrease; appreciate C) An increase; depreciate D) A decrease; depreciate

80) ______

81) ________ in the domestic interest rate causes the demand for domestic assets to ________ and

81) ______

82) ________ in the domestic interest rate causes the demand for domestic assets to shift to the

82) ______

the domestic currency to appreciate, everything else held constant.

A) An increase; decrease B) A decrease; decrease C) A decrease; increase D) A n increase; increase

________ and the domestic currency to appreciate, everything else held constant.

A) A decrease; right B) A decrease; left C) An increase; left D) A n increase; right

83) ________ in the domestic interest rate causes the demand for domestic assets to ________ and

83) ______

the domestic currency to depreciate, everything else held constant.

A) An increase; increase B) A decrease; decrease C) A decrease; increase D) A n increase; decrease

84) ________ in the domestic interest rate causes the demand for domestic assets to shift to the

84) ______

________ and the domestic currency to depreciate, everything else held constant.

A) A decrease; right B) A decrease; left C) An increase; left D) A n increase; right

85) Suppose that the Federal Reserve enacts expansionary policy. Everything else held constant,

85) ______

this will cause the demand for U.S. assets to ________ and the U.S. dollar to ________.

A) increase; appreciate B) d ecrease; appreciate C) decrease; depreciate D) i ncrease; depreciate

86) Suppose that the Federal Reserve conducts an open market sale. Everything else held constant,

86) ______

this will cause the demand for U.S. assets to ________ and the U.S. dollar will ________.

A) increase; depreciate B) i ncrease; appreciate C) decrease; appreciate D) d ecrease; depreciate

87) An increase in the foreign interest rate causes the demand for domestic assets to ________ and

87) ______

the domestic currency to ________, everything else held constant.

A) decrease; depreciate B) i ncrease; depreciate C) increase; appreciate D) d ecrease; appreciate

88) An increase in the foreign interest rate causes the demand for domestic assets to shift to the

88) ______

________ and the domestic currency to ________, everything else held constant.

A) right; depreciate B) l eft; appreciate C) right; appreciate D) l eft; depreciate

89) A decrease in the foreign interest rate causes the demand for domestic assets to ________ and

89) ______

the domestic currency to ________, everything else held constant.

A) decrease; depreciate B) d ecrease; appreciate C) increase; appreciate D) i ncrease; depreciate

90) A decrease in the foreign interest rate causes the demand for domestic assets to shift to the

90) ______

________ and the domestic currency to ________, everything else held constant.

A) right; appreciate B) l eft; depreciate C) left; appreciate D) r ight; depreciate

91) ________ in the foreign interest rate causes the demand for domestic assets to increase and the

domestic

____ __

currency 91) to ________, everythin g else held constant.

A) An increase; appreciate C) A decrease; depreciate

B) A decrease; appreciate D) A n increase; depreciate

92) ________ in the foreign interest rate causes the demand for domestic assets to shift to the right

92) ______

and the domestic currency to ________, everything else held constant.

A) A decrease; depreciate B) A n increase; appreciate C) An increase; depreciate D) A decrease; appreciate

93) ________ in the foreign interest rate causes the demand for domestic assets to decrease and the 93) ______ domestic currency to ________, everything else held constant.

A) A decrease; depreciate B) A decrease; appreciate C) An increase; depreciate D) A n increase; appreciate

94) ________ in the foreign interest rate causes the demand for domestic assets to shift to the left

94) ______

and the domestic currency to ________, everything else held constant.

A) A decrease; appreciate B) A n increase; depreciate C) A decrease; depreciate D) A n increase; appreciate

95) ________ in the foreign interest rate causes the demand for domestic assets to ________ and the 95) ______ domestic currency to appreciate, everything else held constant.

A) An increase; decrease B) A n increase; increase C) A decrease; decrease D) A decrease; increase

96) ________ in the foreign interest rate causes the demand for domestic assets to shift to the

96) ______

________ and the domestic currency to appreciate, everything else held constant.

A) A decrease; right B) A n increase; left C) A decrease; left D) A n increase; right

97) ________ in the foreign interest rate causes the demand for domestic assets to ________ and the 97) ______ domestic currency to depreciate, everything else held constant.

A) An increase; decrease B) A n increase; increase C) A decrease; increase D) A decrease; decrease

98) ________ in the foreign interest rate causes the demand for domestic assets to shift to the

98) ______

________ and the domestic currency to depreciate, everything else held constant.

A) An increase; left B) A decrease; right C) A decrease; left D) A n increase; right

99) Suppose that the European Central Bank enacts expansionary policy. Everything else held

99) ______

constant, this will cause the demand for U.S. assets to ________ and the U.S. dollar to ________.

A) decrease; depreciate B) i ncrease; depreciate C) decrease; appreciate D) i ncrease; appreciate

100) Suppose that the European Central Bank conducts a main refinancing sale. Everything else held constant, this would cause the demand for U.S. assets to ________ and the U.S. dollar will ________.

100) _____

A) decrease; depreciate C) decrease; appreciate

B) i ncrease; appreciate D) i ncrease; depreciate

101) An increase in the expected future domestic exchange rate causes the demand for domestic

101) _____

assets to ________ and the domestic currency to ________, everything else held constant.

A) increase; depreciate B) d ecrease; appreciate C) increase; appreciate D) d ecrease; depreciate

102) An increase in the expected future domestic exchange rate causes the demand for domestic

102) _____

assets to shift to the ________ and the domestic currency to ________, everything else held constant.

A) right; appreciate B) l eft; appreciate C) right; depreciate D) l eft; depreciate

103) A decrease in the expected future domestic exchange rate causes the demand for domestic

103) _____

assets to ________ and the domestic currency to ________, everything else held constant.

A) decrease; depreciate B) i ncrease; appreciate C) increase; depreciate D) d ecrease; appreciate

104) A decrease in the expected future domestic exchange rate causes the demand for domestic

104) _____

assets to shift to the ________ and the domestic currency to ________, everything else held constant.

A) left; appreciate B) r ight; appreciate C) left; depreciate D) r ight; depreciate

105) ________ in the expected future domestic exchange rate causes the demand for domestic assets 105) _____ to increase and the domestic currency to ________, everything else held constant.

A) An increase; depreciate B) A n increase; appreciate C) A decrease; depreciate D) A decrease; appreciate

106) ________ in the expected future domestic exchange rate causes the demand for domestic assets 106) _____ to shift to the right and the domestic currency to ________, everything else held constant.

A) A decrease; depreciate B) A n increase; appreciate C) An increase; depreciate D) A decrease; appreciate

107) ________ in the expected future domestic exchange rate causes the demand for domestic assets 107) _____ to decrease and the domestic currency to ________, everything else held constant.

A) An increase; depreciate B) A decrease; depreciate C) A decrease; appreciate D) A n increase; appreciate

108) ________ in the expected future domestic exchange rate causes the demand for domestic assets 108) _____ to shift to the left and the domestic currency to ________, everything else held constant.

A) A decrease; appreciate B) A n increase; appreciate C) A decrease; depreciate D) A n increase; depreciate

109) ________ in the expected future domestic exchange rate causes the demand for domestic assets 109) _____ to ________ and the domestic currency to appreciate, everything else held constant.

A) An increase; increase B) A decrease; decrease C) A decrease; increase D) A n increase; decrease

110) ________ in the expected future domestic exchange rate causes the demand for domestic assets 110) _____ to shift to the ________ and the domestic currency to appreciate, everything else held constant.

A) A decrease; left C) An increase; left

B) A n increase; right D) A decrease; right

111) ________ in the expected future domestic exchange rate causes the demand for domestic assets 111) _____ to ________ and the domestic currency to depreciate, everything else held constant.

A) An increase; decrease B) A n increase; increase C) A decrease; decrease D) A decrease; increase

112) ________ in the expected future domestic exchange rate causes the demand for domestic assets 112) _____ to shift to the ________ and the domestic currency to depreciate, everything else held constant.

A) A decrease; right B) A n increase; left C) A decrease; left D) A n increase; right

113) Suppose the Federal Reserve releases a policy statement today which leads people to believe

113) _____

that the Fed will be enacting expansionary monetary policy in the near future. Everything else held constant, the release of this statement would immediately cause the demand for U.S. assets to ________ and the U.S. dollar to ________.

A) increase; depreciate B) d ecrease; depreciate C) decrease; appreciate D) i ncrease; appreciate

114) Suppose a report was released today that showed the Euro-Zone inflation rate is running above

114) _____

the European Central Bank's inflation rate target. This leads people to expect that the European Central Bank will enact contractionary policy in the near future. Everything else held constant, the release of this report would immediately cause the demand for U.S. assets to ________ and the U.S. dollar will ________.

A) increase; depreciate B) d ecrease; appreciate C) decrease; depreciate D) i ncrease; appreciate

115) Suppose that the latest Consumer Price Index (CPI) release shows a higher inflation rate in the

115) _____

U.S. than was expected. Everything else held constant, the release of the CPI report would immediately cause the demand for U.S. assets to ________ and the U.S. dollar would ________.

A) decrease; appreciate B) d ecrease; depreciate C) increase; appreciate D) i ncrease; depreciate

116) In the long run, a one-time percentage increase in the money supply is matched by the same

116) _____

one-time percentage rise in the price level, leaving unchanged the real money supply and ________. This proposition is called money ________.

A) other economic variables such as interest rates; neutrality B) all other economic variables such as interest rates; illusion C) the nominal exchange rate; neutrality D) the nominal exchange rate; illusion

117) Money neutrality means that in the long run the domestic interest rate remains unchanged

117) _____

from an increase in the money supply, implying that the fall in the exchange rate is greater in the ________ run than in the ________ run, a phenomenon called exchange rate overshooting.

A) short; long B) l ong; short C) s hort; short D) l ong; long

118) Evidence from the United States during the period 1973-2002 indicates that the value of the dollar and the measure of the ________ interest rate rose and fell together.

A) expected B) a ctual C) r eal

D) n ominal

ESSAY. Write your answer in the space provided or on a separate sheet of paper.

118) _____

119) Explain and show graphically the effect of an increase in the expected future exchange rate on the equilibrium exchange rate, everything else held constant.

120) Explain and show graphically the effect of an increase in the expected inflation rate on the equilibrium exchange rate, everything else held constant.

1) C 2) C 3) B 4) B 5) B 6) B 7) D 8) D 9) C 10) D 11) D 12) C 13) B 14) C 15) A 16) B 17) A 18) D 19) A 20) D 21) E 22) A 23) A 24) B 25) D 26) D 27) D 28) B 29) C 30) A 31) A 32) B 33) A 34) C 35) A 36) B 37) A 38) B 39) D 40) B 41) A 42) A 43) A 44) B 45) B 46) D 47) C 48) C 49) D 50) B

51) With no trade barriers and low transport costs, the law of one price states that the price of traded goods should be

the same in all countries. The purchasing power parity theory extends the law of one price to total economies. PPP states that exchange rates should adjust to reflect changes in the price levels between two countries. PPP may fail to fully explain exchange rates because goods are not identical, and price levels include traded and nontraded goods and services. Long-run exchange rates are determined by domestic price levels relative to foreign price levels, trade barriers, import and export demand, and productivity.

52) A 53) B 54) B 55) C 56) C 57) B 58) A 59) B 60) B 61) A 62) C 63) A 64) D 65) B 66) D 72) The interest parity condition states that returns on domestic and foreign assets will be equal. The key assumption 67) B 68) for B this condition is capital mobility. The return on domestic assets is equal to the domestic interest rate. The 69) return on foreign assets is equal to the foreign interest rate minus the expected rate of appreciation of the domestic currency.

D 73) B 70) 74) D A 71) 75) C B 76) B 77) C 78) A 79) D 80) D 81) D 82) D 83) B 84) B 85) C 86) B 87) A 88) D 89) C

94) B 95) D 96) A 97) A 98) A 99) D 100) A 101) C 102) A 103) A 104) C 105) B 106) B 107) B 108) C 109) A 110) B 111) C 112) C 113) B 114) D 115) B 116) A 117) A 118) C 119) See figure below.

When the expected future exchange rate increases, the relative expected return on the domestic assets increases.

This will cause the demand for domestic assets to increase and the current value of the exchange rate will appreciate.

120) See figure below.

ed return on domestic assets. Second, through purchasing power parity, the future value of the domestic exchange rate will decline which will decrease the expected return on domestic assets. Since it is generally believed that the effect of the change in the expected future value of the domestic exchange rate is larger than the Fisher effect, the net effect is a lower expected return on domestic assets. This will decrease the demand for domestic assets, which will cause the current value of the domestic exchange rate to depreciate.

When the expect ed inflati on rate increa ses, the relativ e expect ed return on dome stic assets is affecte d two ways.

First, throu gh the Fisher effect, the dome stic nomin al intere st rate will increa se the expect

Exam Name___________________________________ MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question.

1) A central bank ________ of domestic currency and corresponding ________ of foreign assets in

1) _______

the foreign exchange market leads to an equal decline in its international reserves and the monetary base, everything else held constant.

A) sale; purchase B) p urchase; purchase C) purchase; sale D) s ale; sale

2) A central bank ________ of domestic currency and corresponding ________ of foreign assets in

2) _______

the foreign exchange market leads to an equal increase in its international reserves and the monetary base, everything else held constant.

A) sale; purchase B) p urchase; purchase C) sale; sale D) p urchase; sale

3) Suppose that the Bank of Japan buys U.S. dollar assets with yen-denominated assets.

3) _______

Everything else held constant, this transaction will cause ________ in the foreign assets held by the Federal Reserve and ________ in the U.S. monetary base.

A) a decrease; an increase B) a decrease; a decrease C) an increase; an increase D) a n increase; a decrease

4) Suppose that the Bank of Japan buys yen-denominated assets with U.S. dollar assets.

4) _______

Everything else held constant, this transaction will cause ________ in the foreign assets held by the Federal Reserve and ________ in the U.S. monetary base.

A) a decrease; an increase B) a decrease; a decrease C) an increase; an increase D) a n increase; a decrease

5) When the central bank allows the purchase or sale of domestic currency to have an effect on the

5) _______

monetary base, it is called A) a sterilized foreign exchange intervention.

B) an exchange rate feedback rule.

C) a money neutral foreign exchange intervention.

D) an unsterilized foreign exchange intervention.

6) A foreign exchange intervention with an offsetting open market operation that leaves the

6) _______

monetary base unchanged is called A) an unsterilized foreign exchange intervention.

B) a money neutral foreign exchange intervention.

C) an exchange rate feedback rule.

D) a sterilized foreign exchange intervention.

7) Everything else held constant, if a central bank makes an unsterilized purchase of foreign

7) _______

assets, then the domestic money supply will ________ and the domestic currency will ________.

A) decrease; appreciate B) i ncrease; appreciate C) increase; depreciate D) d ecrease; depreciate

8) Everything else held constant, if a central bank makes an unsterilized ________ of foreign assets, then the domestic money supply will increase and the domestic currency will ________.

A) purchase; depreciate B) s ale; depreciate C) purchase; appreciate D) s ale; appreciate

8) _______

9) Everything else held constant, if a central bank makes an unsterilized ________ of foreign

9) _______

assets, then the domestic money supply will ________ and the domestic currency will appreciate.

A) sale; increase B) s ale; decrease C) purchase; increase D) p urchase; decrease

10) Everything else held constant, if a central bank makes an unsterilized sale of foreign assets,

10) ______

then the domestic money supply will ________ and the domestic currency will ________.

A) increase; appreciate B) d ecrease; depreciate C) increase; depreciate D) d ecrease; appreciate

11) Everything else held constant, if a central bank makes an unsterilized ________ of foreign

11) ______

assets, then the domestic money supply will decrease and the domestic currency will ________.

A) sale; appreciate B) s ale; depreciate C) purchase; appreciate D) p urchase; depreciate

12) Everything else held constant, if a central bank makes an unsterilized _________ of foreign

12) ______

assets, then the domestic money supply will ________ and the domestic currency will depreciate.

A) purchase; increase B) s ale; decrease C) purchase; decrease D) s ale; increase

13) Everything else held constant, if a central bank makes a sterilized purchase of foreign assets,

13) ______

then the domestic currency will ________.

A) either appreciate, depreciate, or remain constant B) depreciate C) appreciate D) not be affected

14) Because sterilized interventions mean offsetting open market operations, there is no impact on

14) ______

the monetary base and the money supply, and therefore a sterilized intervention A) causes the exchange rate to undershoot in the short run.

B) causes the exchange rate to overshoot in the short run.

C) causes the exchange rate to depreciate in the short run, but has no effect on the exchange rate in the long run.

D) has no effect on the exchange rate.

15) Everything else held constant, if a central bank makes a sterilized sale of foreign assets, then the

15) ______

domestic currency will ________.

A) not be affected B) depreciate C) appreciate D) either appreciate, depreciate, or remain constant

16) If the United States has a current account deficit with England of $1 million, and the Bank of

16) ______

England sells $1 million worth of pounds in the foreign exchange market, then England ________ $1 million of international reserves and its monetary base ________ by $1 million.

A) loses; rises B) g ains; falls C) l oses; falls D) g ains; rises

ESSAY. Write your answer in the space provided or on a separate sheet of paper.

17) Explain and demonstrate graphically how an unsterilized purchase of foreign assets leads to overshooting

of the

exchange rate, and describe the long-run behavior of the exchange rate, everything else held constant.

MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question.

18) The difference between merchandise exports and imports is called the ________ balance.

18) ______ A) trade B) c urrent account C) capital account D) o fficial reserve transactions 19) The account that shows international transactions involving currently produced goods and services is called the A) balance of payments.

C) current account.

B) t rade balance.

D) c apital account.

20) The account that shows international transactions involving financial transactions (stocks, bonds, bank loans, etc.) is called the A) current account.

C) balance of payments.

19) ______

20) ______

B) t rade balance.

D) c apital account.

21) Which of the following does not appear in the current account part of the balance of payments?

A) Income earned by General Motors from its plants abroad.

B) A loan of $1 million from Chase Manhattan bank to Brazil.

C) Foreign aid to El Salvador.

D) An Air France ticket bought by an American.

21) ______

22) Of the following, the one that appears in the current account of the balance of payments is A) a purchase of a British Treasury bond by the Fed. B) income earned by U.S. subsidiaries of Barclay's Bank of London.

C) an Italian investor's purchase of IBM stock.

D) a loan by a Swiss bank to an American corporation.

22) ______

23) Capital ________ are American purchases of foreign assets, and capital ________ are foreign

23) ______

purchases of American assets.

A) inflows; outflows C) outflows; inflows

B) i nflows; inflows D) o utflows; outflows

24) Which of the following appears in the capital account part of the balance of payments?

A) Income earned by the Honda corporation on its automobile plant in Ohio.

B) A gift to an American from his English aunt.

C) A purchase by the Honda corporation of a U.S. Treasury bill.

D) A purchase by the Bank of England of a U.S. Treasury bill.

24) ______

25) The net amount of international reserves that move between governments to finance

25) ______

international transactions is called the ________ balance.

A) official reserve transactions B) c urrent account C) capital account D) t rade

26) If the current account balance shows a surplus, and the capital account also shows a surplus, then the official reserve transactions balance A) must be negative.

C) must best be zero.

26) ______

B) m ust be positive.

D) c an either be positive, negative, or zero.

27) A current account surplus indicates that America is ________ its claims on foreign wealth,

27) ______

28) Because it provides some indication of what is happening to U.S. claims on foreign wealth and

28) ______

while a deficit indicates that this country is ________ its claims on foreign wealth.

A) increasing; reducing B) r educing; increasing C) reducing; reducing D) i ncreasing; increasing

the demand for imports and exports, the ________ is closely followed by economists wanting information on the future movement of exchange rates.

A) capital account B) c urrent account balance C) trade balance D) s tatistical discrepancy

29) Economists closely follow the current account balance because they believe it can provide information on the future movement of A) exchange rates.

C) interest rates.

29) ______

B) g old flows.

D) s pecial drawing rights.

30) Under a gold standard in which one dollar could be turned in to the U.S. Treasury and

30) ______

exchanged for 1/20th of an ounce of gold and one German mark could be exchanged for 1/100th of an ounce of gold, an exchange rate of ________ marks to the dollar would stimulate a flow of gold from the United States to Germany.

B) 6 C) 5 D) 4 A) 7

31) When gold production was low in the 1870s and 1880s, the money supply grew ________ causing ________.

A) rapidly; disinflation C) slowly; deflation

31) ______

B) r apidly; inflation D) s lowly; disinflation

32) The fixed exchange rate regime established at a meeting in New Hampshire in 1944 has been

32) ______

known as the A) General Agreement on Tariffs and Trade.

B) International Settlement Fund.

C) Bretton Woods system.

D) Balance of Payments Compliance Accord.

33) Under the Bretton Woods system, the organization assigned the task of making loans to

33) ______

countries that were experiencing balance of payments difficulties is known as the A) International Monetary Fund.

B) F ederal Reserve System.

C) World Bank.

D) I nternational Development Association.

34) The Bretton Woods agreement created the ________, which was given the task of promoting the

34) ______

growth of world trade by setting rules for the maintenance of fixed exchange rates and by making loans to countries that were experiencing balance of payments difficulties.

A) IMF B) C entral Settlements Bank C) World Bank D) B ank of International Settlements

35) The World Bank is an international organization that: A) promotes the growth of trade by setting rules for how tariffs and quotas are set by countries.

B) makes loans to countries with balance of payment difficulties.

C) helps developing countries that have been having difficulties in repaying their loans to come to terms with lenders in the West.

35) ______

D) makes loans to countries to finance projects such as dams and roads.

36) Under the Bretton Woods system, the United States was designated as the A) fixed-rate country.

B) d ollar-standard country.

C) reserve-currency country.

D) p ar-standard country.

36) ______

37) Under a fixed exchange rate regime, if the domestic currency is initially ________, that is,

37) ______

________ par, the central bank must intervene to sell the domestic currency by purchasing foreign assets.

A) undervalued; below B) o vervalued; above C) overvalued; below D) u ndervalued; above

38) Under a fixed exchange rate regime, if the domestic currency is initially undervalued, that is,

38) ______

above par, the central bank must intervene to sell the ________ currency by purchasing ________ assets.

A) foreign; domestic B) d omestic; foreign C) foreign; foreign D) d omestic; domestic

39) Under a fixed exchange rate regime, if the domestic currency is initially ________, that is,

39) ______

________ par, the central bank must intervene to purchase the domestic currency by selling foreign assets.

A) undervalued; below B) u ndervalued; above C) overvalued; above D) o vervalued; below

40) Under a fixed exchange rate regime, if the domestic currency is initially overvalued, that is,

40) ______

below par, the central bank must intervene to purchase the ________ currency by selling ________ assets.

A) foreign; domestic B) f oreign; foreign C) domestic; foreign D) d omestic; domestic

41) Under a fixed exchange rate regime, if a central bank must intervene to purchase the ________

41) ______

currency by selling ________ assets, then, like an open market sale, this action reduces the monetary base and the money supply, causing the interest rate on domestic assets to rise.

A) domestic; domestic B) f oreign; foreign C) foreign; domestic D) d omestic; foreign

42) Under a fixed exchange rate regime, if a central bank must intervene to purchase the domestic

42) ______

currency by selling foreign assets, then, like an open market sale, this action ________ the monetary base and the money supply, causing the interest rate on domestic assets to ________.

A) reduces; fall B) i ncreases; rise C) r educes; rise D) i ncreases; fall

43) When the domestic currency is initially overvalued in a fixed exchange rate regime, the central

43) ______

bank must intervene in the foreign exchange market to ________ the domestic currency, thereby allowing the money supply to ________.

A) sell; decline B) s ell; increase C) purchase; increase D) p urchase; decline

44) When the domestic currency is initially undervalued in a fixed exchange rate regime, the central bank must intervene in the foreign exchange market to ________ the domestic currency, thereby allowing the money supply to ________.

A) p urchase; decline C) s ell; increase

B) s ell; decline D) p urchase; increase

44) ______

45) Under a fixed exchange rate regime, if a country has an overvalued exchange rate, then its

45) ______

central bank's attempt to keep its currency from ________ will result in a ________ of international reserves.

A) appreciating; gain B) a ppreciating; loss C) depreciating; loss D) d epreciating; gain

46) Under a fixed exchange rate regime, if a country has an ________ exchange rate, then its central

46) ______

bank's attempt to keep its currency from depreciating will result in a ________ of international reserves.

A) undervalued; loss B) o vervalued; gain C) undervalued; gain D) o vervalued; loss

47) Under a fixed exchange rate regime, if a country has an undervalued exchange rate, then its

47) ______

central bank's attempt to keep its currency from________ will result in a ________ of international reserves.

A) appreciating; loss B) d epreciating; loss C) appreciating; gain D) d epreciating; gain

48) Under a fixed exchange rate regime, if a country has an ________ exchange rate, then its central

48) ______

bank's attempt to keep its currency from appreciating will result in a ________ of international reserves.

A) undervalued; gain B) o vervalued; loss C) undervalued; loss D) o vervalued; gain

49) Under a fixed exchange rate regime, if a country's central bank runs out of international reserves, it cannot keep its currency from A) deflating.

B) i nflating.

C) d epreciating.

49) ______

D) a ppreciating.

50) Under a fixed exchange rate regime, a country that depletes its international reserves in an

50) ______

attempt to keep its currency from ________ will be forced to ________ its currency.

A) depreciating; revalue B) d epreciating; devalue C) appreciating; devalue D) a ppreciating; revalue

51) Under a fixed exchange rate regime, a central bank that does not want to acquire international

51) ______

reserves to keep its currency from ________ will decide to ________ its currency.

A) appreciating; revalue B) a ppreciating; devalue C) depreciating; revalue D) d epreciating; devalue

52) Under a fixed exchange rate system, countries that ran large, persistent balance of payments

52) ______

deficits would ________ international reserves, thereby pressuring them into ________ their exchange rate.

A) lose; revaluing B) l ose; devaluing C) gain; revaluing D) g ain; devaluing

53) Under a fixed exchange rate system, countries that ran large, persistent balance of payments

53) ______

surpluses would ________ international reserves, thereby pressuring them into ________ their exchange rate.

A) gain; revaluing B) g ain; devaluing C) lose; devaluing D) l ose; revaluing

54) A balance of payments ________ is associated with a loss of international reserves, while a

balance of

____ __

payments 54) ________ is associated with a gain.

A) deficit; surplus C) surplus; surplus

B) s urplus; deficit D) d eficit; deficit

55) A balance of payments deficit is associated with a ________ of international reserves, while a balance of payments surplus is associated with a ________.

A) loss; loss B) l oss; gain C) g ain; gain

55) ______

D) g ain; loss

56) To keep from running out of international reserves under the Bretton Woods system, a country

56) ______

had to implement ________ monetary policy to ________ its currency.

A) expansionary; strengthen B) c ontractionary; strengthen C) expansionary; weaken D) c ontractionary; weaken

57) Under the Bretton Woods system, when a country adopted an expansionary monetary policy,

57) ______

thereby causing a balance of payments ________, the country would eventually be forced to implement ________ monetary policy.

A) deficit; expansionary B) s urplus; expansionary C) deficit; contractionary D) s urplus; contractionary

58) Because the United States was the reserve-currency country under the Bretton Woods system, it 58) ______ could run large balance of payments ________ without ________ significant amounts of international reserves.

A) surpluses; losing B) s urpluses; gaining C) deficits; losing D) d eficits; gaining

59) The Bretton Woods system was one in which central banks A) agreed to limit domestic money growth to the average of the seven largest industrial

59) ______

nations.

B) agreed to limit domestic money growth to the average of the five largest industrial nations.

C) bought and sold their own currencies to keep their exchange rates fixed.

D) agreed not to intervene in the foreign exchange market to maintain a fixed exchange rate regime that had existed prior to World War I.

60) The Bretton Woods system broke down in the early 1970s for all but one of the following

60) ______

reasons: A) deficit countries losing international reserves were not willing to devalue their currencies.

B) the United States had been pursuing an inflationary monetary policy to reduce domestic unemployment.

C) surplus countries were not willing to pursue more expansionary policies.

D) surplus countries were not willing to revalue their currencies upwards.

61) To maintain fixed exchange rates when countries had balance of payments deficits and were losing international reserves, the ________ would loan ________ countries international reserves contributed by other members.

A) I MF; surplus C) W orld Bank; deficit

B) W orld Bank; surplus D) I MF; deficit

61) ______

62) Under the Bretton Woods system, the IMF could encourage ________ countries to pursue

62) ______

________ monetary policies that would strengthen their currency or eliminate their balance of payment deficits.

A) surplus; expansionary B) d eficit; contractionary C) deficit; expansionary D) s urplus; contractionary

63) Under the Bretton Woods system, the IMF could encourage deficit countries to pursue

63) ______

contractionary monetary policies that would ________ their currency or eliminate their balance of payment ________.

A) strengthen; deficits B) w eaken; surpluses C) strengthen; surpluses D) w eaken; deficits

64) A weakness of the Bretton Woods system was that the ________ had no way to force surplus

64) ______

countries to either revalue their exchange rates upwards or pursue more expansionary policies.

