Deck 15: Financial Crises and the Economy

Question 1

An early sign that financial innovation might be leading toward a financial crisis is ________.

A)deleveraging
B)a bank panic
C)a credit boom
D)debt deflation

Answer 1

a credit boom

Question 2

The main objective of financial liberalization is ________.

A)to encourage financial innovation
B)to improve the allocation of financial capital
C)to discourage volatility in financial markets
D)to reduce the likelihood of a credit boom

Answer 2

to improve the allocation of financial capital

Question 3

Which of the following best illustrates the adverse selection problem?

A)a professional football team that consistently drafts poor players
B)an economic agent who engages in risky behavior once a loan is received
C)an individual who hides a pre-existing condition from a health insurer
D)an individual who experiences a lost of income by not working while attending college

Answer 3

an individual who hides a pre-existing condition from a health insurer

Question 4

________ refers to a decrease in the willingness of banks to lend,while an impairment of the ability of nonfinancial firms to borrow is a consequence of ________.

A)Adverse selection;moral hazard
B)Deleveraging;debt deflation
C)Fire sales;a bank panic
D)The shadow banking system;agency theory

Question 5

The risk that a borrower has more information about their previous behavior than a potential lender is known as the ________.

A)moral hazard problem
B)adverse selection problem
C)time-space discontinuity
D)tertiary behavior problem

Question 6

Financial institutions that cut back on their lending are engaged in ________.

A)liability management
B)deleveraging
C)financial innovation
D)torsion control

Question 7

The adverse consequences of debt deflation are most evident ________.

A)in the expansion of credit to high-risk borrowers
B)on the balance sheets of nonfinancial businesses
C)in a sharp decline in the real interest rate
D)on the balance sheets of financial businesses

Question 8

Prior to World War II,in the United States,financial crises occurred every ________ years or so.

A)twenty
B)seven
C)fifty
D)three

Question 9

The notion that lenders must select from a pool of bad credit risks,because the most undesirable borrowers are those that most actively seek out a loan is known as the ________.

A)moral hazard problem
B)ornamental torsion problem
C)adverse selection problem
D)asymmetric innovation problem

Question 10

The analysis of asymmetric information problems is called ________.

A)adverse selection
B)microeconomics
C)cybernetics
D)agency theory

Question 11

A rapid increase in the availability of credit to previously underserved borrowers is likely ________.

A)to result from financial liberalization
B)to improve the allocation of capital
C)to confirm the merits of microcredit
D)to result from deleveraging

Question 12

When banks fail during a financial crisis,________.

A)the removal of these weak institutions serves to strengthen the financial system
B)the elimination of competitors is likely to spark a credit boom
C)there is a loss of information that can cause the crisis to worsen
D)surviving banks resort to financial engineering to retain customers

Question 13

According to agency theory,a financial crisis results from ________ that disrupts the flow of funds from lender-savers to borrower-spenders.

A)an increase in asymmetric information
B)a macroeconomic shock
C)the existence of asymmetric information
D)a decrease in saving

Question 14

The failure of a major financial company is often a trigger for a financial crisis.The main reason for trouble at a single firm to become a crisis for the entire economy is that ________.

A)the central bank will suspend operations until the failed firm is restructured
B)it is unclear whether the firm's collapse will remain an isolated event
C)customers of the failed company will organize a boycott to protest their losses
D)employees and owners of the failed company reduce their spending,with adverse effects on other businesses

Question 15

Channeling funds to individuals with productive investment opportunities is the function of ________.

A)the financial sector
B)state and local governments
C)the central bank
D)state,local and federal governments

Question 16

Which of the following best illustrates the problem of moral hazard?

A)a professional baseball team that consistently drafts poor players
B)an individual that is hiding a pre-existing condition from a health insurance provider
C)an increase in the level of one's income will lead to a decrease in demand for inferior goods
D)an economic agent that engages in risky behavior once a loan contract is signed

Question 17

The risk that a borrower has a greater understanding about their potential future behavior than a potential lender is known as ________.

A)the problem of adverse selection
B)the problem of moral hazard
C)ornamental torsion
D)the asymmetric innovation problem

Question 18

Assume that a firm has $100 million in real assets and $90 in real liabilities.The value of its net worth would be ________.

A)a negative $10 million.
B)$190 million.
C)$4190 billion.
D)$10 million.

Question 19

In the period from 1929 through 1933,there were successive ________ in aggregate demand and ________ in short-run aggregate supply.

