Chapter 16 (17)
Fluctuations in the demand for reserves cause the Fed to lose control over a monetary aggregate if the Fed targets A) a monetary aggregate. B) the monetary base. C) an interest rate. D) nominal GDP.
C
A central bank has ________ chance to identify a credit-driven bubble compared to an irrational exuberance bubble. A) a greater B) less of a C) about the same level of a D) a greater, less or about the same level of a
A
A central feature of monetary policy strategies in all countries is the use of a nominal variable that monetary policymakers use as an intermediate target to achieve an ultimate goal such as price stability. Such a variable is called a nominal A) anchor. B) benchmark. C) tether. D) guideline.
A
A nominal variable, such as the inflation rate or the money supply, which ties down the price level to achieve price stability is called ________ anchor.
A
According to the Taylor Principle, when the inflation rate rises, the nominal interest rate should be ________ by ________ than the inflation rate increase. A) increased; more B) increased; less C) decreased; more D) decreased; less
A
After Ben Bernanke became chair of the Fed in 2006, he A) increased Fed transparency. B) abandoned inflation targeting. C) used "just do it" policy. D) increased the opacity of the policymaking.
A
Compared to the United States, Japan's experience with monetary targeting during the 1978-1987 period performed A) better with regard to the inflation rate and output fluctuations. B) worse with regard to the inflation rate and output fluctuations. C) better with regard to the inflation rate, but worse with regard to output fluctuations. D) worse with regard to the inflation rate, but better with regard to output fluctuations.
A
Economists believe that countries recently suffering hyperinflation have experienced A) reduced growth. B) increased growth. C) reduced prices. D) lower interest rates.
A
Estimates from large macroeconometric models of the U.S. economy suggests that it takes over ________ for monetary policy to affect output and over ________ for monetary policy to affect the inflation rate. A) 1 year; 2 years B) 2 years; 1 year C) 1 year; 6 months D) 6 months; 1 year
A
Even if the Fed could completely control the money supply, monetary policy would have critics because A) the Fed is asked to achieve many goals, some of which are incompatible with others. B) the Fed's goals do not include high employment, making labor unions a critic of the Fed. C) the Fed's primary goal is exchange rate stability, causing it to ignore domestic economic conditions. D) it is required to keep Treasury security prices high.
A
Having interest rate stability A) allows for less uncertainty about future planning. B) leads to demands to curtail the Fed's power. C) guarantees full employment. D) leads to problems in financial markets.
A
High inflation can spiral out of control when A) expected inflation increases nominal interest rates, causing the Fed to buy bonds, increasing the money supply and further increasing inflation. B) expected inflation decreases nominal interest rates, causing the Fed to buy bonds, increasing the money supply and further increasing inflation. C) expected inflation increases nominal interest rates, causing the Fed to sell bonds, increasing the money supply and further increasing inflation. D) expected inflation decreases nominal interest rates, causing the Fed to sell bonds, increasing the money supply and further increasing inflation.
A
High unemployment is undesirable because it A) results in a loss of output. B) always increases inflation. C) always increases interest rates. D) reduces idle resources.
A
If the central bank pursues a monetary policy that is more expansionary than what firms and people expect, then the central bank must be trying to A) boost output in the short run. B) constrain output in the short run. C) constrain prices. D) boost prices in the short run.
A
If the central bank targets a monetary aggregate, it is likely to lose control over the interest rate because A) of fluctuations in the demand for reserves. B) of fluctuations in the consumption function. C) bond values will tend to remain stable. D) of fluctuations in the business cycle.
A
In its earliest years, the Federal Reserve's guiding principle for the conduct of monetary policy was known as the A) real bills doctrine. B) liberal liquidity doctrine. C) free reserves doctrine. D) quantity theory of money.
