Deck 14: The Monetary System

Question 1

Which of the following is a liability for the Fed?

A) Government bonds
B) Loans
C) Currency holdings
D) Individuals' deposits in member banks
E) Currency in circulation

Answer 1

Currency in circulation

Question 2

When a bank borrows reserves from the Federal Reserve

A) the monetary base remains unchanged because no new reserves are created.
B) the Fed may choose to nullify the effect on the monetary base through an open market sale.
C) the monetary base increased as new reserves enter the banking system.
D) both b and c.
E) none of the above.

Answer 2

both b and c.

Question 3

^{Which of the following is not included in the calculation of M}2^?

A) currency
B) large savings accounts over $100,000
C) checking account deposits
D) small savings accounts less than $100,000
E) holdings in money market mutual funds

Answer 3

large savings accounts over $100,000

Question 4

Whenever the U.S. government finances expenditure by printing money,

A) it does so by borrowing from the Fed.
B) it increases the monetary base by an amount exactly equal to the number of dollars "printed."
C) it does so in lieu of financing the spending by floating new bonds in public auctions.
D) all of the above.
E) none of the above.

Question 5

In the United States, currency consists of

A) paper money issued by the Federal Reserve.
B) checks drawn on deposit-taking institutions.
C) coin minted by the Treasury Department.
D) all of the above.
E) a and c only.

Question 6

Since 1960, the ratio of checking deposits to GDP in the United States has

A) risen sharply, indicating a strong positive correlation between the demand for checking deposits and the real interest rate.
B) held remarkably constant, indicating no correlation between the demand for checking deposits and the real interest rate.
C) fallen steadily, indicating, a positive correlation between the demand for checking deposits and the real interest rate.
D) fallen steadily, indicating, because interest rates were stable over the period, no information about the correlation between the demand for checking deposits and the real interest rate.
E) none of the above.

Question 7

Suppose that the required reserve ratio is 12 percent and banks are holding excess reserves of 3 percent. If total reserves are $45 billion and the demand for currency is $150 billion, then

A) total deposits equal $300 billion supported in part by $9 billion in excess reserves.
B) total deposits equal $375 billion supported in part by $9 billion in excess reserves.
C) total deposits equal $450 billion supported in part by $36 billion in excess reserves.
D) total deposits equal $450 billion supported in part by $36 billion in required reserves.
E) total deposits equal $525 billion supported in part by $9 billion in excess reserves.

Question 8

The Fed tries to achieve its policy goals in the macroeconomy by manipulating

A) the currency component of the monetary base almost exclusively.
B) the reserve component of the monetary base almost exclusively.
C) the savings behavior of private citizens.
D) both the currency and reserve components of the monetary base.
E) the rate of influx of foreign currency into the country.

Question 9

Suppose the reserve requirement is 10 percent and banks routinely hold 1 percent in excess reserves. If the Fed purchases $440 million in government bonds in an open market operation, then the money supply

A) increases by $4 billion regardless of the effect on the demand for currency.
B) increases by $5 billion regardless of the effect on the demand for currency.
C) increases by some amount above or below $4 billion, depending on whether the demand for currency rose or fell with the stimulus of the open market operation.
D) increases by some amount less than $4 billion because the full money multiplier is diminished by any GDP-induced increase in the demand for currency.
E) none of the above.

Question 10

Two essential elements of any monetary system are the establishment of

A) an accepted means of payment.
B) a stable commodity to back the means of payment.
C) a unit of account.
D) both a and b.
E) both a and c.

Question 11

^{Which of the following ranks M}1^{, M}2^{, and M}3 ^{according to size?}

A)
B)
C)
D)
E)

Question 12

Which of the following is a financial liability for the government?

A) Currency
B) Individuals' deposits in banks that are members of the Fed
C) Excess reserves held by Fed member banks
D) Bonds held at the Fed
E) None of the above

Question 13

Testimony given before Congress by the Federal Reserve Board chairman

A) generally goes unnoticed by news reporters covering Capitol Hill.
B) gets dissected sentence by sentence for clues about upcoming interest rate changes.
C) seldom has any effect on Wall Street and other financial markets.
D) is not legally required but given as a courtesy.
E) both b and d.

Question 14

^{In 2002, the difference between M}1 ^{measured at $1,201 billion and M}2 ^was

A) less than $0.5 trillion.
B) approximately $1 trillion.
C) nearly $3.5 trillion.
D) over $5 trillion.
E) approximately $4.6 trillion.

