Deck 12: Monetary and fiscal policy

Question 1

If investment is not very sensitive to interest rate changes,

A)fiscal policy will be largely ineffective in changing output
B)monetary policy will be very effective in changing output
C)the economy is in the classical case
D)monetary policy cannot be used to lower interest rates
E)the size of the crowding out effect following expansionary fiscal policy will be small

Answer 1

the size of the crowding out effect following expansionary fiscal policy will be small

Question 2

If we have a normal IS-curve but a horizontal LM-curve,

A)fiscal policy is the most effective way to reduce unemployment
B)fiscal policy is at its weakest in reducing unemployment
C)monetary policy can aid fiscal policy in reducing unemployment
D)monetary policy is the most effective way to reduce unemployment
E)neither fiscal nor monetary policy is effective in reducing unemployment

Answer 2

fiscal policy is the most effective way to reduce unemployment

Question 3

The transmission mechanism between an open market purchase by the central bank and an increase in aggregate demand can break down if

A)banks are unwilling to lend to private firms
B)money demand is totally interest inelastic
C)investment is very interest sensitive
D)bond prices increase too much
E)none of the above

Answer 3

banks are unwilling to lend to private firms

Question 4

A change in which of the following will NOT shift the IS-curve?

A)autonomous investment
B)autonomous money demand
C)autonomous consumption
D)autonomous net exports
E)autonomous saving

Question 5

If the Fed undertakes open market sales, then

A)the LM-curve will shift to the right
B)the LM-curve will shift to the left
C)interest rates will decrease and income will increase
D)bond prices will increase
E)both A and C

Question 6

Fiscal policy is weakest and monetary policy is strongest when

A)we are in the liquidity trap
B)money demand is very interest elastic
C)investment is very interest inelastic
D)we are in the classical case
E)the IS-curve is very steep and the LM-curve is very flat

Question 7

Monetary policy becomes more effective as

A)the marginal propensity to save increases
B)the interest sensitivity of money demand decreases
C)the interest sensitivity of investment decreases
D)the income tax rate increases
E)none of the above

Question 8

In an IS-LM model, if we assume that money demand is completely insensitive to changes in the interest rate,

A)fiscal policy cannot change the level of output but will change the composition of GDP
B)monetary policy is totally ineffective in changing the level of output
C)interest rates cannot be lowered by fiscal or monetary policy
D)the economy cannot be stimulated by fiscal or monetary policy
E)monetary policy can change income but not interest rates

Question 9

The liquidity trap exists when

A)the IS-curve is vertical
B)the LM-curve is vertical
C)the LM-curve is horizontal
D)an increase in government spending is always fully crowded out
E)money demand is completely insensitive to changes in the interest rate

Question 10

In the classical case,

A)the fiscal policy multiplier is zero
B)crowding out cannot occur
C)investment does not respond to interest rate changes
D)an increase in the income tax rate cannot lower the budget deficit
E)monetary policy is totally ineffective

Question 11

If we were in a liquidity trap,

A)investment would be totally interest insensitive
B) fiscal expansion would be unlikely to drive interest rates up
C) monetary policy would be more powerful than fiscal policy
D)an increase in government spending would be totally offset by a decrease in private investment
E)crowding out would be made worse by the inability of monetary policy to accommodate fiscal policy

Question 12

One side effect of expansionary fiscal policy is that

A)higher interest rates cause a change in the composition of GDP
B)higher interest rates significantly increase private saving
C)consumption spending is crowded out
D)the Fed has to reinforce the policy through open market sales
E)all of the above

Question 13

If money supply is held constant, a cut in government transfer payments will eventually cause interest rates to

A)decline, enhancing the expansionary impact of the policy
B)decline, decreasing the restrictive impact of the policy
C)increase, decreasing the expansionary impact of the policy
D)increase, decreasing the restrictive impact of the policy
E)increase, enhancing the restrictive impact of the policy

