Deck 9: The Crisis

Question 1

Consider the following balance sheet situation of ABC bank: its total assets consist of loans of $150 and bonds of $350; and its total liabilities consist of deposits of $400 and debt of $100. What is the capital of ABC bank?

A) $75.
B) $100.
C) $0.
D) $25.
E) $50.

Answer 1

$0.

Question 2

Consider the following balance sheet situation of ABC bank: its total assets consist of loans of $150 and bonds of $350; and its total liabilities consist of deposits of $300 and debt of $100. What is the capital of ABC bank?

A) $100.
B) $25.
C) $50.
D) $75.
E) $0.

Answer 2

$100.

Question 3

When the economy is in a liquidity trap with a zero interest rate:

A) the central bank is unable to lower interest rates in response to falling prices.
B) the central bank is unable to raise interest rates in response to rising prices.
C) the central bank abandons monetary policy altogether.
D) the central bank is unable to raise interest rates in response to falling prices.
E) the central bank is unable to lower interest rates in response to rising prices.

Answer 3

the central bank is unable to lower interest rates in response to falling prices.

Question 4

A primary function of banks is to:

A) expand the creation of money.
B) spread the risks from investments to a wide range of savers.
C) match saving flows with real investment flows in an economy.
D) All of the above.
E) None of the above.

Question 5

What was the primary cause of the 2008- 09 financial crisis?

A) There was irrational exuberance in the stockmarket.
B) The biggest housing and credit bubble in decades, originating in the U.S.
C) Consumers embarked on a spending binge.
D) Banks turned away customers with home loan applications.
E) There was a lack of oversight on the banking system.

Question 6

Which of the following will occur when an economy is faced with a liquidity trap situation?

A) A decrease in the price level will cause a leftward shift in the aggregate demand curve.
B) A decrease in the price level will cause a rightward shift in the aggregate demand curve.
C) A decrease in the price level will cause a movement along the aggregate demand curve.
D) The aggregate demand curve is now horizontal.
E) The aggregate demand curve is now upward sloping.

Question 7

Many financial institutions sold insurance contracts against possible defaults of home loans known as:

A) structured investment vehicles.
B) collateralised debt obligations.
C) repurchase agreements.
D) subprime mortgages.
E) credit default swaps.

Question 8

The crisis pushed up borrowing costs, lowered stock prices, and sapped consumer and firm confidence. What effect do these have on the IS curve?

A) There is no effect on the IS curve.
B) The IS curve shifts to the right.
C) The IS curve becomes horizontal.
D) The IS curve becomes vertical.
E) The IS curve shifts to the left.

Question 9

Which of the following is called an unconventional monetary policy measure?

A) Asset easing.
B) Quantitative easing.
C) Financial easing.
D) Qualitative easing.
E) Exchange easing.

Question 10

What are securitised bonds?

A) They appear on the asset side of the bank balance sheet.
B) These are complex, financially engineered instruments.
C) These bonds are given AAA credit rating.
D) Both A and B.
E) Both B and C.

Question 11

Which of the following allows the bank to raise the level of capital during a financial crisis for certainty?

A) Borrow funds from other financial institutions.
B) Sell the remaining assets at fire sale prices.
C) Raise more funds by issuing new shares on the stockmarket.
D) All of the above.
E) None of the above.

Question 12

The effectiveness of expansionary fiscal policy is limited when which of the following occurs?

A) Continual budget surpluses leading to low public debt.
B) Temporary budget deficits leading to high public debt.
C) Continual budget surpluses leading to high public debt.
D) Temporary budget deficits leading to low public debt.
E) Continual budget deficits leading to high public debt.

Question 13

When the economy is in a liquidity trap with a zero interest rate, what happens to output when prices decrease?

A) Output decreases.
B) Output does not change.
C) Output initially decreases then increases.
D) Output increases.
E) Output initially increases then decreases.

Question 14

Consider the following balance sheet situation of ABC bank: its total assets consist of loans of $50 and bonds of $350; and its total liabilities consist of deposits of $400 and debt of $100. What is the capital of ABC bank?

A) $50.
B) - $100.
C) $0.
D) $100.
E) - $50.

Question 15

The process of banks borrowing from other banks and other investors to finance their asset purchases is known as:

A) credit funding.
B) market funding.
C) retailing funding.
D) debt funding.
E) wholesale funding.

Question 16

Which of the following are securitised bonds?

A) Mortgage- based security.
B) Credit default swaps.
C) Collateralised debt obligations.
D) Both A and B.
E) Both B and C.

Question 17

When a liquidity trap situation exists, the most appropriate policy to increase output would be:

A) an increase in taxes.
B) a central bank sale of bonds.
C) a decrease in government spending.
D) an increase in government spending.
E) a central bank purchase of bonds.