A
In pursuing a strategy of monetary targeting, the central bank announces that it will achieve a certain value (the target) of the annual growth rate of a ________. A) a monetary aggregate B) a reserve aggregate C) the monetary base D) GDP
A
In the FOMC's "Statement on Long-Run Goals and Monetary Policy Strategy,"the FOMC agreed to a single numerical value of the inflation objective, 2% on the ________. A) PCE deflator B) GDP deflator C) CPI D) PPI
A
Suppose it takes roughly two years for monetary policy to have a significant impact on inflation. If inflation is currently low but policymakers believe inflation will rise over the next two years with an unchanged stance of monetary policy, when should they tighten monetary policy to prevent the inflationary surge? A) now B) wait until overt signs of inflation appear C) next year D) two years later
A
The European Central Bank (ECB) pursues a hybrid monetary policy strategy that has elements in common with the ________-targeting strategy previously used by the Bundesbank but also includes some elements of ________ targeting. A) monetary; inflation B) inflation; monetary C) monetary; exchange rate D) monetary; nominal GDP
A
The FOMC "Statement on Long-Run Goals and Monetary Policy Strategy"made it clear that the Federal Reserve would be pursuing ________, consistent with its dual mandate. A) a flexible form of inflation targeting B) a strict form of inflation targeting C) a zero inflation targeting D) an implicit inflation targeting
A
The FOMC finally moved to ________ on January 25, 2012, when it issued its "Statement on Long-Run Goals and Monetary Policy Strategy." A) inflation targeting B) zero inflation policy C) "just do it" policy D) monetary targeting
A
The Fed accidentally discovered open market operations in the early A) 1920s. B) 1910s. C) 1900s. D) 1890s.
A
The Fed's mistakes of the early 1930s were compounded by its decision to A) raise reserve requirements in 1936-1937. B) lower reserve requirements in 1936-1937. C) raise the monetary base in 1936-1937. D) lower the monetary base in 1936-1937.
A
The Fed-Treasury Accord of March 1951 provided the Fed greater freedom to A) let interest rates increase. B) let unemployment increase. C) let inflation accelerate. D) let exchange rates increase.
A
The primary goal of the European Central Bank is A) price stability. B) exchange rate stability. C) interest rate stability. D) high employment.
A
The real bills doctrine was the guiding principle for the conduct of monetary policy during the A) 1910s. B) 1940s. C) 1950s. D) 1960s.
A
The time-inconsistency problem with monetary policy tells us that, if policymakers use discretionary policy, there is a higher probability that the ________ will be higher, compared to policy makers following a behavior rule. A) inflation rate B) unemployment rate C) interest rate D) foreign exchange rate
A
Under Alan Greenspan and Ben Bernanke, the Federal Reserve was successful in pursuing a ________ policy. A) preemptive B) inflation targeting C) exchange rate targeting D) monetary targeting
A
When asset prices increase above their fundamental values it is called an A) asset-price bubble. B) irrational bubble. C) asset-price spike. D) irrational spike.
A
Which of the following is a disadvantage to monetary targeting? A) It relies on a stable money-inflation relationship. B) There is a delayed signal about the achievement of a target. C) It implies larger output fluctuations. D) It implies a lack of transparency.
A
Which of the following is a potential operating instrument for the central bank? A) the monetary base B) the M1 money supply C) nominal GDP D) the discount rate
A
Which of the following is an advantage to money targeting? A) There is an immediate signal on the achievement of the target. B) It does not rely on a stable money-inflation relationship. C) It implies lack of transparency. D) It implies smaller output fluctuations.
A
The Federal Reserve System was created to A) make it easier to finance budget deficits. B) promote financial market stability. C) lower the unemployment rate. D) promote rapid economic growth.
B
________ bubble is driven entirely by unrealistic optimistic expectations. A) An irrational exuberance B) A credit-driven C) A stock D) A debt-driven
A
Although the Fed professed employment of a monetary aggregate targeting strategy during the 1970s, its behavior suggests that it emphasized A) free-reserve targeting. B) interest-rate targeting. C) a real-bills doctrine. D) price-index targeting.
B
During World War II, whenever interest rates would ________ and the price of bonds would begin to ________, the Fed would make open market purchases. A) rise; rise B) rise; fall C) fall; rise D) fall; fall
B
During the years 1979 to 1982, the Federal Reserve's announced policy was monetary targeting. During this time period the Federal Reserve A) hit all of their monetary targets. B) did not hit any of their monetary targets because it is believed that controlling the money supply was not the intent of the Federal Reserve. C) did not hit any of their monetary targets because they were unrealistic. D) hit about half of their monetary targets.
