Chapter 20 Money and Banking

4. Over the long run if central banks want to avoid high rates of inflation, they need to be concerned with the: a. unemployment rate. b. money growth rate. c. real economic growth rate. d. productivity of labor.

b. money growth rate.

14. If the equation of exchange is MV = PY the Y represents: a. nominal GDP. b. real GDP. c. potential output. d. economic growth.

b. real GDP.

39. If the nominal interest rate increases: a. the cost of holding money decreases. b. the cost of holding money increases. c. the velocity of money should decrease. d. the cost of holding money increases and the velocity of money should decrease.

b. the cost of holding money increases.

55. A decline in the yields earned by bonds should: a. not impact the demand for money since money doesn't earn any interest. b. also decrease the demand for money. c. increase the demand for money. d. increase the velocity of money

c. increase the demand for money.

42. If real GDP stays the same but the price level increases: a. nominal money demand should remain the same. b. nominal money demand should decrease. c. nominal money demand should increase. d. real money demand should decrease.

c. nominal money demand should increase.

70. Between 1970 and 2000, the Fed: a. published their targets for money growth and often hit these targets. b. never published targets or actual amounts for money growth. c. published targets for money growth and rarely hit them. d. published actual money growth but not targets.

c. published targets for money growth and rarely hit them.

60. The only solution available to a country experiencing extremely high rates of inflation is to: a. raise interest rates. b. peg your currency to another country's currency. c. reduce money growth. d. revert to a gold standard.

c. reduce money growth.

76. During the period of October 1979 to October 1982; the FOMC's primary operating target resulted in: a. the most stable period for the federal funds rate in history. b. reserves being highly volatile. c. the federal funds rate experiencing high volatility. d. the federal funds rate dropping to 2 percent (an all-time low to that date) and not rising above 3 percent.

c. the federal funds rate experiencing high volatility.

74. One cost that potentially could result from central banks targeting money growth is: a. high inflation. b. a slowdown in financial innovation. c. volatile interest rates. d. decreased independence.

c. volatile interest rates.

62. For the Fed to use money growth as a direct monetary policy target, which of the following needs to exist? a. A highly variable deposit expansion multiplier b. A stable link between the monetary base and the quantity of money c. A predictable link between the quantity of money and the deposit expansion multiplier d. A stable link between the monetary base and the quantity of money and a predictable relationship between the quantity of money and the rate of inflation

d. A stable link between the monetary base and the quantity of money and a predictable relationship between the quantity of money and the rate of inflation

5. Which of the following statements is most correct? a. The current rate of inflation is the result of money growth. b. Money growth is the result of inflation. c. There is no clear link between high, sustained inflation and the monetary aggregates. d. It is impossible to have high, sustained inflation without monetary accommodation.

d. It is impossible to have high, sustained inflation without monetary accommodation.

22. If we look at the equation for money demand from Irving Fisher, which of the following statements is true? a. Velocity does not play any role in the equation b. Money demand is not a factor of nominal income c. The price level does not impact money demand d. There isn't an explicit role for the interest rate in the equation

d. There isn't an explicit role for the interest rate in the equation

49. In high inflation countries, inflation rates can exceed the rate of growth of money because: a. high inflation increases the velocity of money. b. high rates of inflation increase the opportunity cost of holding money. c. money loses value quickly with inflation. d. all of the answers given are correct.

d. all of the answers given are correct.

65. A cause of the decline in the velocity of money during the 2007-2009 financial crisis was a result of: a. the fiscal stimulus provided by the U.S. government. b. the lowering of the discount rate by the Fed. c. the use of unconventional policy tools by the Fed. d. an increase in uncertainty.

d. an increase in uncertainty.

36. During economic slowdowns (recessions) the velocity of money tends to: a. remain relatively stable. b. increase slightly. c. increase dramatically. d. decrease.

d. decrease.

15. If M2 is four times larger than M1, the velocity of M1 should be: a. one-fourth of the velocity of M2. b. equal to the velocity of M2. c. equal to four. d. four times larger than the velocity of M2.

d. four times larger than the velocity of M2.

27. Equilibrium in the money market would be expressed by which of the following? a. Ms = (1/V)Y b. Ms =Md c. Ms = (1/V)P d. Md = (1/V)P

b. Ms =Md

20. Using the equation of exchange, if inflation is 1%, the velocity of money grows by 1.0% and the growth rate of money is 3.0%; what is real growth? a. +3.0% b. 1% c. 4.0% d. -1.0%

a. +3.0%

67. The relationship between the velocity of money and interest rates is: a. positive but not stable. b. negative but not stable. c. positive and stable. d. negative and stable.

a. positive but not stable.

