How Monetary and Fiscal Policy Impact Aggregate Demand

Which of the following statements is true about the Kennedy administration in the early 1960s?

The Kennedy administration made considerable use of fiscal policy to stimulate the economy.

On the graph that depicts the theory of liquidity preference, which of the following is NOT true?

The demand-for-money curve is vertical.

Which of the following is an example of an increase in government purchases?

The government builds new bridges.

Which of the following is NOT an automatic stabilizer?

an increase in money supply

Jason is a critic of stabilization policy. Which of the following statements would he NOT agree with?

The Fed should try to fine-tune the economy during times of economic fluctuations.

The multiplier for changes in government spending is calculated as

1/(1 - MPC).

Which of the following is an example of crowding out?

A decrease in taxes increases interest rates, causing investment to fall.

Which of the following shifts aggregate demand to the left?

A decrease in the money supply.

According to liquidity preference theory, which of the following is NOT true?

A decrease in the price level shifts money demand to the right.

Which of the following illustrates how the investment accelerator works?

An increase in government expenditures increases aggregate spending so that Starshine Inc. finds it profitable to update its car-wash equipment.

Which of the following is NOT correct?

As the interest rate falls, the quantity of money demanded falls.

Which of the following does fiscal policy not primarily affect in the long run?

aggregate demand

Which of the following Fed actions would increase the money supply?

Buying bonds

Sometimes during times of heightened national security, government expenditures are larger than normal. What could the Fed do to reduce the effects this spending creates on interest rates?

Increase the money supply by buying bonds.

Suppose Jason believes that the government should follow an active stabilization policy when the economy is experiencing severe unemployment. Which of the following policies would he recommend in this case?

Decrease taxes.

Which of the following is NOT true according to classical macroeconomics theory?

For any given level of output, the interest rate adjusts to balance the supply of, and demand for, money.

Refer to the Figure. Which of the following is true?

If the current interest rate is 2 percent, people will sell more bonds, which drives interest rates up.

Which of the following is true about liquidity preference theory?

It is most relevant to the short run of interest rates.

Which of the following is NOT true about the Employment Act of 1946?

It states that the government should not promote full employment and production.

Which of the following Fed actions would decrease the money supply?

Raising the reserve requirement

Which of the following policy actions does NOT shift the aggregate-demand curve?

a change in the price level

Which of the following events would cause the Fed to stabilize output through increasing the money supply?

an increase in taxes

Changes in taxes or government spending that increase aggregate demand without requiring policy makers to act when the economy goes into a recession are called

automatic stabilizers.

If the Federal Reserve decided to lower interest rates, it could

buy bonds to raise the money supply.

A reduction in personal income taxes increases aggregate demand through an increase in private savings.

false

According to liquidity preference theory, the opportunity cost of holding money is the inflation rate.

false

During periods of expansion, automatic stabilizers cause government expenditures to rise and taxes to fall.

false

If the Fed conducts open-market purchases, the money supply decreases and aggregate demand shifts right.

false

Refer to the Figure. You can explain a decrease in Y from Y1 to Y2 in the following way: A decrease in P in P2 to P1 causes the money-demand curve to shift from MD1 to MD2; this shift of MD causes r to increase from r1 to r2; and this increase in r causes Y to decrease from Y1 to Y2.

false

The Federal Funds Rate is the interest rate the Fed charges depository institutions for short-term loans.

false

The interest-rate effect stems from the idea that a higher price level decreases the real value of households' money holdings.

false

The multiplier effect states that there are additional shifts in aggregate supply from fiscal policy because it increases income and thereby increases consumer spending.

false

The theory of liquidity preference only attempts to explain the nominal interest rate.

false

When the interest rate increases, the opportunity cost of holding money decreases, so the quantity of money demanded decreases.

false

Mark is having a policy debate with his cousin Gina. Gina points out that the political process is mostly responsible for the lag in implementing

fiscal policy

In the short run, which of the following statements is true about the effects of an increase in the money supply?

it will raise the cost of borrowing

Steve is having a policy debate with his brother Brian. He points the fact that business firms make investment plans far in advance. This is a lag problem associated with

monetary policy.

The government builds a new recycling plant. The manager of the company hires workers and pays them an annual salary. These workers then increase their spending. The firms that sell the goods these workers buy also increase their output. This type of effect on spending illustrates the

multiplier effect

Temporary tax cuts shift the aggregate-demand curve

not as far to the right as do permanent tax cuts.

An increase in U.S. net exports would shift U.S. aggregate demand

rightward. In an attempt to stabilize the economy, the government could decrease expenditures.

If money demand shifted to the left and the Federal Reserve desired to return the interest rate to its original value, it could

sell bonds to decrease the money supply.

To stabilize interest rates, the Federal Reserve will respond to a decrease in money demand by

selling government bonds, which decreases the supply of money.

Refer to the Figure. A decrease in government purchases will

shift aggregate demand from AD 1 to AD 3.

According to liquidity preference theory, an increase in money demand for some reason other than a change in the price level causes

the interest rate to rise, so aggregate demand shifts left.

The fraction of extra income that a household consumes rather than saves is called

the marginal propensity to consume.

If the Fed decreases the money supply, the interest rate increases.

true

If the interest rate is below the Fed's target, the Fed should sell bonds to decrease the money supply.

true

The multiplier effect amplifies the effects of an increase in government expenditures, while the crowding-out effect diminishes the effect.

true

The tax system is the most important automatic stabilizer.

true