Deck 16: Interest Rates and Monetary Policy

Question 1

Which of the following is correct?

A) The asset demand for money is downsloping because the opportunity cost of holding money declines as the interest rate rises.
B) The asset demand for money is downsloping because the opportunity cost of holding money increases as the interest rate rises.
C) The transactions demand for money is downsloping because the opportunity cost of holding money varies inversely with the interest rate.
D) The asset demand for money is downsloping because bond prices and the interest rate are directly related.

Answer 1

The asset demand for money is downsloping because the opportunity cost of holding money increases as the interest rate rises.

Question 2

The total demand for money curve will shift to the right as a result of

A) an increase in nominal GDP.
B) an increase in the interest rate.
C) a decline in the interest rate.
D) a decline in nominal GDP.

Answer 2

an increase in nominal GDP.

Question 3

The asset demand for money is downsloping because

A) the opportunity cost of holding money increases as the interest rate rises.
B) it is more attractive to hold money at high interest rates than at low interest rates.
C) bond prices rise as interest rates rise.
D) the opportunity cost of holding money declines as the interest rate rises.

Answer 3

the opportunity cost of holding money increases as the interest rate rises.

Question 4

The equilibrium rate of interest in the market for money is determined by the intersection of the

A) supply-of-money curve and the asset-demand-for-money curve.
B) supply-of-money curve and the transactions-demand-for-money curve.
C) supply-of-money curve and the total-demand-for-money curve.
D) investment-demand curve and the total-demand-for-money curve.

Question 5

An increase in nominal GDP increases the demand for money because

A) interest rates will rise.
B) more money is needed to finance a larger volume of transactions.
C) bond prices will fall.
D) the opportunity cost of holding money will decline.

Question 6

The opportunity cost of holding money

A) is zero because money is not an economic resource.
B) varies inversely with the interest rate.
C) varies directly with the interest rate.
D) varies inversely with the level of economic activity.

Question 7

The transactions demand for money is most closely related to money functioning as a

A) unit of account.
B) medium of exchange.
C) store of value.
D) measure of value.

Question 8

(Advanced analysis) Assume the equation for the total demand for money is L = 0.4Y + 80 − 4i, where L is the amount of money demanded, Y is gross domestic product, and i is the interest rate. If gross domestic product is $200 and the interest rate is 10 (percent),
What amount of money will society want to hold?

A) $200
B) $120
C) $320
D) $160

Question 9

It is costly to hold money because

A) deflation may reduce its purchasing power.
B) in doing so, one sacrifices interest income.
C) bond prices are highly variable.
D) the rate at which money is spent may decline.

Question 10

In which of the following situations is it certain that the quantity of money demanded by the public will decrease?

A) nominal GDP decreases and the interest rate decreases
B) nominal GDP increases and the interest rate decreases
C) nominal GDP decreases and the interest rate increases
D) nominal GDP increases and the interest rate increases

Question 11

If nominal GDP is $600 billion and, on the average, each dollar is spent three times per year, then the amount of money demanded for transactions purposes will be

A) $1,800 billion.
B) $600 billion.
C) $200 billion.
D) $1,200 billion.

Question 12

The desire to hold money for transactions purposes arises because

A) receipts of income and expenditures are not perfectly synchronized.
B) people fear that prices will rise.
C) households want money on hand in case a good financial investment opportunity arises.
D) low interest rates reduce the opportunity cost of holding money.

Question 13

Which of the following statements is correct? Other things equal,

A) a decline in real output will shift both the transactions demand curve for money and the total money demand curve to the right.
B) a decline in the interest rate will shift the asset demand curve for money to the right but leave the total money demand curve unchanged.
C) deflation will shift both the transactions demand curve for money and the total money demand curve to the left.
D) inflation will shift the transactions demand curve for money to the right but leave the total money demand curve unchanged.

