Concept Check Reading 19
If money neutrality holds, the effect of an increase in the money supply is: a) higher prices b) higher output c) lower unemployment
a) Money neutrality is the theory that changes in the money supply do not affect real output or the velocity of money. Therefore, an increase in the money supply can only increase the price level.
The money supply curve is perfectly inelastic because the: a) money supply is independent of interest rates b) money demand schedule is downward-sloping c) money supply is dependent upon interest rates
a) The money supply schedule is vertical because the money supply is independent of interest rates. Central banks control the money supply.
A central bank conducts monetary policy primarily by altering the: a) policy rate b) inflation rate c) long-term interest rate
a) The primary method by which a central bank conducts monetary policy is through changes in the target short-term rate or policy rate.
Both monetary and fiscal policy are used to: a) balance the budget b) achieve economic targets c) redistribute income and wealth
b) Both monetary and fiscal policies primarily strive to achieve economic targets such as inflation and GDP growth. Balancing the budget is not a goal for monetary policy and is a potential outcome of fiscal policy. Fiscal policy (but not monetary policy) may secondarily be used as a tool to redistribute income and wealth.
A central bank's policy goals least likely include: a) price stability b) minimizing long-term interest rates c) maximizing the sustainable growth rate of the economy
b) Central bank goals often include maximum employment, which is interpreted as the maximum sustainable growth rate of the economy; stable prices; and moderate (not minimum) long-term interest rates.
Which of the. following is least likely a function or objective of a central bank? a) Issuing currency b) Lending money to government agencies c) Keeping inflation within an acceptable range
b) Lending money to government agencies is not typically a function of a central bank. Central bank functions include controlling the country's money supply to keep inflation within acceptable levels and promoting a sustainable rate of economic growth, as well as issuing currency and regulating banks.
Monetary policy is most likely to fail to achieve its objectives when the economy is: a) growing rapidly b) experiencing deflation c) experiencing disinflation
b) Monetary policy has limited ability to act effectively against deflation because the policy rate cannot be reduced below zero and demand for money may be highly elastic (liquidity trap).
Which of the following statements is least accurate? The existence and use of money: a) permits individuals to perform economic transactions b) requires the central bank to control the supply of currency c) increases the efficiency of transactions compared to a barter system
b) Money functions as a unit of account, a medium of exchange, and a store of value. Money existed long before the idea of central banking was conceived.
According to the quantity theory of money, if nominal GDP is $7 trillion, the price index is 150, and the money supply is $1 trillion, then the velocity of the money supply is closest to: a) 4.7 b) 7.0 c) 10.5
b) The equation of exchange is MV = PY Nominal GDP = PY, so that MV = nominal GDP Therefore, ($1.0 trillion)(V) = $7.0 trillion V = $7.0 trillion / $1.0 trillion V = 7.0
A government reduces spending by $50 million. The tax rate is 30%, and consumers exhibit a marginal propensity to consume of 80%. The change in aggregate demand caused by the change in government spending is closest to: a) —$66 million b) —$114 million c) —$250 million
b) fiscal multiplier = 1 / [1 — MPC (1 —T)] = 1 / [1 — 0.80(1 — 0.3)] = 2.27 change in government spending = —$50 million change in aggregate demand = —(50 x 2.27) = —$113.64 million
Suppose an economy has a real trend rate of 2%. The central bank has set an inflation target of 4.5%. To achieve the target, the central bank has set the policy rate at 6%. Monetary policy is most likely: a) balanced b) expansionary c) contractionary
b) neutral rate = trend rate + inflation target = 2% -I, 4.5% = 6.5% Because the policy rate is less than the neutral rate, monetary policy is expansionary.
An increase in the policy rate will most likely lead to an increase in: a) business investment in fixed assets b) consumer spending on durable goods c) the foreign exchange value of the domestic currency
c) An increase in the policy rate is likely to increase longer-term interest rates, causing decreases in consumption spending on durable goods and business investment in plant and equipment. The increase in rates, however, makes investment in the domestic economy more attractive to foreign investors, increasing demand for the domestic currency and causing the currency to appreciate.
