Deck 5: The Open Economy

Question 1

According to the quantity theory of money, ultimate control over the rate of inflation in the United States is exercised by:

A)the Organization of Petroleum Exporting Countries (OPEC).
B)the U.S. Treasury.
C)the Fed.
D)private citizens.

Answer 1

C

Question 2

If the money supply increases 12 percent, velocity decreases 4 percent, and the price level increases 5 percent, then the change in real GDP must be percent.

A)3
B)4
C)9
D)11

Answer 2

A

Question 3

The demand for real money balances is generally assumed to:

A)be exogenous.
B)be constant.
C)increase as real income increases.
D)decrease as real income increases.

Answer 3

C

Question 4

If the transactions velocity of money remains constant while the quantity of money doubles, the:

A)price of the average transaction must double.
B)number of transactions must remain constant.
C)price of the average transaction multiplied by the number of transactions must remain constant.
D)price of the average transaction multiplied by the number of transactions must double.

Question 5

Consider the money demand function that takes the form (M/P)d = kY, where M is the quantity of money, P is the price level, k is a constant, and Y is real output. If the money supply is growing at a 10 percent rate, real output is growing at a 3 percent rate, and k is constant, what is the average inflation rate in this economy?

A)3 percent
B)7 percent
C)10 percent
D)13 percent

Question 6

During the American Revolution, the price of gold measured in continental dollars increased to more than times its previous level.

A)2
B)10
C)50
D)100

Question 7

The real interest rate is equal to the:

A)amount of interest that a lender actually receives when making a loan.
B)nominal interest rate plus the inflation rate.
C)nominal interest rate minus the inflation rate.
D)nominal interest rate.

Question 8

If there are 100 transactions in a year and the average value of each transaction is $10, then if there is $200 of money in the economy, transactions velocity is times per year.

A)0.2
B)2
C)5
B)10

Question 9

The income velocity of money increases and the money demand parameter k when people want to hold money.

A)increases; more
B)increases; less
C)decreases; more
D)decreases; less

Question 10

If the quantity of real money balances is kY, where k is a constant, then velocity is:

A)k.
B)1/k.
C)kP.
D)P/k.

Question 11

Percentage change in P is approximately equal to the percentage change in:

A)M.
B)M minus percentage change in Y.
C)M minus percentage change in Y plus percentage change in velocity.
D)M minus percentage change in Y minus percentage change in velocity.

Question 12

According to the quantity theory of money, if money is growing at a 10 percent rate and real output is growing at a 3 percent rate, but velocity is growing at increasingly faster rates over time as a result of financial innovation, the rate of inflation must be:

A)increasing.
B)decreasing. 7
C)percent.
D)constant.

Question 13

The quantity theory of money assumes that:

A)income is constant.
B)velocity is constant.
C)prices are constant.
D)the money supply is constant.

Question 14

The rate of inflation is the:

A)median level of prices.
B)average level of prices.
C)percentage change in the level of prices.
D)measure of the overall level of prices.

Question 15

Real money balances equal the:

A)sum of coin, currency, and balances in checking accounts.
B)amount of money expressed in terms of the quantity of goods and services it can purchase.
C)number of dollars used as a medium of exchange.
D)quantity of money created by the Federal Reserve.

Question 16

Using decade-long data across countries from 2000-2010, countries with high money growth tend to have inflation.

A)high
B)low
C)constant
D)decreasing

Question 17

The quantity equation for money, by itself:

A)may be thought of as a definition for velocity.
B)implies that the velocity of money is constant.

Question 18

"Inflation tax" means that:

A)as the price level rises, taxpayers are pushed into higher tax brackets.
B)as the price level rises, the real value of money held by the public
C)decreases. as taxes increase, the rate of inflation also increases.
D)in a hyperinflation, the chief source of tax revenue is often the printing of money.

Question 19

If the average price of goods and services in the economy equals $10 and the quantity of money in the economy equals $200,000, then real balances in the economy equal:

A)10.
B)20,000.
C)200,000.
D)2,000,000.