Question 14

On a diagram where the interest rate and the quantity of money demanded are shown on the vertical and horizontal axes respectively, the total demand for money can be found by

A) horizontally adding the transactions and the asset demand for money.
B) vertically subtracting the transactions demand from the asset demand for money.
C) horizontally subtracting the asset demand from the transactions demand for money.
D) vertically adding the transactions and the asset demand for money.

Question 15

On a diagram where the interest rate and the quantity of money demanded are shown on the vertical and horizontal axes, respectively, the transactions demand for money can be represented by

A) a line parallel to the horizontal axis.
B) a vertical line.
C) a downsloping line or curve from left to right.
D) an upsloping line or curve from left to right.

Question 16

If the quantity of money demanded exceeds the quantity supplied,

A) the supply-of-money curve will shift to the left.
B) the demand-for-money curve will shift to the right.
C) the interest rate will rise.
D) the interest rate will fall.

Question 17

On a diagram where the interest rate and the quantity of money demanded are shown on the vertical and horizontal axes respectively, the asset demand for money can be represented by

A) a line parallel to the horizontal axis.
B) a vertical line.
C) a downsloping line or curve from left to right.
D) an upsloping line or curve from left to right.

Question 18

The total demand for money will shift to the left as a result of

A) a decline in nominal GDP.
B) an increase in the price level.
C) a change in the interest rate.
D) an increase in nominal GDP.

Question 19

The asset demand for money

A) is unrelated to both the interest rate and the level of GDP.
B) varies inversely with the rate of interest.
C) varies inversely with the level of real GDP.
D) varies directly with the level of nominal GDP.

Question 20

The asset demand for money is most closely related to money functioning as a

A) unit of account.
B) medium of exchange.
C) store of value.
D) measure of value.

Question 21

Refer to the given market-for-money diagrams. The total demand for money is shown by

A) $D _ { 1 }$
B) $\mathrm { D } _ { 2 }$
C) $D _ { 3 }$
D) S.

Question 22

Refer to the diagram of the market for money. Given $D _ { m } \text { and } S _ { m } \text { an interest rate of } I _ { 3 }$ is not sustainable because the

A) supply of bonds in the bond market will decline and the interest rate will rise.
B) supply of bonds in the bond market will increase and the interest rate will decline.
C) demand for bonds in the bond market will decline and the interest rate will rise.
D) demand for bonds in the bond market will rise and the interest rate will fall.

Question 23

Other things equal, if the supply of money is reduced,

A) the demand for money will increase.
B) the interest rate will fall.
C) bond prices will fall.
D) investment spending will increase.

Question 24

Refer to the diagram of the market for money. Other things equal, the money demand curve in the diagram would shift leftward if

A) the asset demand for money increased.
B) the transactions demand for money increased.
C) nominal GDP decreased.
D) the overall price level rose.

Question 25

Refer to the given market-for-money diagrams. If the interest rate was at 8 percent, people would

A) sell bonds, which would cause bond prices to fall and the interest rate to fall.
B) buy bonds, which would cause bond prices to rise and the interest rate to fall.
C) have insufficient liquidity, which would cause them to reduce their spending on consumer goods.
D) buy bonds, which would cause bond prices to fall and the interest rate to rise.

Question 26

Refer to the given market-for-money diagrams. If each dollar held for transactions is spent four times per year on the average, we can infer that

A) real GDP is $800.
B) nominal GDP is $800.
C) the money supply must be $800.
D) nominal GDP is $1,200.

Question 27

Suppose the demand for money and the supply of money increase simultaneously. We can

A) expect the interest rate to rise and bond prices to fall.
B) expect the interest rate to fall and bond prices to rise.
C) expect the nominal GDP to expand.
D) not accurately predict what will happen to interest rates or bond prices.

Question 28

If, in the market for money, the amount of money supplied exceeds the amount of money households and businesses want to hold, the interest rate will

A) fall, causing households and businesses to hold less money.
B) rise, causing households and businesses to hold less money.
C) rise, causing households and businesses to hold more money.
D) fall, causing households and businesses to hold more money.

