Deck 14: Monetary Policy and the Bank of Canada

Question 1

The monetary base is equal to

A) banks' reserves plus their holdings of Treasury securities.
B) banks' reserves plus Bank of Canada funds.
C) banks' reserves plus currency in circulation.
D) M2 minus M1.

Answer 1

C

Question 2

Vault cash is equal to $2 million, deposits by depository institutions at the Central Bank are $3 million, the monetary base is $10 million, and bank deposits are $25 million. Bank reserves are equal to

A) $2 million.
B) $3 million.
C) $5 million.
D) $10 million.

Answer 2

C

Question 3

Currently, the currency-deposit ratio is 0.3 and the reserve-deposit ratio is 0.2. The Bank of Canada raises the reserve-deposit ratio to 0.25, as a response to a change in the public's currency-deposit ratio, to maintain the old money multiplier. What is the public's approximate new currency-deposit ratio?

A) 0.22
B) 0.25
C) 0.33
D) 0.35

Answer 3

A

Question 4

Assume that the reserve-deposit ratio is 0.2. The Bank of Canada carries out open-market operations, purchasing $1,000,000 worth of bonds from banks. This action increased the money supply by $2,600,000. What is the currency-deposit ratio?

A) 0.2
B) 0.3
C) 0.4
D) 0.5

Question 5

If people hold more currency, other things remaining constant,

A) the money multiplier will decrease.
B) the money multiplier will increase.
C) the money multiplier will remain unchanged.
D) the monetary base will decrease.

Question 6

Assume that the currency-deposit ratio is 0.3 and the reserve-deposit ratio is 0.2. What is the money multiplier?

A) 1.5
B) 2.0
C) 2.6
D) 5.0

Question 7

The money supply is $10 million, currency held by the public is $2 million, and the reserve-deposit ratio is 0.2. Deposits are equal to

A) $1.6 million.
B) $2 million.
C) $4 million.
D) $8 million.

Question 8

The currency-deposit ratio is determined by

A) banks.
B) the public.
C) the Central Bank.
D) Parliament.

Question 9

Fractional reserve banking is the system that

A) allows banks not to insure their deposits.
B) allows banks not to join the Canadian Payments Association.
C) limits banks' activities from crossing provincial lines.
D) allows banks to keep smaller reserves than their deposits.

Question 10

Magog banks currently have 1 million dinars and a system of 100% reserve banking. The government passes a law allowing fractional reserve banking and a minimum reserve-deposit ratio of 10%. Assuming people hold no currency, after the full process of multiple expansion of loans and deposits had worked itself out, the nation's money supply would equal

A) 1,000,000 dinars.
B) 9,000,000 dinars.
C) 10,000,000 dinars.
D) 11,000,000 dinars.

Question 11

Under the 100% reserve banking, banks

A) do not lend and pay negative interest rates.
B) do not lend and pay positive interest rates.
C) lend and pay positive interest rate.
D) lend and pay negative interest rate.

Question 12

Which one of the following statement is true?

A) The money supply created in a multiple expansion of loans and deposits are less than the monetary base.
B) The money supply created in a multiple expansion of loans and deposits are much larger than the monetary base.
C) The money supply created in a multiple expansion of loans and deposits are equal to the monetary base.
D) The money supply created in a multiple expansion of loans and deposits are equal to the total currency.

Question 13

Assume that the currency-deposit ratio is 0.4. The Bank of Canada carries out open-market operations, purchasing $1,000,000 worth of bonds from banks. This action increased the money supply by $1,750,000. What is the reserve-deposit ratio?

A) 0.2
B) 0.3
C) 0.4
D) 0.45

Question 14

Suppose there was a banking crisis. The money supply would shrink by the greatest amount if the public ________ their currency-deposit ratio and the banks ________ their reserve-deposit ratio.

A) decreased; decreased
B) decreased; increased
C) increased; decreased
D) increased; increased

Question 15

Suppose the Bank of Canada decides to increase the money supply by $10 billion. In Canada, the currency-deposit ratio is 0.1485, and the reserve-deposit ratio is 0.0079. How much should the Bank of Canada change the monetary base?

A) $1.4 billion
B) $14.85 billion
C) $10 billion
D) $14.85 million

Question 16

Assume that the currency-deposit ratio is 0.5 and the reserve-deposit ratio is 0.2. The Bank of Canada carries out open-market operations, purchasing $1,000,000 worth of bonds from banks. This action will increase the money supply by

A) $1,428,571.
B) $1,714,285.
C) $2,142,857.
D) $2,400,000.