Question 20

The transactions velocity of money indicates the in a given period, while the income velocity of money indicates the in a given period.

A)number of transactions; amount of income earned
B)quantity of money used for transactions; quantity of money paid as income
C)number of times a dollar bill changes hands; number of times a dollar bill enters someone's income
D)volume of transactions; flow of income

Question 21

In the case of an unanticipated inflation:

A)creditors with an unindexed contract are hurt because they get less than they expected in real terms.
B)creditors with an indexed contract gain because they get more than they contracted for in nominal terms.
C)debtors with an unindexed contract do not gain because they pay exactly what they contracted for in nominal terms.
D)debtors with an indexed contract are hurt because they pay more than they contracted for in nominal terms.

Question 22

According to the classical theory of money, inflation does not make workers poorer because wages increase:

A)faster than the overall price level.
B)more slowly than the overall price level.
C)in proportion to the increase in the overall price level.
D)in real terms during periods of inflation.

Question 23

According to the Fisher effect, the nominal interest rate moves one-for-one with changes in the:

A)inflation rate.
B)expected inflation rate.
C)ex ante real interest rate.
D)ex post real interest rate.

Question 24

The general demand function for real balances depends on the level of income and the:

A)real interest rate.
B)nominal interest rate.
C)rate of inflation.
D)price level.

Question 25

If the real interest rate and real national income are constant, according to the quantity theory and the Fisher effect, a 1 percent increase in money growth will lead to rises in:

A)inflation of 1 percent and the nominal interest rate of less than 1 percent.
B)inflation of 1 percent and the nominal interest rate of 1 percent.
C)inflation of 1 percent and the nominal interest rate of more than 1 percent.
D)both inflation and the nominal interest rate of less than 1 percent.

Question 26

When a person purchases a 90-day Treasury bill, he or she cannot know the:

A)ex post real interest rate.
B)ex ante real interest rate.
C)nominal interest rate.
D)expected rate of inflation.

Question 27

The inconvenience associated with reducing money holdings to avoid the inflation tax is called:

A)menu costs.
B)shoeleather costs.
C)variable yardstick costs.
D)fixed costs.

Question 28

Consider the money demand function that takes the form (M/P)d = Y/4i, where M is the quantity of money, P is the price level, Y is real output, and i is the nominal interest rate. What is the average velocity of money in this economy?

A)i
B)4i
C)1/4i
D)0.25

Question 29

Devoting resources to avoiding the costs of expected inflation leads to:

A)eliminating the costs of expected inflation.
B)fewer relative price changes.
C)economic inefficiency.
D)a decrease in the transaction velocity of money.

Question 30

In the classical model, according to the quantity theory and the Fisher equation, an increase in money growth increases:

A)output.
B)velocity
C)the nominal interest rate.
D)the real interest rate.

Question 31

If the nominal interest rate is 1 percent and the inflation rate is 5 percent, the real interest rate is:

A)1 percent.
B)6 percent.
C)-4 percent.
D)-5 percent.

Question 32

Evidence from the past 40 years in the United States supports the Fisher effect and shows that when the inflation rate is high, the interest rate tends to be .

A)nominal;
B)high nominal;
C)low real;
D)high real; low

Question 33

According to the quantity theory a 5 percent increase in money growth increases inflation by percent. According to the Fisher equation a 5 percent increase in the rate of inflation increases the nominal interest rate by .

A)1; 5
B)5; 1
C)1; 1
D)5; 5

Question 34

The opportunity cost of holding money is the:

A)nominal interest rate.
B)real interest rate.
C)federal funds rate.
D)prevailing Treasury bill rate.

Question 35

If the demand for money depends on the nominal interest rate, then via the quantity theory and the Fisher equation, the price level depends on:

A)only the current money supply.
B)only the expected future money supply.
C)both the current and expected future money supply.
D)neither the current nor the expected future money supply.

Question 36

If the real return on government bonds is 3 percent and the expected rate of inflation is 4 percent, then the cost of holding money is percent.