B
Foreign exchange rate stability is important because a decline in the value of the domestic currency will ________ the inflation rate, and an increase in the value of the domestic currency makes domestic industries ________ competitive with competing foreign industries. A) increase; more B) increase; less C) decrease; more D) decrease; less
B
If the Fed pursues a strategy of targeting an interest rate when fluctuations in money demand are prevalent A) fluctuations of nonborrowed reserves will be small. B) fluctuations of nonborrowed reserves will be large. C) the Fed will probably quickly abandon this policy, as it did in the 1960s. D) the Fed will probably quickly abandon this policy, as it did in the 1950s.
B
In practice, the Fed's policy of targeting money market conditions in the 1960s proved to be A) countercyclical, helping to stabilize the economy. B) procyclical, destabilizing the economy. C) procyclical, helping to stabilize the economy. D) countercyclical, destabilizing the economy.
B
Inflation targets can increase the central bank's flexibility in responding to declines in aggregate spending. Declines in aggregate ________ that cause the inflation rate to fall below the floor of the target range will automatically stimulate the central bank to ________ monetary policy without fearing that this action will trigger a rise in inflation expectations. A) demand: tighten B) demand; loosen C) supply; tighten D) supply; loosen
B
Real interest rates are difficult to measure because A) data on them are not available in a timely manner. B) real interest rates depend on the hard-to-determine expected inflation rate. C) they fluctuate too often to be accurate. D) they cannot be controlled by the Fed.
B
Suppose interest rates are kept very low for a long time such that there is a spike in the amount of lending. Everything else held constant, this could cause ________ bubble. A) an irrational exuberance B) a credit-driven C) a stock D) a debt-driven
B
The Fed accidentally discovered open market operations when A) it came to the rescue of failing banks in the early 1930s, and found that its purchases of bank loans injected reserves into the banking system. B) it purchased securities for income following the 1920-1921 recession. C) it attempted to slow inflation in 1919 by selling securities and found that its sales drained reserves from the banking system. D) it reinterpreted a key provision of the Federal Reserve Act.
B
The ________ problem of discretionary policy arises because economic behavior is influenced by what firms and people expect the monetary authorities to do in the future. A) moral hazard B) time-inconsistency C) nominal-anchor D) rational-expectation
B
The mandate for the monetary policy goals that has been given to the Federal Reserve System is an example of a ________ mandate. A) primary B) dual C) secondary D) hierarchical
B
The mandate for the monetary policy goals that has been given to the Federal Reserve System is an example of a ________ mandate. A) primary B) dual C) secondary D) hierarchical Answer: B
B
The monetary policy strategy that relies on a stable money-income relationship is A) exchange-rate targeting. B) monetary targeting. C) inflation targeting. D) the implicit nominal anchor.
B
The rate of inflation tends to remain constant when A) the unemployment rate is above the NAIRU. B) the unemployment rate equals the NAIRU. C) the unemployment rate is below the NAIRU. D) the unemployment rate increases faster than the NAIRU increases.
B
The type of monetary policy that is used in Canada, New Zealand, and the United Kingdom is A) monetary targeting. B) inflation targeting. C) targeting with an implicit nominal anchor. D) interest-rate targeting.
B
Unemployment resulting from a mismatch of workers' skills and job requirements is called A) frictional unemployment. B) structural unemployment. C) seasonal unemployment. D) cyclical unemployment.
B
Using Taylor's rule, when the equilibrium real federal funds rate is 2 percent, there is no output gap, the actual inflation rate is zero, and the target inflation rate is 2 percent, the nominal federal funds rate should be A) 0 percent. B) 1 percent. C) 2 percent. D) 3 percent.
B
When workers voluntarily leave work while they look for better jobs, the resulting unemployment is called A) structural unemployment. B) frictional unemployment. C) cyclical unemployment. D) underemployment.
B
Which of the following criteria need NOT be satisfied for choosing a policy instrument? A) The variable must be measurable. B) The variable must be controllable. C) The variable must be predictable. D) The variable must be transportable.
B
A credit-driven bubble arises when ________ in lending causes ________ in asset prices which can cause ________ in lending. A) a decrease; a decrease; an increase B) a decrease; an increase; an increase C) an increase; an increase; a further increase D) a decrease; a decrease; a further decrease
C
A nominal anchor promotes price stability by A) outlawing inflation. B) stabilizing interest rates. C) keeping inflation expectations low. D) keeping economic growth low.
