Deck 13: Monetary Policy

Question 1

According to the Quantity Theory of Money,if velocity is rising by 1% per year and real GDP growth is 2.5% per year,then maintaining an annual inflation rate of 1.5% would require annual money supply growth of

A) zero percent
B) 1%
C) 2%
D) 3%
E) 4%

Answer 1

3%

Question 2

According to the simple Quantity Theory of Money,if velocity is constant and real GDP grows by 2% per year,then money supply growth of 3% per year generates

A) an interest rate of 1%
B) an inflation rate of 1%
C) an unemployment rate of 1%
D) an exchange rate of 1%
E) an output gap of 1%

Answer 2

an inflation rate of 1%

Question 3

A reduction in the money supply

A) reduces both interest rates and GDP
B) pushes the LM curve down
C) pushes the LM curve inward
D) shifts the IS curve outward
E) flattens the slope of the LM curve

Answer 3

pushes the LM curve inward

Question 4

Which of the following is most likely to be an intermediate target for monetary policy?

A) short term interest rates
B) the unemployment rate
C) investment expenditures
D) gross domestic product
E) the money supply

Question 5

In practice,effective deflation

A) occurs when the inflation rate is less than 5%
B) requires the inflation rate to be less than or equal to negative one percent
C) occurred more often in the final 3 decades of the 20^th century than it has since
D) is more prevalent among Latin American countries than elsewhere
E) is a relatively rare phenomenon

Question 6

For central banks,short term interest rates are likely to be

A) long run policy targets
B) intermediate-term targets
C) operational instruments
D) taken as exogenously determined
E) irrelevant to policy making

Question 7

Using the money supply as the exclusive intermediate target for policy purposes has fallen out of favor for all but which of the following reasons?

A) the velocity of money is unpredictable
B) the various monetary aggregates often send conflicting signals
C) the decision lag for setting money supply targets is too long
D) there is no reliable formula relating changes in interest rates to changes in the money supply
E) raising interest rates may reduce GDP rather than reducing inflation

Question 8

Central banks commonly aim to keep the price level

A) declining slightly
B) perfectly constant
C) growing by about 1% per year
D) rising by about 2% per year
E) increasing by about 5% per year

Question 9

Which of the following events or trends from the 1970s and 1980s does not help to explain the failure of using monetary aggregates as intermediate targets?

A) oil price shocks
B) the creation of new monetary instruments which brought about new, broader measures of the money supply
C) the invention of automatic teller machines
D) legislative and regulatory changes allowing increased financial competition
E) the widespread adoption of computers throughout the banking industry

Question 10

If a central bank targets the exchange rate,it

A) enhances its ability to achieve full employment
B) raises interest rates whenever the currency appreciates
C) reduces interest rates in order to force its currency to appreciate
D) achieves the same inflation rate as the target country
E) stabilizes GDP by stabilizing net exports

Question 11

Which of the following is the most appropriate model for a central bank conducting discretionary stabilization policy?

A) observe what the unemployment rate has been in recent periods, estimate the difference from the natural rate, and adjust the money supply accordingly
B) observe the current level of GDP, estimate the output gap between actual and potential GDP, and adjust bank reserve requirements accordingly
C) observe the past and current trade-weighted exchange rate, estimate the difference from purchasing power parity, and adjust income taxes accordingly
D) predict the future inflation rate based on current and recent trends in economic variables, estimate the difference from the target rate, and tighten or loosen lending accordingly
E) disregard current trends and simply keep the money supply growing at a rate equal to the long run growth rate of GDP

Question 12

The horizontal and vertical axes of the LM curve diagram represent,respectively,

A) the quantity of money and the price level
B) the quantity of money and the interest rate
C) real GDP and the interest rate
D) real GDP and the price level
E) the unemployment rate and the inflation rate

Question 13

Setting a target of zero for the inflation rate may be sub-optimal because

A) measured inflation is an overestimate, so zero measured inflation effectively implies deflation
B) the redistributive effects of unexpected inflation are Pareto efficient
C) a stagnant price level precludes the possibility of economic growth
D) deflation encourages investment, so the target rate for inflation should be negative
E) all of the above

Question 14

Which of the following is most likely to be an ultimate target for monetary policy?