A) World Bank B) Bank of International Settlements C) IMF D) European Exchange Rate Mechanism (ERM)

65) Under the Bretton Woods system, a country running a balance of payments deficit ________

65) ______

international reserves, and had to implement ________ monetary policy to strengthen its currency.

A) gained; contractionary B) g ained; expansionary C) lost; contractionary D) l ost; expansionary

66) Under the Bretton Woods system, a country running a balance of payments ________ lost

66) ______

international reserves, and had to implement ________ monetary policy to strengthen its currency.

A) surplus; expansionary B) d eficit; expansionary C) surplus; contractionary D) d eficit; contractionary

67) Under the Bretton Woods system, a country running a balance of payments surplus ________

67) ______

international reserves, and had to implement ________ monetary policy to weaken its currency.

A) lost; expansionary B) g ained; expansionary C) lost; contractionary D) g ained; contractionary

68) Under the Bretton Woods system, if IMF loans were insufficient to prevent ________ of a

68) ______

currency, then the country was allowed to devalue its currency by setting a new, ________ exchange rate.

A) depreciation; lower B) a ppreciation; lower C) appreciation; higher D) d epreciation; higher

69) As a result of its power to dictate loan terms to borrowing countries (under the Bretton Woods

69) ______

system), the IMF could encourage ________ countries to pursue ________ monetary policies that would strengthen their currency or eliminate their balance of payments deficits.

A) surplus; contractionary B) d eficit; expansionary C) surplus; expansionary D) d eficit; contractionary

70) Because central banks have not been willing to give up their option of intervening in the foreign exchange market, the current international financial system can best be described as a A) moving-pegged exchange rate system.

70) ______

B) variable-pegged exchange rate system.

C) flexible-exchange, dollar-pegged exchange rate system.

D) hybrid of a fixed exchange rate and flexible exchange rate system.

71) The current international financial system is a managed float exchange rate system because A) all countries allow their exchange rates to fluctuate in response to market forces.

B) some countries keep their currencies pegged to the dollar, which is not allowed to

71) ______

fluctuate.

C) exchange rates fluctuate in response to, but are not determined solely by, market forces.

D) all countries peg their currencies to the dollar which is allowed to fluctuate in response to market forces.

72) Policymakers in a country with a balance of payments surplus may not want to see their

72) ______

country's currency appreciate because this would A) decrease the wealth of the country.

B) hurt domestic businesses by making foreign goods cheaper in their country.

C) hurt consumers in their country by making foreign goods more expensive.

D) increase inflation in their country.

73) Under the current managed float exchange rate regime, countries with balance of payments

73) ______

deficits frequently do not want to see their currencies depreciate because it makes ________ goods more expensive for ________ consumers and can stimulate inflation.

A) foreign; domestic B) f oreign; foreign C) domestic; foreign D) d omestic; domestic

74) Countries with surpluses in their balance of payments frequently do not want to see their

74) ______

currencies ________ because it makes their goods ________ expensive abroad.

A) depreciated; less B) a ppreciate; more C) appreciated; less D) d epreciate; more

75) Countries with balance of payments deficits do not want to see their currencies ________

75) ______

because it makes foreign goods ________ expensive for domestic consumers.

A) depreciate; more B) d epreciate; less C) appreciate; more D) a ppreciate; less

76) Under the current managed float exchange rate regime, countries with ________ in their

76) ______

balance of payments frequently do not want to see their currencies ________ because it makes their goods more expensive abroad and foreign goods cheaper in their countries.

A) surpluses; appreciate B) d eficits; depreciate C) surpluses; depreciate D) d eficits; appreciate

77) Under the current managed float exchange rate regime; countries with surpluses in their

77) ______

balance of payments frequently do not want to see their currencies appreciate because it makes their goods ________ expensive abroad and foreign goods ________ in their countries.

A) less; cheaper B) m ore; cheaper C) m ore; costlier D) l ess; costlier

78) Under the current managed float exchange rate regime, countries with balance of payments ________ frequently do not want to see their currencies ________ because it makes foreign goods more expensive for domestic consumers and can stimulate inflation.

A) surpluses; depreciate B) s urpluses; appreciate C) deficits; appreciate D) d eficits; depreciate

78) ______

79) Which of the following is true?

A) Special drawing rights are not held as international reserves.

B) Special drawing rights are loans to countries made by the IMF. C) Changes in the quantity of special drawing rights are tied to changes in the quantity of

79) ______

gold.

D) Special drawing rights are a paper substitute for gold.

80) An ECU was A) a paper currency issued by the European Common Market.

B) a loan by European countries to the IMF. C) a paper substitute for gold issued by the IMF. D) a monetary unit created by the European Monetary System.

80) ______

81) Under the Exchange Rate Mechanism of the European Monetary System, when the British

81) ______

pound depreciated below its lower limit against the German mark, the Bank of England was required to buy ________ and sell ________, thereby ________ international reserves.

A) marks; pounds; gaining B) m arks; pounds; losing C) pounds; marks; losing D) p ounds; marks; gaining

82) Under the Exchange Rate Mechanism of the European Monetary System, when the British

82) ______

pound depreciated below its lower limit against the German mark, the German central bank was required to buy ________ and sell ________, thereby ________ international reserves.

A) pounds; marks; losing B) m arks; pounds; gaining C) pounds; marks; gaining D) m arks; pounds; losing

83) Under the Exchange Rate Mechanism of the European Monetary System, when the German

83) ______

mark depreciated below its lower limit against the British pound, the Bank of England was required to buy ________ and sell ________, thereby ________ international reserves.

A) marks; pounds; gaining B) m arks; pounds; losing C) pounds; marks; gaining D) p ounds; marks; losing

84) Under the Exchange Rate Mechanism of the European Monetary System, when the German

84) ______

mark depreciated below its lower limit against the British pound, the German central bank was required to buy _____ and sell _____, thereby _____ international reserves.

A) pounds; marks; losing B) p ounds; marks; gaining C) marks; pounds; losing D) m arks; pounds; gaining

85) In September 1992, the Bundesbank attempted to keep the mark from appreciating relative to

85) ______

the British pound, but it failed because participants in the foreign exchange market came to expect the A) revaluation of the dollar.

B) a ppreciation of the mark.

C) end of the Exchange Rate Mechanism.

D) d epreciation of the mark.

86) The East Asia currency crisis in 1997 started in A) Philippines.

B) T hailand.

C) S outh Korea.

D) J apan.

87) Between May and July 1997, concerns about the large current account deficit in Thailand and the weakness in the Thai financial system caused speculators to suspect that Thailand might be forced to A) impose capital controls.

B) d evalue its currency.

C) sell baht to prop up its value.

D) b uy dollars to prop up the baht.

86) ______ 87) ______

ESSAY. Write your answer in the space provided or on a separate sheet of paper.

88) Explain and demonstrate graphically the situation of an overvalued exchange rate in a fixed exchange rate system. What alternative policies are available to eliminate the overvaluation of the exchange rate?

89) Assume that a fixed exchange rate is overvalued. Describe the situation of a speculative crisis against this currency. What can the central bank do to defend the currency? Why might the alternative of devaluation be preferable?

MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question.

90) ______ 90) A capital ________ can promote financial instability in an emerging-market country because it is what forces a country to ________ its currency.

A) outflow; revalue C) inflow; revalue

B) o utflow; devalue D) i nflow; devalue

91) A capital ________ can promote financial instability in an emerging-market country because it

91) ______

can lead to a lending boom and excessive risk-taking on the part of banks, which helps trigger a ________.

A) inflow; currency devaluation B) o utflow; financial crisis C) outflow; currency devaluation D) i nflow; financial crisis

92) A case for capital inflow controls can be made because capital inflows A) can cause a lending boom and lead to excessive risk taking.

B) are less likely to cause financial crises than regulation of banking activities.

C) never finance productive investments.

D) always finance productive investments.

92) ______

93) Which of the following is not a disadvantage of controls on capital outflows?

A) Controls often lead to an increase in government corruption.

B) Capital flight may increase after they are put in place.

C) The controls may lead to excessive risk taking by the domestic banks.

D) They are seldom effective during a crisis.

93) ______

94) In the 1990s this agency has acted like an international lender of last resort to cope with

94) ______

financial instability.

A) European Central Bank B) World Bank C) International Bank for Reconstruction and Development D) IMF

95) An international lender of last resort creates a serious ________ problem because depositors

95) ______

and other creditors of banking institutions expect that they will be protected if a crisis occurs.

A) public choice B) a dverse selection C) strategic choice D) m oral hazard

96) An international lender of last resort creates a serious moral hazard problem because ________

96) ______

and other ________ of banking institutions expect that they will be protected if a crisis occurs.

A) borrowers; debtors B) d epositors; creditors C) depositors; debtors D) b orrowers; creditors

97) Critics of the IMF contend that its lending in the Mexican crisis, which was used to bail out foreign ________, set the stage for the ________ crisis because these ________ expected to be

baileout if d things

went wrong.

____ __

97) A) borrowers; Russian; lenders C) lenders; East Asian; lenders

B) l enders; East Asian; borrowers D) b orrowers; Russian; borrowers

98) Critics of the IMF contend that its lending in the ________ crisis, which was used to bail out

98) ______

foreign lenders, set the stage for the ________ crisis because these lenders expected to be bailed out if things went wrong and thus provided funds that were used to fuel excessive risk taking.

A) Russian; East Asian B) R ussian; Mexican C) Mexican; Russian D) M exican; East Asian

99) An advantage of an international lender of last resort is its ability to prevent ________, in which

99) ______

a successful speculative attack on one currency leads to attacks on others; its disadvantage is the problem of ________ if creditors expect to be protected if a crisis occurs.

A) contagion; adverse selection B) c urrency virus; moral hazard C) contagion; moral hazard D) c urrency virus; adverse selection

100) In the early 1970s, the U.S. ran large balance of payments ________, causing an ________ dollar 100) _____ and an ________ German mark.

A) surpluses; overvalued; undervalued C) surpluses; undervalued; overvalued

B) d eficits; undervalued; overvalued D) d eficits; overvalued; undervalued

101) In response to the overvalued dollar in the early 1970s, the German Bundesbank bought

101) _____

________ and sold ________ to keep the exchange rate fixed, gaining international reserves.

A) dollars; marks B) m arks; pounds C) marks; dollars D) d ollars; pounds

102) In response to the overvalued dollar in the early 1970s, the German Bundesbank bought dollars

102) _____

and sold marks to keep the exchange rate fixed, gaining international reserves. The huge purchase of international reserves meant that the German monetary base began to ________, leading to ________ growth in the German money supply.

A) grow; sluggish B) d ecline; sluggish C) decline; rapid D) g row; rapid

103) The German central bank gained international reserves in the early 1970s because it sold ________ to prevent mark ________.

A) dollars; depreciation C) marks; depreciation

103) _____

B) m arks; appreciation D) d ollars; appreciation

104) Since the abandonment of the Bretton Woods system, balance of payments considerations have

104) _____

become ________ important, and exchange rate considerations ________ important in the conduct of monetary policy.

A) more; more B) l ess; more C) l ess; less D) m ore; less

105) If a central bank does not want to see its currency fall in value, it may pursue ________

105) _____

monetary policy to ________ the domestic interest rate, thereby strengthening its currency.

A) contractionary; lower B) c ontractionary; raise C) expansionary; raise D) e xpansionary; lower

106) If a central bank does not want to see its currency ________ in value, it may pursue contractionary monetary policy to raise the domestic interest rate, thereby ________ its currency.

106) _____

A) fall; strengthening C) rise; weakening

B) r ise; strengthening D) f all; weakening

107) If a central bank does not want to see its currency rise in value, it may pursue ________

107) _____

monetary policy to ________ the domestic interest rate, thereby weakening its currency.

A) contractionary; lower B) e xpansionary; raise C) expansionary; lower D) c ontractionary; raise

108) If a central bank does not want to see its currency ________ in value, it may pursue

108) _____

expansionary monetary policy to lower the domestic interest rate, thereby ________ its currency.

A) fall; strengthening B) f all; weakening C) rise; weakening D) r ise; strengthening

109) If a central bank does not want to allow the domestic currency to appreciate, it will ________

109) _____

international reserves by selling its currency, thereby ________ the monetary base and increasing the risk of higher inflation.

A) lose; decreasing B) a cquire; decreasing C) lose; increasing D) a cquire; increasing

110) If a central bank does not want to allow the domestic currency to depreciate, it will ________

110) _____

international reserves by purchasing its currency, thereby ________ the monetary base and increasing the risk of higher unemployment.

A) acquire; increasing B) a cquire; decreasing C) lose; decreasing D) l ose; increasing

111) A central bank's attempt to prevent an appreciation of its currency can stimulate domestic

111) _____

inflation if the ________ of its currency leads to ________ international reserves which ________ the monetary base.

A) sale; lower; decreases B) p urchase; higher; increases C) purchase; lower; decreases D) s ale; higher; increases

112) A central bank's attempt to prevent an appreciation of its currency can stimulate domestic

112) _____

inflation if the ________ of foreign currencies leads to ________ international reserves which ________ the monetary base.

A) sale; higher; increases B) s ale; lower; decreases C) purchase; higher; increases D) p urchase; lower; decreases

113) A monetary policy strategy that uses a fixed exchange rate regime that ties the value of a

113) _____

currency to the currency of a large, low inflation country is called ________ targeting.

A) monetary B) c urrency C) i nflation D) e xchange-rate

114) Under an exchange-rate targeting rule for monetary policy, a crawling peg A) allows the domestic currency to depreciate at a steady rate so that inflation in the pegging

114) _____

country can be lower than that of the anchor country.

B) fixes the value of the domestic currency to that of a large, low-inflation country.

C) allows the domestic currency to depreciate at a steady rate so that inflation in the pegging country can be higher than that of the anchor country.

D) fixes the value of the domestic currency to a commodity such as gold.

115) An advantage to exchange-rate targeting is it helps keep inflation under control by tying the inflation rate for ________ traded goods to what is found in the ________ country.

115) _____

A) internationally; domestic C) domestically, domestic

B) i nternationally; anchor D) d omestically; anchor

116) Exchange-rate targeting allows a central bank to ________, thus this will ________ the

116) _____

probability of policy developing a time-inconsistency problem.

A) be governed by a policy rule; decrease B) f ollow discretionary policy; increase C) be governed by a policy rule; increase D) f ollow discretionary policy; decrease

117) Which of the following is not an advantage to exchange-rate targeting?

A) It provides a strong nominal anchor to keep inflation under control.

B) It is simple and clear so that the public can easily understand it.

C) It provides an automatic rule for policy to help avoid the time-inconsistency problem.

D) It increases the accountability of policymakers.

117) _____

118) Under exchange-rate targeting, the central bank in the targeting country ________ lose the

118) _____

ability to pursue its own independent monetary policy and any shocks to the anchor country is ________ transmitted to the targeting country.

A) does not; not directly B) d oes; not directly C) does not; directly D) d oes; directly

119) Both France and the United Kingdom successfully used exchange-rate targeting to lower

119) _____

inflation in the late 1980s and early 1990s by tying the value of their currencies to the A) German mark.

B) S wiss franc.

C) E uro.

D) U .S. dollar.

120) Which of the following is not a disadvantage of exchange-rate targeting?

A) The targeting country gives up an independent monetary policy.

B) It can weaken the accountability of policymakers.

C) It relies on a stable money-inflation relationship.

D) The targeting country is left open for a speculative attack.

120) _____

121) Two reasons for industrialized countries to adopt an exchange-rate targeting regime are if the

121) _____

country ________ conduct successful monetary policy on their own, and if the country wants to ________ integration of the domestic economy with its neighbors.

A) can; encourage B) c an; discourage C) cannot; discourage D) c annot; encourage

122) An emerging market country that successfully used exchange-rate targeting to lower its

122) _____

inflation from above 100 percent in 1988 to below 10 percent in 1994 (before devaluation) was A) Philippines.

B) T hailand.

C) I ndonesia.

D) M exico.

123) Because many emerging market countries have not developed the political or monetary

123) _____

institutions that allow the successful use of discretionary monetary policy, A) they have little to gain from using a nominal anchor, because it would mean a monetary policy that is overly expansionary.

B) they have little to gain from pegging their exchange rate to an anchor country like the U.S. or Germany.

C) they would be better off giving their central bankers the independence to use discretion, rather than take their discretion away through any nominal anchor.

D) they have very little to gain from an independent monetary policy, but a lot to lose.

124) Emerging market countries are in effect between a rock and a hard place because A)

124) _____

by adopting the of the anchor country through an exchange rate peg, these countries allow for too little monetary policy monetary expansion and thereby sacrifice economic growth for price stability.

B) t o avoid speculative attacks on their currencies they must peg their exchange rates to an anchor country, but this means giving central bankers in these countries too little discretion.

C) t o avoid speculative attacks on their currencies they must peg their exchange rates to an anchor country, but this means giving central bankers in these countries too much discretion.

D) t hey would be wise to adopt the monetary policy of the United States by pegging their currencies to the dollar, but this policy leaves them open to speculative attacks.

125) _____ 125) W hen a domestic currency is completely backed by a foreign currency and the note-issuing authority establishes a fixed exchange rate to this foreign currency, then the country is said to have

A) a dopted an exchange rate monetary system.

B) c reated a currency board.

C) u ndergone dollarization.

D) a dopted a managed exchange system.

126)as_____ 126) W hen a country forgoes its own currency and starts using another country's currency its own, we say that this country has

A) a dopted an exchange rate monetary system.

B) a dopted a managed exchange system.

C) c reated a currency board.

D) u ndergone dollarization.

127) T he revenue a government gains from issuing money is A) t he inflation tax.

B) i nterest.

C) r ent.

D) s eignorage.

E) t he national dividend.

127) _____

128) _____ 128) A country that dollarizes A) e arns the same amount of seignorage as it would with exchange-rate targeting.

B) e arns the same amount of seignorage as it would with a currency board.

C) m aximizes its seignorage.

D) m ust pay seignorage to other governments to use their currency.

E) e liminates its seignorage.

129) T he seignorage for a government is greater for ________ than for ________.

A) d ollarization; a currency board B) d ollarization; monetary targeting C) d ollarization; exchange-rate targeting D) d ollarization; inflation targeting E) e xchange-rate targeting; dollarization

129) _____

130) E xchange-rate targeting is not an option for the United States because A) t he United States is too large.

B) t he Fed has adopted an inflation targeting strategy.

C) t he Fed has adopted a monetary targeting strategy.

D) t he United States is already dollarized.

130) _____

131) The monetary policy strategy that provides an automatic rule for the conduct of monetary policy is A) inflation targeting.

C) the implicit nominal anchor.

B) e xchange-rate targeting.

D) m onetary targeting.

132) The monetary policy strategy that does not allow the policy to focus on domestic considerations is

A) the implicit nominal anchor.

C) inflation targeting.

131) _____

132) _____

B) e xchange-rate targeting.

D) m onetary targeting.

133) The monetary policy strategy that results in the loss of an independent monetary policy is A) monetary targeting.

B) t he implicit nominal anchor.

C) inflation targeting.

D) e xchange-rate targeting.

133) _____

134) The monetary policy strategy that directly ties down the price of internationally traded goods is A) exchange-rate targeting.

B) t he implicit nominal anchor.

C) inflation targeting.

D) m onetary targeting.

134) _____

ESSAY. Write your answer in the space provided or on a separate sheet of paper.

135) Explain an additional disadvantage for a country undergoing dollarization compared to a currency board or other exchange-rate targeting regimes.

136) Explain the 1992 crisis that led to the breakdown of the European Union's Exchange Rate Mechanism. What disadvantages of exchange-rate targeting were exhibited during this crisis?

1) C 2) A 3) C 4) B 5) D 6) D 7) C 8) A 9) B 10) D 11) A 12) A 13) D 14) D 15) A 16) D 17) See figure below.

A purchase of foreign assets increases the monetary base and money supply, increasing the price level and decreasing the expected appreciation of the domestic currency. In the short run, this decreased expected appreciation of the domestic currency along with the lower domestic interest rate will decrease the relative expected return on domestic assets causing the domestic currency to depreciate. Over the long run, as the domestic interest rate starts to increase, the domestic currency will start to appreciate, but (assuming money neutrality) will still be at a lower value compared to the starting value.

18) A 19) C 20) D 21) B 22) B 23) C 24) C 25) A 26) B 27) A 28) B 29) A 30)

32) C 33) A 34) A 35) D 36) C 37) D 38) B 39) D 40) C 41) D 42) C 43) D 44) C 45) C 46) D 47) C 48) A 49) C 50) B 51) A 52) B 53) A 54) A 55) B 56) B 57) C 58) C 59) C 60) A 61) D 62) B 63) A 64) C 65) C 66) D 67) B 68) A 69) D

83) A 84) C 85) B 86) B 87) See B the figure below.

88)

The par value is above the equilibrium value, resulting in overvaluation of the exchange rate. One approach is to pursue contractionary monetary policies, raising interest rates and increasing the demand for domestic assets. This process continues until equilibrium at par value is restored. Another alternative is for the central bank to purchase domestic currency by selling foreign assets.

89) When the speculative attack begins, the expected depreciation of the domestic currency increases substantially, decreasing the demand for domestic assets. Contrationary monetary policy is needed to increase domestic interest rates enough to defend the currency. The cost to the central bank in terms of the costs of intervention and the contractionary effect on the economy may make devaluation preferable.

90) B 91) D 92) A 93) C 94) D 95) D 96) B 97) C 98) D 99) C 100) D 101) A 102) D 103) B 104) B 105) B 106) A 107) C 108) C 109) D 110) C 111) D 112) C

113) D 114) C 115) B 116) A 117) D 118) D 119) A 120) C 121) D 122) D 123) D 124) D 125) B 126) C 127) D 135) The additional disadvantage to dollarization is that the government loses seignorage. Seignorage is the income 128) E 129) that E a government earns by issuing its own currency.

136) The 1992 crisis began with Germany raising interest rates in 1990 to stem inflationary pressures from reunification.

130) A 131) This B demand shock was immediately transmitted to the other nations in the exchange-rate mechanism. Thus, these countries did not have independent monetary policies and were subject to shocks from the anchor country. This 132) B gave rise to the second problem. Speculators bet that these other countries would not want the increased 133) D unemployment resulting from the tight monetary policy. Betting that their commitment was weak, speculators bet these currencies, and a number were forced to devalue or drop out of the ERM. The disadvantages 134) against A illustrated by this are the lack of independent policy subjecting member nations to shocks from the anchor nation, and the possibility of speculative attacks when commitment is felt to be weak.

Exam Name___________________________________ MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question.

1) The quantity theory of money is a theory of how A) the real value of aggregate income is determined.

B) the nominal value of aggregate income is determined.

C) the money supply is determined.

D) interest rates are determined.

1) _______

2) Because the quantity theory of money tells us how much money is held for a given amount of

2) _______

aggregate income, it is also a theory of A) exchange-rate determination.

C) interest-rate determination.

B) t he demand for assets.

D) t he demand for money.

3) The average number of times that a dollar is spent in buying the total amount of final goods

3) _______

and services produced during a given time period is known as A) the spending multiplier.

B) g ross national product.

C) the money multiplier.

D) v elocity.

4) The velocity of money is A) the average number of times that a dollar is spent in buying the total amount of final

4) _______

goods and services.

B) the average number of times a dollar is spent in buying financial assets.

C) the ratio of the money stock to high-powered money.

D) the ratio of the money stock to interest rates.

5) If the money supply is $500 and nominal income is $3,000, the velocity of money is A) 1/60.

C) 6 .

B) 1 /6.

D) 6 0.

5) _______

6) If the money supply is $600 and nominal income is $3,000, the velocity of money is A) 1/50.

C) 5 .

B) 1 /5.

D) 5 0.

6) _______

7) If the money supply is $500 and nominal income is $4,000, the velocity of money is A) 1/20.

C) 8 .

B) 1 /8.

D) 2 0.

7) _______

8) If the money supply is $600 and nominal income is $3,600, the velocity of money is A) 1/60.

C) 6 .

B) 1 /6.

D) 6 0.

8) _______

9) If nominal GDP is $10 trillion, and the money supply is $2 trillion, velocity is A) 0.2.

B) 5 .

C) 1 0.

D) 2 0.

9) _______

10) If nominal GDP is $8 trillion, and the money supply is $2 trillion, velocity is A) 0.25.

B) 4 .

C) 8 .

10) ______

11) If nominal GDP is $10 trillion, and velocity is 10, the money supply is A) $1 trillion.

B) $ 5 trillion.

C) $ 10 trillion.

12) If the money supply is $2 trillion and velocity is 5, then nominal GDP is A) $1 trillion.

B) $ 2 trillion.

C) $ 5 trillion.

D) 1 6.

D) $ 100 trillion.

D) $ 10 trillion.

11) ______ 12) ______

13) If the money supply is $20 trillion and velocity is 2, then nominal GDP is A) $2 trillion.

B) $ 10 trillion.

C) $ 20 trillion.

14) Velocity is defined as A) P + M + Y.

B) ( P × Y)/M.

C) ( Y × M)/P.

D) $ 40 trillion.

D) ( P × M)/Y.

13) ______ 14) ______

15) The velocity of money is defined as A) real GDP divided by the money supply.

B) real GDP times the money supply.

C) nominal GDP times the money supply.

D) nominal GDP divided by the money supply.

15) ______

16) The equation of exchange states that the quantity of money multiplied by the number of times

16) ______

this money is spent in a given year must equal A) real income.

C) velocity.

B) r eal gross national product.

D) n ominal income.

17) In the equation of exchange, the concept that provides the link between M and PY is called A) aggregate supply.

B) t he money multiplier.

C) the velocity of money.

D) a ggregate demand.

17) ______

18) The equation of exchange is A) M + Y = V + P. B) M × P = V × Y.

18) ______

C) M × V = P ×Y.

D) M + V = P + Y.

19) Irving Fisher took the view that the institutional features of the economy which affect velocity change _____ over time so that velocity will be fairly _____ in the short run.

A) slowly; erratic B) s lowly; stable C) r apidly; stable

19) ______

D) r apidly; erratic

20) In Irving Fisher's quantity theory of money, velocity was determined by A) interest rates.

B) the price level.

C) the institutions in an economy that affect individuals' transactions.

D) real GDP.

20) ______

21) The classical economists' conclusion that nominal income is determined by movements in the

21) ______

money supply rested on their belief that _____ could be treated as _____ in the short run.

A) money; variable B) v elocity; constant C) money; constant D) v elocity; variable

22) The view that velocity is constant in the short run transforms the equation of exchange into the

22) ______

quantity theory of money. According to the quantity theory of money, when the money supply doubles A) nominal incomes falls by 50 percent.

B) v elocity doubles.

C) nominal income doubles.

D) v elocity falls by 50 percent.

23) Cutting the money supply by one-third is predicted by the quantity theory of money to cause A) a decline in output by one-sixth, and a decline in the price level of one-sixth.

B) a decline in real output by one-third.

C) a decline in the price level by one-third.

D) a sharp decline in real output of one-third in the short run, and a fall in the price level by

23) ______

one-third in the long run.

24) T he classical economists believed that if the quantity of money doubled, A) o utput would double.

B) p rices would remain constant.

C) p rices would double.

D) p rices would fall.

24) ______

25) ______ 25) T he classical economists' contention that prices double when the money supply doubles is predicated on the belief that in the short run velocity is _____ and real GDP is _____.

A) v ariable; variable C) c onstant; variable

B) c onstant; constant D) v ariable; constant

26) 26) F or the classical economists, the quantity theory of money provided an explanation of ______ movements in the price level. Movements in the price level result

A) o nly partially from changes in the quantity of money.

B) f rom changes in factors other than the quantity of money.

C) p rimarily from changes in the quantity of money.

D) s olely from changes in the quantity of money.

27) I f initially the money supply is $1 trillion, velocity is 5, the price level is 1, and real 27) GDP______ is $5 trillion, an increase in the money supply to $2 trillion

A) i ncreases real GDP to $10 trillion.

B) c auses velocity to fall to 2.5.

C) i ncreases the price level to 2 and velocity to 10.

D) i ncreases the price level to 2.

28) I f initially the money supply is $2 trillion, velocity is 5, the price level is 2, and real 28) GDP______ is $5 trillion, a fall in the money supply to $1 trillion

A) d ecreases the price level to 1.

B) r educes real GDP to $2.5 trillion.

C) d ecreases the price level to 1 and decreases velocity to 2.5.

D) c auses velocity to rise to 10.

29) A ccording to the quantity theory of money demand, A) a n increase in money will cause the demand for money to fall.

B) i nterest rates have no effect on the demand for money.

C) a decrease in interest rates will cause the demand for money to increase.

D) a n increase in interest rates will cause the demand for money to fall.

29) ______

______ 30) F isher's quantity theory of money suggests that the demand for money is purely a 30) function of _____ , and _____ no effect on the demand for money.