Question 15

The revenue raised by the U.S. government by "printing money" has been

A) roughly equal to the size of the federal deficit in almost every year since 1975.
B) much smaller than the federal deficit in almost every year since 1975.
C) slightly larger than the federal deficit in almost every year since 1975.
D) larger than the federal deficit in some years and smaller in other years with no apparent pattern since 1975.
E) almost negligible in most years since 1975.

Question 16

The reserve requirement is

A) the fraction of deposits the Fed is required to hold in its vaults in case member banks ask to draw on their accounts.
B) the fraction of currency held by banks as required by law.
C) the fraction of deposits banks are required to hold as reserves.
D) the fraction of the money base held in reserve by member banks of the Federal Reserve System.
E) none of the above.

Question 17

The reserve requirement prescribed by the Fed that all banks must hold is

A) 9 percent of their deposits as reserves.
B) 10 percent of their deposits as reserves.
C) 12 percent of their deposits as reserves.
D) 15 percent of their deposits as reserves.
E) 25 percent of their deposits as reserves.

Question 18

^{Which of the following is included in the computation of M}1^?

A) small savings accounts under $100,000
B) large savings accounts over $100,000
C) holdings in money market mutual funds
D) holdings of government securities
E) none of the above

Question 19

The year 1995 was marked in the United States by

A) an increase in the monetary base of $20 billion, less than 2 percent of government expenditures.
B) a decrease in the monetary base of $20 billion, less than 2 percent of government expenditures.
C) an increase in the monetary base of $20 billion, more than 25 percent of government expenditures.
D) an increase in the monetary base of $200 billion, more than 25 percent of government expenditures.
E) none of the above.

Question 20

Which of the following is a financial liability of the private sector?

A) Holdings of currency
B) Deposits in demand and savings accounts
C) Loans
D) Holdings of government bonds
E) All of the above

Question 21

Which of the following was identified by Keynes as an important motive behind the demand for money?

A) the transactions demand for money that reflects the desire of individuals to have enough cash on hand to accommodate their anticipated transactions
B) the precautionary demand for money that reflects the desire of individuals to have enough cash available to cover most unexpected emergency expenditures
C) the speculative demand for money that reflects the desire of individuals to have enough cash available to take advantage of a potential future financial opportunity
D) all of the above
E) none of the above; these motives were identified by Baumol and Tobin

Question 22

Let the reserve requirement be 15 percent for deposits. Assume there are no excess reserves. If currency demand equals 40 percent of deposits and total reserves equal $60 billion, then an open market sale of $1.5 billion in government bonds should

A) increase the money supply from $560 billion to $574 billion.
B) increase the money supply from $400 billion to $410 billion.
C) reduce the money supply from $400 billion to $390 billion.
D) reduce the money supply from $160 billion to $156 billion.
E) reduce the money supply from $560 billion to $546 billion.

Question 23

^{The share of currency in M}1 ^{as of 1990 was about}

A) 40 percent.
B) 30 percent.
C) 18 percent.
D) 10 percent.
E) none of the above.

Question 24

If the reserve requirement were so low that no bank felt it was a constraint, then

A) the relationship between currency and demand deposits would be too uncertain to allow an accurate calculation of the monetary base multiplier.
B) the arithmetic that produced the monetary base multiplier would be invalidated by the uncertainty surrounding the Fed's balance sheet.
C) the relationship between reserves and deposits would be so uncertain that the ability of the Fed to control the money supply through the monetary base would be severely hampered.
D) the monetary base multiplier would have to be infinity and all monetary control would be destroyed.
E) none of the above.

Question 25

Let RBAR represent the percentage of deposits that must be maintained by any bank to maintain its short-run liquidity. RBAR might be different for every bank. The Fed sets the reserve requirement well above RBAR

A) to make extra certain that a bank is always liquid.
B) to make it more likely that any given bank holds a known percentage of deposits in reserve.
C) to make the effect of a change in the monetary base on the money supply more predictable.
D) all of the above.
E) b and c only.

Question 26

Which of the following events should cause the average cash balance that minimizes total carrying costs to increase?