A) short term interest rates
B) reserve ratios
C) the inflation rate
D) exchange rates
E) stock market indexes, such as the S&P 500

Question 15

The LM curve slopes upward because

A) as income rises, the demand for money begins to exceed its supply
B) as interest rates rise, the demand for money rises
C) as the price level rises, the velocity of money increases
D) as the money supply rises, the inflation rate increases
E) as the demand for money rises, the supply of money is increased

Question 16

In the Keynesian model,

A) the IS curve shows all points of informational symmetry between buyers and sellers
B) the IS curve represents international symbiosis between economies
C) the LM curve shows equilibrium positions in the goods market
D) the LM curve gives the locus of points at which imports equal exports
E) the LM curve shows where the supply and demand for money are equal

Question 17

A low,positive rate of price inflation

A) allows real wages to rise when nominal wages are sticky
B) allows real interest rates to become negative when nominal interest rates fall to zero
C) allows unemployment to remain below the natural rate indefinitely
D) allows firms to make economic profits even in perfectly competitive markets
E) prevents the public from forming expectations regarding the price level

Question 18

Suppose that as sales of goods shift from bricks-and-mortar stores to the internet,the transactions demand for cash declines. Then in the absence of any other changes,

A) the IS curve shifts outward
B) the LM curve shifts inward
C) the velocity of money will adjust to keep GDP constant
D) interest rates will fall and GDP will increase
E) interest rates will rise and investment will decline

Question 19

Which of the following characterizes intermediate targeting by central banks?

A) the Federal Reserve targets short term interest rates
B) the European Central Bank targets exchange rates
C) the Bank of England targets inflation
D) increasingly, central banks are exclusively targeting the money supply
E) increasingly, central banks are abandoning the use of explicit targets

Question 20

Italy and the United Kingdom abandoned their exchange rate targets in 1992 because

A) they had achieved their goal of stabilizing output
B) they replaced their domestic currencies with the Euro
C) all the other European countries did the same
D) Germany raised interest rates to fight inflation, but concomitant tightening exacerbated recession in Italy and the UK
E) productivity shocks in Italy and the UK created unexpected currency appreciations too often to counteract successfully with monetary policy

Question 21

Which of the following is true of inflation targeting?

A) it is conducted with openness rather than secrecy
B) it is a specific policy rule
C) it restricts policymakers' attention to one easily identified variable
D) it is a form of monetarism which relies on a relatively narrow interpretation of the Quantity Theory
E) though theoretically legitimate, it has not been adopted in practice by any major central banks

Question 22

The next questions refer to the following.
Suppose the central bank follows the Taylor Rule
nominal interest rate = .03 + .5(output gap) + 1.5(inflation rate - .02).
The real interest rate will be approximately

A) -.01
B) .02
C) .025
D) .05
E) .07

Question 23

The credit channel refers to

A) changes in bank lending which result from monetary policies
B) the interest rate linkage between monetary policy and corporate investment
C) direct lending by the central bank to private banks
D) money market effects on exchange rates
E) the relationships among private banks acting cooperatively rather than competitively

Question 24

If the central bank follows the Taylor Rule nominal interest rate = .04 + α(output gap) + β (inflation rate - .03)
Where α = 0 and β = 1,then each of the following is true except

A) the real interest rate will remain approximately one percent
B) the central bank has a three percent inflation target
C) the policy rule excludes any consideration of employment and/or GDP
D) the nominal interest rate will be at least four percent
E) in the face of one percent deflation, the central bank would cut its nominal interest rate to zero

Question 25

Quantitative Easing refers to

A) A dramatic increase in M2 when interest rates are at or close to zero
B) Cutting interest rates to zero
C) Printing cash to finance government expenditure
D) A dramatic increase in M0 when interest rates are at or close to zero
E) Printing cash to finance tax cuts

Question 26

Which of the following is not a mechanism through which central banks can ordinarily provide increased liquidity to the economy?