Question 29

Refer to the given market-for-money diagrams. The asset demand for money is shown by

A) $D _ { 1 }$
B) $D _ { 2 }$
C) $D _ { 3 }$
D) S.

Question 30

Refer to the given market-for-money diagrams. If the Federal Reserve increased the stock of money, the

A) S curve would shift leftward and the equilibrium interest rate would rise.
B) S curve would shift rightward and the equilibrium interest rate would fall.
C) D3 curve would shift leftward and the equilibrium interest rate would fall.
D) D3 curve would shift leftward and the equilibrium interest rate would rise.

Question 31

Refer to the diagram of the market for money. The vertical money supply curve $S _ { m }$ re?ects the fact that

A) bond prices and interest rates are inversely related.
B) the stock of money is determined by the Federal Reserve System and does not change when the interest rate changes.
C) the rate at which money is spent is zero.
D) lower interest rates result in lower opportunity costs of supplying money.

Question 32

Refer to the given market-for-money diagrams. If the interest rate was at 3 percent, people would

A) sell bonds, which would cause bond prices to fall and the interest rate to rise.
B) buy bonds, which would cause bond prices to fall and the interest rate to rise.
C) sell bonds, which would cause bond prices to rise and the interest rate to rise.
D) buy bonds, which would cause bond prices to rise but have an uncertain effect upon the interest rate.

Question 33

Refer to the diagram of the market for money. The downward slope of the money demand curve $D _ { m }$ is best explained in terms of the

A) transactions demand for money.
B) direct or positive relationship between bond prices and interest rates.
C) asset demand for money.
D) wealth or real-balances effect.

Question 34

Other things equal, if there is an increase in nominal GDP,

A) the demand for money will decrease.
B) the interest rate will rise.
C) bond prices will rise.
D) consumption spending will fall.

Question 35

Which of the following statements is correct?

A) Interest rates and bond prices vary directly.
B) Interest rates and bond prices vary inversely.
C) Interest rates and bond prices are unrelated.
D) Interest rates and bond prices vary directly during inflation and inversely during recessions.

Question 36

Refer to the diagram of the market for money. The equilibrium interest rate is

A) $I_1.$
B) $I _ { 2 }$
C) $I_ { 3 }$
D) not determinable without additional information.

Question 37

If, in the market for money, the quantity of money demanded exceeds the money supply, the interest rate will

A) fall, causing households and businesses to hold less money.
B) rise, causing households and businesses to hold less money.
C) rise, causing households and businesses to hold more money.
D) fall, causing households and businesses to hold more money.

Question 38

If the demand for money and the supply of money both decrease, the equilibrium

A) interest rate will decline, but we cannot predict the change in the equilibrium quantity of money.
B) quantity of money and the equilibrium interest rate will both increase.
C) quantity of money will increase, but we cannot predict the change in the equilibrium interest rate.
D) quantity of money will decline, but we cannot predict the change in the equilibrium interest rate.

Question 39

The price of a bond having no expiration date is originally $8,000 and has a fixed annual interest payment of $800. A fall in the price of the bond by $3,000 will provide a new buyer of the bond an interest rate of

A) 10 percent.
B) 12 percent.
C) 14 percent.
D) 16 percent.

Question 40

Refer to the given market-for-money diagrams. Curve $D _ { 1 }$ represents the

A) total demand for money.
B) transactions demand for money.
C) asset demand for money.
D) stock of money.

Question 41

When a commercial bank borrows from a Federal Reserve Bank,

A) the supply of money automatically increases.
B) it indicates that the commercial bank is unsound financially.
C) the commercial bank's lending ability is increased.
D) the commercial bank's reserves are reduced.