A)increases;decreases
B)decreases;increases
C)decreases;no change
D)increases;increases

Question 20

A likely consequence of deposit insurance,ceteris paribus,is ________.

A)an increase in risk-taking by banks
B)a bank panic
C)a credit boom
D)a reduction in the severity of adverse selection

Question 21

A prominent aspect of the recent Great Recession,but not of the Great Depression of the 1930s,is ________.

A)bank panics
B)mortgage defaults
C)an increase in the credit spread
D)nonconventional monetary policy

Question 22

The Great Depression ________.

A)was largely confined to the United States
B)was largely confined to European markets
C)was largely confined to Asian markets
D)was worldwide in scope

Question 23

Assume that a firm has $100 million in real assets and $90 in real liabilities.If the price level rise by ten percent,the real value of its assets would ________.

A)fall
B)rise
C)change,but more information must be provided to determine their exact movement
D)remain unchanged

Question 24

The decline in net worth that can result from an unanticipated decline in the price level is known as ________.

A)a credit boom
B)deleveraging
C)a debt deflation
D)federal funds rationing

Question 25

In the Great Depression,investment spending fell by ________.

A)nine-tenths of one percent
B)nine percent
C)ninety percent
D)nine hundred percent

Question 26

U.S.financial crises begin in a period of ________.

A)rising incomes
B)adverse selection
C)rising uncertainty
D)moral hazard

Question 27

An individual firm is insolvent when ________.

A)its assets exceed the value of its liabilities
B)its average costs per unit are greater than its marginal cost
C)its average costs per unit are less than its marginal cost
D)its liabilities exceed the value of its assets

Question 28

The main reason that many businesses fail when the price level is falling is that ________.

A)deflation causes a decline in short-run aggregate supply
B)as prices fall,businesses are unable to predict the quantity of output they will be able to sell
C)the real value of the firms assets declines in proportion to the decrease in the price level
D)falling prices mean that regular loan payments become increasingly difficult

Question 29

When banks and other financial institutions become insolvent,________.

A)the problem of asymmetric information becomes more acute
B)it is easier to distinguish the good creditors and borrowers from the bad
C)surviving creditors will attract borrower-spenders by lowering the real interest rate
D)the resulting increase in short-run aggregate supply will discourage investment

Question 30

Assume that a firm has $100 million in real assets and $90 in real liabilities.If the price level falls by ten percent,the real value of liabilities would ________.

A)fall to $81 million
B)change,but more information must be provided to determine the exact movement
C)remain unchanged
D)rise to $99 million

Question 31

An increase in the general level of prices will tend to cause,other things the same ________.

A)an increase in the real value of assets
B)an increase in the real value of liabilities
C)no change in the real value of liabilities
D)a decrease in the real value of liabilities

Question 32

President Franklin Delano Roosevelt declared a bank holiday,closing all U.S.banks in ________.

A)July 1776
B)October 1929
C)March 1933
D)September 2001

Question 33

Most likely,the stock market crash in 1929 was triggered by ________.

A)an autonomous tightening of monetary policy
B)an unexpected increase in tax rates
C)the rise of fascist political parties in Europe
D)a decline in consumer spending

Question 34

The difference between the interest rate on loans to households and firms and the rate on completely safe assets is known as ________.

A)the discount rate
B)the FICO score
C)the credit spread
D)the prime rate

Question 35

The most severe financial crisis in U.S history occurred in the years ________.

A)2006-2008
B)1997-98
C)1929-33
D)1873-93

Question 36

Which of the following statements is correct?

A)assets plus liabilities equal net worth
B)liabilities plus net worth equal assets
C)assets plus net worth equal liabilities
D)liabilities minus net worth equal assets

Question 37

An asset-price bubble entails ________.

A)increasing the value of one's assets to cover liability losses
B)an increase in asset prices above their fundamental economic value
C)reducing the number of participants in the underlying financial derivatives market
D)an economic skins game

Question 38

A prominent aspect of the Great Depression of the 1930s,but not of the recent Great Recession,is ________.

A)bank panics
B)mortgage defaults
C)an increase in the credit spread
D)nonconventional monetary policy

Question 39

The credit spread refers to ________.

A)the extent to which financial instruments are distributed among households at different income levels in a given society
B)the difference between the London Inter-Bank Offered Rate (LIBOR)and the fed funds rate
C)the price elasticity of household debt
D)the interest-rate differential between risky bonds and U.S.Treasury bonds

Question 40

The Great Crash on the New York Stock Exchange occurred in ________.