19. Using the equation of exchange, if real GDP increases by 3.0%, the velocity of money grows by 1.0% and the growth rate of money is 3.0%; what is the rate of inflation? a. +1.0% b. It is constant or a 0% change c. It is the same as the growth rate of money, or 3.0% d. -1.0%

a. +1.0%

28. The quantity theory of money can explain which of the following? a. If the %ΔY > 0 and the %ΔV = 0; the %ΔP < %ΔM b. If the %ΔV = 0 and the %ΔM = 0; the %ΔP must be = 0 c. If %ΔY and the %ΔV = 0; the %ΔP > %ΔM d. If the %ΔP > 0; the %ΔM must also be > 0

a. If the %ΔY > 0 and the %ΔV = 0; the %ΔP < %ΔM

41. Which of the following would reflect the transactions demand for money? a. Keeping funds in your checking account to pay your rent b. Keeping funds in your savings account because the interest rate looks relatively attractive c. Selling common stocks you own and increasing the money in your savings account because you think stock prices will fall soon d. Buying a U.S. Treasury security using funds from your checking account

a. Keeping funds in your checking account to pay your rent

63. To use money growth as a short-term monetary policy instrument, a central bank must: a. believe there is a stable link between the monetary base and the rate of inflation. b. believe that only money matters. c. believe that there is an unpredictable relationship between money aggregates and inflation. d. believe the deposit expansion multiplier is volatile and unpredictable.

a. believe there is a stable link between the monetary base and the rate of inflation.

11. The velocity of money increases if: a. each unit of money is used more frequently. b. each unit of money is used less frequently. c. more purchases are made. d. none of the above answers is correct; the velocity of money is constant.

a. each unit of money is used more frequently.

3. When the currency loses value, causing people to spend it more quickly, this: a. has the same effect on inflation as an increase in money growth. b. has the same effect on inflation as a decrease in money growth. c. causes higher inflation but not as much as an increase in money growth would. d. causes even higher inflation than an increase in money growth would.

a. has the same effect on inflation as an increase in money growth.

64. Empirical research has shown that: a. in the 1990s and 2000s, velocity was more sensitive to an increase in the opportunity cost of holding money than in the 1980s. b. in the 1990s and 2000s, velocity was less sensitive to an increase in the opportunity cost of holding money than in the 1980s. c. during the 1980s and 1990s, the velocity of money was not sensitive to changes in the opportunity cost of holding money. d. during the 1980s and 1990s, the velocity of money actually decreased as the opportunity cost of holding money increased.

a. in the 1990s and 2000s, velocity was more sensitive to an increase in the opportunity cost of holding money than in the 1980s.

46. All other factors equal, as nominal interest rates decrease, checking account balances should: a. increase. b. decrease. c. remain constant. d. be converted to cash.

a. increase.

68. A major contributing factor to the instability of money demand over the past 25 years is the: a. introduction of financial instruments that pay higher returns than money but can be used as a means of payment. b. Fed has changed the way the money aggregates are defined. c. failure of many savings and loans. d. introduction of credit cards.

a. introduction of financial instruments that pay higher returns than money but can be used as a means of payment.

7. Consider the following ratio: the average annual inflation rate/the average annual money growth rate. If a country's rate of money growth consistently exceeds the rate of inflation the ratio would be: a. less than one. b. greater than one. c. that is infinite. d. exactly one.

a. less than one.

53. People have a portfolio demand for money in part because: a. money is part of a well-diversified financial portfolio. b. the return on money is often higher than other financial assets. c. money is needed to pay brokerage commissions. d. there is no cost to holding money which gives it a relatively high return.

a. money is part of a well-diversified financial portfolio.

18. Using the equation of exchange, if inflation is 1.5%, real output grows by 3.0%, and the growth rate of money is 5.0%, the change in the velocity of money is: a. Zero; velocity is constant. b. -0.5%. c. +4.5%. d. +0.5%.

b. -0.5%.

2. Economic researchers have found: a. no examples of countries with high rates of money growth and low inflation rates. b. many examples of countries with low rates of money growth and high inflation rates. c. many examples of countries with high rates of money growth and low inflation rates. d. no relationship between rates of money growth and inflation rates.

a. no examples of countries with high rates of money growth and low inflation rates.

75. For a three-year period from October 1979 to October 1982; the FOMC: a. primarily targeted reserves. b. primarily targeted the real federal funds interest rate. c. primarily targeted M2. d. gave up targeting reserves entirely.

a. primarily targeted reserves.

33. The empirical data reveals the velocity of M2 to be: a. relatively stable in the long run. b. highly volatile in the long run. c. stable only when measured annually. d. higher than the velocity of M1.

a. relatively stable in the long run.