A) g overnment spending; interest rates have B) e xpectations; income has C) i ncome; interest rates have D) i nterest rates; income has

31) ______ 31) _ ____ quantity theory of money suggests that the demand for money is purely a function of income, and interest rates have no effect on the demand for money.

A) T obin's

B) F riedman's

C) K eynes's

D) F isher's

32) ______ 32) I rving Fisher's view that velocity is fairly constant in the short run transforms the equation of exchange into the

A) F riedman's theory of income determination.

B) monetary theory of income determination.

C) quantity theory of money.

D) Keynesian theory of income determination.

33) The empirical evidence regarding the velocity of money indicates that velocity tends to be

33) ______

_____; that is, velocity _____ when economic activity contracts.

A) countercyclical; increases B) p rocyclical; increases C) procyclical; declines D) c ountercyclical; declines

34) Evidence since 1915 indicates that velocity has A) fluctuated too much in the short run to be viewed as a constant.

B) grown at a fairly constant rate, even in the short run.

C) trended downward since 1950 due to technological and financial innovations.

D) remained fairly constant in the short run, but tends to slowly increase.

34) ______

35) In the 20th century, velocity A) has been quite volatile.

B) has been quite stable over periods as long as a decade.

C) has grown at a constant rate.

D) has been quite stable over short, two year periods.

35) ______

36) Velocity, over the business cycle, tends to A) fall during economic expansions.

C) stay constant.

36) ______

B) f all during economic contractions.

D) r ise during economic contractions.

37) Until the Great Depression, economists did not recognize that velocity A) fails to decline during economic contractions.

B) increases during severe economic contractions.

C) declines during rapid economic expansions, since money growth fails to keep pace.

D) declines during severe economic contractions.

37) ______

38) The Keynesian theory of money demand emphasizes the importance of A) interest rates on the demand for money.

B) irrational behavior on the part of some economic agents.

C) a constant velocity.

D) expectations.

38) ______

39) Keynes hypothesized that the transactions component of money demand was primarily

39) ______

determined by the level of A) stock market prices.

C) interest rates.

B) v elocity.

D) i ncome.

40) Keynes argued that the transactions component of the demand for money was primarily

40) ______

determined by the level of people's _____, which he believed were proportional to _____.

A) transactions; age B) i ncomes; wealth C) incomes; age D) t ransactions; income

41) Keynes hypothesized that the precautionary component of money demand was primarily determined by the level of A) stock market prices.

C) interest rates.

B) v elocity.

D) i ncome.

41) ______

42) Keynes argued that the precautionary component of the demand for money was primarily

42) ______

43) The demand for money as a cushion against unexpected contingencies is called the A) speculative motive.

B) p recautionary motive.

C) transactions motive.

D) i nsurance motive.

43) ______

44) Keynes hypothesized that the speculative component of money demand was primarily

44) ______

determined by the level of people's _____, which he believed were proportional to _____.

A) incomes; age B) t ransactions; age C) incomes; wealth D) t ransactions; income

determined by the level of A) stock market prices.

C) income.

B) v elocity.

D) i nterest rates.

45) The speculative motive for holding money is closely tied to what function of money?

A) Medium of exchange.

B) U nit of account.

C) Store of wealth.

D) S tandard of deferred payment.

45) ______

46) Of the three motives for holding money suggested by Keynes, which did he believe to be the

46) ______

most sensitive to interest rates?

A) The altruistic motive.

C) The speculative motive.

B) T he transactions motive.

D) T he precautionary motive.

47) Because Keynes assumed that the expected return on money was zero, he argued that people

47) ______

would A) hold money as a store of wealth only when forced to by government policy.

B) hold money as a store of wealth when the expected return on bonds was negative.

C) never hold money.

D) never hold money as a store of wealth.

48) The Keynesian theory of money demand predicts that people will increase their money holdings if they believe that A) bond prices are about to fall.

C) bond prices are about to rise.

B) e xpected inflation is about to fall.

D) i nterest rates are about to fall.

49) If people expect nominal interest rates to be higher in the future, the expected return to bonds _____, and the demand for money _____.

A) rises; decreases C) falls; decreases

49) ______

B) r ises; increases D) f alls; increases

50) If people expect nominal interest rates to be lower in the future, the expected return to bonds _____, and the demand for money _____.

A) decreases; decreases C) decreases; increases

48) ______

50) ______

B) i ncreases; decreases D) i ncreases; increases

51) Keynes argued that when interest rates were low relative to some normal value, people would

51) ______

expect bond prices to _____ so the quantity of money demanded would _____.

A) increase; increase B) d ecrease; increase C) decrease; decrease D) i ncrease; decrease

52) Keynes argued that when interest rates were high relative to some normal value, people would

expect

52) bond prices to _____ , so the quantity of money demande d would _____.

A) increase; increase C) decrease; decrease

____ __

B) d ecrease; increase D) i ncrease; decrease

53) ______ 53) According to Keynes's theory of liquidity preference, velocity increases when A) wealth increases.

B) b rokerage commissions increase.

C) income increases.

D) i nterest rates increase.

54) Keynes's theory of the demand for money implies that velocity is A) not constant but fluctuates with movements in the price level.

B) not constant but fluctuates with movements in interest rates.

C) a constant.

D) not constant but fluctuates with movements in the time of year.

54) ______

55) Because interest rates have substantial fluctuations, the _____ theory of the demand for money

55) ______

indicates that velocity has substantial fluctuations as well.

A) Pigouvian B) l iquidity preference C) Cambridge D) c lassical

56) Keynes's liquidity preference theory indicates that the demand for money A) is a function of both income and interest rates.

B) is purely a function of interest rates, and income has no effect on the demand for money.

C) is a function of both government spending and income.

D) is purely a function of income, and interest rates have no effect on the demand for money.

56) ______

57) ______ 57) Keynes's theory of the demand for money is consistent with A) a relatively stable velocity.

B) c ountercyclical movements in velocity.

C) a constant velocity.

D) p rocyclical movements in velocity.

58) Keynes's theory of the demand for money is consistent with _____ movements in _____.

A) countercyclical; velocity B) p rocyclical; expectations C) countercyclical; expectations D) p rocyclical; velocity

58) ______

59) Keynes's model of the demand for money suggests that velocity is A) negatively related to interest rates.

B) c onstant.

C) positively related to interest rates.

D) p ositively related to bond values.

59) ______

60) ______ 60) Keynes's liquidity preference theory indicates that the demand for money is A) negatively related to bond values.

B) n egatively related to interest rates.

C) constant.

D) p ositively related to interest rates.

61) Keynes's model of the demand for money suggests that velocity is _____ related to _____.

A) positively; stock prices B) n egatively; interest rates

61) ______

C) positively; interest rates

D) p ositively; bond values

62) Keynes's liquidity preference theory indicates that the demand for money is _____ related to _____.

A) positively; interest rates C) negatively; interest rates

62) ______

B) n egatively; income D) n egatively; wealth

63) The Keynesian demand for real balances can be expressed as A) Md = f(i,Y).

B) M d/P = f(i,Y).

C) M d/P = f(i).

D) M d/P = f(Y).

63) ______

ESSAY. Write your answer in the space provided or on a separate sheet of paper.

64) Explain the Keynesian theory of money demand. What motives did Keynes think determined money

demand? What are the two reasons why Keynes thought velocity could not be treated as a constant?

MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question.

65) The Baumol-Tobin analysis suggests that 65) ______ A) the transactions component of the demand for money is negatively related to the level of interest rates.

B) velocity is relatively constant.

C) the speculative motive is nonexistent.

D) velocity is unrelated to the transactions motive.

66) The Baumol-Tobin analysis suggests that an increase in the brokerage fee for buying and selling

66) ______

bonds will cause the demand for money to ________ and the demand for bonds to ________.

A) decrease; decrease B) i ncrease; increase C) decrease; increase D) i ncrease; decrease

67) The Baumol-Tobin analysis suggests that a decrease in the brokerage fee for buying and selling

67) ______

bonds will cause the demand for money to _____ and the demand for bonds to _____.

A) increase; increase B) i ncrease; decrease C) decrease; increase D) d ecrease; decrease

68) In the Baumol-Tobin analysis of transactions demand for money, either an increase in _____ or a decrease in _____ increases money demand.

A) income; interest rate C) interest rate; income

B) i nterest rates; brokerage fees D) b rokerage fees; income

69) In the Baumol-Tobin analysis of the demand for money, either an increase in _____ or an increase in _____ increases money demand.

A) income; interest rates C) brokerage fees; income

68) ______

69) ______

B) b rokerage fees; interest rates D) i nterest rates; the price level

70) In the Baumol-Tobin analysis of transactions demand, scale economies imply that an increase in real income increases the quantity of money demanded ______, while an increase in the price level increases the quantity of money demanded ______.

A) more than proportionately; proportionately B) less than proportionately; proportionately C) proportionately; less than proportionately D) proportionately; more than proportionately

70) ______

71) Tobin's model of the speculative demand for money improves on Keynes's analysis by showing

71) ______

that

A) the speculative demand for money is interest insensitive.

B) people will hold money or bonds but not both.

C) people will hold a diversified portfolio.

D) the transactions demand for money is interest insensitive.

72) Tobin's model of the speculative demand for money shows that people hold money as a store of wealth as a way of A) reducing income.

C) reducing transactions cost.

B) r educing risk.

D) a voiding taxes.

73) Tobin's model of the speculative demand for money shows that people hold money as a _____ as a way of reducing _____.

A) store of wealth; risk C) store of wealth; transaction costs

73) ______

B) m edium of exchange; transaction costs D) m edium of exchange; risk

74) Tobin's model of the speculative demand for money shows that people can reduce their ____ by _____ their asset holdings.

A) risk; diversifying C) risk; specializing

72) ______

74) ______

B) r eturn; diversifying D) w ealth; diversifying

75) Because Treasury bills pay a higher return than money and have no risk A) the precautionary demand for money may be zero.

B) the speculative demand for money may be zero.

C) the transactions demand for money may be zero.

D) all three of the above motives for holding money will be zero.

75) ______

76) The speculative demand for money may not exist because A) there are alternative riskless assets paying higher returns than the return on money.

B) government regulations have eliminated risk in the financial markets.

C) the transactions demand can be shown to depend on interest rates.

D) banks now pay interest on some types of checkable deposits.

76) ______

ESSAY. Write your answer in the space provided or on a separate sheet of paper.

77) What factors determine the demand for money in the Baumol-Tobin analysis of transactions demand for money? How does a change in each factor affect the quantity of money demanded?

MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question.

78) Friedman's argument that competition among banks will tend to keep the difference between 78) ______ the return on bonds and money relatively constant implies that changes in _____ will have _____ on the demand for money.

A) income; little effect B) i nterest rates; a big impact C) interest rates; little effect D) i ncome; a big impact

79) Since the elimination of interest rate ceilings on deposits, the implicit interest rate on money more closely approaches bond interest rates. This suggests that changes in interest rates will A) have a larger impact on money demand.

B) have a smaller impact on money demand.

C) no longer affect the transactions demand for money.

D) no longer affect the speculative demand for money.

79) ______

80) According to Milton Friedman, the demand for money is insensitive to interest rates because A) people base their investment decisions on expected profits, not interest rates.

B) transactions are not subject to scale economies as wealth increases.

C) the demand for money is insensitive to changes in the opportunity cost of holding

80) ______

money.

D) competition among banks keeps the opportunity cost of holding money relatively constant.

81) In Friedman's modern quantity theory, velocity depends upon the ratio of A) actual to permanent income.

B) p rices to interest rates.

C) interest rates to actual income.

D) m oney to prices.

81) ______

82) In Friedman's modern quantity theory, velocity is procyclical because A) money demand depends on actual income, which is more stable than permanent income.

B) velocity depends upon interest rates, which move procyclically.

C) money demand depends on permanent income, which is more stable than actual income.

D) velocity depends upon interest rates, which are stable over the business cycle.

82) ______

83) In Friedman's modern quantity theory, the implied formula for velocity is A) B) V = Md/f(i).

C) V = Y/f(i).

V = f( )/Y.

83) ______

D) V = Y/f( ).

84) According to Milton Friedman, income declines relative to permanent income during a

84) ______

business cycle contraction, causing the demand for money relative to actual income to increase, thereby causing velocity to A) decline.

B) rise.

C) decline, provided that interest rates increase when the economy contracts.

D) remain unchanged, since velocity depends only on interest rates.

ESSAY. Write your answer in the space provided or on a separate sheet of paper.

85) What factors determine money demand in Friedman's modern quantity theory? How does each affect money demand? What determines velocity in Friedman's theory? What effect do interest rates have on velocity?

MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question.

86) According to Milton Friedman, income rises relative to permanent income during a business 86) ______ cycle expansion, causing the demand for money relative to actual income to decrease, thereby causing velocity to A) remain unchanged, since velocity depends only on interest rates.

B) rise.

C) decline.

D) decline, provided that interest rates increase when the economy contracts.

87) A central question in monetary theory is whether or to what extent the quantity of money demanded is affected by changes in A) income.

B) i nflation.

C) i nterest rates.

87) ______

D) t he price level.

88) If interest rates do not affect the demand for money, then velocity is _____ likely to be _____.

A) more; procyclical B) m ore; unstable

88) ______

C) less; stable

D) more; stable

TRUE/FALSE. Write 'T' if the statement is true and 'F' if the statement is false.

89) True or False: The more sensitive is the demand for money to interest rates, the more

89) ______

unpredictable velocity will be.

MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question.

90) The more sensitive is the demand for money to interest rates, the _____ unpredictable velocity 90) ______ will be, and the link between the money supply and aggregate spending will be _____ clear.

A) more; less B) m ore; more C) l ess; less D) l ess; more

91) The evidence on the interest sensitivity of the demand for money suggests that the demand for

91) ______

money is ________ to interest rates, and there is ________ evidence that a liquidity trap exists.

A) sensitive; little B) i nsensitive; little C) insensitive; substantial D) s ensitive; substantial

92) In the liquidity trap a small change in interest rates produces ________ change in the quantity of money demanded.

A) no C) a small

92) ______

B) a very large D) a proportionate

93) In a liquidity trap, monetary policy has ________ effect on aggregate spending because a change in the money supply has ________ effect on interest rates.

A) a large; a large B) n o; a small C) n o; a large

93) ______

D) n o; no

94) In the liquidity trap, monetary policy A) has a small impact on interest rates.

B) has a large impact on interest rates.

C) has no impact on interest rates.

D) has a proportionate impact on interest rates.

94) ______

95) In the liquidity trap, the money demand curve A) is negatively sloped.

C) is vertical.

95) ______

B) i s horizontal.

D) i s positively sloped.

96) The reason that economists are so interested in the stability of velocity is because if the demand

96) ______

for money is not stable, then steady growth of the money supply A) is going to promote price stability at the expense of low unemployment.

B) can still be used to conduct monetary policy if the goal is price stability.

C) is an ineffective way to conduct monetary policy.

D) is going to promote low unemployment at the expense of price stability.

ESSAY. Write your answer in the space provided or on a separate sheet of paper.

97) Describe what the liquidity trap is. Explain how it can be problematic for monetary policymakers.

MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question.

98) ______ 98) The absence of money illusion means that A) as interest rates double, the demand for money doubles.

B) as the price level doubles, the demand for money doubles.

C) as real income doubles, the demand for money doubles.

D) as the money supply doubles, the demand for money doubles.

99) If there are economies of scale in the transactions demand for money, as income increases, money demand A) does not change.

C) increases proportionately.

99) ______

B) i ncreases less than proportionately.

D) i ncreases more than proportionately.

100) Comparing Tobin's model of the speculative demand for money with Keynesian speculative

100) _____

demand A) both models imply that individuals diversify their asset holdings.

B) the Tobin model implies individuals diversify their asset holdings, while the Keynesian model predicts that individuals hold only money or only bonds.

C) both models imply that individuals hold only money or only bonds.

D) the Keynesian model implies individuals diversify their asset holdings, while the Tobin model predicts that individuals hold only money or only bonds.

ESSAY. Write your answer in the space provided or on a separate sheet of paper.

101) In the Baumol-Tobin model, given that total costs for an individual equals + , where = monthly income, b = brokerage costs, and C = amount raised from each bond transaction, derive the so-called square root rule.

MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question.

102) _____ 102) In one of the earliest studies on the link between interest rates and money demand using United States data, James Tobin concluded that the demand for money is A) not sensitive to changes in income.

B) n ot sensitive to changes in bond values.

C) not sensitive to interest rates.

D) s ensitive to interest rates.

103) Starting in 1974, the conventional M1 money demand function began to A) severely overpredict the demand for money.

B) predict more precisely the demand for money.

C) severely underpredict the demand for money.

D) do none of the above.

103) _____

104) Starting in 1974, the conventional M1 money demand function began to severely ________ the

104) _____

demand for money. Stephen Goldfeld labeled this phenomenon "the case of the missing ________."

A) underpredict; velocity B) u nderpredict; money C) overpredict; money D) o verpredict; velocity

105) Conventional money demand functions tended to ________ money demand in the middle and

105) _____

late 1970s, and ________ velocity beginning in 1982.

A) underpredict; underpredict B) u nderpredict; overpredict C) overpredict; underpredict D) o verpredict; overpredict

106) Researchers at the Federal Reserve found that M2 money demand functions performed ________ in the 1980s, with M2 velocity moving ________ with the opportunity cost of holding M2.

A) p oorly; closely

B) w ell; closely

106) _____

C) well; erratically

D) p oorly; erratically

107) In the early 1990s, M2 growth underwent a dramatic ________, which some researchers believe 107) _____ ________ be explained by traditional money demand functions.

A) surge; cannot B) s urge; can C) slowdown; can D) s lowdown; cannot

108) In the late 1990s, M2 velocity ________, suggesting a ________ normal relationship between M2 108) _____ and macroeconomic variables.

A) stabilized; more C) slowed; less

B) s lowed; more D) s tabilized; less

1) B 2) D 3) D 4) A 5) C 6) C 7) C 8) C 9) B 10) B 11) A 12) D 13) D 14) B 15) D 16) D 17) C 18) C 19) B 20) C 21) B 22) C 23) C 24) C 25) B 26) D 27) D 28) A 29) B 30) C 31) D 32) C 33) C 34) A 35) A 36) B 37) D 38) A 39) D 40) D 41) D 42) D 43) B 44) D 45) C 46) C 47) B 48) A 49) D 50) B

51) B 52) D 53) D 54) B 55) B 56) A 57) D 58) D 59) C 64) Keynes believed the demand for money depended on income and interest rates. Money was held to facilitate 60) B normal transactions and as a precaution for unexpected transactions. For both of these motives, money demand 61) C depended on income. People also held money as an asset, for speculative purposes. The speculative motive 62) C depends on income and interest rates. People hold more money for speculative purposes when they expect bond 63) B

prices to fall, generating a negative return on bonds. Since money demand varies with interest rates, velocity changes when interest rates change. Also, since money demand depends upon expectations about future interest rates, unstable expectations can make money demand, and thus velocity, unstable.

65) A 66) D 67) C 68) A 69) C 70) B 71) C 72) B 73) A 77) The factors are real income, the price level, interest rates, and the brokerage cost of shifting between money and 74) bonds. Increases in real income increase money demand less than proportionately, since the model predicts scale A economies in transactions demand. Increases in prices increase money demand proportionately, since the demand 75) is Bfor real balances. The quantity of money demanded varies inversely with interest rates, since interest is the 76) opportunity cost of holding money. The brokerage fee is the cost of converting other assets (bonds) into money.

A An increase in this cost increases money demand.

78) C 79) B 80) D 81) A 82) C 83) In Friedman's theory, increases in permanent income increase money demand. Increases in the returns on bonds 85) D relative to money and the returns on equities relative to money decrease money demand. Increases in the returns 84) on goods relative to the return on money, which is the expected rate of inflation relative to the return on money, A decrease money demand. Velocity is determined by the ratio of actual to permanent income. As actual income increases in an expansion, permanent income increases less rapidly, so money demand increases less rapidly than income, and velocity rises (and vice versa for contractions). Interest rates do not affect velocity in Friedman's theory, since the relative returns on money and other assets are predicted to remain relatively constant.

86) B 87) C 88) D 89) T RUE 90) A 91) A 92) B 93) D 94) C 95) B 96) C

97) The liquidity trap describes the situation in which the demand for money is ultrasensitive to changes in interest rates (i.e., the money demand curve is infinitely elastic). In this case, monetary policy has no direct effect on aggregate spending because a change in the money supply will not effect interest rates.

98) B 99) B 100) B 101) An individual will minimize their costs. Thus, the optimal level of C is found as follows:

COSTS =

+ =

+

=0

= Since money demand is the average desired holdings of cash balances, C/2:

= = The last expression is the square root rule.

102) D 103) A 104) C 105) D 106) B 107) D 108) A

Exam Name___________________________________ MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question.

1) His analysis started with the recognition that the total quantity demanded of an economy's

1) _______

output was the sum of four types of spending: consumer expenditure, planned investment spending, government spending, and net exports.

A) Milton Friedman B) S ir John Hicks C) Paul A. Samuelson D) J ohn Maynard Keynes

2) Keynes's motivation in developing the aggregate output determination model stemmed from

2) _______

his concern with explaining A) the high unemployment in Great Britain after World War II. B) the high unemployment in Great Britain before World War I. C) why the Great Depression occurred.

D) the hyperinflations of the 1920s.

3) Keynes was especially interested in explaining movements of ________ because he wanted to

3) _______

explain why the Great Depression had occurred and how government policy could be used to increase ________ in a similar economic situation.

A) aggregate output; wages B) w age rates; wages C) aggregate output; employment D) w age rates; employment

4) Keynes was especially concerned with explaining the A) low levels of output and employment during the Great Depression.

B) high unemployment in Great Britain during the 1920s.

C) strong economic growth of the 1920s.

D) recession of 1920-21.

4) _______

5) Keynes was especially concerned with explaining the ________ level of output and employment

5) _______

during the ________.

A) high; 1920s

B) l ow; 1930s

C) l ow; 1920s

D) h igh; 1930s

6) In the simple Keynesian model, equilibrium aggregate output is determined by A) aggregate supply.

B) a ggregate demand.

C) the price level D) t he national demand for labor.

6) _______

7) Keynes argued that the sum of the components that comprise aggregate demand A) could add up to an output smaller than the economy is capable of producing, thus

7) _______

resulting in less than full employment.

B) always equaled the output the economy is capable of producing.

C) could add up to an output greater than the economy is capable of producing, thus resulting in less than full employment.

D) equaled the output the economy is capable of producing by definition.

8) In the simple Keynesian model of aggregate output determination, an equilibrium level of output below that necessary to maintain full employment can be explained by A) minimum wage laws.

B) relatively low aggregate demand.

C) relatively high prices.

D) a generous level of unemployment benefits.

8) _______

9) Under Keynesian analysis, aggregate demand can be written as B) A) C)

= C + I + G - NX = C - I - G - NX

D)

= C + I + G + NX = C + I - G - NX

10) The simple Keynesian model illustrates the idea that the economy can come to rest at a level of aggregate output A) only when wages are stable.

C) only at the full employment level.

9) _______

10) ______

B) b elow the full employment level.

D) o nly when the price level is fixed.

11) Keynes believed that an economy could attain an equilibrium level of output A) only at the full-employment level of output.

B) only if the government took a "hands off" approach.

C) only if prices were falling.

D) below the full-employment level of output.

11) ______

12) Which of the following statements concerning Keynesian analysis is false?

A) Keynes's analysis started with the recognition that the total quantity demanded of an

12) ______

economy's output was the sum of four types of spending: consumer expenditure, planned investment spending, government spending, and net exports.

B) K eynes's analysis explains how the price level will change when the total quantity of output supplied changes.

C) K eynes's analysis involves explaining why aggregate output is at a certain level by understanding what factors affect each component of aggregate demand and how the sum of these components could add up to an output smaller than the economy is capable of producing, resulting in less than full employment.

D) Keynes recognized that equilibrium would occur in the economy when total quantity of output supplied equals quantity of output demanded (Yad), that is, when Y = Yad.

13) Which of the following statements concerning Keynesian analysis are true?

A) Keynes recognized that equilibrium would occur in the economy when total quantity of

13) ______

output supplied (aggregate output produced) equals quantity of output demanded (Yad), that is, when

B) K eynes's analysis explains how the price level will change when the total quantity of output supplied changes.

C) K eynes's analysis started with the recognition that the total quantity demanded of an economy's output was the sum of four types of spending: consumer expenditure, planned investment spending, federal government spending, and state and local government spending.

D) K eynes's analysis involves explaining why wage rates are at a certain level by understanding what factors affect labor demand and why this could cause output to be greater than the economy is capable of producing, resulting in high inflation.

14) Because inflation was not a serious problem during the Great Depression, Keynes's analysis

14) ______

assumed A) that the money supply was fixed.

B) that the price level was fixed.

C) that unemployment also was not a problem.

D) that monetary policy is not effective.

15) Keynes reasoned that consumer expenditure is most closely related to

15) ______

A) the price level.

C) the level of interest rates.

B) t he marginal tax rate.

D) d isposable income.

16) In the Keynesian model of income determination, consumer expenditure includes spending by A) consumers on personal computers.

B) governments on personal computers.

C) businesses on personal computers.

D) foreigners on domestic personal computers.

16) ______

17) The marginal propensity to consume (mpc) can be defined as the fraction of A) a change in income that is spent.

B) i ncome that is saved.

C) income that is spent.

D) a change in income that is saved.

17) ______

18) ______ 18) If the consumption function is expressed as C = a + mpc × YD, then "mpc" represents A) the marginal propensity to consume.

B) t he expenditure multiplier.

C) disposable income.

D) a utonomous consumer expenditure.

19) If the consumption function is expressed as C = a + mpc × YD, then "a" represents A) the marginal propensity to consume.

B) d isposable income.

C) autonomous consumer expenditure.

D) t he expenditure multiplier.

19) ______

20) If the consumption function is C = 20 + 0.5YD, then an increase in disposable income by $100

20) ______

will result in an increase in consumer expenditure by A) $25.

B) $ 70.

C) $ 50.

D) $ 100.

21) If the consumption function is C = 20 + 0.8YD, then an increase in disposable income by $100 will result in an increase in consumer expenditure by A) $58.

B) $ 64.

C) $ 80.

D) $ 100.

22) Assume that autonomus consumption equals $200 and that the mpc equals 0.8. If disposable income equals $1000, then toal consumption equals A) $80 B) $ 200 C) $ 800

C) 0 .65.

26) ______

D) 1 .

27) Everything else held constant, if disposable income increases by 200 and consumption expenditure increases by 150, the mpc is

25) ______

D) 0 .6

26) Everything else held constant, if consumption expenditure increases by 65 for a 100 increase in disposable income, the mpc is A) 0.

B) 0 .5.

24) ______

D) $ 1000

25) Everything else held constant, if total consumption increases from $600 to $800 because of an increase of disposable income of $400, then the mpc is equal to A) 0.2 B) 0 .4 C) 0 .5

23) ______

D) 1 .0

24) Assume that disposable income equals $1000 and the mpc equals 0.6. If total consumption equal $800, then autonomous consumption is equal to A) $0 B) $ 200 C) $ 800

22) ______

D) $ 1000

23) Assume that autonomous consumption equals $200 and disposable income equals $1000. If total consumption equal $800, then the mpc equals A) 0.2 B) 0 .6 C) 0 .8

21) ______

27) ______

A) 0.

B) 0 .15.

C) 0 .5.

D) 0 .75.

28) Everything else held constant, if consumption expenditure falls by 160 when disposable income falls by 200, the mpc is A) 0.

B) 0 .2.

C) 0 .4.

28) ______

D) 0 .8.

29) Economists define investment as the purchase of A) any physical asset, whether new or not, used by business to increase production.

B) any physical asset used by business to increase production and the repurchase of

29) ______

common stock.

C) business spending on capital and household spending on durable goods.

D) a new physical asset such as a new machine or a new house.

30) Actual investment spending is comprised of two components: A) planned investment and fixed investment.

B) unplanned investment and inventory investment.

C) fixed investment and actual inventory investment.

D) fixed business investment and fixed housing investment.

30) ______

31) Planned investment spending, a component of aggregate demand, is equal to A) fixed investment.

B) fixed investment plus planned inventory investment.

C) fixed investment plus actual inventory investment.

D) fixed investment plus unplanned inventory investment.

31) ______

32) There are two types of investment: ________ investment—the spending by business firms on

32) ______

equipment and structures, and planned spending on residential houses—and ________ investment—spending by business firms on additional holdings of raw materials, parts, and finished goods.

A) fixed; gross B) f ixed; inventory C) planned; gross D) p lanned; inventory

33) A fall in inventories is synonymous with ________ investment.

A) positive inventory B) n egative inventory C) positive fixed D) n egative fixed

33) ______

34) A difference between inventory investment and fixed investment is that A) unplanned inventory investment is always zero.

B) fixed investment is never planned.

C) inventory investment is never unplanned.

D) fixed investment is never unplanned.