Question 14

The view that "only money matters" is accurate when

A)investment is completely interest insensitive
B)money demand is completely interest inelastic
C)money demand is completely interest elastic
D)we are in the liquidity trap
E)both C and D

Question 15

When the government employs a "tight fiscal policy," we should expect that

A)the level of output will only be affected by a small amount
B)interest rates will increase
C)monetary policy will be "easy" at the same time
D)inflation will be lowered more than unemployment
E)the budget deficit will decrease

Question 16

The LM-curve is vertical when

A)the interest elasticity of investment is zero
B)the central bank keeps nominal money supply constant
C)we are in the classical case
D)we are in the liquidity trap
E)none of the above

Question 17

The transmission mechanism

A)is the process by which fiscal policy affects aggregate demand
B)works best if money demand is completely interest elastic
C)fails if none of the components of aggregate demand responds to changes in interest rates
D)relates to the effects of tax rate changes on the fiscal multiplier
E)all of the above

Question 18

Fiscal policy becomes more powerful in changing the level of output as

A)investment becomes more interest elastic
B)money demand becomes more interest inelastic
C)money demand becomes more income elastic
D)the marginal propensity to save gets smaller
E)the marginal propensity to consume gets smaller

Question 19

When the LM-curve is vertical,

A)the monetary policy multiplier is zero
B)monetary policy is at its weakest but fiscal policy has a maximum effect on income
C)monetary policy has a maximum effect, but fiscal policy has no effect on income
D)fiscal policy's impact on interest rates will not affect investment
E)monetary policy affects interest rates but no change in investment spending results

Question 20

Monetary policy becomes less effective as

A)the marginal propensity to consume increases
B)the interest sensitivity of money demand decreases
C)the interest sensitivity of investment decreases
D)the LM-curve becomes steeper
E)the IS-curve becomes flatter

Question 21

Expansionary fiscal policy can be successful without a negative impact on the level of investment if

A)the government spending increase is financed by a tax increase
B)the Fed undertakes open market sales at the same time
C)it is implemented via an investment subsidy rather than a cut in personal income taxes
D)money demand is completely interest inelastic
E)it is implemented through a cut in personal income taxes rather than an increase in government purchases

Question 22

Monetary policy is said to be accommodating when

A)the central bank undertakes open market sales to fight inflation
B)the central bank responds to a tax increase by increasing money supply
C)the central bank responds to fiscal expansion by undertaking open market sales
D)in the course of fiscal expansion, the central bank increases money supply to prevent interest rates from rising
E)the central bank does not interfere in any way when the government undertakes fiscal policy

Question 23

The term "quantitative easing" refers to a policy by the Fed to

A)massively buy long-term assets in order to directly lower long-term interest rates
B) massively sell short-term assets in order to quickly change short-term interest rates
C) directly appeal to banks to ease credit in order to stimulate investment spending
D)"peg" the interest rate at a pre-determined level through the use of open market operations
E)none of the above

Question 24

The crowding out effect is zero if

A)the LM-curve is horizontal
B)the LM-curve is vertical
C)the central bank conducts open market sales following fiscal expansion
D)income is stimulated via a tax cut rather than an increase in government spending
E)none of the above

Question 25

In which country did nominal interest rates drop slightly below zero percent in 2012?

A)Denmark
B)Germany
C)Ireland
D)Japan
E)United States

Question 26

The recession of 2001 was very short lived since

A)real GDP already had decreased in the last quarter of 2000, but started to increase again in the third quarter of 2001
B)the Fed aggressively cut interest rates as soon as the economy started to slow down
C)G)W. Bush's tax cuts helped to increase GDP growth
D)all of the above
E)only B and C

Question 27

In an IS-LM framework, fiscal expansion generally leads to income expansion

A)only if it is combined with monetary expansion
B)except if we are in the liquidity trap
C)but interest rates will increase, leading to a lower level of saving
D)but the composition of output will change
E)but most consumption spending will be crowded out

