Deck 14: The Great Recession and the Short-Run Model

Question 1

The risk premium:

A)is equal to zero when the economy is in its long-run equilibrium.
B)is negative in Japan.
C)raises the borrowing rate above the nominal federal funds rate.
D)is equal to the rate of inflation.
E)c and a

Answer 1

E

Question 2

Use the figure below for the following questions;it shows the BAA corporate and 10-Year Treasury Bond yields.
Consider Figure 14.1 above.The difference between these two curves can be interpreted as:

A)the risk premium.
B)inflation expectations.
C)the risk-free rate.
D)a market imperfection.
E)the prime lending rate.

Answer 2

A

Question 3

In response to the Great Recession the federal government responded with __________ for the Troubled Asset Relief Program and __________ for the American Recovery and Reinvestment Act.

A)$700 billion;$787 billion
B)$100 billion;$1 trillion
C)$0;$1.5 trillion
D)$700 million;$787 million
E)$150 billion;$500 million

Answer 3

A

Question 4

Use the figure below for the following questions;it shows the BAA corporate and 10-Year Treasury Bond yields.
In Figure 14.1 above,the ten-year bond yield is considered __________,while the BAA bond yield represents ____.

A)the federal funds rate;the risk premium
B)the saving rate;the lending rate
C)the risk premium,the prime lending rate
D)a risk-free interest rate;a risky interest rate
E)inflation;M1 money growth rate

Question 5

Which of the following represents the AD curve with a risk premium?

A)
B)
C)
D)
E)

Question 6

Use the figure below for the following questions;it shows the BAA corporate and 10-Year Treasury Bond yields.
Consider Figure 14.1.What event likely caused the risk premium to jump to about 6 percent?

A)the financial crisis in September 2008
B)growing unrest in the Middle East
C)the Greek financial crisis
D)the growing trade deficit with China
E)not enough information

Question 7

Adding a risk premium to the short-run model:

A)shifts the MP curve up.
B)shifts the AD curve down.
C)has no (direct)impact on the IS curve.
D)a-c
E)a and c only

Question 8

When we add the risk premium to the AD curve it:

A)is represented by a downward movement along the AD curve.
B)is represented by a downward movement along the AS curve.
C)shifts the AD curve down.
D)shifts the AS curve up.
E)has no impact on the AD curve.

Question 9

In response to the financial crisis,the Fed effectively lowered interest rates to __________ percent.

A)1%.
B)5%
C)zero.
D)-1%
E)3%.

Question 10

When a risk premium is added to the short-run model it:

A)shifts the MP curve up.
B)shifts the IS down.
C)shifts the AD curve down.
D)is represented by a movement along the MP curve.
E)c and a

Question 11

In late September 2008,Fed Chairman told a congressional panel:

A)"In the long run we are all dead."
B)"If we don't do this [the Troubled Asset Relief Program],we may not have an economy on Monday."
C)"A recession is when your neighbor loses his job;a depression is when you lose yours."
D)"Inflation is always and everywhere a monetary phenomenon."
E)"We do not believe that more fiscal stimulus will improve economic performance."

Question 12

Use the figure below for the following questions;it shows the BAA corporate and 10-Year Treasury Bond yields.
In Figure 14.1 above,the risk premium in late 2008 was about __________ percent.

A)9.5
B)12
C)6
D)-6
E)not enough information

Question 13

If
Is the federal funds rate,R is the market interest rate,and
Is the risk premium,what is the equation for the market interest rate?

A)
B)
C)
D)
E)

Question 14

The risk premium is the:

A)difference between federal funds rate and the interest rate in financial markets.
B)interest rate used in subprime loans.
C)difference between long-run inflation and the actual rate of inflation.
D)result of adding the inflation rate to the unemployment rate.
E)variance of the risk-free interest rate.

Question 15

Consider the IS-MP model in Figure 14.2 above.Starting from the long-run equilibrium,the burst of the housing bubble and the appropriate fed response,with a risk premium,can be shown as a movement from point __________ to point __________ and the economy is in __________.

A)d;b;its long-run equilibrium
B)b;a;an expansion
C)d;f;a recession
D)d;c;its long-run equilibrium
E)e;f;a recession

Question 16

Consider the IS-MP model in Figure 14.2 above;starting from the long-run equilibrium,the burst of the housing bubble and the appropriate fed response,without a risk premium,can be shown as a movement from point __________ to point __________ and the economy is in __________.