If a country's inflation rate is below the central bank's target rate, the central bank is most likely to: a) sell government securities b) increase the reserve requirement c) decrease the overnight lending rate
c) Decreasing the overnight lending rate would add reserves to the banking system, which would encourage bank lending, expand the money supply, reduce interest rates, and allow GDP growth and the rate of inflation to increase. Selling government securities or increasing the reserve requirement would have the opposite effect, reducing the money supply and decreasing the inflation rate.
If the money supply is increasing and velocity is decreasing: a) prices will decrease b) real GDP will increase c) the impact on prices and real GDP is uncertain
c) Given the equation of exchange, MV = PY, an increase in the money supply is consistent with an increase in nominal GDP (PY). However, a decrease in velocity is consistent with a decrease in nominal GDP. Unless we know the size of the changes in the two variables, there is no way to tell what the net impact is on real GDP (Y) and prices (P).
A government is concerned about the timing of the impact of fiscal policy changes and is considering requiring the compilation and reporting of economic statistics weekly, rather than quarterly. The new reporting frequency is intended to decrease the: a) action lag b) impact lag c) recognition lag
c) More frequent and current economic data would make it easier for authorities to monitor the economy and to recognize problems. The reduction in the time between economic reports should reduce the recognition lag.
Purchases of securities in the open market by the monetary authorities are least likely to increase: a) excess reserves b) cash in investor accounts c) the interbank lending rate
c) Open market purchases by monetary authorities decrease the interbank lending rare by increasing excess reserves that banks can lend to one another and therefore increasing their willingness to lend.
The Fisher effect states that the nominal interest rate is equal to the real rate plus: a) actual inflation b) average inflation. c) expected inflation
c) The Fisher effect states that nominal interest rates are equal to the real interest rate plus the expected inflation rate.
A government enacts a program to subsidize farmers with an expansive spending program of $10 billion. At the same time, the government enacts a $10 billion tax increase over the same period. Which of the following statements best describes the impact on aggregate demand? a) Lower growth because the tax increase will have a greater effect b) No effect because the tax and spending effects just offset each other c) Higher growth because the spending increase will have a greater effect
c) The amount of the spending program exactly offsets the amount of the tax increase, leaving the budget unaffected. The multiplier for government spending is greater than the multiplier for a tax increase. Therefore, the balanced budget multiplier is positive. All of the government spending enters the economy as increased expenditure, whereas spending is reduced by only a portion of the tax increase.
Sales in the retail sector have been sluggish; and consumer confidence has recently declined, indicating fewer planned purchases. In response, the president sends an expansionary government spending plan to the legislature. The plan is submitted on March 30, and the legislature refines and approves the terms of the spending plan on June 30. What type of fiscal plan is being considered, and what type of delay did the plan experience between March 30 and June 30? Fiscal plan / Type of lag a) Discretionary / Recognition b) Automatic / Action c) Discretionary / Action
c) The expansionary plan initiated by the president and approved by the legislature is an example of discretionary fiscal policy. The lag from the time of the submission (March 30) through time of the vote (June 30) is known as action lag. It took the legislature three months to write and pass the necessary laws.
Assume the Federal Reserve purchases $1 billion of securities in the open market. What is the maximum increase ih the money supply that can result from this action, if the required reserve ratio is 15%? a) $850 million b) $1.00 billion c) $6.67 billion
c) The money multiplier is 1 / 0.15 = 6.67, so the open market purchase can increase the money supply by a maximum of $6.67 billion.
A country that targets a stable exchange rate with another country's currency least likely: a) accepts the inflation rate of the other country b) will sell its currency if its foreign exchange value rises c) must also match the money supply growth rate of the other country
c) The money supply growth rate may need to be adjusted to keep the exchange rate within acceptable bounds, but is not necessarily the same as that of the other country. The other two statements are true.
In the presence of tight monetary policy and loose fiscal policy, the most likely effect on interest rates and the private sector share in GDP are: Interest rates / Share of private sector a) lower / lower b) higher / higher c) higher / lower
c) Tight monetary policy and loose fiscal policy both lead to higher interest rates. Tight monetary policy decreases private sector growth, while loose fiscal policy expands the public sector, reducing the overall share of private sector in the GDP.