Question 17

The monetary base is defined as

A) bank reserves plus currency in circulation.
B) bank reserves minus vault cash.
C) all deposits at the Bank of Canada.
D) deposits at the Bank of Canada plus vault cash.

Question 18

Money multiplier is

A) the number of dollars of money supply that can be created from each dollar of monetary base.
B) the number of dollars of monetary base that can be created from each dollar of currency held by public.
C) the ratio of number of dollars of money demand that can be created from each dollar of monetary base.
D) the number of dollars of money supply that can be created from each dollar of reserves.

Question 19

The money supply is $10 million, currency held by the public is $2 million, and the reserve-deposit ratio is 0.2. Bank reserves are equal to

A) $1.6 million.
B) $2 million.
C) $4 million.
D) $8 million.

Question 20

Suppose the Bank of Canada wanted to increase the money supply without using open-market operations. It could try to get the public to ________ their currency-deposit ratio and ________ banks' reserve requirements, which would in turn change the banks' reserve-deposit ratio.

A) decrease; lower
B) decrease; raise
C) increase; lower
D) increase; raise

Question 21

If the Bank of Canada increases the monetary base by $5 million and the money multiplier is 5, M1 will

A) rise by $25 million.
B) fall by $25 million.
C) rise by $1 million.
D) fall by $1 million.

Question 22

Which of the following will increase the money supply?

A) open-market purchases
B) higher reserve requirements
C) less discount lending
D) tighter credit controls

Question 23

Vault cash is equal to $2 million, deposits by depository institutions at the Central Bank are $4 million, the monetary base is $10 million, and bank deposits are $25 million. The money multiplier is equal to

A) 2.5.
B) 3.0.
C) 4.0.
D) 5.0.

Question 24

The Bank of Canada's largest asset is

A) foreign currency deposits.
B) advances to members of the CPA.
C) notes in circulation.
D) Treasury bills.

Question 25

Suppose that in Mysore the reserve-deposit ratio is res = 0.5 - 2i, where i is the nominal interest rate. The current-deposit ratio is 0.2 and the monetary base equals 100. The real quantity of money demanded is given by the money demand function L(Y, i) = 0.5Y - 10i, where Y is real output. Currently, the real interest rate is 5% and the economy expects an inflation rate of 5%. The money supply equals

A) 200.
B) 240.
C) 300.
D) 400.

Question 26

The Bank of Canada's largest liability is

A) notes in circulation at banks.
B) notes in circulation outside banks.
C) deposits at members of the CPA.
D) Treasury bills.

Question 27

Which of the following tasks does not represent the Bank of Canada's responsibility?

A) implementing monetary policy
B) serving as a lender of last resort
C) implementing fiscal policy
D) acting as fiscal agent for the federal government

Question 28

When was the Bank of Canada created?

A) 1914
B) 1934
C) 1946
D) 1990

Question 29

The money supply is $6 million, currency held by the public is $2 million, and the reserve-deposit ratio is 0.1. The monetary base is equal to

A) $2 million.
B) $2.4 million.
C) $2.6 million.
D) $4 million.

Question 30

Suppose that in Mysore the reserve-deposit ratio is res = 0.5 - 2i, where i is the nominal interest rate. The currency-deposit ratio is 0.2 and the monetary base equals 100. The real quantity of money demanded is given by the money demand function L(Y, i) = 0.5Y - 10i, where Y is real output. Currently, the real interest rate is 5% and the economy expects an inflation rate of 5%. Assume that the price level P is equal to 1. The value of output Y that clears the asset market is

A) 240.
B) 460.
C) 480.
D) 482.

Question 31

Suppose that in Mysore the reserve-deposit ratio is res = 0.5 - 2i, where i is the nominal interest rate. The currency-deposit ratio is 0.2 and the monetary base equals 100. The real quantity of money demanded is given by the money demand function L(Y, i) = 0.5Y - 10i, where Y is real output. Currently, the real interest rate is 5% and the economy expects an inflation rate of 5%. The reserve-deposit ratio equals

A) 0.1.
B) 0.2.
C) 0.3.
D) 0.4.

Question 32

The leadership of the Bank of Canada is provided by

A) the Board of Directors.
B) the department of finance.
C) the federal government.
D) the directors of the main private banks.

Question 33

The Central Bank can increase the money supply by

A) increasing the currency-deposit ratio.
B) increasing the monetary base.
C) increasing reserve requirements.
D) increasing the discount rate.

Question 34

The governor of the Bank of Canada

A) is elected by the government.
B) is appointed by the government.
C) is appointed by the senate.
D) is chosen by the Bank itself.