34) ______

35) In the Keynesian cross diagram, the point at which the aggregate demand function crosses the

35) ______

45 degree line indicates the A) natural level of income.

C) level of full employment income.

B) e quilibrium level of income.

D) a utonomous level of income.

36) Keynes mentioned two factors that influenced planned investment spending: A) interest rates and disposable income.

B) interest rates and business expectations about inflation.

C) disposable income and business expectations about the future.

36) ______

D) interest rates and business expectations about the future.

37) Aggregate demand in an economy with no government or foreign trade is A) consumer expenditure plus planned investment.

B) consumer expenditure plus inventory investment.

C) consumer expenditure plus actual investment.

D) consumer expenditure plus fixed investment.

37) ______

38) It is convenient to separate actual investment into two categories when explaining how the

38) ______

equilibrium level of aggregate output is determined. These two categories are ________ investment and ________ investment.

A) financial; structural B) p lanned; unplanned C) planned; fixed D) p lanned; structural

39) If unplanned investment is positive, firms will ________ production and output will ________.

A) increase; fall B) c ut; rise C) i ncrease; rise D) c ut; fall

39) ______

40) If unplanned investment is negative, firms will ________production and output will ________.

A) increase; fall B) c ut; fall C) i ncrease; rise D) c ut; rise

40) ______

41) In the Keynesian framework, as long as output is below the equilibrium level, unplanned

41) ______

inventory investment will remain ________ and firms will continue to ________ production.

A) positive; raise B) n egative; raise C) positive; lower D) n egative; lower

42) In the Keynesian framework, as long as output is ________ the equilibrium level, unplanned

42) ______

inventory investment will remain ________ and firms will continue to raise production.

A) above; negative B) b elow; negative C) above; positive D) b elow; positive

43) In the Keynesian framework, as long as output is ________ the equilibrium level, unplanned

43) ______

inventory investment will remain ________ and firms will continue to lower production.

A) above; positive B) b elow; negative C) below; positive D) a bove; negative

44) In the Keynesian framework, as long as output is ________ the equilibrium level, unplanned

44) ______

inventory investment will remain positive and firms will continue to ________ production.

A) above; raise B) a bove; lower C) b elow; lower D) b elow; raise

45) In the Keynesian framework, as long as output is above the equilibrium level, unplanned

45) ______

inventory investment will remain ________ and firms will continue to ________ production.

A) positive; lower B) n egative; lower C) positive; raise D) n egative; raise

46) In the Keynesian framework, as long as output is ________ the equilibrium level, unplanned

46) ______

inventory investment will remain negative and firms will continue to ________ production.

A) above; lower B) b elow; raise C) a bove; raise D) b elow; lower

47) In the Keynesian framework, as long as output is below the equilibrium level, unplanned inventory investment will remain negative, firms will continue to ________ production, and output will continue to ________.

A) l ower; rise

B) r aise; rise

C) r aise; fall

D) l ower; fall

47) ______

48) In the Keynesian framework, as long as output is ________ the equilibrium level, unplanned

48) ______

inventory investment will remain ________, firms will continue to raise production, and output will continue to rise.

A) below; positive B) b elow; negative C) above; negative D) a bove; positive

49) In the Keynesian framework, as long as output is ________ the equilibrium level, unplanned

49) ______

inventory investment will remain ________, firms will continue to lower production, and output will continue to fall.

A) below; positive B) a bove; negative C) below; negative D) a bove; positive

50) An increase in unplanned inventory investment for the entire economy equals the excess of A) aggregate supply over output.

B) a ggregate demand over output.

C) output over aggregate supply.

D) o utput over aggregate demand.

50) ______

51) A decrease in unplanned inventory investment for the entire economy equals the excess of A) aggregate demand over output.

B) o utput over aggregate supply.

C) output over aggregate demand.

D) a ggregate supply over output.

51) ______

52) If aggregate demand is less than the level of aggregate output, then ________ inventory

52) ______

investment will be ________.

A) actual; positive C) planned; positive

B) p lanned; negative D) a ctual; negative

53) If aggregate demand falls short of current output, business firms will ________ production to ________ inventories.

A) expand; build up C) cut; keep from accumulating

B) c ut; build up D) e xpand; keep from accumulating

54) If aggregated demand is less than actual output, unplanned inventory ________ will cause output to _____.

A) accumulation; rise C) accumulation; fall

56) ______

B) d ecrease; accumulating D) i ncrease; depleting

57) When the level of unplanned inventory investment is equal to zero, the economy is A) in a recession.

B) i n equilibrium.

C) in disequilibrium.

D) o verheating 58) If aggregate demand equals output, A) the economy is in a recession.

55) ______

B) i ncrease; accumulating D) i ncrease; depleting

56) If actual output is greater than equilibrium output, firms will _________ output to keep from ________ inventories.

A) increase; accumulating C) decrease; depleting

54) ______

B) d epletion; fall D) d epletion; rise

55) If actual output is less than equilibrium output, firms will ________ output to keep from ________ inventories.

A) decrease; depleting C) decrease; accumulating

53) ______

57) ______

58) ______ B) t he economy is at its equilibrium level.

C) output will increase.

D) output will fall.

Situation 20-1 Assume a closed economy with no government. Suppose that autonomous consumption equals $400, planned investment equals $500, and the mpc equals 0.9.

59) Using the information in Situation 20-1, if aggregate output is equal to $10,000, then unplanned inventory investment equals A) -$1000 B) - $100

C) $ 0

D) $ 100

60) Using the information in Situation 20-1, if aggregate output equals $8,000, the unplanned inventory investment equals B) $ 0 A) -$100

C) $ 100

59) ______

60) ______

D) $ 500

61) Using the information in Situation 20-1, the equilibrium level of aggregate output is A) $900 B) $ 8,000 C) $ 9,000 D) $ 10,000

61) ______

62) The expenditure multiplier is the ratio of the change in ________ to a change in the ________.

A) equilibrium output; autonomous expenditure.

B) the money supply; autonomous expenditure.

C) the money supply; monetary base.

D) equilibrium output; monetary base.

62) ______

63) The ratio of the change in aggregate output to a change in planned investment spending is

63) ______

called A) unplanned inventory accumulation.

C) the marginal propensity to consume.

B) a utonomous consumer expenditure.

D) t he expenditure multiplier.

64) The multiplier effect means that a given change in ________ expenditures will change

64) ______

equilibrium ________ by an amount ________ than the initial change in autonomous expenditures.

A) induced; income; less B) a utonomous; income; greater C) autonomous; income; less D) i nduced; income; greater

65) If you know the value of the multiplier and the amount of a change in autonomous investment, you can calculate A) the change in the money supply.

C) the change in money demand.

65) ______

B) t he change in equilibrium output.

D) t he change in the interest rate.

66) For a marginal propensity to consume of 0.75, the value of the multiplier is A) 0.25 B) 3 .00 C) 3 .75 67) If the marginal propensity to consume is .9, the value of the multiplier is A) 0.

B) 1 .

C) 9 .

D) 4 .00.

D) 1 0.

66) ______ 67) ______

68) If the income multiplier is 2, the value of the marginal propensity to consume is A) 0.2.

D) 1 .

B) 0 .5.

C) 0 .75.

68) ______

69) If the income multiplier is 4, the value of the marginal propensity to consume is A) 0.2.

D) 1 .

B) 0 .5.

C) 0 .75.

69) ______

70) For every dollar increase in planned investment spending, aggregate output increases by ________.

A) one dollar C) more than one dollar

70) ______

B) l ess than one dollar D) t wo dollars.

71) Keynes believed that changes in autonomous spending were dominated by changes in A) investment spending.

B) autonomous consumer expenditure.

C) consumer expenditure.

D) taxes.

E) none of the above.

71) ______

72) Keynes believed that changes in autonomous spending were dominated by unstable

72) ______

fluctuations in ________, which are influenced by emotional waves of optimism and pessimism—factors he referred to as "animal spirits."

A) autonomous consumer expenditures B) p lanned investment spending C) unplanned investment spending D) a ctual investment spending

73) After witnessing the events in the Great Depression, Keynes took the view that an economy

73) ______

would continually suffer major output fluctuations because of the volatility of A) autonomous spending, particularly consumer expenditures.

B) induced spending, particularly consumer expenditures.

C) autonomous spending, particularly planned investment spending.

D) autonomous spending, particularly government expenditures.

Situation 20-1 Assume a closed economy with no government. Suppose that autonomous consumption equals $400, planned investment equals $500, and the mpc equals 0.9.

74) Using the information contained in Situation 20-1, if autonomous consumption increases by $100, then equilibrium aggregate output will change by A) -$1,000 B) - $100 C) $ 100

D) $ 1,000

75) Using the information contained in Situation 20-1, if planned investment decreases by $100, the equilibrium aggregate output will change by A) -$1,000 B) $ -100

C) $ 100

75) ______

D) $ 1,000

76) In the simple Keynesian framework, declines in planned investment spending that produce high unemployment can be offset by raising A) business confidence.

C) consumer confidence.

74) ______

76) ______

B) t axes.

D) g overnment spending.

77) The Keynesian framework indicates that government can play an important role in determining

77) ______

aggregate output by A) raising consumer confidence.

B) raising investor confidence.

C) changing the level of government spending or taxes.

D) changing the money supply and interest rates.

78) A tax cut initially A) has no effect on consumption expenditure.

78) ______

B) increases consumption expenditure by an amount greater than the tax cut.

C) increases consumption expenditure by an amount that is less than the value of the tax cut.

D) reduces consumption expenditure by an amount that is less than the value of the tax cut.

E) increases consumption expenditure by an amount equal to the tax cut.

79) Assume equilibrium at full employment for an economy characterized by the simple Keynesian

79) ______

model. If the government raises taxes to eliminate a budget deficit, then A) the rate of interest will fall.

B) the price level will increase.

C) the rate of unemployment will increase.

D) the level of aggregate output will increase.

Situation 20-2 Assume a closed economy. Suppose that autonomous consumption equals $400, planned investment equals $500, government expenditure equals $200, net taxes equals $50, and the mpc equals 0.9.

80) Using the information in situation 20-2, if government spending increases by $100, then the equilibrium aggregate output will change by A) -$1,000 B) - $100

C) $ 100

D) $ 1,000

81) Using the information in Situation 20-2, if taxes increase by $10, then the equilibrium aggregate output will change by A) $90

B) - $90

C) - $10

81) ______

D) $ 10

82) Using the information in situation 20-2, if government increases their spending by $50 and increases net taxes by 50, then equilibrium aggregate output will change by A) -$50 B) - $100 C) $ 100

80) ______

82) ______

D) $ 50

83) In a closed economy, aggregate demand is the sum of A) consumer expenditure, actual investment spending, and government spending.

B) consumer expenditure, actual investment spending, government spending, and net

83) ______

exports.

C) consumer expenditure, planned investment spending, and government spending.

D) consumer expenditure, planned investment spending, government spending, and net exports.

84) In an open economy, aggregate demand is the sum of A) consumer expenditure, actual investment spending, government spending, and net

84) ______

exports.

B) consumer expenditure, planned investment spending, and government spending.

C) consumer expenditure, actual investment spending, and government spending.

D) consumer expenditure, planned investment spending, government spending, and net exports.

85) If net exports increase by 100 and the mpc is 0.75, equilibrium aggregate output increases by A) 100.

B) 2 50.

C) 4 00.

D) 7 50.

85) ______

86) If net exports increase by 250 and the mpc is 0.75, equilibrium aggregate output increases by A) 250.

B) 5 00.

C) 7 50.

D) 1 000.

86) ______

87) If net exports decrease by 250 and the mpc is 0.75, equilibrium aggregate output

87) ______

A) increases by 1000.

C) increases by 750.

B) d ecreases by 750.

D) d ecreases by 1000.

88) Aggregate output is ________ related to autonomous consumer expenditure, and is ________ related to planned investment spending.

A) positively; negatively C) negatively; negatively

B) n egatively; positively D) p ositively; positively

89) Aggregate output is ________ related to autonomous consumer expenditure, and is ________ related to the level of taxes.

A) positively; positively C) positively; negatively

90) Aggregate output is increased by a decrease in A) autonomous consumption.

C) net taxes.

91) Equilibrium output is reduced by an increase in A) government spending.

C) net exports.

88) ______

89) ______

B) n egatively; positively D) n egatively; negatively B) g overnment spending.

D) p lanned investment.

B) p lanned investment.

D) t axes.

90) ______

91) ______

ESSAY. Write your answer in the space provided or on a separate sheet of paper.

92) Keynes believed that unstable investment caused the Great Depression. Using the simple Keynesian model, explain how a fall in investment affects equilibrium output.

93) Show algebraically that the balanced-budget multiplier (that is, a matching change in both government expenditure and net taxes) is equal to one.

MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question.

94) ______ 94) If the interest rate falls, other things being equal, investment spending will A) either rise, fall, or remain unchanged.

B) f all.

C) rise.

D) n ot be affected.

95) When the interest rate rises, A) planned investment rises.

C) planned investment will be unaffected.

B) p lanned investment falls.

D) e quilibrium income increases.

95) ______

96) When the interest rate is ________, ________ investments in physical capital will earn more than 96) ______ the cost of borrowed funds, so planned investment spending is ________.

A) high; few; low B) high; few; high C) high; many; high D) low; few; high E) low; many; low

97) When interest rates rise in the United States (with the price level fixed), the value of the dollar ________, domestic goods become ________ expensive, and net exports ________.

A) falls; less; fall B) r ises; more; fall C) falls; more; rise D) r ises; less; fall

97) ______

98) When interest rates fall in the United States (with the price level fixed), the value of the dollar

98) ______

99) An increase in interest rates A) increases the value of the dollar, net exports, and equilibrium output.

B) reduces the value of the dollar, net exports, and equilibrium output.

C) increases the value of the dollar, reducing net exports and equilibrium output.

D) reduces the value of the dollar, increasing net exports and equilibrium output.

99) ______

100) A decrease in interest rates A) increases the value of the dollar, net exports, and equilibrium output.

B) reduces the value of the dollar, increasing net exports and equilibrium output.

C) increases the value of the dollar, reducing net exports and equilibrium output.

D) reduces the value of the dollar, net exports, and equilibrium output.

100) _____

101) The negative relation between investment spending and the interest rate is what gives the

101) _____

________, domestic goods become ________ expensive, and net exports ________.

A) falls; less; rise B) f alls; more; fall C) r ises; less; fall D) f alls; less; fall

________ curve its ________ slope.

A) IS; downward C) LM; upward

102) Points on the IS curve satisfy A) goods market equilibrium.

C) bond market equilibrium.

B) L M; downward D) I S; upward B) s tock market equilibrium.

D) m oney market equilibrium.

103) The ________ traces out the points for which total quantity of goods produced equals total quantity of goods demanded.

A) consumption function C) investment schedule

102) _____

103) _____

B) I S curve D) L M curve

104) The ________ describes points for which the goods market is in equilibrium.

A) LM curve B) c onsumption function C) investment schedule D) I S curve

104) _____

105) Everything else held constant, if aggregate output is to the right of the IS curve, then there is an

105) _____

excess ________ of goods which will cause aggregate output to ________.

A) demand; fall B) d emand; rise C) s upply; fall

D) s upply; rise

106) Everything else held constant, if aggregate output is to the left of the IS curve, then there is an excess ________ of goods which will cause aggregate output to ________.

A) supply; rise B) s upply; fall C) d emand; rise

106) _____

D) d emand; fall

107) Everything else held constant, if aggregate output is to the ________ of the IS curve, then there

107) _____

is an excess supply of goods which will cause aggregate output to ________.

A) left; fall B) r ight; fall C) r ight; rise D) l eft; rise

108) Everything else held constant, if aggregate output is to the ________ of the IS curve, then there

108) _____

is an excess demand of goods which will cause aggregate output to ________.

A) right; rise B) l eft; fall C) l eft; rise D) r ight; fall

109) Everything else held constant, if aggregate output is to the ________ of the IS curve, then there is an excess ________ of goods which will cause aggregate output to fall.

109) _____

A) left; supply

B) l eft; demand

C) r ight; supply

D) r ight; demand

110) Everything else held constant, if aggregate output is to the ________ of the IS curve, then there is an excess ________ of goods which will cause aggregate output to rise.

A) left; supply B) r ight; supply C) l eft; demand

110) _____

D) r ight; demand

111) The money market is in equilibrium A) at only one point on the LM curve.

B) at any point on the LM curve.

C) at any point on the IS curve.

D) only at the intersection of the IS and LM curves.

111) _____

112) The ________ describes the combinations of interest rates and aggregate output for which the

112) _____

quantity of money demanded equals the quantity of money supplied.

A) consumption function B) I S curve C) investment schedule D) L M curve

113) In the Keynesian model the quantity of money demanded is ________ related to income and ________ related to the interest rate.

A) positively; negatively C) negatively; negatively

113) _____

B) n egatively; positively D) p ositively; positively

114) According to the liquidity preference theory, the demand for money is ________ related to

114) _____

aggregate output and ________ related to interest rates.

A) negatively; negatively B) p ositively; negatively C) positively; positively D) n egatively; positively

115) As interest rates rise, the opportunity cost of holding money ________ and the demand for money ________.

A) rises; falls

B) f alls; falls

C) r ises; rises

115) _____

D) f alls; rises

116) As aggregate output rises, the demand for money ________ and the interest rate ________, so

116) _____

that money demanded equals money supplied and the money market is in equilibrium.

A) increases; rises B) d ecreases; rises C) increases; falls D) d ecreases; falls

117) Everything else held constant, if aggregate output is to the right of the LM curve, then there is

117) _____

an excess ________ of money which will cause the interest rate to ________.

A) demand; fall B) d emand; rise C) s upply; rise D) s upply; fall

118) Everything else held constant, if aggregate output is to the left of the LM curve, then there is an excess ________ of money which will cause the interest rate to ________.

A) supply; fall B) s upply; rise C) d emand; rise

118) _____

D) d emand; fall

119) Everything else held constant, if aggregate output is to the ________ of the LM curve, then there

119) _____

is an excess supply of money which will cause the interest rate to ________.

A) left; fall B) r ight; fall C) l eft; rise D) r ight; rise

120) Everything else held constant, if aggregate output is to the ________ of the LM curve, then there is an excess demand of money which will cause the interest rate to ________.

A) left; rise B) r ight; rise C) l eft; fall D) r ight; fall

120) _____

121) Everything else held constant, if aggregate output is to the ________ of the LM curve, then there is an excess ________ of money which will cause the interest rate to fall.

A) right; supply B) l eft; supply C) r ight; demand

D) l eft; demand

122) Everything else held constant, if aggregate output is to the ________ of the LM curve, then there is an excess ________ of money which will cause the interest rate to rise.

A) left; supply B) l eft; demand C) r ight; demand

121) _____

122) _____

D) r ight; supply

ESSAY. Write your answer in the space provided or on a separate sheet of paper.

123) The Federal Reserve increases interest rates when it wants to reduce aggregate demand to fight inflation.

How do increases in the interest rate reduce aggregate demand?

MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question.

124) Macroeconomic equilibrium requires 124) _____ A) equilibrium in the goods market.

B) equilibrium in both the goods and money markets.

C) equilibrium in the money market.

D) equilibrium in neither the goods nor the money market.

125) When the IS and LM curves are combined in the same diagram, the intersection of the two

125) _____

curves determines the equilibrium level of ________ as well as the ________.

A) money supply; price level B) a ggregate output; interest rate C) aggregate output; price level D) c onsumer expenditures; interest rate

126) If the economy is on the LM curve, but is to the right of the IS curve, aggregate output will ________ and the interest rate will ________.

A) fall; fall B) f all; rise

C) r ise; rise

D) r ise; fall

127) If the economy is on the LM curve, but is to the left of the IS curve, aggregate output will ________ and the interest rate will ________.

A) fall; rise B) r ise; rise

C) r ise; fall

C) r ise; fall

C) r ise; fall

129) _____

D) f all; fall

130) If the economy is on the IS curve, but is to the left of the LM curve, then the ________ market is in equilibrium, but the interest rate is ________ the equilibrium level.

A) goods; above B) g oods; below C) m oney; above

128) _____

D) f all; fall

129) If the economy is on the IS curve, but is to the right of the LM curve, aggregate output will ________ and the interest rate will ________.

A) fall; rise B) r ise; rise

127) _____

D) f all; fall

128) If the economy is on the IS curve, but is to the left of the LM curve, aggregate output will ________ and the interest rate will ________.

A) fall; rise B) r ise; rise

126) _____

130) _____

D) m oney; below

131) If the economy is on the LM curve, but is to the right of the IS curve, then the ________ market is in equilibrium, but aggregate ________ exceeds aggregate ________.

A) money; output; demand B) g oods; demand; output C) goods; output; demand D) m oney; demand; output

131) _____

1) D 2) C 3) C 4) A 5) B 6) B 7) A 8) B 9) B 10) B 11) D 12) B 13) A 14) B 15) D 16) A 17) A 18) A 19) C 20) C 21) C 22) D 23) B 24) B 25) C 26) C 27) D 28) D 29) D 30) C 31) B 32) B 33) B 34) D 35) B 36) D 37) A 38) B 39) D 40) C 41) B 42) B 43) A 44) B 45) A 46) B 47) B 48) B 49) D 50) D

51) A 52) A 53) C 54) C 55) D 56) B 57) B 58) B 59) D 60) A 61) C 62) A 63) D 64) B 65) B 66) D 67) D 68) B 69) C 70) C 71) A 72) B 73) C 74) D 75) A 76) D 77) C 78) C 79) C 92) 80) A fall in investment will reduce aggregate output by a greater amount that the initial fall in investment. This D happens because of the multiplier effect.

93) 81) B 82) The multiplier for a change in government expenditure equals while the multiplier for net taxes equals D 83) C . If government expenditure and taxes are changed in the same direction by the same amount, then the 84) combined (balanced budget) multiplier is: D 85) C 86) D 87) D 88)

=

+

= 1.

94) C 95) B 96) A 97) B 98) A 99) C 100) B 101) A 102) A 103) B 104) D 105) C 106) C 107) B 108) C 109) C 110) C 111) B 112) D 113) A 114) B 115) A 116) A 117) B 118) A 119) A 120) B 121) B 122) C 123) Increases in interest rates reduce planned investment. The decrease in investment reduces equilibrium output by a multiple amount due to the multiplier effect. Also, increases in interest rates increase the value of the dollar, reducing net exports, which reduce aggregate demand and equilibrium output by a multiple amount.

124) B 125) B 126) A 127) B 128) C 129) A 130) A 131) A

Exam Name___________________________________ MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question.

1) Other things equal, a decrease in autonomous consumption shifts the ________ curve to the ________.

A) IS; right

B) L M; right

C) I S; left

1) _______

D) L M; left

2) In the Keynesian cross diagram, a decline in autonomous consumer expenditure causes the

2) _______

aggregate demand function to shift ________ and the equilibrium level of aggregate output to ________, everything else held constant.

A) up; fall B) d own; fall C) u p; rise D) d own; rise

3) In the Keynesian cross diagram, an increase in autonomous consumer expenditure causes the

3) _______

aggregate demand function to shift ________ and the equilibrium level of aggregate output to ________, everything else held constant.

A) down; fall B) d own; rise C) u p; rise D) u p; fall

4) In the Keynesian cross diagram, an increase in autonomous consumer expenditure causes the

4) _______

aggregate demand function to shift ________, the equilibrium level of aggregate output to rise, and the IS curve to shift to the ________, everything else held constant.

A) up; right B) d own; right C) u p; left D) d own; left

5) In the Keynesian cross diagram, a decline in autonomous consumer expenditure causes the

5) _______

aggregate demand function to shift ________, the equilibrium level of aggregate output to fall, and the IS curve to shift to the ________, everything else held constant.

A) down; left B) u p; left C) u p; right D) d own; right

6) In the Keynesian cross diagram, a decline in autonomous consumer expenditure causes the

6) _______

aggregate demand function to shift down, the equilibrium level of aggregate output to ________, and the IS curve to shift to the ________, everything else held constant.

A) fall; right B) r ise; right C) r ise; left D) f all; left

7) In the Keynesian cross diagram, an increase in autonomous consumer expenditure causes the

7) _______

aggregate demand function to shift up, the equilibrium level of aggregate output to ________, and the IS curve to shift to the ________, everything else held constant.

A) rise; right B) r ise; left C) f all; left D) f all; right

8) An increase in autonomous consumer expenditure causes the equilibrium level of aggregate

8) _______

output to ________ at any given interest rate and shifts the ________ curve to the ________, everything else held constant.

A) fall; LM; left B) f all; IS; left C) r ise; IS; right D) r ise; LM; right

9) A decrease in autonomous consumer expenditure causes the equilibrium level of aggregate

9) _______

output to ________ at any given interest rate and shifts the ________ curve to the ________, everything else held constant.

A) rise; IS; right B) f all; IS; left C) f all; LM; left D) r ise; LM; right

10) Everything else held constant, changes in the interest rate affect planned investment spending and hence the equilibrium level of output, but this change in investment spending A) is crowded out by lower consumer expenditures.

10) ______

B) is crowded out by higher government spending.

C) merely causes a movement along the IS curve and not a shift.

D) is crowded out by higher taxes.

11) A rise in autonomous planned investment spending causes the equilibrium level of aggregate

11) ______

output to ________ and shifts the ________ curve to the ________, everything else held constant.

A) fall; LM; left B) r ise; IS; right C) f all; IS; left D) r ise; LM; right

12) A decline in autonomous planned investment spending causes the equilibrium level of

12) ______

aggregate output to ________ and shifts the ________ curve to the ________, everything else held constant.

A) rise; IS; right B) f all; LM; left C) f all; IS; left D) r ise; LM; right

13) In the Keynesian cross diagram, a decrease in investment spending because companies become

13) ______

more pessimistic about investment profitability causes the aggregate demand function to shift ________ and the equilibrium level of aggregate output to ________, everything else held constant.

A) down; rise B) u p; fall C) u p; rise D) d own; fall

14) In the Keynesian cross diagram, an increase in investment spending because companies become 14) ______ more optimistic about investment profitability causes the aggregate demand function to shift ________ and the equilibrium level of aggregate output to ________, everything else held constant.

A) down; rise B) d own; fall C) u p; rise D) u p; fall

15) In the Keynesian cross diagram, an increase in investment spending because companies become 15) ______ more optimistic about investment profitability causes the aggregate demand function to shift ________, the equilibrium level of aggregate output to rise, and the IS curve to shift to the ________, everything else held constant.

A) up; right B) d own; right C) u p; left D) d own; left

16) In the Keynesian cross diagram, a decrease in investment spending because companies become

16) ______

more pessimistic about investment profitability causes the aggregate demand function to shift ________, the equilibrium level of aggregate output to fall, and the IS curve to shift to the ________, everything else held constant.

A) down; left B) u p; right C) u p; left D) d own; right

17) In the Keynesian cross diagram, a decrease in investment spending because companies become

17) ______

more pessimistic about investment profitability causes the aggregate demand function to shift down, the equilibrium level of aggregate output to ________, and the IS curve to shift to the ________, everything else held constant.

A) fall; right B) r ise; left C) f all; left D) r ise; right

18) In the Keynesian cross diagram, an increase in investment spending because companies become 18) ______ more optimistic about investment profitability causes the aggregate demand function to shift up, the equilibrium level of aggregate output to ________, and the IS curve to shift to the ________, everything else held constant.

A) rise; right B) f all; left C) f all; right D) r ise; left

19) A decrease in autonomous planned investment spending, other things equal, shifts the ________ curve to the ________.

A) IS; left B) I S; right

C) L M; right

D) L M; left

19) ______

20) An increase in government spending causes the equilibrium level of aggregate output to

20) ______

________ at any given interest rate and shifts the ________ curve to the ________, everything else held constant.

A) fall; LM; left B) f all; IS; left C) r ise; IS; right D) r ise; LM; right

21) A reduction in government spending causes the equilibrium level of aggregate output to

21) ______

________ at any given interest rate and shifts the ________ curve to the ________, everything else held constant.

A) fall; IS; left B) r ise; IS; right C) r ise; LM; right D) f all; LM; left

22) The IS curve shifts to the left when A) the money supply increases.

B) taxes increase.

C) government spending increases.

D) autonomous planned investment spending increases.

22) ______

23) A decline in taxes ________ consumer expenditure and shifts the ________ curve to the

23) ______

________, everything else held constant.

A) raises; IS; right C) raises; LM; right

B) l owers; LM; left D) l owers; IS; left

24) A tax increase ________ disposable income, ________ consumption expenditure, and shifts the

24) ______

IS curve to the ________, everything else held constant.

A) decreases; increases; left B) i ncreases; decreases; left C) increases; increases; right D) d ecreases; decreases; left

25) A tax cut ________ disposable income, ________ consumption expenditure, and shifts the IS

25) ______

curve to the ________, everything else held constant.