A) A reduction in the opportunity cost of holding cash
B) A reduction in total income
C) A reduction in the cost of a deposit transaction
D) An increase in the opportunity cost of holding cash
E) A simultaneous and proportional increase in the cost of a deposit transaction and the opportunity cost of holding cash

Question 27

The discount rate set by the Fed

A) is the rate of interest charged member banks when they borrow from the Fed to meet their reserve requirements.
B) is the difference between the rate of interest charged to the government for borrowing from the Fed and the rate of interest charged to commercial customers.
C) is the rate at which banks are required to borrow from each other to maintain their compliance with their reserve requirements.
D) is the rate at which the Fed discounts the future when it makes its policy decisions.
E) none of the above.

Question 28

The monetary base is

A) the sum of currency and bond holdings kept by the Fed.
B) the sum of required reserves and outstanding deposits held by member banks of the Federal Reserve System.
C) the sum of bond holdings and currency holdings of private banks across the United States.
D) the sum of currency and required reserves held throughout the United States.
E) none of the above.

Question 29

The Federal Reserve System

A) lists government bonds among its assets and both currency and reserves among its liabilities.
B) lists bonds and reserves among its assets and deposits among its liabilities.
C) lists currency, deposits, and bonds among its assets and loans among its liabilities.
D) lists virtually nothing as assets against bonds issued as liabilities.
E) none of the above.

Question 30

Which of the following influences the opportunity cost of holding cash balances in a checking account?

A) any service charges that might be applied in maintaining the account
B) the difference between the real rate of interest and the rate paid on checking deposits
C) the difference between the nominal rate of interest and the rate paid on checking deposits
D) a and b
E) a and c

Question 31

Let the reserve requirement be 0.25 and let demand deposits exceed currency by a factor of 2. In that case, an increase of $1 billion in the monetary base increases the money supply by

A) $2 billion.
B) $4 billion.
C) $5 billion.
D) $2.5 billion.
E) only $1 billion.

Question 32

A monetary policy that tries to maintain fairly constant interest rates

A) makes random shocks to the IS curve more harmful in terms of variation in GDP.
B) makes random shocks to the IS curve less harmful in terms of variation in GDP.
C) makes random shocks to the LM curve more harmful in terms of variation in GDP.
D) has no effect on the sensitivity of GDP to random shocks in the IS curve.
E) has no effect on the sensitivity of GDP to random shocks in the LM curve.

Question 33

The ratio of checking deposits to GDP in the United States between 1960 and 2002

A) rose sharply, indicating a strong positive correlation between the demand for checking deposits and the real interest rate.
B) held remarkably constant, indicating no correlation between the demand for checking deposits and the real interest rate.
C) fell steadily, indicating a positive correlation between the demand for checking deposits and the real interest rate.
D) fell steadily, indicating, because interest rates were stable over the period, no information about the correlation between the demand for checking deposits and the real interest rate.
E) none of the above.

Question 34

In the United States, any deficit run by the federal government must be financed

A) by increases in the monetary base arranged by the Fed selling existing bonds or changes in government investment patterns.
B) only by increases in the national debt financed by the Treasury's floating new bonds.
C) by increases in the monetary base arranged by the Fed selling existing bonds or changes in the national debt arranged by the Treasury buying back existing bonds.
D) increases in the monetary base arranged by the Fed buying existing bonds or changes in the national debt arranged by the Treasury floating new bonds.
E) by none of the above.

Question 35

Let the LM curve be subject to random shocks. As government spending becomes more positively) responsive to the gap between actual and potential GDP, the desirability of setting monetary policy to achieve

A) an interest rate target necessarily increases.
B) a GDP target necessarily increases.
C) an exchange rate target necessarily increases.
D) a money supply target necessarily increases.
E) an employment target necessarily increases.

Question 36

Let income be $1,600 billion. If the cost of a deposit transaction is $9 and the opportunity cost of holding money is 4.5 percent, then the average cash balance that minimizes total cost is

A) $360 billion.
B) $400 billion.
C) $540 billion.
D) $600 billion.
E) none of the above.

Question 37

Excess reserves held by banks as hedges against seeing their reserves fall below the 10 percent requirement

A) are generally quite small since no interest is earned on them.
B) tend to be largest when interest rates are high, since fewer people borrow money.
C) are generally about half of required reserves, so that banks can cover unexpected withdrawals.
D) have always been greater than zero because of penalties assessed by the Fed if total reserves fall below the reserve requirement.
E) none of the above.

Question 38

The demand for currency depends

A) negatively on the price level.
B) negatively on real GDP.
C) positively on the market rate of interest.
D) positively on the rate of interest paid on checking accounts.
E) none of the above.

