Ch. 19 The Demand for Money

For the classical economists, the quantity theory of money provided an explanation of movements in the price level. Movements in the price level result A) solely from changes in the quantity of money. B) primarily from changes in the quantity of money. C) only partially from changes in the quantity of money. D) from changes in factors other than the quantity of money.

A

In one of the earliest studies on the link between interest rates and money demand using United States data, James Tobin concluded that the demand for money is A) sensitive to interest rates. B) not sensitive to interest rates. C) not sensitive to changes in income. D) not sensitive to changes in bond values.

A

The classical economistsʹ conclusion that nominal income is determined by movements in the money supply rested on their belief that ________ could be treated as ________ in the short run. A) velocity; constant B) velocity; variable C) money; constant D) money; variable

A

The classical economistsʹ contention that prices double when the money supply doubles is predicated on the belief that in the short run velocity is ________ and real GDP is ________. A) constant; constant B) constant; variable C) variable; variable D) variable; constant

A

The speculative motive for holding money is closely tied to what function of money? A) Store of wealth B) Unit of account C) Medium of exchange D) Standard of deferred payment

A

If nominal GDP is $10 trillion, and velocity is 10, the money supply is A) $1 trillion. B) $5 trillion. C) $10 trillion. D) $100 trillion.

A) $1 trillion.

Fisherʹs quantity theory of money suggests that the demand for money is purely a function of ________, and ________ no effect on the demand for money. A) income; interest rates have B) interest rates; income has C) government spending; interest rates have D) expectations; income has

A) income; interest rates have

The equation of exchange states that the quantity of money multiplied by the number of times this money is spent in a given year must equal A) nominal income. B) real income. C) real gross national product. D) velocity.

A) nominal income.

Conventional money demand functions tended to ________ money demand in the middle and late 1970s, and ________ velocity beginning in 1982. A) overpredict; overpredict B) overpredict; underpredict C) underpredict; overpredict D) underpredict; underpredict

A) overpredict; overpredict

The empirical evidence regarding the velocity of money indicates that velocity tends to be ________; that is, velocity ________ when economic activity contracts. A) procyclical; declines B) countercyclical; declines C) countercyclical; increases D) procyclical; increases

A) procyclical; declines

The velocity of money is A) the average number of times that a dollar is spent in buying the total amount of final goods and services. B) the ratio of the money stock to high-powered money. C) the ratio of the money stock to interest rates. D) the average number of times a dollar is spent in buying financial assets.

A) the average number of times that a dollar is spent in buying the total amount of final goods and services.

In the equation of exchange, the concept that provides the link between M and PY is called A) the velocity of money. B) aggregate demand. C) aggregate supply. D) the money multiplier.

A) the velocity of money.

The velocity of money is defined as A) real GDP divided by the money supply. B) nominal GDP divided by the money supply. C) real GDP times the money supply. D) nominal GDP times the money supply.

B) nominal GDP divided by the money supply.

Starting in 1974, the conventional M1 money demand function began to A) severely underpredict the demand for money. B) severely overpredict the demand for money. C) predict more precisely the demand for money. D) do none of the above.

B) severely overpredict the demand for money.

Because the quantity theory of money tells us how much money is held for a given amount of aggregate income, it is also a theory of A) interest-rate determination. B) the demand for money. C) exchange-rate determination. D) the demand for assets.

B) the demand for money.

According to the quantity theory of money demand, A) an increase in interest rates will cause the demand for money to fall. B) a decrease in interest rates will cause the demand for money to increase. C) interest rates have no effect on the demand for money. D) an increase in money will cause the demand for money to fall.

C

Cutting the money supply by one-third is predicted by the quantity theory of money to cause A) a sharp decline in real output of one-third in the short run, and a fall in the price level by one-third in the long run. B) a decline in real output by one-third. C) a decline in output by one-sixth, and a decline in the price level of one-sixth. D) a decline in the price level by one-third.

D

Starting in 1974, the conventional M1 money demand function began to severely ________ the demand for money. Stephen Goldfeld labeled this phenomenon ʺthe case of the missing ________.ʺ A) underpredict; velocity B) overpredict; velocity C) underpredict; money D) overpredict; money

D

The view that velocity is constant in the short run transforms the equation of exchange into the quantity theory of money. According to the quantity theory of money, when the money supply doubles A) velocity falls by 50 percent. B) velocity doubles. C) nominal incomes falls by 50 percent. D) nominal income doubles.

D

If the money supply is $2 trillion and velocity is 5, then nominal GDP is A) $1 trillion. B) $2 trillion. C) $5 trillion. D) $10 trillion.

D) $10 trillion.

Velocity is defined as A) P + M + Y. B) (P × M)/Y. C) (Y × M)/P. D) (P × Y)/M.

D) (P × Y)/M.

The equation of exchange is A) M × P = V × Y. B) M + V = P + Y. C) M + Y = V + P. D) M × V = P ×Y.

D) M × V = P ×Y.

Velocity, over the business cycle, tends to A) rise during economic contractions. B) fall during economic expansions. C) stay constant. D) fall during economic contractions.

D) fall during economic contractions.

The average number of times that a dollar is spent in buying the total amount of final goods and services produced during a given time period is known as A) gross national product. B) the spending multiplier. C) the money multiplier. D) velocity.

D) velocity.

Researchers at the Federal Reserve found that M2 money demand functions performed ________ in the 1980s, with M2 velocity moving ________ with the opportunity cost of holding M2. A) poorly; erratically B) poorly; closely C) well; erratically D) well; closely

D) well; closely

In the Baumol-Tobin model, given that total costs for an individual equals bT0 + iC , where T0 C2 = monthly income, b = brokerage costs, and C = amount raised from each bond transaction, derive the so-called square root rule.