A) decreases; increases; left B) d ecreases; decreases; left C) increases; increases; right D) i ncreases; decreases; right

26) If American college students decide that drinking Mexican-brewed beer helps one get noticed,

26) ______

net exports will tend to fall, causing aggregate demand to ________ and the ________ curve to shift to the left, everything else held constant.

A) fall; IS B) f all; LM C) r ise; IS D) r ise; LM

27) If young business professionals in America suddenly decide that driving German-made cars is

27) ______

an important status symbol, net exports will tend to ________ causing aggregate demand to ________, everything else held constant.

A) rise; fall B) r ise; rise C) f all; fall D) f all; rise

28) An autonomous depreciation of the U.S. dollar makes American goods ________ relative to

28) ______

foreign goods and results in a ________ in U.S. net exports, everything else held constant.

A) more expensive; decline B) c heaper; decline C) more expensive; rise D) c heaper; rise

29) An autonomous appreciation of the U.S. dollar makes American goods ________ expensive relative to foreign goods which ________ net exports in the U.S. A) more; increases B) m ore; decreases C) less; decreases D) l ess; increases

29) ______

30) A shift in tastes toward foreign goods ________ net exports in the U.S. and causes the quantity

30) ______

31) Everything else held constant, a shift in tastes in the U.S. toward Mexican goods will ________

31) ______

of aggregate output demanded to ________ in the U.S., everything else held constant.

A) increases; fall B) d ecreases; fall C) i ncreases; rise D) d ecreases; rise

net exports in the U.S. and cause the quantity of aggregate output demanded to ________ in Mexico.

A) decrease; rise B) i ncrease; fall C) i ncrease; rise D) d ecrease; fall

32) A shift in tastes toward American goods ________ net exports in the U.S. and causes the

32) ______

quantity of aggregate output demanded to ________ in the U.S., everything else held constant.

B) d ecreases; fall C) d ecreases; rise increases; rise D)A) i ncreases; fall

33) Everything else held constant, a shift in tastes in the U.S. towards American goods will

33) ______

________ net exports in the U.S. and cause the quantity of aggregate output demanded to ________in Mexico.

A) increase; rise B) d ecrease; fall C) i ncrease; fall D) d ecrease; rise

34) A shift in tastes toward American goods ________ net exports in the U.S. and causes the IS

34) ______

curve to shift to the ________ in the U.S., everything else held constant.

A) increases; left B) d ecreases; left C) increases; right D) d ecreases; right

35) A shift in tastes toward foreign goods ________ net exports in the U.S. and causes the IS curve

35) ______

to shift to the ________ in the U.S., everything else held constant.

A) increases; left B) i ncreases; right C) decreases; right D) d ecreases; left

36) A depreciation of the U.S. dollar makes American goods cheaper relative to foreign goods,

36) ______

resulting in a ________ in net exports in the U.S. and a ________ shift of the IS curve in the U.S., everything else held constant.

A) rise; rightward B) r ise; leftward C) f all; rightward D) f all; leftward

37) An appreciation of the U.S. dollar makes foreign goods cheaper relative to American goods,

37) ______

resulting in a ________ in net exports in the U.S. and a ________ shift of the IS curve in the U.S., everything else held constant.

A) rise; leftward B) r ise; rightward C) f all; leftward D) f all; rightward

38) Which of the following does not shift the IS curve?

A) A decline in government spending.

B) An increase in government spending.

C) A fall in the interest rate.

D) An increase in autonomous consumption.

38) ______

39) An increase in the money supply, other things equal, shifts the ________ curve to the ________.

A) LM; right B) I S; left C) I S; right D) L M; left

39) ______

40) If the Federal Reserve conducts open market purchases, the money supply ________, shifting

40) ______

the LM curve to the ________, everything else held constant.

A) increases; right B) d ecreases; right C) increases; left D) d ecreases; left

41) If the Federal Reserve conducts open market sales, the money supply ________, shifting the LM

41) ______

curve to the ________, everything else held constant.

A) decreases; right B) i ncreases; left C) increases; right D) d ecreases; left

42) If the Federal Reserve conducts open market ________, the money supply ________, shifting the 42) ______ LM curve to the right, everything else held constant.

A) sales; decreases B) p urchases; decreases C) sales; increases D) p urchases; increases

43) If the Federal Reserve conducts open market ________, the money supply ________, shifting the 43) ______ LM curve to the left, everything else held constant.

A) sales; increases C) purchases; increases

B) p urchases; decreases D) s ales; decreases

44) An increase in the quantity of money supplied shifts the money supply curve to the ________, and the equilibrium interest rate ________, everything else held constant.

A) left; rises B) r ight; falls C) r ight; rises

D) l eft; falls

45) A decrease in the quantity of money supplied shifts the money supply curve to the ________, and the equilibrium interest rate ________, everything else held constant.

A) right; falls B) r ight; rises C) l eft; rises

48) ______

D) s upply; right

49) A decline in the money supply shifts the LM curve to the left, causing the interest rate to ________ and output to ________, everything else held constant.

A) rise; fall B) f all; fall C) r ise; rise

47) ______

D) l eft; right

48) A decline in the money ________ shifts the LM curve to the ________, causing the interest rate to rise and output to fall, everything else held constant.

A) supply; left B) d emand; right C) d emand; left

46) ______

D) l eft; left

47) A decrease in the quantity of money supplied shifts the money supply curve to the ________, and the LM curve to the ________, everything else held constant.

A) right; right B) r ight; left C) l eft; left

45) ______

D) l eft; falls

46) An increase in the quantity of money supplied shifts the money supply curve to the ________ and the LM curve to the ________, everything else held constant.

A) left; right B) r ight; left C) r ight; right

44) ______

49) ______

D) f all; rise

50) An increase in the money ________ shifts the LM curve to the ________, causing the interest rate 50) ______ to fall and output to rise, everything else held constant.

A) demand; left B) d emand; right C) s upply; right

D) s upply; left

51) An increase in the money supply shifts the LM curve to the right, causing the interest rate to ________ and output to ________, everything else held constant.

B) f all; fall rise; fall C)A) f all; rise

51) ______

D) r ise; rise

52) When the central bank ________ the money supply, the LM curve shifts to the right, interest rates ________, and equilibrium aggregate output ________, everything else held constant.

A) increases; rise; decreases B) d ecreases; fall; increases C) increases; fall; increases D) d ecreases; rise; decreases

52) ______

53) An autonomous decrease in money demand, other things equal, shifts the ________ curve to the ________.

A) LM; right

B) I S; left

C) L M; left

D) I S; right

54) An autonomous increase in money demand, other things equal, shifts the ________ curve to the ________.

A) LM; left

B) L M; right

C) I S; left

C) r ises; rises

55) ______

D) r ises; falls

56) An autonomous rise in ________ shifts the LM curve to the ________, everything else held constant.

A) net exports; right C) money demand; right

54) ______

D) I S; right

55) As bonds become a riskier asset, the demand for money ________ and, all else constant, the equilibrium interest rate ________.

A) falls; falls B) f alls; rises

53) ______

56) ______

B) m oney demand; left D) n et exports; left

57) In the ISLM framework, an expansionary monetary policy causes aggregate output to ________

57) ______

and the interest rate to ________, everything else held constant.

A) decrease; decrease B) i ncrease; increase C) decrease; increase D) i ncrease; decrease

58) An expansionary monetary policy shifts the LM curve to the ________, reducing ________,

58) ______

everything else held constant.

A) right; both interest rates and real output B) left; output and increasing interest rates C) right; interest rates and increasing real output D) left; both real output and interest rates

59) A monetary expansion is characterized by A) rising output and interest rates.

C) falling output and rising interest rates.

59) ______

B) f alling output and interest rates.

D) r ising output and falling interest rates.

60) A contractionary monetary policy shifts the LM curve to the ________, reducing ________,

60) ______

everything else held constant.

A) left; both real output and interest rates B) left; output and increasing interest rates C) right; both interest rates and real output D) right; interest rates and increasing real output

61) A monetary contraction is characterized by A) falling output and rising interest rates.

C) rising output and interest rates.

61) ______

B) f alling output and interest rates.

D) r ising output and falling interest rates.

62) In the money market, a condition of excess demand for money can be eliminated by a ________

62) ______

in aggregate output or a ________ in the interest rate, everything else held constant.

A) rise; fall B) f all; fall C) f all; rise D) r ise; rise

63) In the money market, a condition of excess supply of money can be eliminated by a ________ in aggregate output or a ________ in the interest rate, everything else held constant.

A) rise; fall B) r ise; rise C) f all; fall D) f all; rise

63) ______

64) In the ISLM framework, an expansionary fiscal policy causes aggregate output to ________ and

64) ______

65) In the ISLM framework a contractionary fiscal policy causes aggregate output to ________ and

65) ______

the interest rate to ________, everything else held constant.

A) increase; decrease B) i ncrease; increase C) decrease; decrease D) d ecrease; increase

the interest rate to ________, everything else held constant.

A) increase; increase B) d ecrease; decrease C) decrease; increase D) i ncrease; decrease

66) In the case of an expansionary ________ policy, the interest rate rises, while in the case of an

66) ______

expansionary ________ policy, the interest rate falls.

A) monetary; fiscal B) m onetary; monetary C) fiscal; fiscal D) f iscal; monetary

67) Aggregate output and the interest rate are ________ related to government spending and are ________ related to taxes.

A) negatively; negatively C) positively; positively

B) p ositively; negatively D) n egatively; positively

68) An increase in spending that results from expansionary ________ policy causes the interest rate to ________, everything else held constant.

A) fiscal; fall B) f iscal; rise

67) ______

C) i ncomes; rise

68) ______

D) i ncomes; fall

69) Despite an expansionary monetary policy, an economy experiences a recession. Everything else

69) ______

held constant, the recession could occur in spite of the rightward shift of the LM curve if A) the money supply increases.

B) t axes are cut.

C) there is an investment boom.

D) c onsumer confidence decreases sharply.

70) If an economy experiences high interest rates and high unemployment, the ISLM framework

70) ______

predicts that _________ policy has been too ________ .

A) monetary; contractionary B) m onetary; expansionary C) fiscal; contractionary D) f iscal; expansionary

71) Which of the following statements concerning Keynesian ISLM analysis is true?

A) Changes in net exports arising from a change in interest rates causes a shift in the IS

71) ______

curve.

B) A fall in the money supply shifts the LM curve to the right.

C) Expansionary fiscal policy will cause the interest rate to fall.

D) For a given change in taxes, the IS curve will shift less than for an equal change in government spending.

ESSAY. Write your answer in the space provided or on a separate sheet of paper.

72) Using the ISLM model, explain the effects of a monetary expansion combined with a fiscal contraction.

How do the equilibrium level of output and interest rate change?

73) Using the ISLM model, show graphically and explain the effects of a monetary contraction. What is the effect on the equilibrium interest rate and level of output?

MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question.

74) If the quantity of money demanded is not affected by changes in the interest rate, the LM curve is ________ and fiscal policy will be ________.

A) horizontal; ineffective C) vertical; ineffective

74) ______

B) h orizontal; very effective D) v ertical; very effective

75) The LM curve will be vertical and fiscal policy ineffective when A) the demand for money is unaffected by changes in income.

B) the demand for money is unaffected by changes in the interest rate.

C) investment is unaffected by changes in income.

D) investment is unaffected by changes in the interest rate.

75) ______

76) The situation in which expansionary fiscal policy does not lead to a rise in aggregate output is

76) ______

referred to as A) a recession.

C) fiscal neutrality.

B) i nflation.

D) c omplete crowding out.

77) Crowding out will be more pronounced the closer to vertical is A) the LM curve.

B) t he consumption function.

C) the aggregate demand function.

D) t he IS curve.

77) ______

78) The less interest-sensitive is money demand, A) the flatter is the LM curve.

B) the more effective is monetary policy relative to fiscal policy.

C) the more effective is fiscal policy relative to monetary policy.

D) the steeper is the IS curve.

78) ______

79) The more interest-sensitive is money demand, A) the steeper is the IS curve.

B) the more effective is fiscal policy relative to monetary policy.

C) the steeper is the LM curve.

D) the more effective is monetary policy relative to fiscal policy.

79) ______

80) If the economy is characterized by a certain and stable LM curve, then ________ target produces 80) ______ ________ fluctuations in aggregate output.

A) an interest rate; smaller C) an exchange rate; larger

B) a money supply; larger D) a money supply; smaller

81) If the economy is characterized by a stable IS curve and an unstable LM curve, then ________

81) ______

target produces ________ fluctuations in aggregate output.

A) a money supply; smaller B) a money supply; larger C) an interest rate; larger D) a n exchange rate; smaller

82) If the ________ curve is relatively more unstable than the ________ curve, a money supply target is preferred.

A) LM; IS

B) I S; LM

C) I S; IS

82) ______

D) L M; LM

83) If the ________ curve is relatively more unstable than the ________ curve, an interest rate target 83) ______ is preferred.

A) IS; IS

B) L M; IS

C) I S; LM

D) L M; LM

84) If the Fed adopts a policy of pegging the interest rate, a ________ in government spending forces the Fed to increase the money supply to prevent interest rates from _________.

84) ______

A) fall; increasing C) rise; increasing

B) fall; decreasing D) rise; decreasing

ESSAY. Write your answer in the space provided or on a separate sheet of paper.

85) Using the ISLM model, explain and show graphically the effect of a fiscal expansion when the demand for money is completely insensitive to changes in the interest rate. What is this effect called?

86) Show graphically and explain why targeting an interest rate is preferable when money demand is unstable and the IS curve is stable.

MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question.

87) The rate of output at which the price level has no tendency to rise or fall is called the 87) ______ A) potential level of income.

B) e fficient level of output.

C) bliss point.

D) n atural rate of output.

88) In the long-run ISLM model and with everything else held constant, as long as the level of

88) ______

output ________ the natural rate level, the price level will continue to ________, shifting the LM curve to the ________, until finally output is back at the natural rate level.

A) exceeds; rise; left B) r emains below; fall; left C) exceeds; rise; right D) r emains below; rise; right

89) In the long-run ISLM model and with everything else held constant, as long as the level of

89) ______

output ________ the natural rate level, the price level will continue to ________, shifting the LM curve to the ________, until finally output is back at the natural rate level.

A) exceeds; fall; left B) r emains below; rise; left C) exceeds; rise; right D) r emains below; fall; right

90) In the long-run ISLM model and with everything else held constant, an increase in the money

90) ______

supply leaves the level of output and interest rates unchanged, an outcome called A) the long-run Phillips curve.

B) l ong-run money neutrality.

C) long-run crowding out.

D) i nterest rate overshooting.

91) In the long-run ISLM model and with everything else held constant, the long-run effect of an

91) ______

expansionary monetary policy is to A) increase real output and the interest rate.

B) increase the interest rate and leave real output unchanged.

C) not change either real output or the interest rate.

D) increase real output and leave the interest rate unchanged.

92) The long-run neutrality of money refers to the fact that in the long run, monetary policy A) changes only the real interest rate.

B) changes both real output and the real interest rate.

C) has no effect on either real output or the real interest rate.

D) changes only real output.

92) ______

93) In the long-run ISLM model and with everything else held constant, the long-run effect of an

93) ______

expansionary fiscal policy is to A) increase the interest rate and leave real output unchanged.

B) increase real output and leave the interest rate unchanged.

C) not change either real output or the interest rate.

D) increase real output and the interest rate.

94) In the long-run ISLM model and with everything else held constant, the long-run effect of a

94) ______

contractionary fiscal policy is to A) decrease real output and leave the interest rate unchanged.

B) not change either real output or the interest rate.

C) decrease real output and the interest rate.

D) decrease the interest rate and leave real output unchanged.

95) In the long-run ISLM model and with everything else held constant, the long-run effect of a cut

95) ______

in government spending is to A) not affect real output and increase the interest rate.

B) not affect real output and reduce the interest rate.

C) increase real output and not affect the interest rate.

D) increase real output and the interest rate.

96) In the long-run ISLM model and with everything else held constant, the long-run effect of a tax

96) ______

cut is to A) not affect real output and increase the interest rate.

B) increase real output and not affect the interest rate.

C) not affect real output and reduce the interest rate.

D) increase real output and the interest rate.

97) In the long-run ISLM model and with everything else held constant, the long-run effect of an

97) ______

autonomous increase in investment is to A) increase real output and the interest rate.

B) not affect real output and increase the interest rate.

C) increase real output and not affect the interest rate.

D) not affect real output and reduce the interest rate.

98) In the long-run ISLM model and with everything else held constant, the long-run effect of a fall

98) ______

in net exports is to A) not affect real output and reduce the interest rate.

B) increase real output and the interest rate.

C) increase real output and not affect the interest rate.

D) not affect real output and increase the interest rate.

99) In the long-run ISLM model and with everything else held constant, the long-run effect of an

99) ______

autonomous fall in consumption expenditure is to A) increase real output and the interest rate.

B) not affect real output and reduce the interest rate.

C) not affect real output and increase the interest rate.

D) increase real output and not affect the interest rate.

100) In the long-run the ISLM model predicts that A) only fiscal policy can change real output.

B) only monetary policy can change real output.

C) both monetary and fiscal policy can change real output.

D) neither monetary nor fiscal policy can change real output.

100) _____

101) If the price level increases, other things equal, the ________ curve shifts to the ________.

A) LM; left B) I S; right C) I S; left D) L M; right

101) _____

ESSAY. Write your answer in the space provided or on a separate sheet of paper.

102) Using the long-run ISLM model, explain and demonstrate graphically the neutrality of money, for the case of an increase in the money supply.

MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question.

103) _____ 103) The relationship between the price level and the quantity of aggregate output for which the goods and money markets are in equilibrium is called A) the aggregate demand curve.

B) t he LM curve.

C) the production function.

D) t he IS curve.

104) If the price level decreases, other things equal, the ________ curve shifts to the ________.

A) IS; left B) I S; right C) L M; right D) L M; left

104) _____

105) Other things equal, a decrease in the price level will A) shift the aggregate demand curve to the right.

B) move the economy down a given aggregate demand curve.

C) move the economy up a given aggregate demand curve.

D) shift the aggregate demand curve to the left.

105) _____

106) In deriving the aggregate demand curve a ________ in the price level leads to ________ in the

106) _____

real money supply because the nominal quantity of dollars can purchase ________ goods and services.

A) decline; a decrease; more B) d ecline; an increase; more C) rise; a decrease; more D) r ise; an increase; fewer

107) In deriving the aggregate demand curve a ________ price level ________ the money supply in

107) _____

real terms, raises interest rates, and ________ the equilibrium level of aggregate output.

A) lower; increases; lowers B) h igher; reduces; lowers C) higher; reduces; raises D) l ower; increases; raises

108) The aggregate demand curve slopes down and to the right because A) a decrease in the price level increases the nominal money supply, lowering interest rates.

B) a decrease in the price level raises the real money supply, decreasing output.

C) an increase in the price level increases the real money supply, lowering interest rates.

D) a decrease in the price level raises the real money supply, lowering interest rates.

108) _____

109) The aggregate demand curve has the usual downward slope, since a ________ price level

109) _____

________ the real money supply, raises interest rates, and lowers the equilibrium level of aggregate output.

A) higher; reduces B) l ower; reduces C) lower; increases D) h igher; increases

110) The aggregate demand curve has the usual downward slope, since a higher price level reduces

110) _____

the real money supply, ________ interest rates, and ________ the equilibrium level of aggregate output.

A) raises; raises B) l owers; raises C) r aises; lowers D) l owers; lowers

111) Other things being equal, an increase in government spending will cause A) the quantity of aggregate demand to increase.

B) aggregate demand to decrease.

111) _____

C) the quantity of aggregate demand to decrease.

D) aggregate demand to increase.

112) Expansionary monetary policies, all else remaining the same, will cause A) the quantity of aggregate demand to decrease.

B) aggregate demand to decrease.

C) aggregate demand to increase.

D) the quantity of aggregate demand to increase.

112) _____

113) Contractionary monetary policies, other things being equal, will cause A) aggregate demand to decrease.

B) the quantity of aggregate demand to decrease.

C) aggregate demand to increase.

D) the quantity of aggregate demand to increase.

113) _____

114) Everything else held constant, a purchase of government securities by the Fed will cause A) the quantity of aggregate demand to decrease.

B) aggregate demand to increase.

C) the quantity of aggregate demand to increase.

D) aggregate demand to decrease.

114) _____

115) Everything else held constant, an increase in autonomous consumer spending will cause the IS

115) _____

curve to shift to the ________ and aggregate demand will ________.

A) left; decrease B) l eft; increase C) r ight; increase

D) r ight; decrease

116) Everything else held constant, a decrease in autonomous consumer spending will cause the IS curve to shift to the ________ and aggregate demand will ________.

A) right; increase B) l eft; increase C) l eft; decrease

116) _____

D) r ight; decrease

117) Everything else held constant, an increase in autonomous planned investment spending will

117) _____

cause the IS curve to shift to the ________ and aggregate demand will ________.

A) left; increase B) l eft; decrease C) r ight; decrease D) r ight; increase

118) Everything else held constant, a decrease in autonomous planned investment spending will

118) _____

cause the IS curve to shift to the ________ and aggregate demand will ________.

A) left; decrease B) r ight; increase C) l eft; increase D) r ight; decrease

119) Everything else held constant, a decrease in net taxes will cause the IS curve to shift to the ________ and aggregate demand will ________.

A) left; increase B) r ight; increase

C) l eft; decrease

D) r ight; decrease

120) Everything else held constant, an increase in net taxes will cause the IS curve to shift to the ________ and aggregate demand will ________.

A) left; decrease B) r ight; decrease

C) l eft; increase

121) _____

D) l eft; decrease

122) Everything else held constant, a depreciation of the domestic currency will cause the IS curve to shift to the ________ and aggregate demand will ________.

A) right; decrease B) r ight; increase C) l eft; decrease

120) _____

D) r ight; increase

121) Everything else held constant, an appreciation of the domestic currency will cause the IS curve to shift to the ________ and aggregate demand will ________.

A) right; increase B) l eft; increase C) r ight; decrease

119) _____

D) l eft; increase

122) _____

123) Everything else held constant, a decrease in government spending will cause the IS curve to shift to the ________ and aggregate demand will ________.

A) right; increase B) l eft; decrease C) l eft; increase

123) _____

D) r ight; decrease

124) An increase in the interest sensitivity of money demand will _________ the fiscal policy

124) _____

multiplier and will ________ the monetary policy multiplier.

A) increase; increase B) d ecrease; decrease C) increase; decrease D) d ecrease; increase

125) An increase in the interest sensitivity of planned investment spending will _________ the fiscal

125) _____

policy multiplier and will ________ the monetary policy multiplier.

A) decrease; increase B) i ncrease; decrease C) increase; increase D) d ecrease; decrease

126) An autonomous appreciation of the domestic exchange rate A) increases output, and decreases net exports and the interest rate.

B) decreases output, net exports, and the interest rate.

C) increases output, net exports, and the interest rate.

D) decreases output and net exports and increases the interest rate.

126) _____

127) An autonomous depreciation of the domestic exchange rate A) decreases output and net exports and increases the interest rate.

B) decreases output, net exports, and the interest rate.

C) increases output, net exports, and the interest rate.

D) increases output, and decreases net exports and the interest rate.

127) _____

1) C 2) B 3) C 4) A 5) A 6) D 7) A 8) C 9) B 10) C 11) B 12) C 13) D 14) C 15) A 16) A 17) C 18) A 19) A 20) C 21) A 22) B 23) A 24) D 25) C 26) A 27) C 28) D 29) B 30) B 31) A 32) A 33) C 34) C 35) D 36) A 37) C 38) C 39) A 40) A 41) D 42) D 43) D 44) B 45) C 46) C 47) C 48) A 49) A 50) C

51) C 52) C 53) A 54) A 55) C 56) B 57) D 58) C 59) D 60) B 61) A 62) C 63) A 64) B 65) B 66) 72) The monetary expansion shifts the LM curve to the right which by itself would cause the interest rate to decrease D 67) and B aggregate output to increase. The fiscal contraction shifts the IS curve to the left which by itself would cause 68) the B interest rate to decrease and aggregate output to decrease. Therefore, the equilibrium interest rate unambiguously falls, while the effect on output is indeterminate.

69) 73) See figure below.

D 70) A 71) D

The monetary contraction shifts the LM curve to the left. The result is that the equilibrium level of output falls and the equilibrium interest rate increases.

74) C 75) B 76) D 77) A 78) B 79) B 80) D 81) B 82) B 83) B

84) C 85) See figure below.

This is the total crowding out effect. The LM curve is vertical, so any shift of the IS curve affects only interest rates.

The level of output is constant. The fiscal expansion shifts the IS curve rightward, increasing the interest rate.

86) See figure below.

Unstable money demand causes the LM curve to shift between LM' and LM". If the money supply is targeted, output fluctuates between ' and ". With an interest rate target, output remains stable at objective is to minimize output fluctuations, targeting the interest rate is preferable.

87) D 88) A 89) D 90) B 91) C 92) C 93) A 94) D 95) B 96) A 97) B 98) A 99) B 100) D 101) A

102) See figure below.

. Since the

The increase in the money supply shifts LM to the right, increasing output to

, above the natural rate

. The

interest rate falls from to . Excess demand increases the price level, reducing the real value of the money supply. The LM curve shifts back until the all pressure on prices is eliminated by the return to the natural rate of output. The initial and final levels of output and interest rate are the same. No real variables have changed.

103) A 104) C 105) B 106) B 107) B 108) D 109) A 110) C 111) D 112) C 113) A 114) B 115) C 116) C 117) D 118) A 119) B 120) A 121) D 122) B 123) B 124) C 125) A 126) B 127) C

Exam Name___________________________________ MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question.

1) The aggregate demand curve is the total quantity of an economy's A) intermediate goods demanded at a particular price level.

B) intermediate goods demanded at all price levels.

C) final goods and services demanded at different price levels.

D) final goods and services demanded at a particular price level.

1) _______

2) The total quantity of an economy's final goods and services demanded at different price levels

2) _______

is

A) the Phillips curve.

C) the aggregate expenditure function.

B) t he aggregate demand curve.

D) t he aggregate supply curve.

3) According to the quantity theory of money, changes in the money supply are A) unrelated to shifts in the aggregate demand curve.

B) the primary source of changes in aggregate spending.

C) unrelated to changes in inflation.

D) unrelated to changes in the price level.

3) _______

4) The quantity theory of money concludes that changes in aggregate spending are primarily

4) _______

determined by changes in A) government spending and taxes.

C) the velocity of money.

B) i nterest rates.

D) t he money supply.

5) The average number of times per year that a dollar is spent on final goods and services is called A) velocity.

B) t he equation of exchange.

C) acceleration.

D) n ominal output.

5) _______

6) Suppose nominal GDP is equal to $200 trillion and the money supply equals $50 trillion. In

6) _______

this case, the velocity of money is equal to ________.

B) 2 C) 1 A) 5

D) 4

7) Suppose real GDP is equal to $100 trillion, the money supply is equal to $50 trillion and the

7) _______

price level is equal to 2. In this case, the velocity of money is equal to ________.

B) 1 C) 2 D) 4 A) 5

8) The quantity theory of money is derived from A) the equation of exchange.

B) the concept of velocity.

C) the Keynesian monetary transmission mechanism.

D) the money supply.

8) _______

9) As approached through the quantity theory of money, aggregate demand is derived from A) the spending multiplier.

B) its four component parts: consumer expenditure, investment spending, government

9) _______

spending, and net exports.

C) its three component parts: consumer expenditure, investment spending, and government spending.

D) the equation of exchange.

10) The aggregate demand curve slopes downward because a decrease in the price level means

10) ______

________ in the real money supply and therefore a ________ level of real spending.

A) a decrease; lower B) a n increase; lower C) an increase; higher D) a decrease; higher

11) According to the quantity theory of money approach to aggregate demand, an increase in the

11) ______

money supply, other things equal, ________ aggregate ________.

A) decreases; supply B) i ncreases; supply C) increases; demand D) d ecreases; demand

12) According to the quantity theory of money approach to aggregate demand, a decrease in the

12) ______

money supply, other things equal, ________ aggregate ________.

A) decreases; supply B) i ncreases; demand C) increases; supply D) d ecreases; demand

13) One way to derive aggregate demand is by looking at its four component parts, which are: A) consumer expenditures, planned investment spending, government spending, and gross

13) ______

exports.

B) consumer expenditures, planned investment spending, government spending, and taxes.

C) consumer expenditures, actual investment spending, government spending, and net exports.

D) consumer expenditures, planned investment spending, government spending, and net exports.

14) By analyzing aggregate demand through its component parts, we can conclude that, everything

14) ______

else held constant, a decline in the price level causes A) an increase in the real money supply, an increase in interest rates, a decline in investment spending, and a decline in aggregate output demand.

B) a decline in the real money supply, an increase in interest rates, a decline in investment spending, and a decline in aggregate output demand.

C) an increase in the real money supply, a decline in interest rates, an increase in investment spending, and an increase in aggregate output demand.

D) a decline in the real money supply, a decline in interest rates, an increase in investment spending, and an increase in aggregate output demand.