Question 35

If the money multiplier is 10, the sale of $1 billion of securities by the Bank on the open market causes

A) a $10 billion decrease in the money supply.
B) a $1 billion decrease in the money supply.
C) a $1 billion increase in the money supply.
D) a $10 billion increase in the money supply.

Question 36

Which of the following is not listed in the assets of the Bank of Canada's balance sheet?

A) Treasury bills
B) Government of Canada's deposits
C) Other government securities
D) Foreign reserves

Question 37

The Bank of Canada is

A) on the north shore of the Ottawa river.
B) a Toronto fast-food outlet.
C) a money laundering service.
D) the Central Bank of Canada.

Question 38

Suppose the Bank of Canada decides to reduce the interest rate. Which of the following actions will produce the desired outcome?

A) The Bank sells treasury bills in the open-market operations.
B) The Bank reduces the Bank rate.
C) The Bank buys treasury bills in the open-market operations.
D) The Bank increases the desired reserve ratio.

Question 39

Suppose that in Mysore the reserve-deposit ratio is res = 0.5 - 2i, where i is the nominal interest rate. The currency-deposit ratio is 0.2 and the monetary base equals 100. The real quantity of money demanded is given by the money demand function L(Y, i) = 0.5Y - 10i, where Y is real output. Currently, the real interest rate is 5% and the economy expects an inflation rate of 5%. The money multiplier equals

A) 2.00.
B) 2.40.
C) 3.00.
D) 4.00.

Question 40

Which of the following are included in the Bank of Canada's Board of Directors?

A) the governor, the senior deputy governor, the deputy minister of finance, and 12 private citizens
B) the governor, minister of finance, and 12 part time CEOs of private firms
C) the governor, prime minister, and 12 part time citizens
D) the governor, the senior deputy governor, and 12 member of parliament

Question 41

Monetarists suggest doing which of the following?

A) maintain a steady growth rate of the money supply
B) use fiscal policy to combat unemployment in the short run
C) use monetary policy to combat unemployment in the long run
D) use fiscal policy to combat inflation in the long run

Question 42

There is an election coming up. Liberals can persuade firms whether or not to raise prices; Conservatives can persuade the Bank whether or not to increase the money supply. The Liberals move first. The amount of money raised by each party and the resulting inflation and unemployment rates are given below. What will be the outcome of this game? $$\begin{array} { l l l } & \text { Raise prices } & \text { Don't raise prices } \\\hline \text { Liberal strategy } & \text { Outcome A } & \text { Outcome B } \\\text { Raise } M & \text { Cons.: } \$ 40 & \text { Cons.: \$80 } \\& \text { Libs.: \$60 } & \text { Libs.: \$20 } \\& \pi = 8 \% & \pi = 0 \% \\& u = 8 \% & u = 6 \% \\\text { Conservative strategy } & \text { Outcome C } & \text { Outcome D } \\& \text { Cons.: \$20 } & \text { Cons.: \$60 } \\\text { Don't raise } M & \text { Libs.: } \$ 80 & \text { Libs.: } \$ 40 \\& \pi = 8 \% & \pi = 0 \% \\& u = 9 \% & u = 8 \%\end{array}$$

A) Outcome A
B) Outcome B
C) Outcome C
D) Outcome D

Question 43

Which of the following statements would Milton Friedman agree with concerning the conduct of monetary policy?

A) Information lags are short, enabling the Central Bank to respond quickly to changes in the economy.
B) There is little uncertainty over the effect of a change in the money supply on the economy.
C) There are long and variable lags between monetary policy actions and their economic results.
D) Wage and price adjustments are relatively slow, so changing the money supply will have a minimal impact on the real economy.

Question 44

When Canadian banks borrow from one another, they must pay the

A) bank rate.
B) prime rate.
C) overnight rate.
D) Interbank Offer Rate.

Question 45

Suppose the Bank of Canada reduces the Bank rate. This will cause

A) the interest rate to fall, the exchange rate to depreciate, and lending by banks to increase.
B) the interest rate to fall, the exchange rate to appreciate, and lending by banks to increase.
C) the interest rate to rise, the exchange rate to appreciate, and lending by banks to decrease.
D) the interest rate to rise, the exchange rate to depreciate, and lending by banks to decrease.

Question 46

The Bank of Canada influences the movement of the Canadian dollar exchange rates through

A) open-market operations.
B) overnight rates.
C) intervention using the exchange fund account.
D) SPRAs.