A) printing currency
B) purchases of government securities from member banks
C) reducing reserve requirements
D) increased lending through the discount window
E) all of the above mechanisms are available to the central bank for providing liquidity, and all are routinely used

Question 27

If the central bank targets the money supply,it will

A) provide increased liquidity when the demand for money rises
B) raise interest rates to encourage lending whenever banks hold excess reserves
C) conduct open market sales of securities whenever the demand for money falls
D) allow interest rates to rise when the demand for money rises
E) not act to offset credit tightening by banks

Question 28

Which of the following would reduce short term interest rates?

A) the issuance of new government bonds by the central bank
B) a sale of bonds by the central bank
C) an increase in discount window lending
D) an increase in reserve requirements
E) a tighter credit policy by banks

Question 29

When the central bank undertakes an open market purchase,

A) the national debt increases
B) bank reserves decrease
C) interest rates rise
D) the money supply increases
E) the monetary base declines

Question 30

Higher short term interest rates can be used to prevent inflation because they

A) discourage saving
B) increase the debt-service expense for the government
C) cause the country's currency to depreciate on the world market
D) enhance consumer confidence
E) discourage investment

Question 31

The monetary base consists of

A) gold and silver
B) gold plus currency
C) coins, currency, and demand deposits
D) currency and bank reserves
E) M3 - M1

Question 32

Inflation targeting most commonly consists of

A) a 6 month goal of 6% inflation in consumer prices
B) a 9 month goal of 4% inflation in consumer prices
C) a 1 to 2 year goal of 2% to 3% inflation in consumer prices
D) a 1 to 2 year goal of zero inflation, plus-or-minus 1%, in producer prices
E) a 5 year goal of 3% to 5% inflation in producer prices

Question 33

Targeting interest rates and targeting the money supply are equivalent if

A) money demand is stable
B) banks hold no excess reserves
C) exchange rates are fixed
D) central banks practice inflation targeting
E) consumers exhibit rational expectations

Question 34

Open market operations refer to

A) all economic transactions not undertaken on the black market
B) imports and exports of goods
C) international currency transactions
D) central banks holding reserves and lending to member banks
E) the purchase and sale of treasury securities by central banks

Question 35

Which of the following is not a valid reason for adopting inflation targeting?

A) policy rules are often too restrictive
B) discretionary policy can reduce credibility
C) constrained discretion operates with excessive lags
D) inflation targeting provides flexibility for dealing with shocks
E) inflation targeting examines trends in several variables, whereas policy rules use limited information

Question 36

A 1% increase in the fed funds rate,an overnight inter-bank rate often targeted by the Federal Reserve,is most likely to cause

A) a 1% increase in prices within a year
B) a nearly instantaneous increase in output and a reduction in unemployment
C) a 1% increase in the money supply (M1) over a two-year period
D) gradual reductions in the money supply, inflation, output, and employment
E) other interest rates throughout the economy to fall by about 1%

Question 37

Which of the following is not a mechanism through which Quantitative Easing (QE) could affect the wider economy

A) An announcement effect whereby the mere announcement of a QE programme influences expectations and causes individuals to alter their spending and saving decisions.
B) A direct spending effect whereby cash given to individuals increases their spending
C) An excess M0 effect whereby banks are more willing to lend when their cash balances are large
D) An asset price effect whereby assets purchased through the QE programme tend to rise in price and so influence borrowing and lending decisions in the economy
E) An inflation expectations effect whereby QE raises expectations of future inflation.

Question 38

The next questions refer to the following.
Suppose the central bank follows the Taylor Rule
nominal interest rate = .03 + .5(output gap) + 1.5(inflation rate - .02).
For an economy at full employment with an inflation rate of .04,the central bank will set its nominal interest rate equal to

A) .03
B) .05
C) .06
D) .065
E) .09

Question 39

If the nominal interest rate is currently .03 and the central bank follows the rule nominal interest rate = .03 + .5(output gap) + 1.5(inflation rate - .04),
Then it will leave nominal rates unchanged in each of the following cases except

A) full employment with four percent inflation
B) a three percent output gap and three percent inflation
C) a supply shock causing six percent inflation and a negative output gap of six percent
D) a technology jump causing a fifteen percent output gap and one percent deflation
E) a two percent output gap and two percent inflation