15) By looking at aggregate demand via its component parts, we can conclude that the aggregate

15) ______

demand curve is downward sloping because A) a higher price level, holding the nominal quantity of money constant, leads to a smaller quantity of money in real terms, causes the interest rate to fall, and stimulates planned investment spending.

B) a lower price level, holding the nominal quantity of money constant, leads to a larger quantity of money in real terms, causes the interest rate to fall, and stimulates planned investment spending.

C) a lower price level, holding the nominal quantity of money constant, leads to a larger quantity of money in nominal terms, causes the interest rate to rise, and stimulates planned investment spending.

D) a higher price level, holding the nominal quantity of money constant, leads to a larger quantity of money in real terms, causes the interest rate to fall, and stimulates planned investment spending.

16) By looking at aggregate demand through its component parts, we can conclude that a

16) ______

17) By analyzing aggregate demand via its component parts, we can conclude that changes in the

17) ______

_________ price level _________ the real quantity of money, ________ higher spending.

B)A) h igher; encouraging higher;contracts; expands; encouraging D)C) l ower; expands; encouraging lower; contracts; discouraging

money supply A) affect aggregate demand in the same direction as the change in government spending.

B) have no effect on aggregate demand.

C) affect the quantity of aggregate output demand.

D) affect aggregate demand in the opposite direction of the change in government spending.

18) An increase in government spending, other things equal, ________ aggregate ________.

A) increases; supply B) d ecreases; supply C) increases; demand D) d ecreases; demand

18) ______

19) A decrease in government spending, other things equal, ________ aggregate ________.

A) decreases; demand B) d ecreases; supply C) increases; demand D) i ncreases; supply

19) ______

20) A decrease in net taxes, other things equal, ________ aggregate ________.

A) decreases; supply B) d ecreases; demand C) increases; demand D) i ncreases; supply

20) ______

21) An increase in net taxes, other things equal, ________ aggregate ________.

A) increases; supply B) i ncreases; demand C) decreases; demand D) d ecreases; supply

21) ______

22) Everything else held constant, a balanced budget increase in government spending (that is, an

22) ______

increase in government spending that is matched by an identical increase in net taxes) will A) increase aggregate demand by more than if just government spending increases.

B) decrease aggregate demand.

C) will not affect aggregate demand.

D) increase aggregate demand, but not by as much if just government spending increases.

23) An increase in net exports, other things equal, ________ aggregate ________.

A) decreases; supply B) d ecreases; demand C) increases; supply D) i ncreases; demand

23) ______

24) A decrease in net exports, other things equal, ________ aggregate ________.

A) decreases; demand B) i ncreases; demand C) increases; supply D) d ecreases; supply

24) ______

25) Everything else held constant, an increase in planned investment expenditure ________

25) ______

aggregate ________.

A) increases; supply C) increases; demand

B) d ecreases; supply D) d ecreases; demand

26) Everything else held constant, a decrease in planned investment expenditure ________ aggregate ________.

A) decreases; supply

B) d ecreases; demand

26) ______

C) increases; demand

D) i ncreases; supply

27) Everything else held constant, aggregate demand increases when 27) ______ A) taxes are cut.

B) t he money supply is reduced.

C) animal spirits decrease.

D) g overnment spending is reduced.

28) Everything else held constant, aggregate demand increases when A) planned investment spending B) et exports decrease.

D) n t he money supply decreases.

28) ______

increases.

C) taxes increase.

29) Everything else held constant, which of the following does not cause aggregate demand to increase?

A) An increase in net exports.

C) An increase in consumer optimism.

29) ______

B) A n increase in taxes.

D) A n increase in government spending.

ESSAY. Write your answer in the space provided or on a separate sheet of paper.

30) Explain through the component parts of aggregate demand why the aggregate demand curve slopes down with respect to the price level. Be sure to discuss two channels through which changes in prices affect demand.

MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question.

31) The aggregate supply curve is the total quantity of 31) ______ A) intermediate and final goods and service offered for sale at different price levels.

B) raw materials offered for sale at different prices.

C) final goods and services offered for sale at the current price level.

D) final goods and services offered for sale at different price levels.

32) The aggregate supply curve shows the relationship between A) the price level and the level of inputs.

B) the wage rate and the level of employment.

C) the price level and the level of aggregate output supplied.

D) the level of inputs and aggregate output.

32) ______

33) The long-run rate of unemployment to which an economy always gravitates is the A) inflationary rate of unemployment.

B) n atural rate of unemployment.

C) normal rate of unemployment.

D) n eutral rate of unemployment.

33) ______

34) The long-run aggregate supply curve is A) a vertical line through the natural rate level of output.

B) a horizontal line through the current level of output.

C) a vertical line through the current level of output.

D) a vertical line through the non-inflationary rate of output.

34) ______

35) The long-run aggregate supply curve is a vertical line passing through A) the natural-rate price level.

B) t he expected rate of inflation.

C) the actual rate of unemployment.

D) t he natural rate of output.

35) ______

36) The short-run aggregate supply curve is upward sloping because in the short run, costs of

for a of unit output

many factors that go into producing goods and services are ________, meaning that the price

____ __

36) will ________ relative to input prices and the profit per unit will rise.

A) fixed; rise

B) f lexible; rise

C) f ixed; fall

D) flexible; fall

37) The positively sloped short-run aggregate supply curve reflects the assumption that factor

37) ______

prices are A) perfectly flexible in both the short run and the long run.

B) less flexible than output prices.

C) fixed in the long run.

D) more flexible than output prices.

38) Everything else held constant, an increase in the cost of production ________ aggregate ________.

A) decreases; demand C) increases; supply

B) d ecreases; supply D) i ncreases; demand

39) Everything else held constant, a decrease in the cost of production ________ aggregate ________.

A) increases; demand C) increases; supply

39) ______

B) d ecreases; supply D) d ecreases; demand

40) Everything else held constant, when output is ________ the natural rate level, wages will begin to ________, increasing short-run aggregate supply.

A) above; rise B) b elow; fall C) a bove; fall

to ________, decreasing short-run aggregate supply.

A) above; fall B) a bove; rise C) b elow; rise

40) ______

D) b elow; rise

41) Everything else held constant, when output is ________ the natural rate level, wages will begin

41) ______

D) b elow; fall

42) Everything else held constant, when actual output exceeds the natural rate of output ________ aggregate supply ________.

A) long-run; decreases C) short-run; increases

38) ______

42) ______

B) s hort-run; decreases D) l ong-run; increases

43) If workers demand and receive higher real wages (a successful wage push), the cost of

43) ______

production ________ and the short-run aggregate supply curve shifts ________.

A) rises; leftward B) f alls; rightward C) rises; rightward D) f alls; leftward

44) Everything else held constant, if workers expect an increase in the price level, ________ aggregate supply ________.

A) short-run; increases C) short-run; decreases

B) l ong-run; decreases D) l ong-run; increases

45) Everything else held constant, a change in workers' expectations about the aggregate price level will cause ________ to change.

44) ______

45) ______

A) aggregate demand C) the production function

B) l ong-run aggregate supply D) s hort-run aggregate supply

46) A decrease in the availability of raw materials that increases the price level is called a ________ shock

A) negative supply C) negative demand

46) ______

B) p ositive supply D) p ositive demand

47) ______ 47) A negative supply shock causes ________ to ________.

A) short-run aggregate supply; decrease B) a ggregate demand; decrease C) aggregate demand; increase D) s hort-run aggregate supply; increase 48) ______ 48) A positive supply shock causes ________ to ________.

A) aggregate demand; increase B) s hort-run aggregate supply; increase C) aggregate demand; decrease D) s hort-run aggregate supply; decrease 49) Which of the following increases aggregate supply in the short-run, everything else held

49) ______

constant?

A) Expectations of a higher aggregate price level.

B) An increase in the price of crude oil.

C) A successful wage push by workers.

D) A technological improvement that increases worker productivity.

50) ______ 50) The fact that an economy always returns to the natural rate level of output is known as A) the natural rate of unemployment.

B) t he price-adjustment mechanism.

C) the self-correcting mechanism.

D) t he excess demand hypothesis.

51) Assuming the economy is starting at the natural rate of output and everything else held

51) ______

constant, the effect of ________ in aggregate ________is a rise in both the price level and output in the short-run, but in the long-run the only effect is a rise in the price level.

A) an increase; supply B) a decrease; demand C) a decrease; supply D) a n increase; demand

52) The aggregate demand-aggregate supply framework indicates that the long-run effect of a

52) ______

_________ in the money supply is an increase in _________, everything else held constant.

A) rise; aggregate output B) f all; aggregate output C) rise; the price level D) f all; the price level

53) Suppose the economy is producing at the natural rate of output. Everything else held

53) ______

constant, the development of a new, more productive technology will cause ________ in the unemployment rate and ________ in the aggregate price level in the short run.

A) a decrease; an increase B) a decrease; a decrease C) an increase; an increase D) n o change; no change

54) Suppose the economy is producing at the natural rate of output. Assuming a fixed natural rate

54) ______

of output and everything else held constant, the development of a new, more productive technology will cause ________ in the unemployment rate and ________ the aggregate price level in the long run.

A) no change; no change B) a n increase; an increase C) a decrease; an increase D) a decrease; a decrease

55) Suppose the economy is producing at the natural rate of output. An increase in consumer and

business

____ __

confidenc 55) e will cause ________ in real GDP and ________ in the aggregate price level in the short run, everythin g else held constant.

A) no change; a decrease C) an increase; an increase

B) a decrease; a decrease D) n o change; an increase

56) Suppose the economy is producing at the natural rate of output. An increase in consumer and

56) ______

business confidence will cause ________ in real GDP and ________ in the aggregate price level in the long run, everything else held constant.

A) no change; an increase B) a decrease; a decrease C) no change; a decrease D) a n increase; an increase

57) Suppose the economy is producing at the natural rate of output. A decrease in consumer and

57) ______

business confidence will cause ________ in real GDP and ________ in the aggregate price level in the short run, everything else held constant.

A) a decrease; a decrease B) n o change; a decrease C) no change; an increase D) a n increase; an increase

58) Suppose the economy is producing at the natural rate of output. A decrease in consumer and

58) ______

business confidence will cause ________ in real GDP and ________ in the aggregate price level in the long run, everything else held constant.

A) an increase; an increase B) n o change; a decrease C) a decrease; a decrease D) n o change; an increase

59) Suppose the economy is producing at the natural rate of output. An open market purchase of

59) ______

bonds by the Fed will cause ________ in real GDP and ________ in the aggregate price level in the short run, everything else held constant.

A) no change; a decrease B) n o change; an increase C) a decrease; a decrease D) a n increase; an increase

60) Suppose the economy is producing at the natural rate of output. An open market purchase of

60) ______

bonds by the Fed will cause ________ in real GDP and ________ in the aggregate price level in the long run, everything else held constant.

A) a decrease; a decrease B) n o change; a decrease C) an increase; an increase D) n o change; an increase

61) Suppose the economy is producing at the natural rate of output. An open market sale of bonds by the Fed will cause ________ in real GDP and ________ in the aggregate price level in the short run, everything else held constant.

A) a n increase; an increase

B) n o change; a decrease

61) ______

C) no change; an increase

D) a decrease; a decrease

62) Suppose the economy is producing at the natural rate of output. An open market sale of

62) ______

bonds by the Fed will cause ________ in real GDP and ________ in the aggregate price level in the long run, everything else held constant.

A) no change; a decrease B) n o change; an increase C) an increase; an increase D) a decrease; a decrease

63) Suppose the U.S. economy is producing at the natural rate of output. A depreciation of the

63) ______

U.S. dollar will cause ________ in real GDP and ________ in the aggregate price level in the short run, everything else held constant. (Assume the depreciation causes no effects in the supply side of the economy.)

A) an increase; an increase B) n o change; an increase C) no change; a decrease D) a decrease; a decrease

64) Suppose the U.S. economy is producing at the natural rate of output. A depreciation of the

64) ______

U.S. dollar will cause ________ in real GDP and ________ in the aggregate price level in the long run, everything else held constant. (Assume the depreciation causes no effects in the supply side of the economy.)

A) a decrease; a decrease B) n o change; a decrease C) no change; an increase D) a n increase; an increase

65) Suppose the U.S. economy is producing at the natural rate of output. An appreciation of the

65) ______

U.S. dollar will cause ________ in real GDP and ________ in the aggregate price level in the short run, everything else held constant. (Assume the appreciation causes no effects in the supply side of the economy.)

A) an increase; an increase B) n o change; an increase C) a decrease; a decrease D) n o change; a decrease

66) Suppose the U.S. economy is producing at the natural rate of output. An appreciation of the

66) ______

U.S. dollar will cause ________ in real GDP and ________ in the aggregate price level in the long run, everything else held constant. (Assume the appreciation causes no effects in the supply side of the economy.)

A) no change; an increase B) a n increase; an increase C) no change; a decrease D) a decrease; a decrease

67) Suppose the economy is producing below the natural rate of output and the government is

67) ______

suffering from large budget deficits. To deal with the deficit problem, suppose the government takes a policy action to reduce the size of the deficits. This policy action will cause ________ in the unemployment rate and ________ in the aggregate price level in the short run, everything else held constant.

A) an increase; a decrease B) a decrease; an increase C) an increase; an increase D) a decrease; a decrease

68) Suppose the economy is producing at the natural rate of output and the government passes

68) ______

legislation that severely restricts a company's ability to reduce production costs via outsourcing. Everything else held constant, this policy action will cause ________ in the unemployment rate and ________ in the aggregate price level in the short run.

A) an increase; an increase B) a decrease; a decrease C) no change; no change D) a decrease; an increase

69) Suppose the U.S. economy is operating at potential output. A negative supply shock that is

accommod

____ __

ated by an69) open market purchase by the Federal Reserve will cause ________ in real GDP and ________ in the aggregate price level in the long run, everythin g else held constant.

A) an increase; an increase C) no change; an increase

B) n o change; a decrease D) a decrease; a decrease

70) A theory of aggregate economic fluctuations called real business cycle theory holds that A) aggregate supply shocks do affect the natural rate of output.

B) changes in the real money supply are the only demand shocks that affect the natural rate

70) ______

of output.

C) changes in net exports are the only demand shocks that affect the natural rate of output.

D) aggregate demand shocks do affect the natural rate of output.

71) This theory views shocks to tastes (workers' willingness to work, for example) and technology

71) ______

(productivity) as the major driving forces behind short-run fluctuations in the business cycle because these shocks lead to substantial short-run fluctuations in the natural rate of output.

A) The natural rate hypothesis B) H ysteresis C) The Phillips curve model D) R eal business cycle theory

72) Because shifts in aggregate demand are not viewed as being particularly important to

72) ______

aggregate output fluctuations, they do not see much need for activist policy to eliminate high unemployment. "They" refers to proponents of A) the Phillips curve model.

B) t he natural rate hypothesis.

C) monetarism.

D) r eal business cycle theory.

73) A group of economists believe that the natural rate of output is affected by aggregate ________

73) ______

shocks. They contend that the natural rate level of unemployment and output are subject to ________, a departure from full employment levels as a result of past high unemployment.

A) demand; hysterisis B) d emand; systerisis C) supply; systerisis D) s upply; hysterisis

74) A reduction of aggregate demand may raise the natural rate of unemployment above the full employment level, meaning that the self-correcting mechanism will only be able to return the economy to the natural rate level of output and unemployment—not to the full employment levels. Such a view is consistent with

74) ______

A) monetarism.

C) hysterisis.

B) K eynesianism.

D) r eal business cycle theory.

75) According to aggregate demand and supply analysis, America's involvement in the Vietnam

75) ______

War had the effect of A) decreasing aggregate output, raising unemployment, and lowering the price level.

B) decreasing aggregate output, lowering unemployment, and lowering the price level.

C) increasing aggregate output, lowering unemployment, and raising the price level.

D) increasing aggregate output, raising unemployment, and raising the price level.

76) According to aggregate demand and supply analysis, the negative supply shocks of 1973-1975

76) ______

and 1978-1980 had the effect of A) increasing aggregate output, raising unemployment, and raising the price level.

B) increasing aggregate output, lowering unemployment, and raising the price level.

C) decreasing aggregate output, raising unemployment, and lowering the price level.

D) decreasing aggregate output, raising unemployment, and raising the price level.

77) According to aggregate demand and supply analysis, the favorable supply shock of 1995-1999

77) ______

had the effect of A) increasing aggregate output, lowering unemployment, and raising inflation.

B) decreasing aggregate output, raising unemployment, and raising inflation.

C) decreasing aggregate output, raising unemployment, and lowering inflation.

D) increasing aggregate output, lowering unemployment, and lowering inflation.

78) According to aggregate demand and supply analysis, the negative demand shock of 2000-2004

78) ______

had the effect of A) increasing aggregate output, lowering unemployment, and raising inflation.

B) decreasing aggregate output, raising unemployment, and raising inflation.

C) decreasing aggregate output, raising unemployment, and lowering inflation.

D) increasing aggregate output, lowering unemployment, and lowering inflation.

ESSAY. Write your answer in the space provided or on a separate sheet of paper.

79) Using the aggregate demand-aggregate supply model, explain and demonstrate graphically the short-run and log-run effects of an increase in the money supply.

80) Explain and demonstrate graphically the effects of a negative supply shock in both the short-run and long-run.

MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question.

81) The Phillips curve indicates that when the labor market is ________, production costs will 81) ______ ________ and aggregate supply increases.

A) easy; rise B) t ight; rise

C) e asy; fall

D) t ight; fall

82) The Phillips curve indicates that when the labor market is ________, production costs will ________ and aggregate supply decreases.

A) easy; rise B) t ight; fall

C) t ight; rise

D) e asy; fall

83) The expectations-augmented Phillips curve implies that as expected inflation increases, nominal wages ________ to prevent real wages from ________.

A) rise; falling B) f all; falling C) r ise; rising

82) ______

D) f all; rising

83) ______

84) The Lucas supply function indicates that deviations of unemployment from the natural rate level respond to A) any increase in aggregate demand.

C) unanticipated inflation.

B) a supply shock.

D) e xpected changes in inflation.

84) ______

1) C 2) B 3) B 4) D 5) A 6) D 7) D 8) A 9) D 10) C 11) C 12) D 13) D 14) C 15) B 16) D 17) A 18) C 19) A 20) C 21) C 22) D 23) D 24) A 25) C 26) B 27) A 28) A 29) B 30) A fall in the price level increases the real value of a fixed nominal money supply. This increase in the real money supply lowers interest rates. Lower rates increase investment, thereby increasing aggregate demand. Lower interest rates also cause depreciation of the domestic currency, increasing net exports and aggregate demand.

31) D 32) C 33) B 34) A 35) D 36) A 37) B 38) B 39) C 40) B 41) B 42) B 43) A 44) C 45) D 46)

49) D 50) C 51) D 52) C 53) B 54) A 55) C 56) A 57) A 58) B 59) D 60) D 61) D 62) A 63) A 64) C 65) C 66) C 67) A 68) 79) A See figure below.

69) C 70) A 71) D 72) D 73) A 74) C 75) C 76) D 77) D 78) An C increase in the money supply increases aggregate demand, from

to . The economy moves from point 1 to point 1'. In the short run both the price level and real output increase. In the long run, wages adjust, decreasing short-run aggregate supply, to , raising prices further and reducing real output until the economy returns to the natural level of output. The long-run result is to only increase the price level. The path is from 1 to 1' to 2.

80) See figure below.

The supply shock decreases short-run aggregate supply from to , reducing real output and raising the price level, or from points 1 to 2 in the graph. In the long run, the supply curve eventually adjusts back to the original position as wages fall. The economy adjusts from 2 back to 1.

81) C 82) C 83) A 84) C

Exam Name___________________________________ MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question.

1) Evidence that examines whether one variable has an effect on another by simply looking

1) _______

2) Evidence that is based on a variable having its effect on another variable through channels

2) _______

directly at the relationship between the two variables is A) reduced-form evidence.

B) d irect-model evidence.

C) organizational-model evidence.

D) s tructural-model evidence.

rather than a direct effect is known as A) structural-model evidence.

C) reduced-form evidence.

B) o rganizational-model evidence.

D) i ndirect-model evidence.

3) On the evening news you hear of a scientific study that directly links premature births to cigarette smoking. This is an example of A) direct-model evidence.

C) reduced-form evidence.

3) _______

B) i nformed voter-model evidence.

D) s tructural-model evidence.

4) The monetarist-Keynesian debate on the importance of monetary policy is unresolved because

4) _______

monetarists and Keynesians focus on two different types of evidence that generate conflicting conclusions. Monetarists tend to focus on A) reduced-form evidence, while Keynesians focus on structural-model evidence.

B) structural-model evidence, while Keynesians focus on reduced-form evidence.

C) reduced-form evidence, while Keynesians focus on direct-model evidence.

D) structural-model evidence, while Keynesians focus on direct-model evidence.

5) The channels through which monetary policy affects economic activity are called the ________ of monetary policy.

A) flow mechanisms C) allocational mechanisms

5) _______

B) t ransmission mechanisms D) d istribution mechanisms

6) A model that is composed of many equations that show the channels through which monetary

6) _______

and fiscal policy affect aggregate output and spending is called a A) reduced-form model.

B) i nformed median-voter model.

C) structural model.

D) m edian-voter model.

7) Monetarists directly study the link between money and economic activity using A) experimental models.

B) s tructural models.

C) reduced-form models.

D) s cientific models.

7) _______

8) The monetarist reduced-form evidence does not specify the working of the economy and thus

8) _______

is considered to be a A) black box.

C) open model.

B) b lack hole.

D) s cientific model.

9) Which of the following is not an advantage of a correctly specified structural model?

A) Structural models may allow economists to more accurately predict the impact institutional changes have on the link between monetary policy and income.

B) A structural model imposes no restrictions on the way monetary policy affects the economy.

9) _______

C) Structural models may help us to more accurately predict the effect that monetary policy has on economic activity.

D) A structural model provides more pieces of evidence about monetary policy's effect on economic activity.

10) Predicting the impact of institutional change on the effectiveness of monetary policy is best done with a A) scientific model.

C) black-box model.

B) r educed-form model.

D) s tructural model.

11) The monetarists complained that early Keynesian structural models tended to ignore the impact of monetary policy changes on A) investment spending.

C) capital goods spending.

10) ______

11) ______

B) i nterest rates.

D) c onsumption spending.

12) Monetarists contend that the channels of monetary influence in Keynesian structural models

12) ______

are too ________ defined, ________ the importance of monetary policy.

A) narrowly; understating B) b roadly; exaggerating C) narrowly; exaggerating D) b roadly; understating

13) Monetarists claim that ________ models ignore important transmission mechanisms and

13) ______

therefore ________ the importance of the effects of monetary policy on the economy.

A) structural; overstate B) r educed-form; overstate C) structural; understate D) r educed-form; understate

14) Monetarists assert that monetary policy may affect aggregate demand through A) many channels.

B) only an interest rate channel.

C) only an exchange rate channel.

D) only two channels: interest rates and exchange rates.

14) ______

15) If the particular channels through which changes in the money supply affect aggregate income

15) ______

are diverse and continually changing, the best evidence of monetary policy's effect is likely to come from A) median-voter models.

B) r educed-form models.

C) structural models.

D) i ndirect models.

16) Monetarists' preference for reduced-form models is based on their belief that A) money supply changes are always endogenous.

B) reverse causation is a problem.

C) structural models may understate money's effect on economic activity.

D) monetary policy affects only investment spending.

16) ______

17) When Keynesians argue that "correlation does not necessarily imply causation," they are

17) ______

probably criticizing A) reduced-form evidence.

C) indirect-model evidence.

B) s tructural-model evidence.

D) b lack-box evidence.

18) Reverse causation between money and aggregate output is likely to be a problem when a central bank targets A) the exchange rate.

C) the inflation rate.

B) a monetary aggregate.

D) a n interest rate.

18) ______

19) With regard to aggregate demand, early Keynesians tended to believe that 19) ______ A) monetary policy mattered most.

B) m onetary policy mattered.

C) monetary policy did not matter.

D) m onetary policy was all that mattered.

20) The ________ held the view that monetary policy does not matter at all for movements in aggregate output.

A) new Keynesian economists C) early classical economists

B) e arly monetarists D) e arly Keynesians

21) Early Keynesians felt that ________ policy was ________, so they stressed the importance of ________ policy.

A) fiscal; too potent; monetary C) fiscal; ineffective; monetary

21) ______

B) m onetary; ineffective; fiscal D) m onetary; potent; monetary

22) Early Keynesians believed that ________ interest rates during the Great Depression indicated that monetary policy had been ________.

A) low; expansionary C) high; expansionary

20) ______

22) ______

B) h igh; contractionary D) l ow; contractionary

23) Early Keynesians viewed monetary policy as influencing aggregate demand solely through its

23) ______

impact on ________ interest rates, which, in turn, affect ________ spending. real; consumer B)A) n ominal; consumer real; investment D)C) n ominal; investment

24) Early Keynesians believed that ________ interest rates during the Great Depression indicated that monetary policy was ________.

A) low; tight B) h igh; easy

C) l ow; easy

D) h igh; tight

25) Early Keynesians believed that low ________ during the Great Depression indicated that ________ policy was easy.

A) interest rates; fiscal C) money growth; fiscal

24) ______

25) ______

B) i nterest rates; monetary D) m oney growth; monetary

26) Early Keynesians concluded that changes in monetary policy had no impact on aggregate

26) ______

output because early empirical studies found no linkage between movements in ________ and ________.

A) investment spending; aggregate output B) nominal interest rates; investment spending C) real interest rates; investment spending D) money supply; aggregate output

27) In response to the early Keynesians, monetarists contended that A) evidence from the Great Depression demonstrated the ineffectiveness of monetary policy.

B) bank failures during the Great Depression were not the cause of the decline in the money

27) ______

supply.

C) monetary policy during the Great Depression was not easy.

D) there is a weak link between interest rates and investment spending.

28) Milton Friedman and Anna Schwartz showed that monetary policy during the Great Depression had A) been essentially neutral.

28) ______

B) never been more contractionary.

C) been quite inflationary.

D) been more expansionary than in the 1920s.

29) By the standard of low-grade bonds, interest rates were ________ and monetary policy was ________ during the Great Depression.

A) high; easy B) l ow; easy

C) l ow; tight

29) ______

D) h igh; tight

30) During the Great Depression, real interest rates A) rose only slightly above the long-run trend.

B) fell to unprecedentedly low levels.

C) fell only slightly below the long-run trend.

D) rose to unprecedentedly high levels.

30) ______

31) Movements of ________ interest rates indicate that, contrary to the early Keynesians' beliefs,

31) ______

monetary policy was ________ during the Great Depression.

A) real; easy B) r eal; tight C) n ominal; tight

D) n ominal; easy

32) Movements of real interest rates indicate that, contrary to the early Keynesians' beliefs,

32) ______

________ policy was ________ during the Great Depression.

A) monetary; tight B) f iscal; tight C) monetary; easy D) f iscal; easy

33) Periods of price deflation, such as the Great Depression, are characterized by A) real rates of interest lower than the nominal rate of interest.

B) low nominal rates but high real rates of interest.

C) low nominal and real interest rates.

D) high nominal and real rates of interest.

33) ______

34) Monetarists contend that A) monetary policy may affect aggregate demand through many channels.

B) monetary policy affects aggregate demand solely through consumption.

C) monetary policy affects aggregate demand solely through investment.

D) a weak link between nominal interest rates and investment spending implies monetary

34) ______

policy ineffectiveness.

35) In the early 1960s, monetarists used reduced-form timing, statistical, and historical evidence to

35) ______

show that A) fiscal policy had a strong impact on economic activity.

B) monetary policy had a weak impact on economic activity.

C) monetary policy had a strong impact on economic activity.

D) neither monetary nor fiscal policy had a strong impact on economic activity.

36) In a study published in 1963, Milton Friedman and Anna Schwartz found that in every business

36) ______

cycle they studied over nearly a hundred-year period, the growth rate of the ________ decreased before ________ decreased.

A) budget deficit; interest rates B) b udget deficit; output C) money supply; output D) m oney supply; interest rates

37) Friedman and Schwartz found that the rate of money growth fell prior to business cycle downturns in A) four out of every five instances.

37) ______

B) a bout two out of every three instances.

C) every instance studied.

D) a bout three out of every four instances.

38) In a study published in 1963, Milton Friedman and Anna Schwartz found that in every business

38) ______

cycle they studied over nearly a hundred-year period, A) the growth rate of the money supply decreased before output decreased.

B) interest rates decreased before output decreased.

C) the growth rate of state and local government spending decreased before output decreased.

D) the growth rate of federal government spending decreased before output decreased.

39) Timing evidence is valid only if it is known that the first event is 39) ______ A) a leading indicator of the second event.

B) e ndogenous.

C) exogenous.

D) a lagging indicator of the second event.

40) Because ________ evidence is of a ________ nature, there is always the possibility of reverse

40) ______

causation, in which output growth causes money growth.

