Chapter 25
Many central banks consider price stability to be the most appropriate long-term goal of monetary policy. Which of the following is not a rationale for this view?
Deflation is a much more desirable condition than inflation.
In 2009, in the wake of the global financial crisis when interest rates were at their lowest, the U.S. government instituted a "cash for clunkers" program, and later a "cash for appliances" program. Both rebate programs were designed in part to stimulate new spending on automobiles and major appliances. What does this say about views of the health of the interest-rate channel during that time?
Despite very low interest rates, expenditures on consumer durables were weak, indicating the interest-rate channel was not very healthy.
Economist Franco Modigliani found that the most important transmission mechanisms of monetary policy involve consumer expenditure. Which of the following is not a channel through which monetary policy can affect consumer expenditure?
Expansionary monetary policy can increase the value of stocks, raising Tobin's q.
In the 2007-2009 recession, the value of common stocks in real terms fell by nearly 50%. Which of the following shows a transmission mechanism through which the decline in the stock market might have affected aggregate demand and thus contributed to the severity of the recession?
Falling stock prices lead to a fall in financial wealth, and thus consumption spending falls, reducing aggregate demand.
"A decrease in short-term nominal interest rates necessarily implies a stance of monetary easing." Is this statement true, false, or uncertain? Explain your answer.
False. Monetary policy easing should be associated with changes in real interest rates and not nominal rates.
Contractionary monetary policy reduces stock prices, which reduce the value of financial assets and increase the probability of household financial distress. Households with less access to liquid assets spend less on consumption and residential investment. This statement describes which of the following monetary transmission channels?
Household liquidity effects.
Why does the credit view imply that monetary policy has a greater effect on small businesses rather than large firms?
Small businesses are more dependent on the availability of bank loans than large firms.
If adverse selection and moral hazard increase, how does this affect the ability of monetary policy to address economic downturns?
With increased adverse selection, monetary policy must be more powerful to offset the contractionary effects of adverse selection and moral hazard.
The credit market channel of monetary transmission acts primarily through the effect of:
asymmetric information on lending and balance sheets.
From mid-2008 to early 2009, the Dow Jones Industrial Average declined by approximately 50%, while real interest rates were low or were falling. What does this suggest about Tobin's q during the global financial crisis? During the global financial crisis, Tobin's q ... because
decreased a decline in the stock market caused the market value of firms to fall.
If nominal interest rates are high, the exchange rate is low, and asset prices are high, then monetary policy is best described as:
easy
Consider the following statement: "The cost of financing investment is related only to interest rates; therefore, the only way that monetary policy can affect investment spending is through its effects on interest rates." This statement is Which of the following is a correct transmission channel that shows how monetary policy can affect investment, without relating investment to interest rates? A. Expansionary monetary policy can decrease the value of stocks, which lowers a firm's net worth, reducing the firm's ability to borrow and thus decreasing investment. B. Expansionary monetary policy can increase the value of stocks, lowering Tobin's q, and thus increasing investment. C. Expansionary monetary policy can increase the value of stocks, raising household wealth, and thus increasing consumption. D. Expansionary monetary policy can increase the value of stocks, raising Tobin's q, and thus increasing investment.
false D. Expansionary monetary policy can increase the value of stocks, raising Tobin's q, and thus increasing investment.
Following the global financial crisis, mortgage rates reached record low levels in 2011. What effect should this have, according to the household liquidity effect channel? Lower mortgage rates should lead to ... housing prices, which ... the value of housing wealth. This leads to a ... probability of financial distress, thus ... consumer durable and housing expenditure. During the same time, most banks raised their credit standards significantly, making it much more difficult to qualify for home loans and refinance existing loans. How does this alter your previous answer?
higher, raises, lower, increasing With higher credit standards, the likelihood of financial distress would remain elevated, resulting in no increase in consumer housing expenditure.
The Federal Reserve steadily raised interest rates during 2004 and 2005. Higher interest rates cause the value of the dollar to ... which causes net exports to ... and thus output would be expected to ... This is an example of which of the following monetary transmission mechanisms?
increase, decrease decrease Exchange rate effects.