Question 39

The demand for checking deposits depends

A) positively on the price level.
B) positively on real GDP.
C) negatively on the market rate of interest.
D) positively on the rate of interest paid on checking deposits.
E) all of the above.

Question 40

The ratio of currency to GDP in the United States over the past four decades

A) fell slightly until 1990 then rose sharply; this indicates a recent increase in the sensitivity of currency demand to changes in the real interest rate.
B) fell significantly over the entire period; this indicates a positive correlation between currency demand and the real interest rate.
C) rose slightly until 1990 then fell sharply; this indicates limited sensitivity in currency demand to changes in the real interest rate.
D) held remarkably constant; this indicates absolutely no sensitivity in currency demand to changes in the real interest rate.
E) none of the above.

Question 41

A decision on the part of the FOMC to lower interest rates must necessarily be followed by

A) Fed open market purchases, which lower the money supply and reduce interest rates.
B) Fed open market purchases, which increase the money supply and reduce interest rates.
C) Fed open market sales, which lower the money supply and reduce interest rates.
D) Fed open market sales, which increase the money supply and reduce interest rates.

Question 42

Given a monetary policy that targets the monetary base, the appropriate LM representation shows

A) a stationary LM curve with the real interest rate climbing with GDP to keep the demand for money in line with the supply.
B) a horizontal line at the equilibrium rate of interest, indicating little or no sensitivity of the real rate to changes in GDP.
C) the real interest rate falling, as GDP climbs, to keep the demand for money in line with the supply.
D) a nearly vertical line above the level of GDP associated directly with the target base and invariant to changes in the interest rate.
E) none of the above.

Question 43

Since the mid 1980s, the FOMC's chief policy focus has been the decision over

A) setting the growth rate of the money supply.
B) setting the federal funds rate.
C) setting margin requirements on stock purchases.
D) setting the discount rate.
E) setting reserve requirements.

Question 44

Which of the following statements is accurate?

A) The derived demand for the money base depends negatively on the interest rate; it is strong when checking accounts earn market rates and weak when they earn only small returns.
B) The derived demand for the money base depends negatively and proportionately on the price level because currency and checking deposit demand are both correlated with nominal GDP.
C) The derived demand for the money base depends negatively and proportionately on real GDP because currency and checking deposit demand are both correlated with nominal GDP.
D) All of the above.
E) None of the above.

Question 45

In which of the following periods were short-term interest rates the highest?

A) 1973-1975
B) 1980-1982
C) 1983-1985
D) 1988-1990
E) 1992-1994

Question 46

The distinction between fiscal policy and monetary policy is that

A) fiscal policy involves either bond-financed changes or open market operations in government finance while monetary policy involves only open market operations.
B) fiscal policy involves only government spending and tax policies. Deficits are handled by the Treasury, and monetary policy requires congressional approval.
C) fiscal policy can be conducted without the Fed's approval but monetary policy requires congressional approval.
D) fiscal policy involves only bond-financed changes in government finance while monetary policy involves some form of open market operations.
E) none of the above descriptions is accurate.

Question 47

The ultimate objectives) of monetary policy is are) best summarized as

A) stability of interest rates.
B) steady growth in the price level.
C) price level stability and steady growth in output.
D) interest rate and price level stability.
E) interest rate stability and steady growth in output.

Question 48

Which of the following statements is most accurate?

A) Monetary policy set to achieve money supply targets best insulates GDP from random shifts in the IS curve.
B) Monetary policy set to achieve an interest rate target best insulates GDP from random shifts in the LM curve.
C) Monetary policy set to achieve a money supply target represents a compromise that insulates GDP from simultaneous random shifts in both the IS curve and the LM curve.
D) All of the above.
E) Only a and b.

Question 49

Under which policy regime is GDP most insulated from random shifts in the LM curve?

A) A monetary policy targeted at a constant interest rate with checking accounts paying no interest
B) A monetary policy targeted at a constant monetary base with checking accounts paying no interest
C) A monetary policy targeted at a constant interest rate with checking accounts paying competitive interest rates
D) A monetary policy targeted at a constant money supply with checking accounts paying competitive interest rates
E) Either a or c regardless of economic conditions

Question 50

Allowing checking deposits to earn interest should not make the LM curve vertical because

A) the demand for checking deposits remains insensitive to changes in the interest rate.
B) the demand for currency remains sensitive to changes in the interest rate.
C) the rates paid to checking deposits usually move up when the returns paid to other assets moved down and vice versa.
D) banks do not immediately pay interest on checking accounts and depositors' reacting to the expectation of future earnings on checking deposits neutralize any potential stimulus.
E) none of the above.