A) timing; structural B) h istorical; structural C) statistical; structural D) t iming; reduced-form

41) If the movements of the level of the money supply and real output are perfectly coordinated the

41) ______

growth rate of money A) will move in synchronization with the level of real output.

B) will lag the level of real output.

C) can either lead or lag the level of real output.

D) will lead the level of real output.

42) The monetarist statistical evidence examines the correlations between both ________ and

42) ______

________ with ________.

A) money; autonomous expenditures; the unemployment rate B) money; aggregate spending; the unemployment rate C) money; autonomous expenditures; aggregate spending D) money; consumption spending; aggregate spending

43) A criticism of the monetarist autonomous spending variable is that A) some types of autonomous spending do not affect aggregate demand.

B) Keynesians do not think that autonomous spending affects aggregate demand.

C) some types of autonomous spending affect aggregate demand only long after they occur.

D) some types of autonomous spending affect aggregate demand before the spending

43) ______

occurs. Some types of autonomous spending affect aggregate demand when they occur.

44) One of the best examples of an episode in which a change in monetary policy appears to have

44) ______

been an exogenous event is A) the decrease in reserve requirements in 1818-1819.

B) the increase in reserve requirements in 1936-1937.

C) the increase in reserve requirements in 1818-1819.

D) the decrease in reserve requirements in 1936-1937.

45) The monetarist position on the importance of monetary policy is probably best supported by A) historical evidence.

B) s tructural evidence.

C) timing evidence.

D) s tatistical evidence.

46)

45) ______

46) The monetaris t _________ evidence in which declines in money growth are followed by recessions provides the strongest support for their position that monetary policy matters.

A) statistical

____ __

B) t iming

C) s tructural

D) h istorical

47) As a result of recent empirical research, there has been a convergence of Keynesian and monetarist opinion to the view that A) fiscal policy is all that matters.

C) money does matter.

47) ______

B) m oney does not matter.

D) m oney is all that matters.

48) Real business cycle theorists are critical of monetarist reduced-form evidence because they

48) ______

believe A) there is reverse causation from the business cycle to money.

B) there is reverse causation from money to the business cycle.

C) business cycles do not exist.

D) money is the most important cause of changes in aggregate demand.

49) Real business cycle theory states that the most important cause of business cycles is A) shocks to tastes and technology.

B) i nterest rate shocks.

C) Federal Reserve policy decisions.

D) s hocks to the money supply.

49) ______

50) Economic theory suggests that ________ interest rates are ____ important than ________ interest 50) ______ rates in explaining investment behavior.

A) nominal; more; real C) market; more; real

B) r eal; more; nominal D) r eal; less; nominal

51) According to the traditional interest-rate channel, expansionary monetary policy lowers the real interest rate, thereby raising expenditure on A) net exports C) government expenditure.

51) ______

B) c onsumer nondurables.

D) b usiness fixed investment.

52) The monetary transmission mechanism that links monetary policy to GDP through real interest

rates and

____ __

investmen 52) t spending is called the

A) wealth effects.

C) cash flow channel.

B) T obins' q theory.

D) t raditional interest-rate channel.

53) If the aggregate price level adjusts slowly over time, then an expansionary monetary policy

53) ______

lowers A) the short-term nominal, the short-term real, and the long-term real interest rates.

B) only the short-term real interest rate.

C) only the short-term nominal interest rate.

D) both the short-term nominal and real interest rates.

54) If monetary policy can influence __________ prices and conditions in _________ markets, then it 54) ______ can affect spending through channels other than the traditional interest-rate channel.

A) commodity; credit B) c ommodity; labor C) asset; labor D) a sset; credit

55) An expansionary monetary policy lowers the real interest rate, causing the domestic currency to _________, thereby _________ net exports.

A) depreciate; lowering C) appreciate; raising

55) ______

B) a ppreciate; lowering D) d epreciate; raising

56) An expansionary monetary policy increases net exports by A) raising real interest rates and increasing the value of the dollar.

B) lowering nominal interest rates and decreasing the value of the dollar.

C) lowering real interest rates and decreasing the value of the dollar.

D) raising nominal interest rates and increasing the value of the dollar.

56) ______

57) A contractionary monetary policy raises the real interest rate, causing the domestic currency to

57) ______

_________, thereby _________ net exports.

A) depreciate; lowering C) depreciate; raising

B) a ppreciate; raising D) a ppreciate; lowering

58) A contractionary monetary policy decreases net exports by A) lowering real interest rates and decreasing the value of the dollar.

B) raising nominal interest rates and increasing the value of the dollar.

C) raising real interest rates and increasing the value of the dollar.

D) lowering real interest rates and increasing the value of the dollar.

58) ______

59) Tobin's q is defined as A) market value of firms minus replacement cost of capital.

B) market value of firms divided by replacement cost of capital.

C) market value of firms plus replacement cost of capital.

D) market value of firms times replacement cost of capital.

59) ______

60) Tobin's q is defined as A) the market value of firms less the replacement cost of capital.

B) the market value of firms divided by the replacement cost of capital.

C) the replacement cost of capital divided by the market value of firms.

60) ______

D) the replacement cost of capital divided by the new cost of capital.

61) Tobin's q theory suggests that monetary policy may affect investment spending through its impact on A) stock prices.

B) b ond prices.

C) i nterest rates.

61) ______

D) c ash flow.

62) In the late 1990s, the stock market bubble ________ the value of Tobin's q, and caused ________ 62) ______ in business equipment.

A) increased; underinvestment C) increased; overinvestment

B) d ecreased; underinvestment D) d ecreased; overinvestment

63) The deflation of the stock market bubble of the late 1990s likely resulted in A) a surge in net exports.

B) a collapse of housing investment.

C) a collapse of business investment spending.

D) a collapse of federal government spending.

63) ______

64) During the Great Depression, Tobin's q A) rose dramatically, as did real interest rates.

B) stayed fairly constant, in contrast to most other economic measures.

C) fell to unprecedentedly low levels.

D) rose only slightly, in spite of Hoover's attempts to prop it up.

64) ______

65) According to Tobin's q theory, ________ policy can affect ________ spending through its effect

65) ______

on the prices of common stock.

A) fiscal; consumption C) monetary; investment

B) f iscal; investment D) m onetary; consumption

66) According to Tobin's q theory, when q is ________, firms will not purchase new investment

66) ______

goods because the market value of firms is ________ relative to the cost of capital.

A) high; low B) l ow; high C) h igh; high D) l ow; low

67) According to Tobin's q theory, if q is ________, new plant and equipment capital is ________

67) ______

relative to the market value of business firms, so companies can buy a lot of new investment goods with only a ________ issue of stock.

A) low; cheap; small B) high; cheap; large C) high; cheap; small D) high; dear; large E) low; cheap; large

68) According to Tobin's q theory, when equity prices are low the market price of existing capital is

68) ______

________ relative to new capital, so expenditure on fixed investment is ________.

A) dear; high B) c heap; low C) d ear ; low D) c heap; high

69) According to Tobin's q theory, when equity prices are high the market price of existing capital

69) ______

is ________ relative to new capital, so expenditure on fixed investment is ________.

A) dear; high B) c heap; high C) c heap; low D) d ear ; low

70) Franco Modigliani has found that an expansionary monetary policy can cause stock market prices to ________ and consumption to ________.

A) increase; increase

B) d ecrease; decrease

70) ______

C) decrease; increase

D) i ncrease; decrease

71) The sharp drop in housing purchases in 1966 and 1969, when market interest rates rose above Regulation Q ceilings, is consistent with the A) cash flow channel.

C) balance sheet channel.

B) t raditional interest-rate channel.

D) b ank lending channel.

72) A rise in stock prices ________ the net worth of firms and so leads to ________ investment spending because of the reduction in moral hazard.

A) reduces; lower C) raises; lower

71) ______

72) ______

B) r aises; higher D) r educes; higher

73) Because of the presence of asymmetric information problems in credit markets, an

73) ______

expansionary monetary policy causes a ________ in net worth, which ________ the adverse selection problem, thereby _________ increased lending to finance investment spending.

A) rise; reduces; encouraging B) d ecline; reduces; discouraging C) rise; increases; discouraging D) d ecline; increases; encouraging

74) Due to asymmetric information in credit markets, monetary policy may affect economic activity

74) ______

through the balance sheet channel, where an increase in the money supply A) lowers the value of the dollar, increasing net exports and aggregate demand.

B) raises stock prices, lowering the cost of new capital relative to firms' market value, thus increasing investment spending.

C) raises firms' net worth, decreasing adverse selection and moral hazard problems, thus increasing banks' willingness to lend to finance investment spending.

D) raises the level of bank reserves, deposits, and bank loans, thereby raising spending by those individuals who do not have access to credit markets.

75) An expansionary monetary policy raises firms' cash flows by A) lowering real interest rates.

B) r aising nominal interest rates.

C) lowering nominal interest rates.

D) r aising real interest rates.

75) ______

76) If a contractionary monetary policy lowers the price level by more than expected, it raises the

76) ______

real value of consumer debt. This reduces consumer expenditure through A) the household liquidity effect.

B) t he bank lending channel.

C) the traditional interest-rate channel.

D) T obin's q.

77) An expansionary monetary policy may cause asset prices to rise, thereby reducing the

77) ______

likelihood of financial distress and causing consumer durable and housing expenditures to rise.

This monetary transmission mechanism is referred to as A) the household liquidity effect.

B) T obin's q theory.

C) the cash flow effect.

D) t he wealth effect.

78) According to the household liquidity effect, an expansionary monetary policy causes a

78) ______

__________ in the value of households' financial assets, causing consumer durable expenditure to _________.

A) decline; rise B) r ise; rise C) d ecline; fall D) r ise; fall

79) According to the household liquidity effect, higher stock prices lead to increased consumption expenditures because consumers A) want to sell stocks and spend the proceeds before stock prices fall.

B) believe that their wages will increase due to increased profitability of firms.

79) ______

C) can now afford more expensive imports.

D) feel more secure about their financial position.

80) Corporate scandals involving Enron and Arthur Andersen reduced investment and aggregate

80) ______

spending because these scandals A) forced the Fed to raise interest rates.

B) worsened adverse selection and moral hazard.

C) caused bank failures.

D) caused appreciation of the dollar.

81) In a period of deflation, when there is a declining price level, ________ nominal interest rates do

81) ______

not necessarily indicate that the cost of borrowing is ____ or that monetary policy is easy.

A) low; high B) h igh; low C) h igh; high D) l ow; low

82) In a period of deflation, when there is a declining price level, low nominal interest rates do not

82) ______

necessarily indicate that the cost of borrowing is ____ or that monetary policy is ________.

A) high; tight B) l ow; tight C) l ow; easy D) h igh; easy

ESSAY. Write your answer in the space provided or on a separate sheet of paper.

83) Explain the traditional interest-rate channel for expansionary monetary policy. Explain how a tight monetary policy affects the economy through this channel.

84) Explain how expansionary and contractionary monetary policies affect aggregate demand through the exchange rate channel.

85) Discuss three channels by which monetary policy affects stock prices and aggregate spending.

MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question.

86) ______ 86) Analysis of the transmission mechanisms of monetary policy provides four basic lessons for a central bank's conduct of monetary policy. These lessons include: A) Avoiding fluctuations in the level of unemployment is an important objective of monetary policy, thus providing a rationale for interest-rate stability as the primary long-run goal for monetary policy.

B) R ising interest rates indicate a tightening of monetary policy, whereas falling interest rates indicate an easing of monetary policy.

C) O ther asset prices beside those on short-term debt instruments do not contain important information about the stance of monetary policy because they are not important elements in various monetary policy transmission mechanisms.

D) Monetary policy can be highly effective in reviving a weak economy even if short-term interest rates are already near zero.

87) Analysis of the transmission mechanisms of monetary policy provides four basic lessons for a

87) ______

central bank's conduct of monetary policy. Which of the following is not one of these lessons?

A) Avoiding unanticipated fluctuations in the price level is an important objective of monetary policy, thus providing a rationale for price stability as the primary long-run goal for monetary policy.

B) R ising interest rates indicate a tightening of monetary policy, whereas falling interest rates indicate an easing of monetary policy.

C) M onetary policy can be highly effective in reviving a weak economy even if short-term interest rates are already near zero.

D) O ther asset prices beside those on short-term debt instruments do not contain important

information of monetary policy because they are important elements in various monetary policy about the stance transmission mechanisms.

88) I n the late 1990s and early 2000s, the Japanese economy has experienced A) t ight monetary policy as indicated by falling asset prices.

B) e asy monetary policy as indicated by falling nominal interest rates.

C) t ight monetary policy as indicated by short-term interest rates near zero.

D) e asy monetary policy as indicated by short-term interest rates near zero.

88) ______

89) ______by 89) R ecent Japanese experience has been characterized by tight monetary policy, as indicated A) s hort-term interest rates near zero. B) f alling asset prices.

C) f alling interest rates.

D) l ow real interest rates.

1) A 2) A 3) C 4) A 5) B 6) C 7) C 8) A 9) B 10) D 11) D 12) A 13) C 14) A 15) B 16) C 17) A 18) D 19) C 20) D 21) B 22) A 23) D 24) C 25) B 26) B 27) C 28) B 29) D 30) D 31) B 32) A 33) B 34) A 35) C 36) C 37) C 38) A 39) C 40) D 41) D 42) C 43) D 44) B 45) A 46) D 47) C 48) A 49) A 50) B

51) D 52) D 53) A 54) D 55) D 56) C 57) D 58) C 59) B 60) B 61) A 62) C 63) C 64) C 65) C 66) D 67) C 68) B 69) A 70) A 71) D 72) B 83) 73) In the traditional channel, a monetary expansion reduces real interest rates, lowering the cost of capital and A increasing investment spending. The increase in investment increases aggregate demand. A monetary contraction 74) has C the opposite effect, raising real interest rates, lowering investment and aggregate spending.

84) 75) An C expansionary monetary policy reduces real interest rates, causing depreciation of the domestic currency. This depreciation increases net exports and aggregate spending. A monetary contraction increases real interest rates, 76) causing appreciation of the domestic currency, reducing net exports and aggregate spending.

A 85) 77) The answer should include three of the following: A In Tobin's q theory, a monetary expansion increases stock prices, increasing the value of the firm relative to the 78) cost B of new capital. This stimulates investment in new capital goods, which in turn increases aggregate spending.

79) A monetary expansion increases stock prices, increasing wealth and stimulating consumption and aggregate D spending. monetary policy increases equity prices. This improves firms' balance sheets, reducing adverse 80) Expansionary B selection and moral hazard and increasing lending for investment, which increases aggregate spending.

81) In the household liquidity effect, the increase in equity prices due to a monetary expansion improves consumer D balance sheets, reducing the probability of financial distress, and increasing consumer spending on durable goods 82) and C housing.

86) D 87) B 88) A 89) B

Exam Name___________________________________ MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question.

1) The condition of a continually rising price level is defined as A) inflation.

B) s tagnation.

C) d isinflation.

D) s tagflation.

2) The economist who proposed that, "Inflation is always and everywhere a monetary phenomenon" was A) Milton Friedman.

C) John R. Hicks.

2) _______

B) F ranco Modigliani.

D) J ohn Maynard Keynes.

3) Complete Milton Friedman's famous proposition: "Inflation is always and everywhere a ________ phenomenon."

A) policy

1) _______

B) p olitical

C) b udgetary

3) _______

D) m onetary

4) At first cut, the simple solution to fighting inflation is A) limiting the number of terms that politicians can serve in elective office.

B) returning the economy to barter by prohibiting the use of fiat money.

C) to impose price controls on businesses that attempt to raise prices.

D) reducing the growth rate of the money supply.

4) _______

5) "How do we prevent the inflationary fire from igniting again and stop the roller coaster ride in

5) _______

the inflation rate of the last 40 years?" Milton Friedman's famous proposition suggests the simple solution: A) increase the marginal tax rates on businesses that hike prices in excess of 5 percent per year.

B) reduce the marginal tax rate on low-income wage earners.

C) reduce the number of terms that politicians are allowed to serve.

D) reduce the growth rate of the money supply.

6) Milton Friedman's proposition concerning the cause of inflation implies a simple solution to the

6) _______

inflation problem: A) reduce government budget deficits.

B) reduce the growth rate of the money supply.

C) limit the number of terms that politicians are allowed to serve.

D) limit the ability of fiscal policymakers to bring pressure to bear on the monetary authority.

7) Milton Friedman's proposition that inflation is always and everywhere a monetary

7) _______

phenomenon holds only if A) the price level rises continually.

B) the United States does not experience more than one negative supply shock per decade.

C) the unemployment rate does not rise continually.

D) government budget deficits do not rise continually.

8) Inflation occurs whenever A) the price level rises.

B) the price level falls continuously over a period of time.

C) the price level rises continuously over a period of time.

D) the money supply increases.

8) _______

9) Evidence strongly supports the view that countries with high inflation also have 9) _______ A) the lowest nominal interest rates.

B) t he highest rates of money growth.

C) the lowest interest rates.

D) t he smallest budget deficits.

10) ______ 10) Countries with the highest inflation rates are likely to have A) nonaccomodating monetary policy.

B) s mall budget deficits relative to GDP. C) the lowest interest rates.

D) t he highest rates of money growth.

11) The proposition that inflation is the result of a high rate of money growth is A) held only by sociologists and is no longer believed by economists.

B) supported by evidence from inflationary episodes throughout the world.

C) largely a political fabrication designed to make the Fed a scapegoat for poor fiscal policy.

D) not supported by evidence from the German hyperinflation.

11) ______

12) Which of the following would provide the strongest evidence that rapid money growth is the

12) ______

driving force behind inflation?

A) An exogenous increase in the money supply that lagged the onset of inflation.

B) An endogenous increase in the money supply that lagged the onset of inflation.

C) An endogenous increase in the money supply that preceded the onset of inflation.

D) An exogenous increase in the money supply that preceded the onset of inflation.

13) The German hyperinflation of the 1920s supports the proposition that excessive monetary

13) ______

growth causes inflation and not the other way around since the increase in monetary growth appears to have been A) intentional.

B) e ndogenous.

C) e xogenous.

D) u nintentional.

14) The German hyperinflation of 1921-1923 provides important support for the view that high

14) ______

money growth results when A) the government sets an employment target that is too high.

B) the government sells bonds to the public.

C) the government expands the money supply to finance its expenditures.

D) the government raises taxes to finance its expenditures.

15) Evidence for Latin American countries over the ten-year period 1989-1999 indicates that A) a country can experience high inflation for a sustained period of time without an increase

15) ______

in its rate of money growth.

B) a country can experience a significant increase in its money supply for a sustained period of time without an increase in its rate of inflation.

C) in every case in which a country's inflation rate is extremely high for any sustained period of time, its rate of money growth is extremely high.

D) there seems to be no relation between the rate of money growth and the inflation rate over this time period.

16) A one-time increase in the price level A) is regularly reported by the news media as inflation, but is not considered to be inflation by economists.

B) is regularly reported by the news media as inflation because it is considered to be inflation by economists.

C) is rarely reported by the news media as inflation, but is nevertheless considered to be inflation by economists.

D) is rarely reported by the news media as inflation because it is not considered to be

16) ______

inflation by

economists.

17) ______ 17) W hen inflation is defined to be a condition of a continually rising price level, ________ economists agree with Milton Friedman's proposition that inflation is a monetary phenomenon.

A) a lmost all C) a bout half of practicing

B) n o D) v ery few

18) A ccording to aggregate demand and supply analysis, inflation is caused by A) r ising prices.

B) e xpansionary monetary policies.

C) e xpansionary fiscal policies.

D) s upply shocks.

18) ______

______ 19)supply 19) A ccording to aggregate demand and supply analysis, a continually increasing money causes a ________ in aggregate demand, everything else held constant.

A) c ontinual decrease C) o ne-time increase

B) c ontinual increase D) o ne-time decrease

______ 20)else 20) A ccording to aggregate demand and supply analysis of inflation and with everything held constant, a continually increasing money supply causes

A) a ggregate demand to increase along a stationary aggregate supply curve, leading to continually increasing aggregate output and prices.

B) a ggregate demand to increase continually as aggregate supply decreases continually, leading to higher and higher price levels.

C) a ggregate demand to decrease continually as aggregate supply increases continually, leading to higher and higher price levels.

D) a ggregate supply to decrease along a stationary aggregate demand curve, leading to continually contracting aggregate output and prices.

21) ______ 21) A ggregate demand and supply analysis conclude that continuously growing ________ will cause the price level to rise continually, thus generating an inflation.

A) m oney supply C) i nterest rates

B) c onsumer expenditure D) g overnment spending

______ a 22) A ccording to aggregate demand and supply analysis and with everything else held22) constant, continuous increase in the money supply causes

A) i nflation.

B) t he price level to fall.

C) o utput to increase, but leaves the price level and inflation unchanged.

D) t he price level to increase, but has no lasting effect on the inflation rate.

23) ______ 23) A ccording to aggregate demand and supply analysis, an increase in government spending will cause aggregate demand to ________, causing output to ________ , everything else held constant.

A) d ecrease; fall

B) d ecrease; rise

C) i ncrease; fall

D) i ncrease; rise

24) A ggregate demand and supply analysis indicates that negative supply shocks A) d ecrease both the price level and the inflation rate.

B) d ecrease the price level, but cannot decrease the inflation rate.

C) i ncrease both the price level and the inflation rate.

D) i ncrease the price level, but cannot increase the inflation rate.

24) ______

25) ______ 25) S uppose that the economy is at the natural rate of output. In the absence of accommodating policy and everything else held constant, the net result of a negative supply shock is that

A) aggregate output increases above the natural rate level, but only temporarily.

B) the economy returns to full employment at a higher price level.

C) the economy returns to full employment at a lower price level.

D) the economy returns to full employment at the initial price level.

ESSAY. Write your answer in the space provided or on a separate sheet of paper.

26) Explain and show graphically why continuous monetary growth is needed to generate inflation. Describe how the inflation process is generated.

27) Suppose that the economy is at the natural rate of output. Explain how a positive supply shock, followed by a more restrictive monetary policy, allows policymakers a painless way to reduce inflation.

MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question.

28) To say that inflation is a monetary phenomenon seems to beg the question: 28) ______ A) Why is the Fed independent?

B) Why does the U.S. Treasury print so much money?

C) Why does inflationary monetary policy occur?

D) Why do politicians seek reelection?

29) The combination of a successful wage push by workers and the government's commitment to high employment leads to A) supply-side inflation.

C) demand-pull inflation.

B) c ost-push inflation.

D) s upply-shock inflation.

30) If the Fed responds by increasing the money supply in response to a successful wage push by workers, monetary policy is said to be A) accomplishing.

C) accommodating.

29) ______

30) ______

B) n onaccommodating.

D) n onaccomplishing.

31) If workers do not believe that policymakers are serious about fighting inflation, they are most

31) ______

likely to push for higher wages, which will ________ aggregate ________ and lead to unemployment or inflation or both, everything else held constant.

A) decrease; supply B) i ncrease; demand C) increase; supply D) d ecrease; demand

32) Workers will have greater incentives to push for higher wages when government policymakers

32) ______

place greater concern on ________ than ________ and are thus ________ likely to adopt accommodative policies.

A) unemployment; inflation; more B) u nemployment; inflation; less C) inflation; unemployment; less D) i nflation; unemployment; more

33) In the absence of an accommodating monetary policy, a push by workers to get higher wages will cause A) demand-pull inflation.

C) a lower price level.

B) h igher unemployment.

D) c ost-push inflation.

34) If workers believe that government policymakers will increase aggregate demand to avoid a politically unpopular increase in unemployment when workers demand higher wages, then workers will not fear higher unemployment and their wage demands will result in

A) c ost-push inflation.

C) d eflation.

33) ______

B) h yperinflation.

D) d emand-pull inflation.

34) ______

35) If policymakers set a target for unemployment that is too low because it is less than the natural

35) ______

36) Theoretically, one can distinguish a demand-pull inflation from a cost-push inflation by

36) ______

rate of unemployment, this can set the stage for a higher rate of money growth and A) cost-push inflation.

B) d emand-push inflation.

C) demand-pull inflation.

D) c ost-pull inflation.

comparing A) the unemployment rate with its natural rate level.

B) when prices rise relative to wages.

C) government debt to real GDP. D) how fast prices rise relative to wages.

37) Demand-pull inflation can result when A) workers get numerous wage increases.

B) a persistent budget deficit is financed by selling bonds to the public.

C) a persistent budget deficit is financed by selling bonds to the central bank.

D) policymakers set an unemployment target that is too high.

37) ______

38) Which of the following is least likely to lead to inflationary monetary policy?

A) Declining oil prices B) C onflict in the Middle East C) Expanding federal budget deficits D) R ising unemployment

38) ______

39) Which of the following is most likely to lead to inflationary monetary policy?

A) The enactment of a free-trade agreement with Mexico B) Resolution of conflict in the Middle East C) Rising unemployment D) Declining oil prices

39) ______

40) Which of the following is most likely to lead to inflationary monetary policy?

A) Resolution of conflict in the Middle East B) Declining oil prices C) Rising government budget deficits D) The enactment of a free-trade agreement with Mexico

40) ______

41) Methods of financing government spending are described by an expression called the

41) ______

government budget constraint, which states the following: A) the government budget deficit must equal the sum of the change in the monetary base and the change in government bonds held by the public.

B) the government budget deficit must equal the difference between the change in the monetary base and the change in government bonds held by the Treasury.

C) the government budget deficit must equal the difference between the change in the monetary base and the change in government bonds held by the public.

D) the government budget deficit must equal the difference between the change in the monetary base and the change in government bonds held by the Fed.

42) Methods of financing government spending are described by an expression called the

42) ______

government budget constraint, which states the following: A) DEFICIT = (G - T) = ΔMB - ΔBONDS. B) D EFICIT = (G - T) = ΔBONDS - ΔMB. C) DEFICIT = (G - T) = ΔMB/ΔBONDS. D) D EFICIT = (G - T) = ΔMB + ΔBONDS.

43) If the government finances its spending by issuing debt to the public, the monetary base will

__________

____ __

_ and the 43) money supply will ________ _ __.

A) not change; not change C) decrease; increase

B) i ncrease; decrease D) i ncrease; increase

44) If the government finances its spending by selling bonds to the central bank, the monetary base

44) ______

will ___________ and the money supply will ___________.

A) decrease; decrease B) n ot change; not change C) increase; increase D) i ncrease; decrease

45) Financing government spending with taxes A) causes both reserves and the monetary base to rise.

B) has no net effect on the monetary base.

C) causes both reserves and the monetary base to decline.

D) causes reserves to rise, but the monetary base to decline.

45) ______

46) Financing government spending by selling bonds to the public, which pays for the bonds with

46) ______

currency, A) leads to a temporary increase in the monetary base.

B) leads to a permanent increase in the monetary base.

C) has no net effect on the monetary base.

D) leads to a permanent decline in the monetary base.

47) The financing of government spending by issuing debt A) causes both reserves and the monetary base to rise.

B) causes reserves to rise, but the monetary base to decline.

C) causes both reserves and the monetary base to decline.

D) has no net effect on the monetary base.

47) ______

48) The finance of government spending through a Treasury sale of bonds which are then

48) ______

purchased by the Fed A) has no net effect on the monetary base.

B) causes reserves to rise, but the monetary base to decline.

C) causes both reserves and the monetary base to rise.

D) causes both reserves and the monetary base to decline.

49) This method of financing government spending is frequently called printing money because

49) ______

high-powered money (the monetary base) is created in the process.

A) Financing government spending by selling bonds to the public, which pays for the bonds with checks.

B) Financing government spending by selling bonds to the public, which pays for the bonds with currency.

C) The finance of government spending through a Treasury sale of bonds that are then purchased by the Fed. D) Financing government spending with taxes.

50) Only when budget deficits are financed by money creation does the increased government spending lead to ________ in the ________.

50) ______

A) an increase; money multiplier C) a decrease; monetary base

B) a n increase; monetary base D) a decrease; money multiplier

51) If the deficit is financed by selling bonds to the ________, the money supply will ________,

51) ______

increasing aggregate demand, and leading to a rise in the price level.

A) central bank; rise B) p ublic; fall C) public; rise D) c entral bank; fall

52) If the deficit is financed by selling bonds to the ________, the money supply will ________, causing aggregate demand to ________.

A) central bank; fall; decrease C) public; rise; increase

52) ______

B) c entral bank; rise; increase D) p ublic; fall; decrease

53) Kayla, an economist, is interested in knowing if government deficits have been a factor in

53) ______

explaining rapid money growth in her country in the past twenty years. What ratio should Kayla examine?

A) The ratio of government debt to GDP B) The ratio of money to government debt C) The ratio of money to the monetary base D) The ratio of currency to demand deposits

54) If an economist were interested in testing whether government budget deficits had been the

54) ______

cause of excessive monetary growth for a country for the period 1950-2000, she would examine the behavior of A) interest rates.

B) the ratio of government spending to GDP. C) the money supply-to-monetary-base ratio.

D) the government debt-to-GDP ratio.