A)c;e;its long-run equilibrium
B)d;b;its long-run equilibrium
C)b;a;an expansion
D)a;d;a recession
E)a;d;an expansion

Question 17

The burst of the housing bubble can be represented in the IS-MP model as a(n):

A)decline in a¯ .
B)rise in r¯.
C)decline in inflation.
D)increase in m¯ .
E)rise in a¯ .

Question 18

In the IS-MP framework,when the Fed __________ the federal funds rate in the aftermath of the decline in housing prices,the __________ caused a(n)__________ in the real interest rate.

A)raised;higher inflation rate;fall
B)held constant;Okun effect;decline
C)lowered;risk premium;increase
D)manipulated;Fisher effect;increase
E)raised;unemployment rate;fall

Question 19

Consider the IS-MP model in Figure 14.2 above.Starting from the long-run equilibrium,the burst of the housing bubble can be shown as a movement from point __________ to point __________.

A)d;b
B)d;a
C)a;d
D)f;e
E)d;c

Question 20

When a risk premium is added to the MP curve we have:

A)
B)
C)
D)
E)

Question 21

The effect of the subprime loan crisis pushed the __________.This pushes the MP curve __________ and the AD __________.

A)risk premium up;up;down
B)inflation rate up;up;down
C)unemployment rate down;down;up
D)risk-free interest rate up;down;up
E)federal funds rate to zero;down,down

Question 22

The liquidity trap occurs when:

A)nominal interest rates are high.
B)real interest rates are high.
C)there is not enough money in bank vaults.
D)the Fed interferes with market interest rates.
E)there are too many excess reserves.

Question 23

For the following questions refer to Figure 14.3 below.
Consider Figure 14.3 above.If the economy begins in its long-run equilibrium and there is an increase in the economy's risk premium,the economy would move from point __________ to __________.

A)c;d
B)a;d
C)b;c
D)b;a
E)d;a

Question 24

When there is deflation,

A)the real interest rate rises.
B)it has no effect on the output gap.
C)it has no effect on the unemployment rate.
D)there is decline in real money.
E)nominal interest rates are negative.

Question 25

Refer to Figure 14.4 below,which shows the inflation rate and ten-year bond yield,for the following questions.
Throughout the first three-fourths or so of 2009,

A)real interest rate on ten-year bonds was higher than the nominal interest rate.
B)the ten-year bonds nominal interest rate was higher than the real interest rate.
C)real interest rate was zero.
D)real interest rate was negative.
E)a and d

Question 26

When the Fed lowers the nominal interest rate to zero,what is the real interest rate?

A)
B)
C)zero
D)equal to the nominal interest rate
E)undetermined

Question 27

In the IS-MP framework,when the Fed __________ the federal funds rate in the aftermath of the decline in housing prices,the risk premium gave rise to a(n)__________ in the real interest rate which caused a(n)__________.

A)lowered;increase;deeper recession
B)raised;decline;commodity bubble
C)lowered;decline;expansion
D)held constant;economic "settling"
E)lowered;decrease;deeper recession

Question 28

If the rate of inflation is -2 percent,the output gap is -5 percent,the nominal interest rate is 5 percent,and the unemployment rate is 8 percent,what is the real interest rate?

A)10 percent
B)0 percent
C)-3 percent
D)7 percent
E)3 percent

Question 29

Refer to Figure 14.4 below,which shows the inflation rate and ten-year bond yield,for the following questions.
For most of 2008,

A)real interest rate was negative.
B)the ten-year bonds nominal interest rate was less than the real interest rate.
C)real interest rate was zero.
D)real interest rate was positive.
E)not enough information

Question 30

According to the Fisher equation,the real interest rate is:

A) .
B) .
C) .
D) .
E) .

Question 31

In the AS/AD framework,the risk premium appears as a(n):

A)negative demand shock.
B)negative supply shock.
C)the risk premium is only present in the IS-MP model.
D)positive supply shock.
E)a change in the long-run real interest rate.

Question 32

During the Great Depression,

A)deflation raised the real interest rate.
B)unemployment lowered the nominal interest rate.
C)deflation lowered the real interest rate.
D)unemployment increased the output gap.
E)high interest rates increased inflation.

Question 33

For the following questions refer to Figure 14.3 below.
The effect of the subprime loan crisis pushed the __________.In Figure 14.3,this is shown as a movement from point __________ to __________.