C
According to the Taylor rule, the Fed should raise the federal funds interest rate when inflation ________ the Fed's inflation target or when real GDP ________ the Fed's output target. A) rises above; drops below B) drops below; drops below C) rises above; rises above D) drops below; rises above
C
Due to the lack of timely data for the price level and economic growth, the Fed's strategy A) targets the exchange rate, since the Fed can control this variable. B) targets the price of gold, since it is closely related to economic activity. C) uses an intermediate target, such as an interest rate. D) stabilizes the consumer price index, since the Fed can control the CPI.
C
During World War II, the Fed in effect relinquished its control of monetary policy through its policy of A) continually lowering reserve requirements. B) continually raising reserve requirements. C) pegging interest rates. D) targeting free reserves.
C
During World War II, whenever interest rates would rise and the price of bonds would begin to fall, the Fed would A) lower reserve requirements. B) raise reserve requirements. C) make open market purchases of government securities. D) make open market sales of government securities.
C
Everything else held constant, a credit-drive bubble is generally considered to have the potential to cause ________ damage to an economy compared to an irrational exuberance bubble. A) less B) about the same amount of C) more D) either more, less, or the same amount of
C
In both New Zealand and Canada, what has happened to the unemployment rate since the countries adopted inflation targeting? A) The unemployment rate increased sharply. B) The unemployment rate remained constant. C) The unemployment rate has declined substantially after a sharp increase. D) The unemployment rate declined sharply immediately after the inflation targets were adopted.
C
Monetary policy is considered time-inconsistent because A) of the lag times associated with the implementation of monetary policy and its effect on the economy. B) policymakers are tempted to pursue discretionary policy that is more contractionary in the short run. C) policymakers are tempted to pursue discretionary policy that is more expansionary in the short run. D) of the lag times associated with the recognition of a potential economic problem and the implementation of monetary policy.
C
One of the factors that contributed to the success German policymakers had using a monetary targeting type policy starting in the mid-1970s and continuing through the next two decades was that A) they used a rigid target for the money growth rate. B) they implemented policy so their inflation rate goal was met in the short run. C) the money target was flexible to allow the Bundesbank to concentrate on other goals as needed. D) they rarely communicated the intentions of policy to the public in order to keep the public from panicking.
C
The Fed was committed to keeping interest rates low to assist Treasury financing of budget deficits A) only during World War I. B) during the Great Depression. C) during World War I and World War II. D) throughout the entire existence of the Fed.
C
The first country to adopt inflation targeting was A) the United Kingdom. B) Canada. C) New Zealand. D) Australia.
C
The goal for high employment should be a level of unemployment at which the demand for labor equals the supply of labor. Economists call this level of unemployment the A) frictional level of unemployment. B) structural level of unemployment. C) natural rate level of unemployment. D) Keynesian rate level of unemployment.
C
The rate of inflation increases when A) the unemployment rate equals the NAIRU. B) the unemployment rate exceeds the NAIRU. C) the unemployment rate is less than the NAIRU. D) the unemployment rate increases faster than the NAIRU increases.
C
The theory that monetary policy conducted on a discretionary, day-by-day basis leads to poor long-run outcomes is referred to as the A) adverse selection problem. B) moral hazard problem. C) time-inconsistency problem. D) nominal-anchor problem.
C
The time-inconsistency problem in monetary policy can occur when the central bank conducts policy A) using a nominal anchor. B) using a strict and inflexible rule. C) on a discretionary, day-by-day basis. D) using a flexible, discretionary rule.
C
The type of monetary policy regime that the Federal Reserve has followed From the 1980s up until the time Ben Bernanke became chair of the Federal Reserve in 2006 can best be described as A) monetary targeting. B) inflation targeting. C) policy with an implicit nominal anchor. D) exchange-rate targeting.