Question 18

Which of the following is characteristic of a bank with a high leverage ratio?

A) The bank is taking on more risk.
B) The bank is more likely to go bankrupt.
C) The bank expects higher profits in the future.
D) All of the above.
E) None of the above.

Question 19

An open market purchase of bonds by the central bank will cause which of the following when a liquidity trap situation exists?

A) The interest rate will not change.
B) Output will decrease.
C) The interest rate will decrease.
D) Output will increase.
E) The money supply will not change.

Question 20

Capital ratio is defined as:

A) the ratio of assets to liabilities.
B) the ratio of capital to assets.
C) the ratio of liabilities to capital.
D) the ratio of assets to capital.
E) the ratio of capital to liabilities.

Question 21

Which of the following is the aggregate supply explanation of the slow U.S. recovery?

A) The banking crisis has increased the natural level of employment.
B) The banking crisis has decreased the natural rate of unemployment.
C) The banking crisis has decreased the natural level of output.
D) The banking crisis has increased the natural rate of interest.
E) The banking crisis has increased the level of productivity.

Question 22

The TED spread is a useful indicator of the perceived lending risk in the financial markets because:

A) the measure rises when the risk of bank insolvency falls.
B) the measure becomes negative when the risk of bank insolvency rises.
C) the measure falls when the risk of bank insolvency rises.
D) the measure becomes negative when the risk of bank insolvency falls.
E) the measure rises when the risk of bank insolvency rises.

Question 23

The effectiveness of expansionary monetary policy is limited when which of the following occurs?

A) Interest rate trap.
B) Credit trap.
C) Liquidity trap.
D) Output trap.
E) Financial trap.

Question 24

The term financial intermediation is used to describe:

A) the matching of investors with stockbrokers in the sharemarket.
B) the matching of employees with firms in the labour market.
C) the matching of saving flows in an economy with real investment flows.
D) the matching of bank customers with a suitable home loan.
E) the matching of buyers with sellers in the housing market.

Question 25

Which of the following defines bank capital?

A) Total liabilities minus deposits.
B) Total liabilities plus bonds.
C) Total assets plus total liabilities.
D) Total assets minus total liabilities.
E) Total assets minus bonds.

Question 26

The decrease in Japanese stock prices in the 1990s was most likely the result of which of the following?

A) A decrease in inflation.
B) The end of a speculative bubble.
C) Contractionary fiscal policy.
D) Contractionary monetary policy.
E) An increase in inflation.

Question 27

Which of the following refers to a situation of pent- up demand?

A) Future demand is brought forward to the present time.
B) There is a rise in supply to meet future expected increases in demand.
C) There is an increase in consumer savings.
D) There is an increase in firm inventories.
E) Current demand is delayed for some time into the future.

Question 28

In response to the crisis, the U.S. policymakers implemented:

A) only expansionary monetary policy.
B) expansionary fiscal policy and contractionary monetary policy.
C) expansionary fiscal policy and expansionary monetary policy.
D) contractionary fiscal policy and expansionary monetary policy.
E) contractionary fiscal policy and contractionary monetary policy.

Question 29

The leverage ratio is defined as:

A) the ratio of capital to assets.
B) the ratio of assets to capital.
C) the ratio of liabilities to capital.
D) the ratio of assets to liabilities.
E) the ratio of capital to liabilities.

Question 30

When a liquidity trap situation exists, we know that:

A) expansionary monetary policy will be deflationary.
B) fiscal policy will have no effect on the demand for goods.
C) an open market operation will have no effect on the monetary base.
D) an open market operation will have no effect on the interest rate.
E) an open market operation will have no effect on the supply of money.

Question 31

An increase in government spending will cause which of the following when a liquidity trap situation exists?

A) The interest rate will decrease.
B) Output will increase.
C) Output will not change.
D) Output will decrease.
E) The interest rate will increase.

Question 32

Bank insolvency is more likely to occur during a financial crisis because:

A) wholesale funding dries up.
B) most of the assets become toxic.
C) banks stop lending to each other.
D) All of the above.
E) None of the above.

Question 33

Why do banks maintain a certain level of bank capital?

A) These funds are required to satisfy shareholders in annual statements.
B) These funds are reserved as salary bonuses for top management.
C) These precautionary funds are held against the illiquidity risks of loans and bonds.
D) These are funds to be invested in emerging market economies.
E) These funds are set aside for taxation purposes.

Question 34

Which of the following is the aggregate demand explanation of the slow U.S. recovery?