A)inflation rate down;c;d
B)long-run real interest rate down;c;b
C)risk premium up;c;d
D)market real interest rate down;a;b
E)unemployment rate up;c;d

Question 34

If the rate of inflation is 2 percent,the output gap is 0 percent,the nominal interest rate is 3 percent,and the unemployment rate is 10 percent,what is the real interest rate?

A)1 percent
B)2 percent
C)-7 percent
D)-1 percent
E)3 percent

Question 35

The liquidity trap occurs when:

A)real interest rates are above the marginal product of capital.
B)firms have no access to stock markets.
C)too little money is held in excess reserves.
D)market interest rates are negative.
E)the Fed loses control of money supply.

Question 36

The Fisher equation is given by:

A) .
B) .
C) .
D) .
E) .

Question 37

When inflation is negative it:

A)raises the real interest rate.
B)increases the positive output gap.
C)has no effect on the unemployment rate.
D)increases the growth of money.
E)is called disinflation.

Question 38

For the following questions refer to Figure 14.3 below.
Consider Figure 14.3 above.If the economy begins in its long-run equilibrium and there is a decrease in the economy's risk premium,the economy would move from point __________ to __________.

A)c;d
B)a;d
C)b;c
D)a;b
E)b;a

Question 39

Refer to Figure 14.4 below,which shows the inflation rate and ten-year bond yield,for the following questions.
To eradicate deflation during the Great Depression,the Fed __________ and __________.

A)raised the real interest rate;lowered the inflation rate
B)bought subprime loans from banks;lowered nominal interest rates
C)lowered the nominal interest rate;abandoned the gold standard
D)temporarily closed;operated under the Treasury Department
E)printed money;borrowed heavily from the United Kingdom

Question 40

Refer to Figure 14.4 below,which shows the inflation rate and ten-year bond yield,for the following questions.
Between 2006 and 2007,

A)real interest rate was negative.
B)the ten-year bonds nominal interest rate was lower then inflation.
C)real interest rate was higher than nominal interest rate.
D)real interest rate was positive.
E)not enough information

Question 41

The effects of deflation mimic the analysis of:

A)rising unemployment.
B)lowering the nominal interest rate.
C)the risk premium.
D)reducing money supply.
E)Ricardian equivalence.

Question 42

The Monetary History of the United States,1867-1960 was written by:

A)Ben Bernanke and Alan Greenspan.
B)Peter Diamond,Dale Mortensen,and Christopher Pissarides.
C)Milton Friedman and Anna Schwartz.
D)Paul Krugman and Greg Mankiw.
E)Christina Romer.

Question 43

The Taylor rule predicted federal funds rate (in the text)was derived from which of the following equations?

A)
B)
C)
D)
E)

Question 44

A recent FOMC statement asserts: "Measures of underlying inflation are currently at levels somewhat below those the Committee judges most consistent,over the longer run,with its mandate to promote ...price stability." Your parents have taken interest in your fascinating Macroeconomics course and ask you to interpret this quote.* You tell them:

A)"The Fed believes that unemployment is recovering quickly."
B)"The Fed is worried about spiking inflation."
C)"The Fed is worried about deflation or inflation that is too low."
D)"The economy has recovered,and it's business as usual."
E)"The Fed is trying to appease stock markets."

Question 45

The Taylor rule expresses the federal funds rate as the weighted average of:

A)the unemployment rate and inflation.
B)inflation and short-run output.
C)the misery index,money growth rate,and the mortgage rate.
D)the CPI and real GDP.
E)long-run output and the natural rate of unemployment.

Question 46

In the aftermath of the financial crisis that began in 2008,the Fed's assets on its balance sheet:

A)grew to $100 billion.
B)shrank to almost zero.
C)grew to over $2 trillion.
D)stayed more or less the same.
E)grew to about $1 trillion.

Question 47

Between approximately 2001 and 2006,the Taylor rule predicted federal funds rate:

A)was greater than the actual federal funds rate.
B)was less than the actual federal funds rate.
C)was statistically equal to the actual federal funds rate.
D)The Taylor rule is used to predict the natural rate of unemployment.
E)was negatively correlated with the federal funds rate.

Question 48

Prior to the recent financial crisis,the bulk of the Fed's assets on its balance sheet were __________ and its liabilities were __________.

A)U.S.Treasury bills;currency
B)loans;Treasury accounts
C)reserves;vault cash
D)stocks;foreign currency
E)currency;reserves

Question 49

The high growth rates of money in the late 2000s is likely due to:

A)the Fed not wanting to repeat mistakes made during the Great Depression.
B)the rise in the overall price level.
C)a rise in inflation expectations.
D)the appointment of a new Fed chairman.
E)prodding from the Bush and Obama administrations.