Question 42

Assume the reserve ratio is 25 percent and Federal Reserve Banks buy $4 million of U.S. securities from the public, which deposits this amount into checking accounts. As a result of these transactions, the supply of money is

A) not directly affected, but the money-creating potential of the commercial banking system is increased by $12 million.
B) directly increased by $4 million and the money-creating potential of the commercial banking system is increased by an additional $16 million.
C) directly reduced by $4 million and the money-creating potential of the commercial banking system is decreased by an additional $12 million.
D) directly increased by $4 million and the money-creating potential of the commercial banking system is increased by an additional $12 million.

Question 43

The securities held as assets by the Federal Reserve Banks consist mainly of

A) corporate bonds.
B) Treasury bills, Treasury notes, and Treasury bonds.
C) common stock.
D) certificates of deposit.

Question 44

$$\begin{array} { | c | c | c | c | } \hline \text { Interest Rate } & \begin{array} { c } \text { Transactions Demand for } \\\text { Money }\end{array} & \text { Asset Demand for Money } & \text { Money Supply } \\\hline 2 \% & \$ 220 & \$ 300 & 4460 \\\hline 4 & 220 & 280 & 460 \\\hline 6 & 220 & 260 & 460 \\\hline 8 & 220 & 240 & 460 \\\hline 10 & 220 & 220 & 460 \\\hline\end{array}$$ Based on the given table, an increase in the money supply of $20 billion will cause the equilibrium interest rate to

A) fall by 4 percentage points.
B) fall by 2 percentage points.
C) rise by 4 percentage points.
D) rise by 2 percentage points.

Question 45

Federal Reserve Notes in circulation are

A) an asset as viewed by the Federal Reserve Banks.
B) a liability as viewed by the Federal Reserve Banks.
C) neither an asset nor a liability as viewed by the Federal Reserve Banks.
D) part of M1 but not of M2.

Question 46

Reserves must be deposited in the Federal Reserve Banks by

A) only commercial banks that are members of the Federal Reserve System.
B) depository institutions, that is, commercial banks and thrift institutions.
C) state-chartered commercial banks only.
D) federally chartered commercial banks only.

Question 47

In the United States, monetary policy is the responsibility of the

A) U.S. Treasury.
B) Department of Commerce.
C) Board of Governors of the Federal Reserve System.
D) U.S. Congress.

Question 48

Assume the legal reserve ratio is 25 percent and the Fourth National Bank borrows $10,000 from the Federal Reserve Bank in its district. As a result,

A) commercial bank reserves are increased by $10,000.
B) the supply of money automatically declines by $7,500.
C) commercial bank reserves are increased by $7,500.
D) the supply of money is automatically increased by $10,000.

Question 49

$$\begin{array} { | c | c | c | c | } \hline \text { Interest Rate } & \begin{array} { c } \text { Transactions Demand for } \\\text { Money }\end{array} & \text { Asset Demand for Money } & \text { Money Supply } \\\hline 2 \% & \$ 220 & \$ 300 & \$ 460 \\\hline 4 & 220 & 280 & 460 \\\hline 6 & 220 & 260 & 460 \\\hline 8 & 220 & 240 & 460 \\\hline 10 & 220 & 220 & 460 \\\hline\end{array}$$ Based on the given table, the equilibrium interest rate is

A) 2 percent.
B) 4 percent.
C) 6 percent.
D) 8 percent.

Question 50

Open-market operations include

A) changes in the reserve ratio.
B) repos and reverse repos.
C) paying interest on excess reserves held at Federal Reserve Banks.
D) changes in the discount rate.

Question 51

Which of the following is an asset on the consolidated balance sheet of the Federal Reserve Banks?

A) loans to commercial banks
B) Federal Reserve Notes in circulation
C) Treasury deposits
D) reserves of commercial banks

Question 52

The four main tools of monetary policy are

A) tax-rate changes, the discount rate, open-market operations, and the federal funds rate.
B) tax-rate changes, changes in government expenditures, open-market operations, and interest on excess reserves.
C) the discount rate, the reserve ratio, interest on excess reserves, and open-market operations.
D) changes in government expenditures, the reserve ratio, the federal funds rate, and the discount rate.