Question 28

Crowding out occurs when

A)an increase in defense spending causes a decrease in consumption
B)expansionary monetary policy fails to stimulate economic growth
C)expansionary fiscal policy causes interest rates to rise, thereby reducing private spending
D)tax increases result in a drop in consumption
E)a policy designed to increase the budget surplus causes the economy to enter a recession

Question 29

Crowding out

A)does not occur in the liquidity trap
B)is caused by a rise in interest rates resulting from expansionary fiscal policies
C)cannot happen if the LM-curve is horizontal
D)cannot happen if the IS-curve is vertical
E)all of the above

Question 30

A policy mix designed to promote increased investment spending by firms might involve

A)open market sales combined with income tax cuts
B)a government spending increase financed by a tax increase
C)cuts in government purchases combined with higher investment tax credits
D)an increase in government purchases combined with monetary restriction
E)removal of investment subsidies

Question 31

Assume the government cuts the level of government purchases and the Fed responds by increasing money supply.Which of the following is the most likely result?

A)lower interest rates and a higher budget surplus
B)a large decrease in the interest rate and output
C)a decrease in investment and the budget deficit
D)an increase in consumption and lower tax revenues
E)a decrease in consumption and investment

Question 32

In a normal IS-LM framework, crowding out may be avoided if

A)banks ration credit
B)the government matches a tax increase with an increase in government purchases
C)the central bank increases the money supply to accommodate fiscal expansion
D)the central bank sells government bonds on a large scale
E)both C and D

Question 33

Assume you would like to stimulate investment but leave the level of GDP roughly the same. What policy mix would you propose?

A) an income tax cut combined with monetary expansion
B) a tax cut combined with monetary restriction
C) a cut in government spending combined with monetary expansion
D) a cut in government spending combined with monetary restriction
E) an investment subsidy combined with monetary expansion

Question 34

Which of the following describes a part of the transmission mechanism?

A)a change in real money balances causes a portfolio disequilibrium and asset holders' reactions influence interest rates
B)an income tax rate cut stimulates private spending but the resulting interest rate increase dampens the income expansion
C)an increase in government spending is partially offset by the crowding out of private investment
D)the central bank undertakes open market purchases and the resulting interest rate increase encourages people to save more
E)both B and C

Question 35

Assume we combine restrictive monetary policy with expansionary fiscal policy.Which is most likely to occur?

A)unemployment and interest rates will both go down
B)unemployment will go down but interest rates will stay the same
C)investment and consumption will both increase
D)interest rates and the budget deficit will both decrease
E)investment will decrease and the budget deficit will increase

Question 36

When conducting monetary policy, a central bank should

A)never monetize the budget deficit since this will lower the level of investment
B)be less concerned with current conditions than with future conditions
C)always try to keep interest rates low
D)always respond to expansionary fiscal policy by expanding money supply
E)none of the above

Question 37

Assume the government wants to increase the level of consumption and investment.Which of the following policies should be implemented?

A)higher investment tax credits
B)removal of investment subsidies combined with monetary restriction
C)an income tax cut combined with monetary restriction
D)an increase in government transfer payments to low income households financed by a tax increase on high income households
E)none of these

Question 38

During the recession of 2007-09, the U.S.Fed

A)lowered the federal funds rate to almost zero percent
B)bought large numbers of securities that were backed by private mortgages
C)took actions that increased the monetary base to more than double its original size
D)made loans to targeted sectors of the financial market
E)all of the above

Question 39

Given a normal IS-LM model, which of the following is FALSE?