Question 50

In financial economics models,a stock price is approximately equal to the:

A)corporate value of the company.
B)value of current corporate profits.
C)present discounted value of expected future profits.
D)results of complicated accounting formulae.
E)future value of expected future revenues.

Question 51

The Troubled Asset Relief Program was originally designed to __________ but funds were ultimately used for __________.

A)purchase and insure assets held by financial institutions;purchase equity financial institutions and bail out U.S.automakers
B)nationalize banks;unemployment insurance and financing the wars in Iraq and Afghanistan
C)bail out banks;purchases of "toxic assets"
D)bolster bank stock prices;paying bank executive bonuses
E)prevent takeovers of U.S.banks by foreign nationals;insure assets held by member banks

Question 52

In the aftermath of the financial crisis that began in 2008,the Fed's assets grew primarily as:

A)currency and loans.
B)U.S.Treasury bills.
C)holdings of foreign currency.
D)reserves.
E)loans and "other."

Question 53

When an economy is in a deflationary spiral,and nominal interest rates are close to zero,it may be necessary:

A)for the Fed to print money.
B)to raise taxes.
C)to cut unemployment insurance.
D)to lay off government workers.
E)to conduct contractionary monetary policy.

Question 54

When an economy is in a deflationary spiral,and nominal interest rates are close to zero,it may be necessary:

A)for the Fed to print money.
B)for the Fed to buy financial securities.
C)to use fiscal stimulus.
D)all of the above
E)c and a

Question 55

In the aftermath of the recent financial crisis,the Fed's assets on its balance sheet grew to include which of the following?

A)term auction credit
B)mortgage backed securities
C)bank reserves.
D)a and b
E)Treasury accounts

Question 56

To identify an asset bubble,economists,and analysts,frequently rely on:

A)the price-earnings ratio.
B)the present discounted value of expected profits.
C)the current stock market price growth relative to average stock price growth.
D)a stock's "beta."
E)corporate annual reports.

Question 57

An explanation for the low federal funds rate in 2003 was:

A)a fear of deflation.
B)falling unemployment.
C)rising inflation.
D)the decline of the dollar vis-à-vis the euro.
E)an attempt to boost house sales.

Question 58

Deflation usually arises due to __________.This in turn __________ interest rate,which __________.

A)loose fiscal policy;reduces the market;causes hyperinflation
B)tight monetary policy;pushes up the nominal;always leads to a recession
C)a recession;raises the real;deepens the recession
D)an exchange rate depreciation;lowers the real;makes imports more expensive
E)oil price declines;increases the mortgage;slows housing price growth

Question 59

The rapid growth of money supply,
And
,was due,in part,to the

A)federal government's response to the rise in foreclosures in the United States.
B)private banks hoarding cash because of a rise in the risk premium.
C)Fed's response to deflationary concerns.
D)sale of thousands of mortgages by Fannie Mae and Freddie Mac.
E)purchases of firms of their own stock.

Question 60

__________ reduced loans despite the Fed's attempts to get liquidity flowing in financial markets after 2008.

A)Lessening regulatory control over banks
B)Record real estate foreclosures
C)Commercial banks' reluctant take on more risk
D)Interest payments on bank reserves
E)c and d

Question 61

The event which likely caused the risk premium to jump to about 6 percent in September 2008 was the growing unrest in the Middle East.

Question 62

When a financial institution is deemed too systematically important to go under,it is __________.This leads to __________.

A)a monopoly;above marginal cost pricing
B)too big to fail;moral hazard
C)an "umbrella" bank;less competition
D)a bank holding company;adverse selection
E)an investment bank;nationalization

Question 63

The return to a risk asset can be written as
.

Question 64

In financial markets a "living will" is:

A)a set of instructions of how a bank failure should be carried out.
B)a set of instructions of the order of repaying shareholders.
C)a list of steps that must be taken by all banks in the event of insolvency.
D)how bank bond and shareholders should divide a bank's remaining assets after insolvency.
E)instructions of the succession in the event of a bank president's death.

Question 65

Bailouts of the financial sector:

A)worsen the moral hazard problem.
B)alleviate future fears of financial crisis.
C)make financial institutions weaker.
D)are a step toward the nationalization of banks.
E)increase confidence in the banking system.