A)October 1929
B)July 1776
C)September 2001
D)March 1933

Question 41

How can improvements in statistical analysis of financial data cause the amount of information in financial markets to decline?

Question 42

An increase in asymmetric information that increases financial frictions will tend to ________.

A)increase the moral hazard and adverse selection problems in credit markets
B)decrease financial frictions
C)improve market efficiency
D)decrease the moral hazard problem

Question 43

Instruments which provide payments to holders of bonds in the event of default are known as ________.

A)collateralized bond obligations
B)tertiary payment devices
C)credit default swaps
D)mortgage-backed securities

Question 44

Hedge funds,investment banks,and other non-depository financial firms are known as ________.

A)the shadow banking system
B)repurchasers
C)subprime lenders
D)CDOs

Question 45

Financial innovations may be expected to cause a decline in ________.

A)the ability of lenders and borrowers to fully understand the latest financial opportunities
B)the ability of government regulators to foresee emerging threats to financial stability
C)incentives for financial intermediaries to avoid high-risk loans
D)all of the above
E)none of the above

Question 46

The financial innovation of numerical credit scoring contributed to the ________.

A)"democratization of credit"
B)reduction of loan-to-value ratios
C)"depersonalization of credit"
D)reduction of information asymmetries

Question 47

The financial market events of September and October 2008 ________.

A)sparked a sharp widening of the credit spread
B)signalled the success of the policy response to the financial crisis
C)reduced some of the uncertainty that had paralyzed financial markets
D)resulted from the federal funds rate having fallen below zero

Question 48

A $100 million loan with a haircut of four percent requires collateral valued at ________.

A)$104 million
B)$96 million
C)$4 million
D)$400,000

Question 49

The worst weekly decline in U.S.stock market history occurred during the week beginning with ________.

A)March 20,1933
B)December 7,1941
C)September 12,2001
D)October 6,2008

Question 50

Financial innovations may be expected to cause a decline in ________.

A)aggregate demand
B)asset prices
C)the real interest rate on investments
D)all of the above
E)none of the above

Question 51

Describe the role of uncertainty at the beginning of and in the unfolding of a financial crisis.

Question 52

If the value of a home falls below the amount owed on the mortgage for that property,the house is said to be ________.

A)underwater
B)collateralized
C)swamped
D)in short sale

Question 53

A haircut (in finance)is ________.

A)the payment of a block of funds as part of a refinancing arrangement
B)the percentage by which the value of collateral exceeds the value of the loan
C)the issue of equities rather than debt in acquiring access to money capital
D)the immediate end of lending to subprime borrowers

Question 54

From 1995-2007,the Irish economy ________.

A)suffered from severe unemployment,famine and labor migration
B)witnessed a boom in the real economy,but suffered through a collapse in asset prices
C)enjoyed one of the highest growth rates in the world
D)suffered through a period of prolonged deflation

Question 55

How is a financial crisis like a power blackout?

Question 56

The most direct and important consequence of an increase in asymmetric information problems is ________.

A)a decrease in the probability of loan repayment
B)inability to assess the probability of loan repayment
C)unwillingness of borrowers to accept the market rate of interest
D)inability of creditors to acquire enough funds to meet borrowers' demand

Question 57

During the Great Depression,as real interest rates rose,good credit risks were less likely to seek loans.This process illustrates the phenomenon of ________.

A)adverse selection
B)moral hazard
C)poor monetary policy
D)debt deflation

Question 58

The practice of approving mortgages in order to sell them as mortgage-backed securities is known as ________.

A)originate-to-distribute
B)principal-agent engineering
C)predatory lending
D)a credit default swap

Question 59

Subprime borrowers ________.

A)are those individuals who owe more on their mortgage than the value of their home
B)possess a relatively low FICO score
C)rely on mortgage-backed securities to support their mortgage applications
D)are those with an income level below the value of their mortgage

Question 60

Financial innovations may be expected to cause a decline in ________.

A)financial frictions
B)the credit spread
C)the real interest rate on investments
D)all of the above
E)none of the above

Question 61

In the event that nominal short-term interest rates cannot be lowered further,the Federal Reserve might rely on ________.

A)federal government fiscal policy
B)targeting the fed funds rate
C)quantitative easing
D)targeting the inflation rate

Question 62

The Troubled Asset Relief Program ________.

A)led to the creation of the Federal Reserve System
B)helped contribute to the stock market crash of 2006-2007
C)shifted non-performing assets off the balance sheet of the Federal Deposit Insurance Corporation onto the balance sheet of Fannie Mae and Freddie Mac
D)authorized the Treasury to by mortgages from troubled financial institutions

Question 63

Which of the following is among the possible reasons that the 2007-2009 financial crisis did not result in an economic depression?