A)expansionary monetary policy will increase the level of investment and consumption
B)lower income tax rates will raise the level of consumption but lower the level of investment
C)a cut in government transfer payments will reduce consumption and interest rates
D)an investment subsidy will increase the level of investment but not the level of consumption
E)restrictive monetary policy will lower consumption, investment, and the budget surplus

Question 40

In an IS-LM model, if the government enacts restrictive fiscal policy through a tax increase or a cut in government purchases,

A)the interest rate will decline, lowering the incentive to save and thus also the level of investment spending
B)the level of income will decrease but the interest rate will increase
C)both income and the interest rate will decrease
D)the LM-curve will shift to the left
E)the IS-curve will shift to the left, followed by a shift of the LM-curve to the left since this policy will change interest rates and therefore money demand

Question 41

An interesting aspect of the recession of 1990/91 was that

A)because of rising oil prices, the inflation rate did not fall
B)unemployment and inflation both increased sharply all through 1991
C)fiscal policy was highly restrictive and the Fed was very inactive
D)fiscal policy was immobilized due to a large budget deficit, while monetary policy did not work well due to credit rationing by banks
E)while the war against Iraq stimulated the economy, the Fed restricted money supply

Question 42

Which of the following was true for the recession of 1981/82?

A)nominal interest rates declined from 14.0% in 1981 to 10.7% in 1982, while real interest rates increased from 4.0% to 4.5%
B)the unemployment rate went above 11%, a higher level than in the Great Depression
C)the T-bill rate was lower than it ever was in the 1970s
D)real interest rates decreased steadily after 1981
E)all of the above

Question 43

In a normal IS-LM framework, if government purchases and taxes are both increased by the same amount, the level of output

A)will increase by exactly that amount
B)will remain the same but its composition will change
C)will not change and neither will the composition of output
D)will increase as will the interest rate
E)will increase but only if this fiscal policy is accommodated by expansionary monetary policy

Question 44

If short-term interest rates hit the lower zero bound and the Fed buys a large quantity of long-term assets to reduce long-term interest rates directly, the Fed is employing

A)a zero lower bound policy
B)a federal funds policy
C)a policy of monetary transmission
D)a policy of quantitative easing
E)anticipatory monetary policy

Question 45

Which of the following is TRUE?

A)the German policy mix in the early 1990s was the exact opposite of that in the U.S. in the early 1980s
B)the inflation rate in Germany in 1991 was 5.1% and was a matter of great concern
C)nominal interest rates in Germany decreased from 1990-92, while real interest rates increased
D)real GDP growth remained remarkably strong in Germany from 1990-92
E)none of the above

Question 46

The re-unification of Germany required a large increase in government spending, but the Bundesbank refused to accommodate the expansionary fiscal policy due to concerns about rising inflation.What was the outcome?

A)rising real interest rates
B)a deficit in the current account of the balance of payments
C)an increase in the budget deficit
D)a change in the composition of Germany's GDP
E)all of the above

Question 47

When bankers talk about "one basis point," they generally refer to a change in

A)money supply by one percent
B)the monetary base by one percent
C)interest rates by one percent
D)interest rates by one-tenth of a percent
E)interest rates by one-hundredth of a percent

Question 48

Assume that policy mix A combines restrictive monetary policy with expansionary fiscal policy, while policy mix B combines expansionary monetary policy with restrictive fiscal policy.Compared to policy mix B, policy mix A will cause

A)a lower level of investment
B)a higher level of investment
C)a lower level of consumption
D)a higher level of saving
E)both C and D

Question 49

During the recession of 2007-09 in the United States,

A)the monetary base more than doubled but M-2 did not, as banks were reluctant to fund loans
B)short-term interest rates fell close to zero percent, so the Fed felt compelled to buy large quantities of financial assets to reduce long-term interest rates
C)a strong fiscal stimulus package intended to stimulate aggregate demand was implemented
D)all of the above
E)only A and C

Question 50

In an IS-LM model, if net exports is no longer assumed to be exogenous (that is, NX = NX?), but instead is assumed to decrease as the level of income increases (that is, NX = NX? - mY, with m > 0), then

A)the IS-curve will become steeper and shift to the left
B)the IS-curve will become flatter and shift to the right
C)the LM-curve will become steeper and shift to the left
D)the LM-curve will become flatter and shift to the right
E)the fiscal policy multiplier will become larger