C
Which of the following is NOT a requirement in selecting a policy instrument? A) measurability B) controllability C) flexibility D) predictability
C
Which of the following is not an advantage of inflation targeting? A) reduction of the time-inconsistency problem B) increased monetary policy transparency C) There is an immediate signal on the achievement of the target. D) consistency with democratic principles
C
Which of the following is not an element of inflation targeting? A) a public announcement of medium-term numerical targets for inflation B) an institutional commitment to price stability as the primary long-run goal C) an information-inclusive approach in which only monetary aggregates are used in making decisions about monetary policy D) increased accountability of the central bank for attaining its inflation objectives
C
Which set of goals can, at times, conflict in the short run? A) high employment and economic growth B) interest rate stability and financial market stability C) high employment and price level stability D) exchange rate stability and financial market stability
C
Explain and demonstrate graphically how targeting the federal funds rate can result in fluctuations in nonborrowed reserves. Answer: See figure below. With a federal funds rate target, fluctuations in demand for reserves require similar changes in the nonborrowed reserves to keep the federal funds rate constant.
Check graph folder
During the 1950s, the Fed targeted A) M1. B) M2. C) the monetary base. D) money market conditions.
D
If the Taylor Principle is not followed and nominal interest rates are increased by less than the increase in the inflation rate, then real interest rates will ________ and monetary policy will be too ________. A) rise; tight B) rise; loose C) fall; tight D) fall; loose
D
If the relationship between the monetary aggregate and the goal variable is weak, then A) monetary aggregate targeting is superior to exchange-rate targeting. B) monetary aggregate targeting is superior to inflation targeting. C) inflation targeting is superior to exchange-rate targeting. D) monetary aggregate targeting will not work.
D
Inflation results in A) ease of planning for the future. B) ease of comparing prices over time. C) lower nominal interest rates. D) difficulty interpreting relative price movements.
D
Supply-side economic policies seek to A) raise interest rates through contractionary monetary policy. B) increase federal government expenditures. C) increase consumption expenditures by increasing taxes. D) increase saving and investment using tax incentives.
D
Targeting interest rates can be procyclical because A) an increase in income increases interest rates, causing the Fed to buy bonds, increasing the monetary base and money supply, leading to further increases in income. B) an increase in interest rates increases income, causing the Fed to buy bonds, increasing the monetary base and money supply, leading to further increases in income. C) an increase in the monetary base increases the money supply, causing the Fed to buy bonds, increasing the monetary base and money supply, leading to further increases in income. D) an increase in income increases the monetary base and money supply, causing the Fed to buy bonds to increase interest rates and income.
D
The decision by inflation targeters to choose inflation targets ________ zero reflects the concern of monetary policymakers that particularly ________ inflation can have substantial negative effects on real economic activity. A) below; high B) below; low C) above; high D) above; low
D
The guiding principle for the conduct of monetary policy that held that as long as loans were being made for "productive" purposes, then providing reserves to the banking system to make these loans would not be inflationary became known as the A) free reserves doctrine. B) Benjamin Strong doctrine. C) efficient liquidity doctrine. D) real bills doctrine.
D
The mandate for the monetary policy goals that has been given to the European Central Bank is an example of a ________ mandate. A) primary B) dual C) secondary D) hierarchical
D
The most common definition that monetary policymakers use for price stability is A) low and stable deflation. B) an inflation rate of zero percent. C) high and stable inflation. D) low and stable inflation.
D
The problems of raising the level of the inflation target include A) if the zero-lower-bound problem is rare, then the benefits of a higher inflation target are not very large. B) the costs of higher inflation in terms of the distortions it produces in the economy are high. C) it is more difficult to stabilize the inflation rate at a higher targeting level. D) all of the above.
D
Using Taylor's rule, when the equilibrium real federal funds rate is 3 percent, the positive output gap is 2 percent, the target inflation rate is 1 percent, and the actual inflation rate is 2 percent, the nominal federal funds rate target should be A) 5 percent. B) 5.5 percent. C) 6 percent. D) 6.5 percent.
D
When it comes to choosing an policy instrument, both the ________ rate and ________ aggregates are measured accurately and are available daily with almost no delay. A) three-month T-bill; monetary B) three-month T-bill; reserve C) federal funds; monetary D) federal funds; reserve
D
Which of the following is NOT an argument against using monetary policy to prick asset-price bubbles? A) The effect of increasing interest rates on asset prices is uncertain. B) A bubble may only exist in some asset-prices and monetary policy will affect all asset prices. C) Using monetary policy to prick an asset-price bubble may have adverse effect on the aggregate economy. D) Even though credit-drive bubbles are easier to identify, they are still relatively hard to identify.