A)new lending programs by the central bank
B)privatization of Fannie Mae and Freddie Mac
C)a substantial increase in exports to China
D)rapid foreclosure of "underwater" properties

Question 64

Attempts by a central bank to increase bank deposits without a decrease in nominal short-term interest rates are referred to as ________.

A)quantitative easing
B)credit channeling
C)open market operations
D)liquidity provision

Question 65

The key objective of purchases by the Federal Reserve of over $1 trillion worth of debt issued by private firms was ________.

A)to avoid the bankruptcy of the issuing firms
B)to manage expectations
C)to prevent such firms from being acquired by foreign companies
D)to stimulate spending by firms and households

Question 66

In an attempt to manage expectations,a central bank may prefer to announce an unconditional commitment,because an unconditional commitment ________ than a conditional commitment.

A)is inherently more credible
B)may have an impact on expectations that is stronger
C)places fewer constraints on policy makers
D)is less likely to have unintended consequences

Question 67

The Economic Recovery Act of 2008 included a temporary increase in the federal deposit insurance ceiling from $100,000 to $250,000.The likely objective was to ________.

A)boost bank profitability
B)increase the money supply
C)discourage withdrawals from banks
D)bail out the Federal Deposit Insurance Corporation (FDIC)

Question 68

Management of expectations by a central bank is based on the view that ________.

A)decreasing the federal funds rate will lead to a reduction in the discount rate
B)if economic agents believe that the price of an individual asset will rise in the future,they will buy that asset today,contributing to its eventual price increase
C)if households expect an increase in prices in the future,they will engage in spending today
D)households will increase their spending today if they believe that the monetary authorities are committed to maintaining low interest rates

Question 69

How might the globalization of financial markets affect the role of financial frictions in business fluctuations?

Question 70

The zero-lower-bound problem eliminates the ability of the central bank to use which of the following in implementing policy?

A)open market operations
B)discount lending
C)the federal funds rate
D)the required reserve ratio

Question 71

Central bank lending to bail out troubled firms is known as ________,while allowing troubled firms to conceal the true value of their assets is called ________.

A)crony capitalism;larceny
B)liquidity provision;regulatory forbearance
C)securitization;nonconventional monetary policy
D)subprime lending;regulatory arbitrage

Question 72

Which of the following is among the possible reasons that the 2007-2009 financial crisis did not result in an economic depression?

A)the declaration of a bank holiday by the nation's President
B)international policy coordination
C)strict reliance on conventional monetary policy
D)government spending restraint

Question 73

The most important component of the Economic Recovery Act passed by the Bush Administration was ________.

A)the creation of the Federal Reserve discount window
B)the establishment of the Troubled Asset Relief Program (TARP)
C)the decrease in taxes for the wealthiest one percent of all Americans
D)the creation of the Federal Reserve

Question 74

Fiscal policy involves the manipulation of ________.

A)U.S.interest rates
B)wages and prices
C)federal government spending and tax revenues
D)the supply of money

Question 75

Following the collapse of its housing and stock markets around 1990,the Japanese government ________.

A)effectively managed the crisis,limiting the damage to the Japanese economy
B)took only limited action in response to the crisis
C)was able to rely on private initiatives in quickly reversing the course of GDP in the 1990s
D)fixed the value of the yen to the Euro and pursued an aggressive monetary policy

Question 76

The rate targeted by the Federal Reserve System as it conducts monetary policy is the ________.

A)discount rate
B)prime rate
C)Treasury bill rate
D)fed funds rate

Question 77

Monetary policy in the United States is primarily the responsibility of ________.

A)the President and Congress
B)the Federal Reserve System
C)the U.S.Treasury
D)the Comptroller of the Currency

Question 78

Which of the following is among the possible reasons that the 2007-2009 financial crisis did not result in an economic depression?

A)tax cuts
B)elimination of nonessential government spending
C)rapid prosecution of predatory lenders
D)closure of the shadow banking system

Question 79

What are the effects of a financial crisis on short-run aggregate supply? How might long-run aggregate supply be affected?

Question 80

Compared to the central bank response to the financial crisis in 2007-2009,the response to the Great Depression of the 1930s may be characterized as ________,while the response of Japan's central bank to the banking crisis in the early 1990s merits the label ________.

A)hasty;sluggish
B)intrusive;tenacious
C)complacent;indulgent
D)corrupt;technocratic