Question 53

Which of the following will increase commercial bank reserves?

A) the purchase of government bonds in the open market by the Federal Reserve Banks
B) a decrease in the reserve ratio
C) an increase in the discount rate
D) the sale of government bonds in the open market by the Federal Reserve Banks

Question 54

Which of the following is a tool of monetary policy?

A) open-market operations
B) changes in banking laws
C) changes in tax rates
D) changes in government spending

Question 55

$$\begin{array} { | c | c | c | c | } \hline \text { Interest Rate } & \begin{array} { c } \text { Transactions Demand for } \\\text { Money }\end{array} & \begin{array} { c } \text { Asset Demand for } \\\text { Money }\end{array} &Money~Supply\\\hline 2 \% & \$ 220 & \$ 300 & \$ 460 \\\hline 4 & 220 & 280 & 460 \\\hline 6 & 220 & 260 & 460 \\\hline 8 & 220 & 240 & 460 \\\hline 10 & 220 & 220 & 460 \\\hline\end{array}$$ Based on the given table, at equilibrium in the given market for money, the total amount of money demanded is

A) $500.
B) $480.
C) $460.
D) $440.

Question 56

The Federal Reserve Banks buy government securities from commercial banks. As a result, the checkable deposits

A) of commercial banks are unchanged, but their reserves increase.
B) and reserves of commercial banks both decrease.
C) of commercial banks are unchanged, but their reserves decrease.
D) and reserves of commercial banks are both unchanged.

Question 57

Since the 2008 financial crisis, the Federal Reserve has added a significant amount of which of the following securities?

A) corporate bonds
B) mortgage-backed securities
C) common stock of financial institutions
D) certificates of deposit

Question 58

The Federal Reserve Banks sell government securities to the public. As a result, the checkable deposits

A) of commercial banks are unchanged, but their reserves increase.
B) and reserves of commercial banks both decrease.
C) of commercial banks are unchanged, but their reserves decrease.
D) and reserves of commercial banks are both unchanged.

Question 59

The commercial banking system borrows from the Federal Reserve Banks. As a result, the checkable deposits

A) of commercial banks are unchanged, but their reserves increase.
B) and reserves of commercial banks both decrease.
C) of commercial banks are unchanged, but their reserves decrease.
D) and reserves of commercial banks are both unchanged.

Question 60

Which of the following is not a tool of monetary policy?

A) open-market operations
B) changes in banking laws
C) changes in the rate of interest paid on reserves held at Federal Reserve Banks
D) Fed lending or borrowing with repos or reverse repos

Question 61

The collateral used for repos and reverse repos is (are)

A) corporate securities.
B) autos.
C) homes.
D) government bonds.

Question 62

Which of the following Fed actions will decrease the money supply?

A) reverse repos
B) repos
C) open-market purchases of bonds
D) raising taxes

Question 63

Refer to the given balance sheets. If the reserve ratio is 25 percent, commercial banks have excess reserves of

A) $12.
B) $22.
C) $16.
D) $24.

Question 64

All else equal, if the Fed engages in a repo transaction, then it means the Fed is attempting to

A) decrease the money supply.
B) increase the money supply.
C) foreclose on a failed bank.
D) raise interest rates.

Question 65

Open-market operations change

A) the size of the monetary multiplier but not commercial bank reserves.
B) commercial bank reserves but not the size of the monetary multiplier.
C) neither commercial bank reserves nor the size of the monetary multiplier.
D) both commercial bank reserves and the size of the monetary multiplier.

Question 66

Suppose the Federal Reserve Banks sell $2 billion of government bonds to the public, which pays for them by drawing checks. As a result, commercial bank reserves will

A) increase by $10 billion.
B) remain unchanged.
C) decrease by $2 billion.
D) increase by $2 billion.