56. If an investor thinks interest rates are likely to rise, she would: a. sell her bonds and hold more money. b. buy more bonds now and hold less money. c. not alter her bond portfolio until interest rates actually rise. d. not change her money holdings at all.

a. sell her bonds and hold more money.

78. If the nominal interest rate decreases: a. the cost of holding money decreases. b. the cost of holding money increases. c. the velocity of money should increase. d. the cost of holding money increases and the velocity of money should decrease.

a. the cost of holding money decreases.

43. The higher the nominal interest rate: a. the less money individuals will hold for any given level of transactions and the higher the velocity of money. b. the more money individuals will hold for any given level of transactions and the higher the velocity of money. c. the more money individuals will hold for any given level of transactions and the lower the velocity of money. d. the less money individuals will hold for any given level of transactions and the lower the velocity of money.

a. the less money individuals will hold for any given level of transactions and the higher the velocity of money.

44. The opportunity cost of holding money is: a. the nominal interest rate. b. the real interest rate. c. the nominal interest rate less the cost of converting a bond to cash. d. the rate of inflation.

a. the nominal interest rate.

25. Milton Friedman's assertion that "inflation is a monetary phenomenon" is based on: a. the quantity theory of money. b. the assumption of constant nominal GDP growth. c. the assumption that the price level grows at the same rate as real GDP. d. the assumption that the central bank increases the money supply by a constant rate every year.

a. the quantity theory of money

45. All other factors equal, if the costs of converting bonds and other financial securities to a means of payment increase: a. the transactions demand for money should increase. b. the transactions demand for money should decrease. c. it shouldn't impact the transactions demand for money. d. nominal interest rates should decrease.

a. the transactions demand for money should increase.

16. According to the equation of exchange, if real output and the money supply stay the same and the price level increases: a. the velocity of money has to increase. b. the velocity of money has to decrease. c. the real GDP had to rise. d. nominal GDP remains constant.

a. the velocity of money has to increase.

29. The quantity theory of money along with the assumption of a constant velocity can explain which of the following? a. At a given level of money growth, the higher the level of real growth the higher the level of inflation will be. b. At a given level of money growth, the higher the level of real growth the lower the level of inflation will be. c. If real growth is higher than money growth, the price level must be rising. d. If real growth equals money growth, the price level is falling.

b. At a given level of money growth, the higher the level of real growth the lower the level of inflation will be.

73. Which of the following statements is true? a. While the Fed emphasizes money growth more than the ECB, both central banks have chosen interest rates as their operating target. b. While the Fed emphasizes money growth less than the ECB, both central banks have chosen interest rates as their operating target. c. Because the Fed emphasizes money growth less than the ECB, the Fed uses interest rates as their operating target while the ECB looks at growth in money aggregates. d. Both the Fed and the ECB use growth in money aggregates as their operating target.

b. While the Fed emphasizes money growth less than the ECB, both central banks have chosen interest rates as their operating target.

9. Inflation can be thought of as: a. an increase in the price of money. b. a decrease in the price of money. c. no change in the price of money, just in the supply of money. d. no change in the price of money, just in the demand for money.

b. a decrease in the price of money

37. When nominal interest rates are high, the velocity of money should: a. be low. b. also be high. c. not change; the velocity of money does not vary with the interest rate. d. decrease by the same percent that the nominal interest rate has increased.

b. also be high.

6. Consider the following ratio: the average annual inflation rate/the average annual money growth rate. A country with a ratio less than one would have: a. an average inflation rate greater than the average rate of money growth. b. an average inflation rate less than the average rate of money growth. c. to have a high unemployment rate. d. an economy suffering from a recession.

b. an average inflation rate less than the average rate of money growth.

8. If money were valued in terms of how many minutes a person needs to work to buy a dollar, an increase in the number of minutes of work needed would be: a. a decline in the price of money. b. an increase in the price of money. c. no change in the real price of money, just the nominal price increases. d. no change in the real or nominal price of money.

b. an increase in the price of money.

32. Control of money growth to stabilize inflation only works if velocity were constant. In practice, changes in velocity: a. can safely be ignored in countries with relatively low inflation rates. b. are important when inflation is low. c. must be taken into account no matter what the inflation rate. d. can always safely be ignored

b. are important when inflation is low.

51. Money held for precautionary reasons is included in the demand for money: a. as a third, separate category called the precautionary demand for money. b. as part of transactions demand. c. as part of portfolio demand. d. partly as transactions demand and partly as portfolio demand.

b. as part of transactions demand.