55) Evidence from episodes of hyperinflation indicates that A) supply shocks have been the ultimate source of inflationary monetary policies.

B) wage-push demands have been the ultimate source of inflationary monetary policies.

C) huge government budget deficits have been the ultimate source of inflationary monetary

55) ______

policies.

D) there is no common source of inflationary monetary policies.

56) Analysis of episodes of hyperinflation indicate that the rapid money growth leading to the

56) ______

inflation is the result of A) central banks' attempts to peg interest rates.

B) central banks' attempts to peg exchange rates.

C) governments financing massive budget deficits by printing money.

D) increases in taxes.

57) Although the U.S. has a well-developed government bond market and has experienced relatively small budget deficits relative to GDP, deficits can be inflationary if A) the Fed refuses to purchase government bonds.

B) deficits put upward pressure on interest rates, and the Fed attempts to keep interest rates from rising.

C) deficits put upward pressure on interest rates, and fiscal authorities raise taxes in an attempt to keep interest rates from rising.

D) the world's supply of gold expands because of new gold discoveries.

57) ______

58) Moderate deficits, such as those experienced by the United States in the last decade, present an

58) ______

inflationary problem if A) they put upward pressure on interest rates, and the Fed has a goal of preventing high interest rates.

B) the Fed responds by reducing the growth of high-powered money.

C) the Fed cuts money growth to offset the expansionary fiscal effects.

D) they put upward pressure on interest rates, and the Fed has a goal of preventing interest rates from falling too low.

59) If moderate deficits put ________ pressure on interest rates, the Fed may ________ bonds, leading to an increase in high-powered money.

A) upward; buy C) downward; buy

B) d ownward; sell D) u pward; sell

60) If moderate deficits put upward pressure on interest rates, the Fed may ________ bonds, leading to a _________ in high-powered money.

A) sell; fall B) s ell; rise

59) ______

C) b uy; rise

60) ______

D) b uy; fall

61) If the Fed pursues a policy goal of A) preventing high stock prices, and deficits cause stock prices to rise, then deficits will lead

61) ______

to money creation.

B) preventing high interest rates, and deficits cause interest rates to rise, then deficits will lead to money creation.

C) preventing high bond prices, and deficits cause bond prices to rise, then deficits will lead to money creation.

D) preventing high inflation, and deficits cause inflation to rise, then deficits will lead to money creation.

62) Proponents of Ricardian Equivalence reject the view that deficits A) cannot be inflationary, even when financed by tax hikes.

B) cause the monetary base to decrease.

C) have no effect on the monetary base.

D) cause the monetary base to increase.

62) ______

63) According to economists who believe in Ricardian Equivalence, when the government runs a

63) ______

deficit and issues bonds, A) the public recognizes that it will be subject to higher taxes in the future in order to pay off these bonds.

B) the Fed must sell bonds to keep the interest rate from rising.

C) the public works less to avoid these future taxes, causing the demand for bonds to decrease.

D) the Fed must purchase bonds to keep the interest rate from rising.

64) Evidence from the time period 1960-1980 indicates that inflation in the United States resulted

64) ______

from

A) the excessive sale of government bonds to the public.

B) the government's inability to sell bonds to the Fed. C) an expansion in the money supply to finance federal government expenditures.

D) an employment target that was set too high.

65) Because policies in the United States were too expansionary from 1965 through 1973, the U.S. suffered

65) ______

A) neither demand-pull nor cost-push inflation.

B) demand-pull inflation.

C) both demand-pull and cost-push inflation.

D) cost-push inflation, as workers sought higher wages in order to keep up with inflation.

66) In the period 1965 through the 1970s, policymakers pursued ________ policies in order to achieve ________.

A) contractionary; high employment C) expansionary; high employment

66) ______

B) c ontractionary; low inflation D) e xpansionary; low inflation

67) If aggregate output is below the natural rate level, advocates of activist policy would

67) ______

recommend that the government A) try to eliminate the high unemployment by attempting to shift the aggregate demand curve to the left.

B) do nothing.

C) try to eliminate the high unemployment by attempting to shift the aggregate supply curve to the right.

D) try to eliminate the high unemployment by attempting to shift the aggregate demand curve to the right.

68) If aggregate output is below the natural rate level, advocates of nonactivist policy would

68) ______

recommend that the government A) try to eliminate the high unemployment by attempting to shift the aggregate demand curve to the left.

B) try to eliminate the high unemployment by attempting to shift the aggregate demand curve to the right.

C) try to eliminate the high unemployment by attempting to shift the aggregate supply curve to the right.

D) do nothing.

69) The time that it takes for an activist policy to actually influence economic activity is called the A) legislative lag.

B) e ffectiveness lag.

C) recognition lag.

D) i mplementation lag.

69) ______

70) The time it takes for policymakers to change policy instruments once they have decided on a

70) ______

new policy is called the A) implementation lag.

C) effectiveness lag.

B) l egislative lag.

D) r ecognition lag.

71) The time it takes for a policy to have an impact on the economy, once it has been implemented,

71) ______

is called the A) legislative lag.

B) effectiveness lag.

C) data lag.

D) inside lag.

E) implementation lag.

72) The ________ lag is the time it takes for policymakers to obtain the data that tell them what is happening to the economy, while the ________ lag is the time it takes for policymakers to be sure of what the data are signaling about the future course of the economy.

A) r ecognition; data C) d ata; recognition

B) d ata; implementation D) i mplementation; recognition

72) ______

73) The ________ lag is the time it takes for policymakers to be sure of what the data are signaling

73) ______

about the future course of the economy, while the ________ lag represents the time it takes to pass legislation to implement a particular (fiscal) policy.

A) recognition; legislative B) i mplementation; legislative C) data; legislative D) d ata; recognition

74) The ________ lag represents the time it takes to pass legislation to implement a particular

74) ______

(fiscal) policy, while the ________ lag is the time it takes for policymakers to change policy instruments once they have decided on the new policy.

A) legislative; recognition B) l egislative; implementation C) implementation; legislative D) l egislative; effectiveness

75) The ________ lag is the time it takes for policymakers to change policy instruments once they

75) ______

have decided on the new policy, while the ________ lag is the time it takes for the policy to actually have an impact on the economy.

A) legislative; effectiveness B) r ecognition; implementation C) implementation; effectiveness D) i mplementation; recognition

76) The ________ lag is the time it takes for policymakers to obtain the information that tells them

76) ______

what is happening to the economy, while the ________ lag represents the time it takes to implement a particular fiscal policy.

A) data; legislative B) d ata; implementation C) recognition; legislative D) r ecognition; data

77) The ________ lag is the time it takes for policymakers to be sure of what the information is

77) ______

signaling about the future course of the economy, while the ________ lag is the time it takes for policymakers to change policy instruments once they have decided on the new policy.

A) recognition; legislative B) r ecognition; implementation C) data; legislative D) d ata; implementation

78) Of the five time lags that prevent an activist policy from returning aggregate output to full

78) ______

employment instantaneously, two do not slow the effectiveness of monetary policy—the A) recognition and effectiveness lags.

B) l egislative and implementation lags.

C) implementation and effectiveness lags.

D) l egislative and effectiveness lags.

79) Activists usually view ________ policy as having a shorter effectiveness lag than ________

79) ______

policy, but there is substantial uncertainty about how long this lag is.

A) fiscal; monetary B) m onetary; incomes C) fiscal; incomes D) m onetary; fiscal

80) Activists usually view ________ policy as having a longer effectiveness lag than ________

80) ______

policy, but there is substantial uncertainty about how long this lag is.

A) fiscal; monetary B) m onetary; incomes C) fiscal; incomes D) m onetary; fiscal

81) Economists usually view ________ policy as having a shorter implementation lag than ________ 81) ______ policy, but there is substantial uncertainty about how long this lag is.

A) fiscal; monetary B) m onetary; fiscal C) fiscal; incomes D) m onetary; incomes

82) Economists usually view ________ policy as having a longer implementation lag than ________

policy, but

____ __

82) there is substantia l uncertaint y about how long this lag is.

B) m onetary; fiscal D) m onetary; incomes

A) fiscal; monetary C) fiscal; incomes

83) If output adjusts ________ to the natural rate level, and if time lags between policy actions and

83) ______

changes in aggregate output are relatively ________, then the case for activist policy is strengthened.

A) slowly; short B) q uickly; short C) q uickly; long D) s lowly; long

84) If output adjusts ________ to the natural rate level, and if time lags between policy actions and

84) ______

changes in aggregate output are relatively ________, then the case for activist policy is weakened.

A) slowly; short B) q uickly; short C) q uickly; long D) s lowly; long

85) Nonactivists contend that an activist policy of shifting the aggregate ________ curve will be

85) ______

costly because it produces ________ volatility in both the price level and output.

A) supply; less B) d emand; more C) s upply; more D) d emand; less

86) Some economists contend that a policy of shifting the aggregate demand curve will be costly

86) ______

because it produces more volatility in both the price level and output. These economists likely A) discretionary policy.

B) a ctivist policy.

C) nonactivist policy.

D) d emand-management policy.

87) The existence of lags prevents the instantaneous adjustment of the economy to policies

87) ______

changing aggregate demand, thereby strengthening the case for A) nonactivist policy.

B) d iscretionary policy.

C) activist policy.

D) d emand-management policy.

88) Which of the following views are consistent with the case for nonactivist macroeconomic

88) ______

policy?

A) Even with time lags, activist policy moves the economy to full employment before the economy's self-correcting mechanism would.

B) Workers will come to expect expansionary policies whenever the economy moves below full employment.

C) An activist, accommodating policy of shifting the aggregate demand curve will produce less volatility in both the price level and output due to the short time it takes to shift aggregate demand.

D) The wage and price adjustment process being extremely slow, a nonactivist policy results in a large loss of output.

89) If expectations about policy affect how wages are set, then the case for a(n) ________ policy is much stronger.

A) stabilization

B) n onactivist

C) a ctivist

D) i nterventionist

90) Nonactivists emphasize the importance of a constant money growth rate rule more than the balanced-budget amendment or restrictions on union power because

89) ______

90) ______

A) they regard high tax rates as the cause of inflation.

B) they believe that excessive government spending, not excessive monetary growth, is the cause of inflation.

C) they believe that while unions cause inflation, they are too politically powerful to deal with.

D) they regard excessive money growth as the cause of inflation.

91) Nonactivists contend that a policy of shifting the aggregate demand curve will be costly

91) ______

because it produces more volatility in both the price level and output. Thus they favor A) a constant-money-growth-rate rule.

B) a policy of variable money supply growth.

C) demand-management policy.

D) discretionary policy.

92) A credible, nonaccommodating policy rule has the ________ that it makes a cost-push by

92) ______

workers ________ likely and thus helps to reduce the output loss from controlling inflation.

A) disadvantage; more B) d isadvantage; less C) advantage; more D) a dvantage; less

ESSAY. Write your answer in the space provided or on a separate sheet of paper.

93) Suppose the economy is at the natural rate of output. Explain how a tax increase reduces demand and

increases unemployment. Why is the speed of the adjustment of wages and/or the role of expectations important in this situation?

1) A 2) A 3) D 4) D 5) D 6) B 7) A 8) C 9) B 10) D 11) B 12) D 13) C 14) C 15) C 16) A 17) A 18) B 19) B 20) B 21) A 22) A 23) D 24) D 25) D 26) See figure below.

Only continuous monetary growth can cause continuous increases in aggregate demand of the sort needed to generate inflation. Other factors can increase demand and the price level, but none can increase demand continuously. In the graph, the monetary expansion increases AD. The increase in output above the natural rate increases wages and decreases AS. Monetary expansion increases AD repeatedly, and wages continue to adjust upward.

27) The positive supply shock increases aggregate supply, exerting downward pressure on prices. Policymakers can now reduce demand to further reduce inflationary pressure without reducing output below the natural rate.

28) C 29) B 30) C

31) A 32) A 33) B 34) A 35) C 36) A 37) C 38) A 39) C 40) C 41) A 42) D 43) A 44) C 45) B 46) C 47) D 48) C 49) C 50) B 51) A 52) B 53) A 54) D 55) C 56) C 57) B 58) A 59) A 60) C 61) B 62) D 63) A 64) D 65) B 66) C 67) D 68)

82) A 83) A 84) C 85) B 86) C 87) A 88) B 89) B 90) 93) The tax increase decreases aggregate demand. Output falls below the natural rate, increasing unemployment. If D wages are slow to adjust, the economy remains below the natural rate for a long time, but adjustment back to the 91) natural rate is rapid if wages adjust quickly or if expectations lead to rapid adjustment of wages.

A 92) D

Exam Name___________________________________ MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question.

1) Whether one views the activist policies of the 1960s and 1970s as destabilizing or believes the

1) _______

2) The argument that econometric policy evaluation is likely to be misleading if policymakers

2) _______

economy would have been less stable without these policies, most economists agree that A) the nonactivist policymakers were right in believing that the private economy is inherently stable.

B) stabilization policies proved not to be inflationary.

C) the activist policymakers were right in believing that the private economy is inherently stable.

D) stabilization policies proved more difficult in practice than many economists had expected.

assume stable economic relationships is known as A) the Lucas critique.

C) public choice theory.

B) t he monetarist revolution.

D) n ew Keynesian theory.

3) Lucas argues that when policies change, expectations will change thereby A) forcing the Fed to keep its deliberations secret.

B) changing the relationships in econometric models.

C) causing the government to abandon its activist stance.

D) making it easier to predict the effects of policy changes.

3) _______

4) The rational expectations hypothesis implies that when macroeconomic policy changes, A) the economy will become highly unstable.

B) people will make systematic mistakes.

C) people will be slow to catch on to the change.

D) the way expectations are formed will change.

4) _______

5) The Lucas critique indicates that A) activists' criticisms of rational expectations models are not well-founded.

B) activists' criticisms of rational expectations models are well-founded.

C) expectations are important in determining the outcome of an activist policy.

D) expectations are not important in determining the outcome of an activist policy.

5) _______

6) The Lucas critique is an attack on the usefulness of A) conventional econometric models as indicators of the potential impacts on the economy

6) _______

of particular policies.

B) conventional econometric models as forecasting tools.

C) rational expectations models of macroeconomic activity.

D) the relationship between the quantity theory of money and aggregate demand.

7) The Lucas critique argues that an econometric model constructed using past data A) is inappropriate for policy analysis and short-run forecasting.

B) may be appropriate for short-run forecasting, but is inappropriate for policy analysis.

C) is appropriate for short-run forecasting and policy analysis.

D) may be appropriate for policy analysis, but is inappropriate for short-run forecasting.

7) _______

8) The interest rate thought to have the most important impact on aggregate demand is the A) long-term interest rate.

B) s hort-term interest rate.

C) T-bill rate.

D) r ate on 90-day CDs.

8) _______

9) A rise in short-term interest rates that is believed to be only temporary A) will have a bigger impact on long-term interest rates than if the rise in short-term rates

9) _______

had been permanent.

B) is likely to have only a small impact on long-term interest rates.

C) cannot possibly affect long-term interest rates.

D) is likely to have a significant effect on long-term interest rates.

10) According to the Lucas critique, if past increases in the short-term interest rate have always

10) ______

been temporary, then A) the term-structure relationship using past data will show no effect of changes in the short-term interest rate on the long-term rate.

B) the term-structure relationship using past data will nevertheless show a strong effect of changes in the short-term interest rate on the long-term rate because of a change in the way expectations are formed.

C) one cannot predict the term-structure relationship as it depends on expectations.

D) the term-structure relationship using past data will then show only a weak effect of changes in the short-term interest rate on the long-term rate.

11) The new classical macroeconomic model assumes that expectations are ________ formed and

11) ______

that wages and prices are ________ with respect to the expected price level.

A) adaptively; sticky B) r ationally; sticky C) rationally; completely flexible D) a daptively; completely flexible

12) In the new classical macroeconomic model developed by Lucas and Sargent, an anticipated

12) ______

monetary expansion will A) increase aggregate output and the aggregate price level.

B) have no effect on aggregate output.

C) increase aggregate output.

D) reduce aggregate output.

13) In the new classical macroeconomic model developed by Lucas and Sargent, expansionary

13) ______

macropolicies affect aggregate output A) relatively quickly, provided the policy is anticipated.

B) only after a long and variable lag, provided the policy is anticipated.

C) only when the macropolicy change is anticipated.

D) only when the macropolicy change is unanticipated.

14) An expansionary monetary policy will cause aggregate output to expand in the new classical

14) ______

macroeconomic model A) only after a long and variable lag, provided the policy is anticipated.

B) never; output will never expand in the new classical model when monetary policy is changed.

C) if the policy is unanticipated.

D) if the policy is anticipated.

15) According to the new classical model, A) unanticipated policy has no effect on the business cycle.

B) only anticipated policy can influence the business cycle.

15) ______

C) unanticipated policy may or may not have an effect on the business cycle.

D) anticipated policy has no effect on the business cycle.

16) Steve the economist tells his students that one anticipated policy is just like any other—none

16) ______

has any effect on aggregate output. You can probably infer that he is a A) new classical economist.

B) K eynesian economist.

C) monetarist.

D) p roponent of activist policies.

17) In the view of the new classical economists, an increase in the money supply will affect

17) ______

aggregate output and employment only if the increase in money supply is A) expected.

B) the result of an announced open market operation.

C) anticipated.

D) unanticipated.

18) In the new classical model, an anticipated increase in the money stock will cause A) aggregate output to increase.

B) no effect on either the price level or aggregate output.

C) the price level and aggregate output to increase.

D) the price level to increase.

18) ______

19) In the new classical model, A) wages and prices are sticky with respect to expected changes in the price level.

B) an anticipated increase in the money supply will increase aggregate output temporarily.

C) unanticipated policy has no effect on aggregate output and unemployment.

D) a rise in the expected price level results in an immediate and equal rise in wages and

19) ______

prices.

20) Suppose that the Federal Reserve announces a 50 basis point decrease in the target for the

20) ______

federal funds rate that was completely anticipated. According to the new classical model and with everything else held constant, this action by the Federal Reserve will cause real GDP to ________.

A) decrease B) increase C) either increase, decrease or remain constant D) remain constant

21) In the new classical model, an anticipated policy of a continually increasing money supply

21) ______

causes A) aggregate supply decreases along a stationary aggregate demand curve, leading to continually contracting aggregate output and prices.

B) aggregate demand continually decreases while simultaneously aggregate supply continually increases, leading to higher and higher price levels.

C) aggregate demand continually increases while simultaneously aggregate supply continually decreases, leading to higher and higher price levels.

D) aggregate demand increases along a stationary aggregate supply curve, leading to continually increasing aggregate output and prices.

22) The short-run response to an anticipated expansionary policy in the new classical model includes _________ in the price level and _________ in aggregate output.

A) an increase; no change B) a n increase; an increase C) no change; an increase D) n o change; no change

22) ______

23) In the new classical model, an unanticipated increase in the money supply causes A) aggregate demand increases along a stationary aggregate supply curve.

B) both aggregate demand and supply decrease.

C) both aggregate demand and supply increase.

D) aggregate demand increases as aggregate supply decreases.

23) ______

24) _________ policies do not change aggregate real output or the unemployment rate in the

24) ______

_________ model.

A) Unanticipated; new Keynesian C) Unanticipated; new classical

B) A nticipated; new Keynesian D) A nticipated; new classical

25) The new classical model has the word classical associated with it because, when an increase in

25) ______

the money supply is anticipated, aggregate output A) remains at the natural rate level.

B) increases in the short run, but not in the long run.

C) drops below the natural rate level.

D) rises above the natural rate level.

26) The policy ineffectiveness proposition A) implies that an anticipated expansionary monetary policy will not cause the price level to

26) ______

rise.

B) implies that an anticipated contractionary monetary policy cannot reduce the rate of inflation.

C) rules out output effects from policy surprises.

D) asserts that anticipated changes in monetary policy cannot affect real aggregate output.

27) The notion that anticipated monetary policy has no effect on the real aggregate output is commonly called the A) Lucas critique.

C) natural rate hypothesis.

27) ______

B) n ew Keynesian proposition.

D) p olicy ineffectiveness proposition.

28) An important feature of the new classical model is that an expansionary policy, such as an

28) ______

increase in the rate of money growth, can lead to a decline in aggregate output if the A) public expects an even more expansionary policy than the one that is actually implemented.

B) policy is anticipated.

C) public expects a less expansionary policy than the one that is actually implemented.

D) policy comes as a surprise.

29) In the new classical model, an expansionary monetary policy will lead to a decline in aggregate output if the increase in money supply is ________ anticipated.

C) a s A) less than B) g reater than

29) ______

D) n ot

30) The similarity between nonactivists and the new classical economists is that both believe that A) only unanticipated policies can affect aggregate output and employment.

B) discretionary policies will be ineffective in changing aggregate output and employment.

C) only anticipated policies can affect aggregate output and employment.

D) discretionary policies may be destabilizing.

30) ______

ESSAY. Write your answer in the space provided or on a separate sheet of paper.

31) Demonstrate graphically and explain the short-run and long-run effects of an unanticipated monetary

expansion in the new classical model.

32) In the new classical model, show graphically and explain how an expected monetary expansion that is less than expected reduces real output in the short run. What is the long-run result?

MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question.

33) The model that assumes that expectations are formed rationally but does not assume complete 33) ______ wage and price flexibility is known as the A) Keynesian model.

C) monetarist model.

B) n ew Keynesian model.

D) n ew classical model.

34) Wage and price rigidities created by long-term contracts suggest that an anticipated monetary

34) ______

expansion will have A) no effect on aggregate output.

B) no effect on the aggregate price level.

C) an effect on both aggregate output and the price level.

D) an effect on aggregate output only.

35) New Keynesians object to which of the following assumptions?

A) Wage and price stickiness B) Long-term contracts as a source of wage and price rigidities C) Rational expectations D) Complete wage and price flexibility

35) ______

36) Rigidities that diminish wage and price flexibility such as long-term contracts suggest that an

36) ______

increase in the expected price level A) might cause aggregate demand to decrease.

B) might cause aggregate supply to increase.

C) might not translate into complete adjustment of wages and prices.

D) will have no effect on the short-run aggregate supply curve.

37) It is the existence of rigidities such as sticky wages, not adaptive expectations, that explains

37) ______

why ________ policies can affect real output in the ________ model.

A) unanticipated; new classical B) a nticipated; new Keynesian C) anticipated; new classical D) u nanticipated; new Keynesian

38) In the new Keynesian model A) only unanticipated policy can affect aggregate output and unemployment.

B) unanticipated policy has no effect on aggregate output and unemployment.

C) only anticipated policy can affect aggregate output and unemployment.

D) wages and prices are assumed to be sticky with respect to expected changes in the price

38) ______

level.

39) Like the new classical model, the new Keynesian model A) distinguishes between the effects of anticipated versus unanticipated policy, with unanticipated policy having a greater effect.

B) distinguishes between the effects of anticipated versus unanticipated policy, with anticipated policy having a greater effect.

C) concludes that anticipated policies do not affect aggregate output and unemployment.

D) assumes that wages and prices are perfectly flexible with respect to changes in the expected price level.

39) ______

40) In the new Keynesian model, an unanticipated increase in the money supply causes A) aggregate demand to increase along a stationary aggregate supply curve.

B) aggregate demand to increase as aggregate supply decreases.

C) both aggregate demand and supply to decrease.

D) both aggregate demand and supply to increase.

40) ______

41) In the new Keynesian model, an expansionary monetary policy will A) have a greater effect on aggregate output if the policy is anticipated.

B) have a greater effect on aggregate output if the policy is unanticipated.

C) have no effect on the price level.

D) not cause aggregate output to increase, even if the policy is unanticipated.

41) ______

42) Mariann the economist argues that expectations are formed rationally, yet a pre-announced

42) ______

monetary expansion will lower unemployment. Mariann is probably a A) new classical economist.

B) m onetarist.

C) Keynesian economist.

D) n ew Keynesian economist.

43) Kristin the economist argues that an anticipated monetary expansion will cause aggregate

43) ______

output to increase but believes that aggregate output would increase by an even greater amount if the monetary expansion came as a surprise to everyone. Kristin is probably a A) monetarist.

B) n ew classical economist.

C) new Keynesian.

D) K eynesian economist.

ESSAY. Write your answer in the space provided or on a separate sheet of paper.

44) In the new Keynesian model, explain and depict graphically why an expected increase in the money supply increases real output in the short run. What is the long-run result?

MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question.

45) ______ 45) An anticipated increase in the money supply has no effect on aggregate output in the ________ model.

A) new Keynesian C) Keynesian

B) t raditional D) n ew classical

46) An anticipated increase in the money supply increases short-run real output by the largest amount in A) all three models.

C) the new classical model.

B) t he new Keynesian model.

D) t he traditional model.

47) An anticipated increase in the money supply causes the largest long-run increase in real output in

46) ______

47) ______

A) the new classical model.

B) no model, as monetary policy does not affect real output in the long run.

C) the traditional model.

D) the new Keynesian model.

48) An anticipated increase in the money supply causes the largest short-run increase in the price level in A) the new Keynesian model.

C) the traditional model.

B) t he new classical model.

D) a ll three models.

48) ______

49) In the traditional model, the cost of lost output for each one percentage point reduction in the inflation rate is A) 4 percent of a year's real GDP. C) 25 percent of a year's real GDP.

49) ______

B) 0 .25 percent of a year's real GDP. D) 0 .04 percent of a year's real GDP.

50) Rational expectations theory suggests that the success of an anti-inflationary policy depends on

50) ______

the

A) imposition of wage and price controls.

B) credibility of the policy in the eyes of the public.

C) adoption of a gold standard.

D) passage of a tax cut.

51) In a new classical view of the world, the best anti-inflation policy, when viewed as being

51) ______

credible, is A) a cold turkey policy.

B) a gradualist policy.

C) an activist policy.

D) a complete monetary and fiscal reform measure.

52) When expectations of inflation are formed rationally, an anti-inflationary policy will be more successful if it is A) unanticipated.

B) a nnounced.

C) c redible.

52) ______

D) a surprise.

53) It may be necessary to cut the deficit as part of a credible anti-inflationary policy because the

53) ______

public knows that large deficits A) put pressure on the Fed to contract the money supply to prevent employment from rising.

B) put pressure on the Fed to expand the money supply to keep interest rates from rising.

C) are inflationary by themselves in the long run.

D) create inefficiencies.

54) By _________ its deficit, the government's credibility of anti-inflationary policy ________.

A) not changing; increases B) r educing; decreases C) reducing; increases D) n ot changing; remains the same

54) ______

ESSAY. Write your answer in the space provided or on a separate sheet of paper.

55) Explain why anticipated policy has different short-run effects on real output and the price level in the new classical, new Keynesian, and traditional models. What are the long-run effects of anticipated policy in each model?

MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question.

56) ______ 56) Today, most economists A) believe that the Lucas critique has been discredited.

B) accept the notion that there is no role for activist stabilization policy.

C) believe that having policy credibility is not an important factor to a successful anti-inflation policy.

D) accept that expectations formation will change when the behavior of forecasted variables changes.

1) D 2) A 3) B 4) D 5) C 6) A 7) B 8) A 9) B 10) D 11) C 12) B 13) D 14) C 15) D 16) A 17) D 18) D 19) D 20) D 21) C 22) A 23) A 24) D 25) A 26) D 27) D 28) A 29) A 30) D 31) See figure below.

In the new classical model, unexpected monetary expansion increases aggregate demand. Since this is unexpected, aggregate supply is not affected, and output increases in the short run. As expectations adjust, aggregate supply decreases and output returns to the natural rate, with only prices rising.

32) See figure below.

Demand does not increase as much as expected, so aggregate supply decreases more than the increase in aggregate demand. The result in the short run is a lower aggregate output. In the long-run, AS adjusts to the actual increase in demand with higher prices and no increase in output.

33) B 34) C 35) D 36) C 37) B 38) D 39) A 40) A 44) See figure below.

41) B 42) D 43) C

Although the increase in demand is expected, rigidities prevent aggregate supply from decreasing as much as aggregate demand increases. Thus, short-run real output increases. In the long run, with complete adjustment, there will be higher prices and unchanged real output.

45) D 46) D 47) B 48) B 49) A 50) B 51) A In the new classical model, wages and prices are fully flexible, and expectations are formed rationally. In the new 55) 52) C 53) B 54) C

classicresults in a matching adjustment of wages and prices. Thus, AD and AS shift by matching amounts in the opposite al direction. This results in no change in real output, and the largest change in the price level is in the short run. In modelthe new Keynesian model, expectations are rational, but rigidities keep wages and prices from adjusting fully even , an when policy is anticipated. Thus, AD shifts by more than AS. As a result, real output and prices both change, with anticiprices changing by less than in the new classical model. In the traditional model, expectations are formed pated adaptively, so policy changes do not affect expectations and AS in the short run. Thus, demand changes cause the policy largest changes in real output, and smallest initial price level changes of any of the three models. In all three changmodels, the long-run result is that real output does not change, and prices adjust fully to changes in demand. e

56) D