An individual will minimize their costs. Thus, the optimal level of C is found as follows: COSTS = bT0 + iC C2 dCOSTS = -bT0 + i = 0 dC C2 2 Md= 1 2bT0 = bT0 2 i 2i The last expression is the square root rule.

Evidence since 1915 indicates that velocity has A) grown at a fairly constant rate, even in the short run. B) fluctuated too much in the short run to be viewed as a constant. C) trended downward since 1950 due to technological and financial innovations. D) remained fairly constant in the short run, but tends to slowly increase.

B

If people expect nominal interest rates to be lower in the future, the expected return to bonds ________, and the demand for money ________. A) increases; increases B) increases; decreases C) decreases; increases D) decreases; decreases

B

If there are economies of scale in the transactions demand for money, as income increases, money demand A) increases proportionately. B) increases less than proportionately. C) increases more than proportionately. D) does not change.

B

In the late 1990s, M2 velocity ________, suggesting a ________ normal relationship between M2 and macroeconomic variables. A) stabilized; less B) stabilized; more C) slowed; less D) slowed; more

B

The demand for money as a cushion against unexpected contingencies is called the A) transactions motive. B) precautionary motive. C) insurance motive. D) speculative motive.

B

Until the Great Depression, economists did not recognize that velocity A) increases during severe economic contractions. B) declines during severe economic contractions. C) declines during rapid economic expansions, since money growth fails to keep pace. D) fails to decline during economic contractions.

B

Comparing Tobinʹs model of the speculative demand for money with Keynesian speculative demand A) both models imply that individuals hold only money or only bonds. B) the Keynesian model implies individuals diversify their asset holdings, while the Tobin model predicts that individuals hold only money or only bonds. C) the Tobin model implies individuals diversify their asset holdings, while the Keynesian model predicts that individuals hold only money or only bonds. D) both models imply that individuals diversify their asset holdings.

C

If initially the money supply is $2 trillion, velocity is 5, the price level is 2, and real GDP is $5 trillion, a fall in the money supply to $1 trillion A) reduces real GDP to $2.5 trillion. B) causes velocity to rise to 10. C) decreases the price level to 1. D) decreases the price level to 1 and decreases velocity to 2.5.

C

If people expect nominal interest rates to be higher in the future, the expected return to bonds ________, and the demand for money ________. A) rises; increases B) rises; decreases C) falls; increases D) falls; decreases

C

In the 20th century, velocity has A) been quite stable over periods as long as a decade. B) grown at a constant rate. C) been quite volatile. D) been quite stable over short, two year periods.

C

The Keynesian theory of money demand emphasizes the importance of A) a constant velocity. B) irrational behavior on the part of some economic agents. C) interest rates on the demand for money. D) expectations.

C

The classical economists believed that if the quantity of money doubled, A) output would double. B) prices would fall. C) prices would double. D) prices would remain constant.

C

The reason that economists are so interested in the stability of velocity is because if the demand for money is not stable, then steady growth of the money supply A) is going to promote price stability at the expense of low unemployment. B) is going to promote low unemployment at the expense of price stability. C) is an ineffective way to conduct monetary policy. D) can still be used to conduct monetary policy if the goal is price stability.

C

If the money supply is $600 and nominal income is $3,000, the velocity of money is A) 1/50. B) 1/5. C) 5. D) 50.

C) 5.

If the money supply is $500 and nominal income is $3,000, the velocity of money is A) 1/60. B) 1/6. C) 6. D) 60.

C) 6.

If the money supply is $500 and nominal income is $4,000, the velocity of money is A) 1/20. B) 1/8. C) 8. D) 20.

C) 8.

If initially the money supply is $1 trillion, velocity is 5, the price level is 1, and real GDP is $5 trillion, an increase in the money supply to $2 trillion A) increases real GDP to $10 trillion. B) causes velocity to fall to 2.5. C) increases the price level to 2. D) increases the price level to 2 and velocity to 10.

C) increases the price level to 2.

Because interest rates have substantial fluctuations, the ________ theory of the demand for money indicates that velocity has substantial fluctuations as well. A) classical B) Cambridge C) liquidity preference D) Pigouvian

C) liquidity preference

In the early 1990s, M2 growth underwent a dramatic ________, which some researchers believe ________ be explained by traditional money demand functions. A) surge; cannot B) surge; can C) slowdown; cannot D) slowdown; can

C) slowdown; cannot

Irving Fisher took the view that the institutional features of the economy which affect velocity change ________ over time so that velocity will be fairly ________ in the short run. A) rapidly; erratic B) rapidly; stable C) slowly; stable D) slowly; erratic

C) slowly; stable

In Irving Fisherʹs quantity theory of money, velocity was determined by A) interest rates. B) real GDP. C) the institutions in an economy that affect individualsʹ transactions. D) the price level.

C) the institutions in an economy that affect individualsʹ transactions.

The quantity theory of money is a theory of how A) the money supply is determined. B) interest rates are determined. C) the nominal value of aggregate income is determined. D) the real value of aggregate income is determined.

C) the nominal value of aggregate income is determined.

Describe what the liquidity trap is. Explain how it can be problematic for monetary policymakers.

The liquidity trap describes the situation in which the demand for money is insensitive to changes in interest rates (i.e., the money demand curve is infinitely elastic). In this case, monetary policy has no direct affect on aggregate spending because a change in the money supply will not affect interest rates.