Question 47

There is an election coming up. Conservatives are currently in government, and will be able to raise more money for the next federal election if they keep inflation and unemployment low. Conservatives can persuade firms whether or not to raise prices; Liberals can persuade the Bank whether or not to increase the money supply. The amount of money raised by each party and the resulting inflation and unemployment rates are given below. If the Liberals can move first, what will be the outcome of this game? $$\begin{array} { l l l } & \text { Raise prices } & \text { Don't raise prices } \\\hline \text { Conservative strategy } & \text { Outcome } \mathrm { A } & \text { Outcome B } \\\text { Raise } M & \text { Cons.: } \$ 40 & \text { Cons.: \$80 } \\& \text { Libs.: } \$ 60 & \text { Libs.: } \$ 20 \\& \pi = 8 \% & \pi = 0 \% \\& u = 8 \% & u = 6 \% \\\text { Liberal Strategy } & \text { Outcome } \mathrm { C } & \text { Outcome } \mathrm { D } \\\text { Don't raise } & \text { Cons.: } \$ 20 & \text { Cons.: } \$ 60 \\M & \text { Libs.: } \$ 80 & \text { Libs.: } \$ 40 \\& \pi = 8 \% & \pi = 0 \% \\u = 9 \% & u = 8 \% \\\hline\end{array}$$

A) Outcome A
B) Outcome B
C) Outcome C
D) Outcome D

Question 48

Which of the following variables is likely to serve as an intermediate target for monetary policy?

A) money supply
B) inflation rate
C) open-market operations
D) unemployment rate

Question 49

Intermediate targets

A) are what the Bank of Canada ultimately cares about.
B) can be controlled directly.
C) can be influenced predictably.
D) cannot be affected at all.

Question 50

The primary criticism by Keynesians of the credibility argument for rules is that

A) reputations are a less costly method of gaining credibility.
B) reputations are a less costly method of maintaining credibility.
C) the cost of losing flexibility over policy choices may exceed the cost of gaining credibility.
D) rules that reduce government influence over monetary policy could ultimately be harmful to the economy.

Question 51

Milton Friedman would eliminate the destabilizing effect of the Central Bank's monetary policy by

A) eliminating the Central Bank.
B) removing the Central Bank's political independence.
C) requiring that the Central Bank choose a monetary aggregate and increase it at a fixed percentage rate each year.
D) eliminating the Central Bank's right to carry out open-market operations.

Question 52

Which of the following statements would Milton Friedman disagree with?

A) Monetary policy has few short-run effects on the real economy.
B) In the long run, changes in the money supply primarily affect the price level.
C) In practice, there is little scope for using monetary policy actively to smooth out business cycles.
D) The Central Bank cannot be relied on to effectively smooth out business cycles.

Question 53

If a bank borrows from the Bank of Canada, the interest rate is called

A) the prime rate.
B) the bank rate.
C) the overnight rate.
D) the reserve availability rate.

Question 54

Which of the following might the Bank rely on as an intermediate target?

A) the monetary base
B) the bank rate
C) M2
D) the inflation rate

Question 55

There is an election coming up. Conservatives are currently in government, and will be able to raise more money for the next election campaign if they keep inflation and unemployment low. Conservatives can persuade firms whether or not to raise prices; Liberals can persuade the Bank whether or not to increase the money supply. The amount of money raised by each party and the resulting inflation and unemployment rates are given below. If the Conservatives can move first, what will be the outcome of this game? $$\begin{array} { l l l } & \text { Raise prices } & \text { Don't raise prices } \\\hline \text { Conservative strategy } & \text { Outcome A } & \text { Outcome B } \\\text { Raise } M & \text { Cons.: } \$ 40 & \text { Cons.: \$80 } \\& \text { Libs.: } \$ 60 & \text { Libs.: \$20 } \\& \pi = 8 \% & \pi = 0 \% \\& u = 8 \% & u = 6 \% \\\text { Liberal Strategy } & \text { Outcome C } & \text { Outcome } \mathrm { D } \\\text { Don't raise } & \text { Cons.: } \$ 20 & \text { Cons.: } \$ 60 \\M & \text { Libs.: \$80 } & \text { Libs.: \$40 } \\& \pi = 8 \% & \pi = 0 \% \\& u = 9 \% & u = 8 \%\end{array}$$

A) Outcome A
B) Outcome B
C) Outcome C
D) Outcome D

Question 56

The problem with the strategy of achieving credibility through reputation is that

A) reputations are rarely credible.
B) reputations lack any commitment.
C) serious costs may be incurred during the period in which reputation is established.
D) rules always have a lower cost than reputations in maintaining credibility.