A)1
B)3
C)4
D)7

Question 37

Inflation the variability of relative prices and allocative efficiency.

A)increases; increases
B)increases; decreases
C)decreases; decreases
D)decreases; increases

Question 38

A positive relationship between nominal interest rates and inflation in the United States is obvious in:

A)both recent data and nineteenth-century data.
B)recent data but not nineteenth-century data.
C)nineteenth-century data but not recent data.
D)neither nineteenth-century data nor recent data.

Question 39

If the real interest rate declines by 1 percent and the inflation rate increases by 2 percent, the nominal interest rate must:

A)increase by 2
B)percent.
B)increase by 1 percent.
C)remain constant.
D)decrease by 1 percent.

Question 40

The ex ante real interest rate is equal to the nominal interest rate:

A)minus the inflation rate.
B)plus the inflation rate.
C)minus the expected inflation rate.
D)plus the expected inflation rate.

Question 41

In classical macroeconomic theory, the concept of monetary neutrality means that changes in the money supply do not influence real variables. Explain why changes in money growth affect the nominal interest rate, but not the real interest rate.

Question 42

Econoland finances government expenditures with an inflation tax.
a. Explain who pays the tax and how it is paid.
b. What are costs of the tax, assuming the tax rate is expected?

Question 43

If the demand for money depends positively on real income and depends inversely on the nominal interest rate, what will happen to the price level today, if the central bank announces (and people believe) that it will decrease the money growth rate in the future, but it does not change the money supply today?

Question 44

Mary Tsai is paid $3,000 every 30 days. Her salary is deposited directly in her bank. She spends all her money at a constant rate over the 30 days and must pay cash. She can (1) withdraw all of the money at once; (2) withdraw half at once and the rest after 15 days; (3) withdraw one-third at once, one-third after 10 days, and one-third at 20 days; or (4) make any number of evenly spaced withdrawals. Each withdrawal costs her $2 in terms of time and inconvenience. For each day that Mary has a dollar in the bank, she gets .03 cents (.0003 per dollar) in interest. Thus, if she withdraws half of her money immediately and half in 15 days, she has $1,500 in the bank for 15 days and earns $6.75 interest.
a. Create a table showing transaction costs, interest earned, and total net earnings (+) or cost (-) associated with one, two, three, or four withdrawals per month.
b. How many withdrawals per month lead to the largest net earnings? If Mary chooses this number, what will be her average amount of cash on hand over the 30 days?

Question 45

Interest rates played a part in the 1984 U.S. presidential debates. Some politicians claimed that interest rates rose over the 1981-1983 period, while others claimed rates fell. Below is a table showing interest rates and annual inflation rates from 1981 to 1983.

Question 46

Consider two countries, Hitech and Lotech. In Hitech new arrangements for making payments, such as credit cards and ATMs, have been enthusiastically adopted by the population, thereby reducing the proportion of income that is held as real money balances. Over this period no such changes occurred in Lotech. If the rate of money growth and the growth rate of real GDP were the same in Hitech and Lotech over this period, then how would the rate of inflation differ between the two countries? Carefully explain your answer.

Question 47

The costs of expected inflation cause productive resources of an economy to be directed away from their efficient allocation. Explain how each of the following costs of expected inflation distort the allocation of productive resources:
a. shoeleather costs
b. menu costs
c. the inconvenience of a changing price level

Question 48

A classical economist wears a T-shirt printed with the slogan "Fast Money Raises My Interest!" Use the quantity theory of money and the Fisher equation to explain the slogan.

Question 49

Assume that the demand for real money balance (M/P) is M/P = 0.6Y - 100i, where Y is national income and i is the nominal interest rate (in percent). The real interest rate r is fixed at 3 percent by the investment and saving functions. The expected inflation rate equals the rate of nominal money growth.
a. If Y is 1,000, M is 100, and the growth rate of nominal money is 1 percent, what must i and P be?
b. If Y is 1,000, M is 100, and the growth rate of nominal money is 2 percent, what must i and P be?