Question 66

In standard circumstances a firm __________ when its __________.In financial markets this approach didn't work following the ____.

A)files for bankruptcy;liabilities exceed its assets;collapse of Lehman Brothers
B)sells its assets at fire sale prices;profits are negative;AIG debacle
C)increases its risky holdings;revenues fall;volatility of exchange rates in Japan
D)borrows liquidity from the Fed;its leverage ratio rises above 75;passage of the TARP legislation
E)outsources its labor;net revenues are negative;purchase of Merrill Lynch by the Bank of America

Question 67

Which of the following financial reforms were suggested by the Squam Lake Group?

A)allow banks to choose the amount of risk
B)allow a bank to choose its own regulator
C)enhance capital requirements
D)allow bonuses to be paid out for only short-term investments
E)increase leverage ratios

Question 68

Moral hazard in the banking system can occur because:

A)of high capital requirements.
B)financial regulations ensure banks are prudent.
C)banks rarely make risky bets.
D)of low return on assets.
E)of high leverage ratios.

Question 69

Economists believe that the way that policymakers handled the financial crisis:

A)reduces the probability of another financial crisis.
B)will shrink the number of banks.
C)increases moral hazard.
D)will lead to less risk-taking by banks.
E)bankrupted the federal government.

Question 70

The difference between the three-month bond yield and the six-month bond yield represents a risk premium.

Question 71

By linking bank executive compensation to long-term performance,__________ hopes to __________ in financial markets.

A)Long Term Capital Management;increase the use of complicated financial algorithms
B)the Squam Lake Group;reduce systematic risktaking
C)American Insurance Group;increase the use of collateralized insurance obligations
D)the Fed;increase risk-sharing through the use of collateralized debt obligations
E)Fannnie Mae;reduce subprime loans

Question 72

__________ encourage banks to __________ which __________.

A)Loans;increase lending;lowers market liquidity
B)Increased capital requirements;take more risk;leads to future bank bailouts
C)Increased leverage ratios;take less risk;strengthens the banking industry
D)Lower return on assets;hold more cash;increases the "lemon" problem
E)Bailouts;take more risk;worsens the moral hazard problem

Question 73

Adding the risk premium to the AS/AD model is represented by a downward movement along the AD curve.

Question 74

The risk premium raises the borrowing rate above the nominal federal funds rate.

Question 75

In a paper by Minneapolis Fed bank president Narayana Kocherlakota,he argues that research in macroeconomics is hampered by:

A)too many disagreements by macroeconomists.
B)a fundamental misunderstanding of the macroeconomy.
C)the state of technology.
D)the Lucas critique.
E)models which are too complicated.

Question 76

The American Recovery and Reinvestment Act is an approximately __________ stimulus package.About __________ takes the form of tax cuts and __________ is new government spending on __________.

A)$500 billion;$150 billion;$450 billion;bailing out U.S.automakers and purchases of equity from financial institutions
B)$1 billion;$100 million;$900 million;subsidies to U.S.farmers and energy producers
C)$787 billion;$250 billion;$537 billion;infrastructure and aid to state and local governments
D)$100 billion;$50 billion;$50 billion;the space program
E)$1 trillion;$500 billion;$500 billion;unemployment insurance and financing the wars in Iraq and Afghanistan

Question 77

The Squam Lake Group is a group of:

A)bankers which attempted to centralize bank power within a small number of large commercial banks.
B)government regulators charged with improving banking guidelines.
C)academic economists who warned of the hazards of banking practices in the years leading up to the recent financial crisis.
D)investors who encouraged financial institutions to take on more risk.
E)financial economists who suggested a list of financial reforms.

Question 78

The burst of the housing bubble can be represented in the IS-MP model as a decline in
.

Question 79

According to projections by the Congressional Budget Office,the federal budget deficit will __________ by the end of 2009 from __________ in 2008.

A)grow to 12 percent of GDP;3 percent of GDP
B)equal 92 percent of GDP;120 percent of GDP
C)be -10 percent of GDP;0.2 percent of GDP
D)grow to 120 percent of GDP;-20 percent of debt
E)equal 0;-12 percent of GDP

Question 80

Suppose a bank purchases $100 of an asset.To finance this purchase it uses $99 dollars of borrowed funds and $1 of bank capital.To what does this lead?

A)moral hazard
B)adverse selection
C)Ricardian equivalence
D)the Butterfly effect
E)irrational exuberance