Question 57

Suppose the Bank of Canada's target for inflation is 2 percent. If deviation of output from full-employment output is 1 percent, and the rate of inflation over the previous four quarters is 4 percent, what overnight interest rate the Bank should choose if it follows the Taylor rule?

A) 5.7 percent
B) 4 percent
C) 7.5 percent
D) 3 percent

Question 58

Open-market operations directly and immediately affect

A) the monetary base.
B) banks' holdings of securities.
C) the Bank's holdings of foreign exchange.
D) the money multiplier.

Question 59

Which of the following is not a policy instrument of the Bank?

A) open-market operations
B) overnight rates operating board
C) changes in reserve requirements
D) changes in the government deficit

Question 60

The primary purpose of the lender of last resort is to

A) influence the nation's money supply.
B) prevent financial crises.
C) control banks' excess reserves.
D) influence the amount of loans that banks provide to the public.

Question 61

There is an election coming up. Conservatives are currently in government, and will be able to raise more money for the next election campaign if they keep interest rates and unemployment low. Conservatives can persuade firms whether or not to raise prices; Liberals can persuade the Bank whether or not to increase interest rates. The amount of money raised by each party and the resulting inflation and unemployment rates are given below. a. If the Conservatives can move first, what will be the outcome of this game?
b. Now suppose the Liberals move first. What will be the outcome?
c. Suppose the roles are reversed and Liberals can influence prices, while Conservatives influence the money supply. What is the outcome if Liberals move first? If Conservatives move first?

Question 62

Why is it important to policymakers that people believe them when they say they are going to reduce inflation? How can they increase their credibility?

Question 63

If you could determine the goals of the Bank of Canada, what goals would you choose? Should the Bank's policy be activist? Discuss the pros and cons.

Question 64

Suppose the Bank of Canada strictly followed a rule of keeping money supply at $900 billion. This level of money is consistent with the economy's initial general equilibrium.
a. Assume that GDP has increased. How will the interest rate change?
b. Assume that banks have introduced checking accounts that pay interest. How will the interest rate change?
c. What are the effects of the Bank's money targeting policy on the economy?
d. If the Bank decides to target the interest rate instead of money, what will be the effects of the shocks in a and b on aggregate demand?
e. Compare the effects of the two money targeting and the interest rate targeting policies on the economy. Will the money targeting policy make the aggregate demand more stable or less stable than it would be if the interest rate were constant?

Question 65

Suppose the reserve-deposit ratio is res = 0.5 - 2i, where i is the nominal interest rate. The currency-deposit ratio is 0.2 and the monetary base equals 100. The real quantity of money demanded is given by the more demand function L(Y, I) = 0.5Y - 10i, where Y is real output. Currently the real interest rate is 5% and the economy expects an inflation rate of 5%. Assume the price level P is equal to 1.
a. Calculate the money multiplier.
b. Calculate the reserve-deposit ratio.
c. Calculate the money supply.
d. Calculate the value of output Y that clears the asset market.

Question 66

Should the Central Bank be independent? Or should the Central Bank be required to confer with Parliament to coordinate fiscal and monetary policies? Explain the pros and cons.

Question 67

Suppose the Bank of Canada has just learned that some foreign economies are headed for recession, which will reduce Canadian exports. This is an economic shock that shifts the IS curve down. What would you do in response to the shock if you want to keep the economy at full-employment equilibrium under each of the following cases?
a. You use the classical (RBC) model.
b. You use the Keynesian (efficiency wage) model.
c. You use the extended classical model with misperceptions.
In each case, show the IS-LM-FE diagram associated with your answer.

Question 68

The money supply is $12 million, currency held by the public is $2 million, and the reserve-deposit ratio is 0.2.
a. What is the quantity of bank deposits?
b. What is the quantity of bank reserves?
c. What is the quantity of the monetary base?
d. What is the money multiplier (give a number)?

Question 69

Describe, in general terms, the strategy of monetary-policy, explaining how monetary-policy tools are used to achieve the goals of monetary policy. What intermediate stages are important in going from tools to goals? What are the links between the different stages? How does the Bank of Canada use this strategy today?

Question 70

What types of rules for monetary policy may be sensible for policymakers to consider? What is the advantage of using rules over discretion? What problems might there be with rules?

Question 71

Suppose the Bank of Canada cares only about keeping the economy close to full-employment output. The Bank can target the real money supply (thus keeping the LM curve fixed) or it can target the real interest rate-changing the money supply and shifting the LM curve, however, is necessary to prevent a change in the real interest rate.
a. Which is the best policy if the main shocks to the economy are shocks to the IS curve? Explain why.
b. Which is the best policy if the main shocks to the economy are shocks to real money demand? Explain why.