A) There is insufficient credit to return the economy to the natural level of output.
B) There is insufficient demand to return the economy to the natural level of output.
C) The unemployment rate is too low to return the economy to the natural level of output.
D) The interest rate is too low to return the economy to the natural level of output.
E) Government spending is too low to return the economy to the natural level of output.

Question 35

How was the financial crisis in the U.S. transmitted to the macro economy?

A) Dramatic falls in consumer and firm confidence.
B) Large increases in the interest rates at which consumers and firms borrow.
C) Many financial institutions become insolvent.
D) Both A and B.
E) Both B and C.

Question 36

Deposit guarantees are put in place by the government for the purpose of:

A) increasing the collateral owned by banks.
B) satisfying terms and conditions set out in the bank charter.
C) boosting the share prices of the financial institutions.
D) making bank customers happy with the service.
E) protecting financial institutions from the danger of bank runs.

Question 37

What happens to the AD curve when the economy is in the liquidity trap with a zero interest rate?

A) The AD curve becomes horizontal.
B) The AD curve becomes downward- sloping.
C) The AD curve becomes upward- sloping.
D) The AD curve becomes U- shaped.
E) The AD curve becomes vertical.

Question 38

What was the revised goal of the Troubled Asset Relief Program introduced by the U.S. government?

A) To decrease leverage by providing funds to decrease capital ratios.
B) To decrease leverage by demanding collateral from banks.
C) To decrease leverage by providing funds to increase capital ratios.
D) To increase leverage by providing funds to decrease capital ratios.
E) To increase leverage by providing funds to increase capital ratios.

Question 39

An open market sale of bonds by the central bank will cause which of the following when a liquidity trap situation exists?

A) Output will decrease.
B) The money supply will not change.
C) The interest rate will increase.
D) The interest rate will not change.
E) Output will increase.

Question 40

Which of the following conditions will most likely coincide with the existence of a liquidity trap?

A) Inflation is zero.
B) The real interest rate is negative.
C) Inflation is rising.
D) Individuals prefer to hold only money and not bonds.
E) Inflation is constant.

Question 41

What are the two channels in which the effects of the financial crisis was transmitted to the macro economy in the U.S.?

Question 42

A tax cut will cause which of the following when a liquidity trap situation exists?

A) Output will not change.
B) Output will increase.
C) The interest rate will decrease.
D) Output will decrease.
E) The interest rate will increase.

Question 43

Suppose a liquidity trap exists. Graphically illustrate and explain the effects of an increase in government spending using the IS- LM model.

Question 44

In response to the speculative bubble crash, Japanese policymakers pursued:

A) monetary expansion.
B) labour supply expansion.
C) fiscal expansion.
D) Both A and B.
E) Both B and C.

Question 45

Discuss why the balance sheet of a bank may be distressed in the event of a financial crisis?

Question 46

What was the original goal of the Troubled Asset Relief Program introduced by the U.S. government?

A) To appease creditors by removing complex assets from the balance sheet of banks.
B) To conduct an audit of the balance sheet of banks.
C) To negotiate with potential buyers of troubled banks.
D) To decrease uncertainty by removing complex assets from the balance sheet of banks.
E) To increase uncertainty by removing complex assets from the balance sheet of banks.

Question 47

Explain what is meant by a liquidity trap. Also discuss the implications of a liquidity trap for the shapes of the money demand and LM curves.

Question 48

To what extent have monetary policy and fiscal policy been able to limit the severity of the Japanese Slump? Explain.

Question 49

What roles do banks serve in the economy?

Question 50

Which of the following signals the rise in perceived risks in the financial markets?

A) Much higher interest rates are demanded of borrowers.
B) A widening of the TED spread.
C) Only short- term lending to households and firms.
D) All of the above.
E) None of the above.

Question 51

The Nikkei, a Japanese stock price index, reached its peak in which of the following years?

A) 1989.
B) 1995.
C) 1992.
D) 1985.
E) 1990.

Question 52

When output deviates from the natural level of output, the economy is believed to "self- correct" over time. That is, the economy will return to the natural level of output without any policy intervention. First, explain how this process works when output is below the natural level of output. Second, briefly discuss what factors would hinder this self- correcting adjustment when the economy is in a liquidity trap.

Question 53

Subprime mortgages are home loans granted to borrowers that:

A) have poor credit rating and are likely to default on the loans.
B) have sound retirement plans.
C) have high quality collateral.
D) have sound credit rating and ability for repayments.
E) have inside connection with bank managers.

Question 54

What is bank capital and its function?

Question 55

Use the IS- LM model to answer this question. Suppose there is an increase in inflation that also causes an increase in expected inflation. Explain the effects of this on the economy and on the aggregate demand curve.

Question 56

Explain the interaction between bank leverage, asset complexity, and liquidity in amplifying the housing problem into a financial crisis in the U.S.