80. All other factors equal, as nominal interest rates increase, checking account balances should: a. increase. b. decrease. c. remain constant. d. be converted to cash.

b. decrease.

40. In May of 2003, the European Central Bank (ECB) decided to: a. focus almost exclusively on money growth as their target. b. downgrade the role of money growth in their policymaking strategy. c. limit the role of interest rate targeting to be second in importance to money growth targeting. d. switch from an inflation target to a money growth target.

b. downgrade the role of money growth in their policymaking strategy.

35. If money growth and real output growth are both zero, the change in the price level will: a. also be zero. b. equal the percentage change in velocity. c. be indeterminate. d. be the inverse of the percentage change in velocity.

b. equal the percentage change in velocity.

21. If on average, a dollar is spent 4 times each year to purchase real output, the velocity of money is: a. one-fourth. b. four. c. the money supply divided by 4. d. nominal GDP divided by four.

b. four.

31. Nobel-laureate economist Milton Friedman suggested that policymakers strive to ensure that the monetary aggregates: a. grow at a rate equal to the rate of inflation. b. grow at a rate equal to the rate of real growth plus the desired level of inflation. c. grow at a rate equal to the rate of real growth less the desired level of inflation. d. remain constant in terms of dollar amounts.

b. grow at a rate equal to the rate of real growth plus the desired level of inflation.

61. Stable velocity as a contributing factor to successfully using money growth as a stabilizing monetary policy tool, is more important in an environment where: a. inflation is extremely high (e.g., over 100 percent). b. inflation is low (e.g., less than 10 percent). c. inflation occurs, the problems caused by a variable velocity are just as severe at low levels of inflation as at high levels of inflation. d. there is deflation.

b. inflation is low (e.g., less than 10 percent).

58. The demand for money varies: a. directly with the liquidity of other financial assets. b. inversely with the liquidity of other financial assets. c. not all with the liquidity of other assets since money is liquid. d. inversely with wealth.

b. inversely with the liquidity of other financial assets.

10. If we look at the value of money in terms of how many units of a good it takes to buy one dollar, then inflation means: a. it would take more goods to buy the same dollar. b. it would take fewer goods to buy the same dollar. c. the same number of goods would buy fewer dollars. d. it would take fewer dollars to buy the same goods.

b. it would take fewer goods to buy the same dollar.

During this period: a. the velocity of money should have been stable. b. money demand as well as velocity should have also been shifting and volatile. c. it should have been easy for the Fed to predict the velocity of money. d. the Fed was actually targeting the short-term interest rate.

b. money demand as well as velocity should have also been shifting and volatile.

71. Between 1970 and 2000, if the Fed had tried to hit the money growth targets: a. the economy would have likely experienced very high inflation. b. the federal funds rate would have changed often and by large amounts. c. the interest rates would have likely been more stable. d. the economy would have likely experienced very high inflation but the interest rates would have likely been more stable.

b. the federal funds rate would have changed often and by large amounts.

52. The portfolio demand for money reflects: a. the money we hold for our everyday transactions. b. the portion of wealth people desire to hold in the form of money. c. the money we hold to purchase stocks and bonds and other financial securities. d. the money we hold for our everyday transactions and the money we hold to purchase stocks and bonds and other financial securities.

b. the portion of wealth people desire to hold in the form of money.

69. The Lucas critique focuses specifically on: a. the relationship between Fed policy and the money supply. b. the role that economic policymaking has on people's economic behavior. c. the inability to measure economic performance accurately. d. the moving away from fixed exchange rates to flexible exchange rates.

b. the role that economic policymaking has on people's economic behavior.

79. All other factors equal, if the costs of converting bonds and other financial securities to a means of payment decrease: a. the transactions demand for money should increase. b. the transactions demand for money should decrease. c. it shouldn't impact the transactions demand for money. d. nominal interest rates should decrease.

b. the transactions demand for money should decrease.

24. Key assumptions behind the quantity theory of money include: a. the money supply is fixed. b. the velocity of money is constant. c. the percentage change in the price level equals the percentage change in real GDP. d. the change in nominal GDP is zero.

b. the velocity of money is constant.

13. If M = the money supply; Y = real output, P = the price level, and V = velocity, which of the following equals the velocity of money? a. (Y × M)/P b. (P × M)/Y c. (P × Y)/M d. (P × Y) + M

c. (P × Y)/M

17. Which of the following expresses the equation of exchange? a. MY = PV b. MV = Y c. MV = PY d. MP = VY

c. MV = PY

26. If we let Md reflect money demand, then we can write the equation for money demand as: a. Md =VY. b. Md = PY. c. Md = (1/V) PY. d. Md = V(Y/P).

c. Md = (1/V) PY.

