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

Question 1

When a financial friction is added to the short-run model it:

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

Answer 1

shifts the MP curve up.

Question 2

Refer to the following figure when answering the following questions.
Figure 14.2: IS-MP Curve
Consider Figure 14.2. 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

Answer 2

d; c

Question 3

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

A) decline in .
B) rise in .
C) decline in inflation.
D) increase in .
E) rise in .

Answer 3

decline in .

Question 4

The financial friction:

A) is equal to zero when the economy is in its long-run equilibrium.
B) is negative in Japan.
C) lowers the borrowing rate below the nominal federal funds rate.
D) is equal to the rate of inflation.
E) is lower in uncertain economic situations.

Question 5

Adding a financial friction to the short-run model:

A) shifts the MP curve down.
B) shifts the AD curve down.
C) shifts the IS curve up.
D) All of these answers are correct.
E) None of these answers is correct.

Question 6

Refer to the following figure when answering the following questions.
Figure 14.2: IS-MP Curve
Consider Figure 14.2. Starting from the long-run equilibrium, the burst of the housing bubble and the appropriate Fed response, with a large, positive financial friction, 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 7

Figure 14.1: BAA and 10-Year Bonds, 2006-2010

-Consider Figure 14.1. The difference between these two curves can be interpreted as:

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

Question 8

Refer to the following figure when answering the following questions.
Figure 14.2: IS-MP Curve
Consider Figure 14.2. Starting from the long-run equilibrium, the burst of the housing bubble and the appropriate Fed response, WITHOUT a financial friction, 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 9

When a financial friction is added to the MP curve we have:

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

Question 10

Which of the following represents the AD curve with a financial friction?

A)
B)
C)
D)
E)

Question 11

The financial friction is the:

A) difference between the federal funds rate and interest rates 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 12

Figure 14.1: BAA and 10-Year Bonds, 2006-2010

-In Figure 14.1 above, the financial friction in late 2008 was about ________ percent.

A) 9.5
B) 11
C) 6
D) -7
E) Not enough information is given.

Question 13

Figure 14.1: BAA and 10-Year Bonds, 2006-2010

-Consider Figure 14.1. What event likely caused the financial friction 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 is given.

Question 14

Figure 14.1: BAA and 10-Year Bonds, 2006-2010

-In Figure 14.1 above, the 10-year bond yield is considered ________, while the BAA bond yield represents ________.

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

Question 15

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

A) 1
B) 5
C) 0
D) -1
E) 3

Question 16

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

Question 17

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

A)
B)
C)
D)
E)

Question 18

The quote "When banking stops, credit stops, and when credit stops, trade stops, and when trade stops-well, the city of Chicago had only eight days of chlorine on hand for its water supply. . . . The entire modern world is premised on the ability to buy now and pay later" is credited to:

A) Henry Paulson.
B) Michael Lewis.
C) Fed chairman Ben Bernanke.
D) Frank Partnoy.
E) the Wall Street Journal.

Question 19

What did the Fed chairman tell a congressional panel in late September 2008?

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 20

When we add the financial friction 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 21

When there is deflation:

A) the central bank cannot push the real interest rate to zero.
B) it has no effect on the output gap.
C) it has no effect on the unemployment rate.
D) there is a decline in real money.
E) nominal interest rates are negative.

Question 22

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

A) financial friction 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 23

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 the money supply.

Question 24

When inflation is negative it:

A) raises the demand for investment.
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 25

The effects of deflation mimic the analysis of:

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

Question 26

The effect of the subprime loan crisis pushed the ________. In Figure 14.3, this is shown as a movement from point ________ to point ________.

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

Question 27

Refer to the following figure when answering the following questions.
Figure 14.3: AS/AD Model

Consider Figure 14.4. Throughout the first three-fourths or so of 2009 the:

A) real interest rate on 10-year bonds was lower than the nominal interest rate.
B) 10-year-bonds' nominal interest rate was higher than the real interest rate.
C) inflation rate was negative.
D) real interest rate was negative.
E) inflation rate was higher than the nominal interest rate.

Question 28

Refer to the following figure when answering the following questions.
Figure 14.3: AS/AD Model
Consider Figure 14.3. If the economy begins in its long-run equilibrium and there is a decrease in the economy's financial friction, the economy would move from point ________ to point ________.

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

Question 29

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 30

Refer to the following figure when answering the following questions.
Figure 14.3: AS/AD Model
Consider Figure 14.3. If the economy begins in its long-run equilibrium and there is an increase in the economy's financial friction, the economy would move from point ________ to point ________.

A) c; d
B) a; d
C) b; c
D) d; a
E) Neither curve would shift.

Question 31

Refer to the following figure when answering the following questions.
Figure 14.3: AS/AD Model

Consider Figure 14.3. Between 2006 and 2007 the:

A) real interest rate was negative.
B) 10-year-bonds' nominal interest rate was lower than inflation.
C) real interest rate was higher than the nominal interest rate.
D) real interest rate was positive.
E) None of these answers is correct.

Question 32

In the IS/MP framework, when the Fed ________ the federal funds rate in the aftermath of the decline in housing prices, the financial friction 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"; disinflation
E) lowered; decrease; deeper recession

Question 33

In the AS/AD framework, the financial friction appears as a:

A) negative demand shock.
B) negative supply shock.
C) change in the long-run real interest rate.
D) positive supply shock.
E) The financial friction is only present in the IS/MP model.