D
Which of the following is NOT an operating instrument? A) nonborrowed reserves B) monetary base C) federal funds interest rate D) discount rate
D
Which of the following is not a disadvantage of of the Fed's "just do it" approach to monetary policy? A) There is low transparency of policy. B) There is low accountability for central bankers. C) This type of policy make the Fed more susceptible to the time-inconsistency problem. D) It relies on a stable money-inflation relationship.
D
Which of the following is not a disadvantage to inflation targeting? A) There is a delayed signal about achievement of the target. B) Inflation targets could impose a rigid rule on policymakers. C) There is potential for larger output fluctuations. D) There is a lack of transparency.
D
Lessons that economists and policy makers have learned from the recent global financial crisis include A) Developments in the financial sector have a far greater impact on economic activity than was earlier realized. B) The zero lower bound on interest rates can be a serious problem. C) The cost of cleaning up after a financial crisis is very high. D) Price and output stability do not ensure financial stability. E) All of the above.
E
The "Greenspan doctrine"—central banks should not try to prick bubbles—was based on which of the following arguments? A) Asset-price bubbles are nearly impossible to identify. B) Monetary actions would be likely to affect asset prices in general, rather than the specific assets that are experiencing a bubble. C) Raising interest rates has often been found to cause a bubble to burst more severely. D) Monetary policy actions to prick bubbles can have harmful effects on the aggregate economy. E) All of the above.
E
Explain the Taylor rule, including the formula for setting the federal funds rate target, and the components of the formula. If the Fed were to use this rule, how many goals would it use to set monetary policy?
The Taylor rule specifies that the target federal fund rates should be set to equal the equilibrium real federal funds rate, plus the rate of inflation (for the Fisher effect), plus one-half times the output gap, plus one-half times the inflation gap. The formula is Federal funds rate target = equilibrium real federal funds rate + inflation rate + (output gap) + (inflation gap) The output gap is the percentage deviation of real GDP from potential full-employment real GDP. The inflation gap is the difference between actual inflation and the central bank's target rate of inflation. The equilibrium real federal funds rate is the real rate consistent with full employment in the long run. The inflation rate is the actual rate of inflation. The Taylor rule sets the federal funds rate recognizing the goals of low inflation and full employment (or equilibrium long-run economic growth).
Explain what inflation targeting is. What are the advantages and disadvantages of this type of monetary policy strategy?
There are five main elements to inflation targeting: 1. a public announcement of a medium-term target for the inflation rate; 2. a commitment to price stability as the primary long-term goal of policy; 3. many variables are used in making decisions about policy moves; 4. increased transparency about policy strategy with the public; 5. the central bank has increased accountability for attaining policy goals. The advantages of inflation targeting include: 1. the simplicity and clarity of a numerical target for the inflation rate; 2. there is increased accountability of the central bank; 3. reduces the effects of inflationary shocks. The disadvantages of inflation targeting include: 1. there is a delayed signal about the achievement of the target; 2. it could lead to a rigid rule where the only focus is the inflation rate (has not happened in practice); 3. if sole focus is the inflation rate, larger output fluctuations can occur (has not happened in practice).
Explain and demonstrate graphically how targeting nonborrowed reserves can result in federal funds rate instability. Answer: See figure below. When nonborrowed reserves are held constant, increases in the demand for reserves result in the federal funds rate increasing and decreases in the demand for nonborrowed reserves result in the federal funds rate declining. Since fluctuations in demand do not cause monetary policy actions, the result is the federal funds rate will fluctuate (assuming the equilibrium federal funds rate is below the discount rate).
When nonborrowed reserves are held constant, increases in the demand for reserves result in the federal funds rate increasing and decreases in the demand for nonborrowed reserves result in the federal funds rate declining. Since fluctuations in demand do not cause monetary policy actions, the result is the federal funds rate will fluctuate (assuming the equilibrium federal funds rate is below the discount rate). Check graph
Explain the time-inconsistency problem. What is the likely outcome of discretionary policy? What are the solutions to the time-inconsistency problem?
With policy discretion, policymakers have an incentive to attempt to increase output by pursuing expansionary policies once expectations are set. The problem is that this policy results not in higher output, but in higher actual and expected inflation. The solution is to adopt a rule to constrain discretion. Nominal anchors can provide the necessary constraint on discretionary behavior.