Question 51

Suppose that a series of banking emergencies suddenly increased the demand for currency and reduced the demand for checking deposits. You would expect, in that case, to see

A) interest rates climb and nominal GDP fall unless the Fed increased the monetary base.
B) interest rates fall and nominal GDP rise unless the Fed reduced the monetary base.
C) a monetary policy targeted at maintaining a constant monetary policy be less effective in maintaining a constant level of GDP than a policy that targeted a constant monetary base.
D) a and c only.
E) b and c only.

Question 52

Against which LM curve listed here does a change in goods market spending have the greatest impact in moving GDP around in the short run?

A) A vertical LM curve
B) A steeply sloped LM curve
C) A gently sloped LM curve
D) A horizontal LM curve
E) Not determinable from the information provided

Question 53

Under which circumstance does a change in government spending have the largest effect on the real interest rate?

A) A monetary policy targeted at a constant monetary base with checking accounts paying no interest
B) A monetary policy targeted at a constant interest rate with checking accounts paying no interest
C) A monetary policy targeted at a constant money supply with checking accounts paying competitive interest rates
D) A monetary policy targeted at a constant monetary base with checking accounts paying competitive interest rates
E) Either a or d depending on macroeconomic conditions

Question 54

Which of the following are functions of the Federal Open Market Committee?

A) ^{The specification of growth rates for the major money aggregates: M}1^{, M}2^{, and M}3
B) The specification of the discount rate
C) The specification of instructions for week-to-week Fed activity at the New York Trading Desk
D) The specification of the reserve requirement
E) a and c

Question 55

Which of the following LM curves is the most appropriate representation of a monetary policy targeted at the money base with checking accounts earning no interest?

A) A vertical LM curve
B) A steeply sloped LM curve
C) A gently sloped LM curve
D) A horizontal LM curve
E) A negatively sloped LM curve

Question 56

Fiscal policy is most effective when monetary policy is set to achieve

A) ^{a money supply M}1^{) target.}
B) an interest rate target.
C) a GDP target.
D) either a money supply target or an interest rate target.
E) either a money supply target or a GDP target.

Question 57

Allowing banks to pay interest on their checking account deposits should cause

A) the LM curve to get flatter because larger increases in GDP could be accommodated by the same adjustment in real rates.
B) the LM curve to get steeper because currency demand still is correlated with the real interest rate.
C) ^{the LM curve to get steeper because demand for M}1 ^{becomes less} sensitive to changes in interest rates when rates paid on checking deposits parallel those paid by other financial assets.
D) ^{the LM curve to become vertical because demand for M}1 ^becomes totally independent of the interest rate.
E) none of the above.

Question 58

Under which policy regime is GDP most insulated from the effects of random shifts in the IS schedule?

A) A monetary policy targeted at a constant interest rate with checking accounts paying no interest
B) A monetary policy targeted at a constant money supply with checking accounts paying no interest
C) A monetary policy targeted at a constant money supply with checking accounts paying competitive interest rates
D) A monetary policy targeted at a constant monetary base with checking accounts paying competitive interest rates
E) Either a or c depending on economic circumstance

Question 59

The effects of any change in monetary policy lag

A) in part because they work through changes in the interest rate to alter investment and it takes a long time for investment projects to come to fruition.
B) in part because they work through changes in the interest rate to alter net exports and it takes a long time for international markets to register the permanence of such a change.
C) by such a long time that the maximum effect is generally felt one to two years after the policy adjustment.
D) by such a long time that policy makers are reluctant to make large adjustments for fear of exacerbating a future problem in the event that conditions turn around.
E) all of the above.

Question 60

A zero bound on nominal interest rates exists because

A) inflation can never be greater than nominal interest rates.
B) bank regulations do not allow a zero rate of interest.
C) the FOMC would not buy bonds at a rate fast enough to drive interest rates to zero.
D) people would prefer to hold cash at a zero rate of return.
E) both a and c.

Question 61

In comparing the lags of the effects of monetary policy

A) determining the effects on prices is easier than the effect on GDP.
B) GDP effects take much longer to show up than price effects.
C) the economy's predictable response simplifies monetary policy.
D) price effects take much longer to show up than GDP effects.
E) both effects take about the same time to show up.