Question 34

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

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

Question 35

Refer to the following figure when answering the following questions.
Figure 14.3: AS/AD Model

Consider Figure 14.3. For most of 2008 the:

A) real interest rate was negative.
B) 10-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) None of these answers is correct.

Question 36

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; financial friction; increase
D) manipulated; Fisher effect; increase
E) raised; unemployment rate; fall

Question 37

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 38

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 39

The Fisher equation is given by:

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

Question 40

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 41

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 42

P/E ratio stands for ________ ratio.

A) price-earnings
B) price-expenditure
C) stock index-GDP
D) home price-easing
E) physical education

Question 43

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) mortgage-backed securities and "other."

Question 44

________ 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' reluctance to take on more risk
D) Higher federal funds rates
E) Low real interest rates

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, the 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

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

A)
B)
C)
D)
E)

Question 47

The rapid growth of money supply, M1 and M2, between 2001 and 2006 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 financial friction.
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 48

The average P/E ratio over the past century or so has been about ________, but in 2000 it reached approximately ________.

A) 16; 10
B) 40; 12
C) 1; 4
D) 16; 43
E) 20; 100

Question 49

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 50

The March 20, 2013, Federal Open Market Committee statement asserts: "To support continued progress toward maximum employment and price stability, the Committee expects that a highly accommodative stance of monetary policy will remain appropriate for a considerable time . . . at least as long as the unemployment rate remains above 6-1/2 percent . . . and longer-term inflation expectations continue to be well anchored." (http://www.federalreserve.gov/newsevents/press/monetary/20130320a.htm)
Your parents have taken interest in your fascinating Macroeconomics course and ask you to interpret this quote. Which of the following do you tell them?

A) "The Fed believes that labor markets are recovering quickly."
B) "The Fed is worried about deflation."
C) "The Fed is not worried about inflation but is concerned about the real economy."
D) "The economy has recovered, and it is business as usual."
E) "The Fed is trying to appease labor unions."

Question 51

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 52

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

A) greater than the actual federal funds rate.
B) less than the actual federal funds rate.
C) statistically equal to the actual federal funds rate.
D) negatively correlated with the federal funds rate.
E) None of these answers is correct; the Taylor rule is used to predict the natural rate of unemployment.

Question 53

When the Fed buys assets other than short-term government bonds it is called:

A) the inflation tax.
B) fiscal policy.
C) term auction credit.
D) quantitative easing.
E) seignorage.

Question 54

In the aftermath of the financial crisis that began in 2008, the Fed's assets and liabilities 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 55

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 56

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

A) the Fed's concern about deflation.
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 57

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 58

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 59

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) liabilities
E) Treasury accounts

Question 60

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 these answers are correct.
E) None of these answers is correct.

Question 61

The Squam Lake Group is a group of:

A) bankers who 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 62

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 that are too complicated.

Question 63

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

Question 64

A constraint to complicated macroeconomic models has been:

A) that firms do not maximize profits.
B) that agents are not rational.
C) that economists have run out of ideas.
D) a lack of computing power.
E) an insufficient understanding of statistics.

Question 65

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 risk-taking
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) Fannie Mae; reduce subprime loans

Question 66

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) a set of instructions regarding succession in the event of a bank president's death.

Question 67

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 68

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 69

________ 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 returns on assets; hold more cash; increases the "lemon" problem
E) Bailouts; take more risk; worsens the moral hazard problem

Question 70

In standard circumstances a firm ________ when its ________. In financial markets this approach did not 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; 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 71

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 72

The American Recovery and Reinvestment Act is an approximately ________ stimulus package. About ________ takes the form of tax cuts and ________ is from 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 73

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 74

The federal budget deficit ________ in 2009 from ________ percent of GDP in 2008.

A) rose to 10 percent of GDP; 3
B) fell to 92 percent of GDP; 120
C) fell to -10 percent of GDP; 0.2
D) rose to 120 percent of GDP;-20
E) rose 0 percent; -12

Question 75

By 2016 (and in the aftermath of the financial crisis), the output gap is:

A) still negative.
B) equal to zero.
C) positive, but small.
D) equal to about 5 percent.
E) Not enough information is given.

Question 76

The Troubled Asset Relief Program was originally designed to ________, but funds were ultimately used ________.

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

Question 77

The Fed's balance sheet normally consists of:

A) reserves and term auction credit.
B) central bank liquidity swaps.
C) reserves and short-term bonds.
D) long-term bonds and mortgage-backed securities.
E) mortgages and cash.

Question 78

According to the secular stagnation explanation, the two "culprits" for why Western economies have not had strong recoveries in the aftermath of the financial crisis are:

A) low TFP and high labor costs.
B) political weakness and austerity policies.
C) a global savings glut and reluctance to invest.
D) negative real interest rates and a depreciating U.S. dollar.
E) low inflation and high unemployment.

Question 79

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 80

The European debt crisis hit all of the following countries very hard EXCEPT:

A) Greece.
B) Spain.
C) Ireland.
D) Italy.
E) Germany.