During and after the global financial crisis, the Fed reduced the fed funds rate to nearly zero. At the same time, the stock market fell dramatically and housing market values declined sharply. Comment on the effectiveness of monetary policy in this period through the wealth channel Monetary policy effects through the wealth channel were ... during the global financial crisis because:
ineffective though real interest rates were low, stock and housing values declined sharply, which decreased aggregate demand.
During and after the global financial crisis, the Fed provided banks with large amounts of liquidity. Banks' excess reserves increased sharply, while credit extended to households and firms decreased sharply. Comment on the effectiveness of the bank lending channel during this time. The bank lending channel was ... during the global financial crisis because:
ineffective the increased reserves did not translate into higher lending because of perceived credit risks by lending banks.
It is dangerous to always associate the easing or tightening of monetary policy with a fall or a rise in short-term nominal interest rates because Which of the following is not one of the four basic policy lessons:
movements in nominal interest rates do not always correspond to movements in real interest rates. Monetary policy is ineffective in reviving a weak economy if short-term interest rates are already near zero.
One of the classic features of the global financial crisis is the failure of high-profile investment banks and financial firms, such as Lehman Brothers, Bear Stearns, and AIG. These firms experienced sharp contractions in the value of their balance sheets due to risky asset holdings. Which of the following schematics correctly identifies how this would affect the economy, as it relates to the balance sheet channel?
r↑ → Ps↓ → firms' net worth↓ → adverse selection↑, moral hazard↑ → lending↓ → I↓ → Yad↓
In the late 1990s, the stock market was rising rapidly, the economy was growing, and the Federal Reserve kept interest rates relatively low. Identify the correct schematic that explains how this policy stance would affect the economy as it relates to the Tobin q transmission mechanisms.
r↓ → Ps↑ → q↑ → I↑ → Yad↑
If an expansionary monetary policy leads to a house price bubble that fuels strong consumer spending, this is an example of According to Tobin's q theory, expansionary monetary policy will lead to an increase in investment spending because
the wealth effect. the market value of firms rises relative to the replacement cost of capital.
Expansionary monetary policy increases stock prices and thus the net worth of firms. As net worth rises, adverse selection and moral hazard problems are reduced, and thus bank lending increases, which increases investment. This statement describes which of the following monetary transmission channels?
Balance sheet channel.
Lars Svensson, a deputy governor of the Swedish central bank, proclaimed that when an economy is at risk of falling into deflation, central bankers should be "responsibly irresponsible" with monetary expansion. What does this mean? How does being "responsibly irresponsible" relate to the monetary transmission mechanism? When central bankers are "responsibly irresponsible" with monetary expansion, they create stimulus through the ... channel, which ... aggregate demand and ... the risk of deflation
Central banks should commit to strong but temporary inflationary policies that are designed to raise inflation expectations. interest-rate, increases, decreases
Which of the following is a true statement about the effect of monetary policy on interest rates?
Changes in short-term nominal interest rates do not always indicate the stance of monetary policy.
How can the interest-rate channel still function when short-term nominal interest rates are at the zero-lower bound?
If the central bank commits to a higher inflation policy, it can raise inflation expectations, thereby lowering real interest rates, even when the nominal interest rate is zero.
Suppose that the nominal interest rate is near zero, and the economy is in a recession. Which of the following is a correct statement about the effectiveness of monetary policy?
Monetary policy can still be highly effective because it can work through channels other than the interest rate
Which of the following does not support the credit view of monetary policy?
The real interest rate can be used to stimulate spending, even when the nominal rate is zero.
"If countries fix their exchange rate, the exchange rate channel of monetary policy does not exist." Is this statement true, false, or uncertain? Explain your answer.
True. When countries fix their exchange rate, they must use monetary policy to affect the interest rate in order to maintain the exchange rate.
Using a schematic, show how the Great Depression demonstrates the unanticipated price level channel.
Unanticipated P↓ → firms' real net worth↓ → adverse selection↑, moral hazard↑ → lending↓ → I↓ → Yad↓
"Considering that consumption is nearly 2/3 of total GDP, this means that the interest rate, wealth, and household liquidity channels are the most important monetary policy channels in the U.S." Is this statement true, false, or uncertain? Explain your answer.
Uncertain. There are other channels that could have a greater effect on investment than those from monetary policy changes.