Question 67

If the Fed were to reduce the legal reserve ratio, we would expect

A) lower interest rates, an expanded GDP, and a higher rate of inflation.
B) lower interest rates, an expanded GDP, and a lower rate of inflation.
C) higher interest rates, a contracted GDP, and a higher rate of inflation.
D) higher interest rates, a contracted GDP, and a lower rate of inflation.

Question 68

Refer to the given balance sheets and assume the reserve ratio is 25 percent. Suppose the Federal Reserve Banks sell $2 in securities directly to the commercial banks. As a result of this transaction, the supply of money

A) will decrease by $2, but the money-creating potential of the commercial banking system will not be affected.
B) is not directly affected, but the money-creating potential of the commercial banking system will decrease by $8.
C) will directly increase by $2, and the money-creating potential of the commercial banking system will decrease by an additional $8.
D) will directly increase by $2, and the money-creating potential of the commercial banking system will increase by an additional $8.

Question 69

When the Fed loans money in exchange for government bonds being posted as collateral, this is known as a

A) mortgage-backed security.
B) Federal Reserve note.
C) repo.
D) credit default swap.

Question 70

In a reverse repo transaction,

A) banks return foreclosed property to the previous owner.
B) banks sell foreclosed property to new owners.
C) the Fed borrows money from financial institutions.
D) the Fed loans money to financial institutions.

Question 71

If the Federal Reserve System buys government securities from commercial banks and the public,

A) commercial bank reserves will decline.
B) commercial bank reserves will be unaffected.
C) it will be easier to obtain loans at commercial banks.
D) the money supply will contract.

Question 72

The Federal Reserve System regulates the money supply primarily by

A) controlling the production of coins at the U.S. mint.
B) altering the reserve requirements of commercial banks and thereby the ability of banks to make loans.
C) altering the reserves of commercial banks, largely through sales and purchases of government bonds.
D) restricting the issuance of Federal Reserve Notes because paper money is the largest portion of the money supply.

Question 73

Refer to the given balance sheets. If the reserve ratio is 25 percent, the maximum money-creating potential of the commercial banking system is

A) $36.
B) $17.
C) $48.
D) $24.

Question 74

Which of the following is correct? When the Federal Reserve buys government securities from the public, the money supply

A) contracts and commercial bank reserves increase.
B) expands and commercial bank reserves decrease.
C) contracts and commercial bank reserves decrease.
D) expands and commercial bank reserves increase.

Question 75

Assume that a single commercial bank has no excess reserves and that the reserve ratio is 20 percent. If this bank sells a bond for $1,000 to a Federal Reserve Bank, it can expand its loans by a maximum of

A) $1,000.
B) $2,000.
C) $800.
D) $5,000.

Question 76

In a repo transaction, the Fed _______ money; in a reverse repo transaction, the Fed _______ money.

A) borrows; loans
B) loans; borrows
C) prints new; destroys
D) destroys; prints new

Question 77

Assume that U.S. National Bank has no excess reserves and that the reserve ratio is 20 percent. If U.S. National borrows $5 million from a Federal Reserve Bank through a repo transaction, it can expand its loans by a maximum of

A) $5 million.
B) $1 million.
C) $25 million.
D) $0.

Question 78

The purchase of government securities from the public by the Fed will cause

A) commercial bank reserves to decrease.
B) the money supply to increase.
C) demand deposits to decrease.
D) the interest rate to increase.

Question 79

Open-market operations refer to

A) purchases of stocks in the New York Stock Exchange.
B) the purchase or sale of government securities, as well as collateralized money loans, by the Fed.
C) central bank lending to commercial banks.
D) the specifying of loan maximums on stock purchases.

Question 80

Which of the following will happen when the Federal Reserve buys bonds from the public in the open market and the amount of cash held by the public does not change?

A) The required reserve ratio will increase.
B) The money supply will decrease.
C) The deposits of commercial banks will decline.
D) Commercial bank reserves will increase.