34. Which of the following statements is most correct? a. The velocity of M2 is relatively stable across all time periods. b. The velocity of M2 is less stable than the velocity of M1. c. The velocity of M2 is more volatile in the short run than the long run. d. Fisher's assumption about money velocity being stable in the long run was incorrect.

c. The velocity of M2 is more volatile in the short run than the long run.

50. Which of the following would be classified as precautionary demand for money? a. You keep a $1,000 in a money market account because the return is better than a savings account at your bank b. You apply for and receive a credit card with a $1,000 limit c. You put $1,000 in a savings account at your bank for emergencies d. You put $1,000 in your checking account each month to cover your regular expenses

c. You put $1,000 in a savings account at your bank for emergencies

59. You graduate from law school and can now begin charging clients fees for your time. What impact will this have on your demand for money? a. Your increased income will likely cause your demand for money to decrease b. Your opportunity cost of making trips to the bank will decrease c. Your increased income will likely cause your demand for money to increase d. Your demand for money will not be affected

c. Your increased income will likely cause your demand for money to increase

30. A rate of inflation that exceeds the growth rate of money for a country could be explained by: a. a growing real economy. b. a constant velocity of money. c. an increasing velocity of money. d. a decreasing velocity of money.

c. an increasing velocity of money.

23. Based on the analysis of the equation of exchange, Irving Fisher, derived the quantity theory of money which states that: a. velocity changes always offset changes in the supply of money. b. changes in the aggregate price level are caused solely by changes in velocity. c. changes in the aggregate price level are caused solely by changes in the quantity of money. d. none of the answers given is correct.

c. changes in the aggregate price level are caused solely by changes in the quantity of money.

1. History shows that: a. countries with low rates of money growth have high rates of inflation. b. money growth and inflation are not related. c. countries with high rates of money growth have high rates of inflation. d. money growth rates equal inflation rates.

c. countries with high rates of money growth have high rates of inflation.

54. As a person's wealth increases we would expect the demand for money to: a. decrease. b. increase dollar for dollar with wealth. c. increase but at a rate less than dollar for dollar. d. not change; money demand does not vary with wealth, only with income.

c. increase but at a rate less than dollar for dollar.

48. Which of the following statements best completes the sentence, "All other factors constant, as the nominal interest rate increases, the opportunity cost of money..."? a. decreases, the velocity of money decreases, and the quantity of money people want to hold decreases. b. increases, the velocity of money decreases, and the quantity of money people want to hold decreases. c. decreases, the velocity of money increases, and the quantity of money people want to hold decreases. d. increases, the velocity of money increases, and the quantity of money people want to hold decreases.

d. increases, the velocity of money increases, and the quantity of money people want to hold decreases.

72. Statistical analysis reveals that the long-run money velocity (for euro-area M3, which is equivalent to U.S. M2): a. is unstable in the euro similar to the instability that exists in the U.S. b. is much more stable in the U.S. than in the euro area. c. has increased in the euro area since 1980. d. is more stable in the euro area than in the U.S.

d. is more stable in the euro area than in the U.S.

66. To say that the relationship between the velocity of money and the opportunity cost of holding money is not stable is the same as saying: a. the supply of money is not stable. b. the money market is always in disequilibrium. c. money demand is stable. d. money demand is not stable.

d. money demand is not stable.

12. The velocity of money equals: a. nominal GDP times the price level. b. nominal GDP times the money supply. c. nominal GDP divided by the price level. d. nominal GDP divided by the money supply.

d. nominal GDP divided by the money supply.

38. In the late 1970s and early 1980s, the velocity of money increased significantly. The main reason(s) for the increase was: a. as presidential election years near the velocity of money increases. b. the introduction of stock and bond mutual funds with draft writing privileges and low nominal interest rates. c. high nominal interest rates. d. the introduction of stock and bond mutual funds with draft writing privileges along with high nominal interest rates.

d. the introduction of stock and bond mutual funds with draft writing privileges along with high nominal interest rates.

57. Crises that occasionally hit financial markets will increase the demand for money since: a. the return on money increases. b. the return on financial assets increases. c. there is no risk with holding money. d. the risk of holding money relative to other financial assets decreases.

d. the risk of holding money relative to other financial assets decreases.

47. If you were going to write a function for money demand, you would say that the demand for money holdings: a. varies directly with both the nominal interest rate and nominal income. b. varies inversely with both the nominal interest rate and nominal income. c. varies inversely with nominal income and directly with the nominal interest rate. d. varies inversely with the nominal interest rate and directly with nominal income.

d. varies inversely with the nominal interest rate and directly with nominal income.