Economics Final
Explain what factors led to the 2006 decrease in housing prices causing a reduction in aggregate demand.
Several factors attributable to the fall in housing prices in 2006 contributed to the subsequent reduction in aggregate demand. Two of the main factors were a reduction in wealth and a reduction in the availability of credit. Lower housing prices caused a reduction in the wealth of homeowners. With less wealth, homeowners reduced their consumption spending. The reduction in consumption spending caused a shift to the left of AD. Falling housing prices also caused mortgage defaults to increase, which caused the banking system to reduce lending. With fewer loans available, household consumption and business investment fell. These reductions in consumption and investment further reduced AD
During the late 1970s and first part of the 1980s, the Fed seemed to react in a counterintuitive manner to the 1970s oil shocks. Explain the reasoning behind the Fed's policy decisions and the effect that they had on the economy.
The negative supply shocks of the 1970s came about as a result of the two oil shocks in 1973 and 1979. This resulted in a situation called stagflation where there was both high inflation and high unemployment. The Fed's ability to increase growth in response to these real shocks was limited and the Fed was particularly concerned about the inflation rate at the time, so they decided to reduce money growth to prevent inflation from rising further. The contractionary effect on aggregate demand resulted in a fall in the inflation rate, but a rise in the unemployment rate. These policies seem counterintuitive if the Fed is viewed as being concerned mainly with unemployment. But the Fed cannot fight both unemployment and inflation with the same policy and so must choose which problem to address, with an understanding that addressing one problem will mean worsening the other problem in the short run.
What, if any, timing challenges exist with the use of discretionary fiscal policy? If there are any, compare and contrast them with the timing challenges of monetary policy.
The same timing challenges, or lags, exist for fiscal policy that we encounter for monetary policy; their lengths, however, vary somewhat. The first lag is the recognition lag, the length of time between a problem's occurrence and its recognition. Monetary policy faces this lag, as well; data must be collected, refined, and analyzed. The second lag is the legislative lag. The Constitution requires that Congress and the president approve all federal expenditures. Reaching an agreement that satisfies both parties in Congress and the president can be a challenging and lengthy process. In contrast, the Federal Reserve only needs to convene the FOMC and can act more quickly when it recognizes a problem. As such, the legislative lag is not an issue with monetary policy. After political approval, spending is in the hands of the government bureaucracy. Often they must adhere to numerous legal requirements that go along with the spending of federal funds. This is the implementation lag, which again is generally not present with monetary policy. Then there is the question of how long it takes for aggregate demand to shift once the spending or tax cut occurs. This is known as the effectiveness lag. Fiscal policy can be effective in shifting demand quicker than monetary policy, since the money will be put directly into the economy. Monetary policy relies on the willingness of banks to lend and the public to borrow in order for an increase in reserves to actually increase aggregate demand. Thus, the effectiveness lag is longer for monetary policy than fiscal policy. Finally, both fiscal and monetary policies require time for evaluation and adjustment. Evaluation and adjustment lags occur as additional information gathering takes place.
Many economists now believe that rising U.S. housing prices in the early 2000s were a bubble. Explain why the Federal Reserve did not pop the bubble.
There are two main reasons why the Federal Reserve did not attempt to pop the bubble. First, at the time it was unclear whether the increase in housing prices was a bubble or simply part of a long-term trend of increasing housing prices. Second, it is difficult, if not impossible, to reduce the price of one type of asset (housing) without reducing the prices of all assets and GDP more generally, since monetary policy affects aggregate demand and not any specific market in an economy. That is, the Federal Reserve likely could not have reduced housing prices without causing deflation and/or a recession in the economy as a whole.
If an economy is operating below its long-run potential growth rate as shown in the graph, what can the Fed do to bring the economy back toward its long-run growth rate? Explain.
To boost AD back toward the long-run growth curve, the Fed could engage in open market purchases (or use one of its other tools such as lowering the discount rate) to increase money growth. The increase in money growth will lower interest rates, thus stimulating investment and shifting the AD curve to the right. This increases the economy's growth rate in the short run, bringing it closer to the long-run potential growth rate shown by the LRAS curve.
Monetary authorities in a country face the following situation: Consumers are not spending, investment is low, and unemployment is relatively high. Explain how monetary policy could work to improve this situation.
Unemployment and low aggregate demand are the central bank's primary concern in this situation. The central bank would therefore increase money supply growth to lower interest rates and increase aggregate demand. This would cause unemployment to fall and in the best case scenario, a return to the economy's long-run potential growth rate.
(Table: Multiple Deposit Expansion) Refer to the table. For the multiple deposit expansion process described in this table, what is the maximum amount of loans that the Second National Bank can make if it holds only the required reserves? A) $338,560 B) $30,470.40 C) $308,089.60 D) $311,475.20
a
A bank is considered illiquid if: A) it has short-term liabilities greater than its short-term assets, but overall assets greater than liabilities. B) it has liabilities greater than the value of its assets. C) the value of its outstanding loans is greater than the value of its deposits. D) it has lost its FDIC coverage.
a
A tariff ______ the world supply of a good. A) reduces B) increases C) does not change D) has no measurable effect on
a
After a pair of wars in the late seventeenth and early eighteenth centuries, French-British relations decayed to the point that England began putting high tariffs on French wines. A large part of the support for this law came from British brewers and distillers who feared the return of French competition after the wars. These tariffs help explain why, to this day, the English prefer beer over wine. Of the arguments against free trade, which seems most likely to apply here, given the information provided? A) saving domestic jobs B) preventing child labor C) the importance of national security D) alcohol being a "key industry"
a
Automatic stabilizers are: A) changes in fiscal policy that stimulate aggregate demand in a recession without the need for explicit action by policymakers. B) subject to significant lags. C) a result of the United States' regressive tax system. D) not very effective fiscal policy.
a
Because the alternative minimum tax (AMT) is not indexed to inflation: A) more American families have become subject to the AMT over time. B) fewer American families have become subject to the AMT over time. C) every American family is subject to the AMT today. D) no American family is subject to the AMT today.
a
Crowding out: A) limits the increase in aggregate demand due to fiscal policy. B) affects contractionary fiscal policy. C) increases the multiplier effect. D) shifts the LRAS curve to the left.
a
Domestic consumers lose more than domestic producers gain because of import restrictions. A) True B) False
a
Easy credit can start or intensify a housing bubble. A) True B) False
a
If the Fed adheres to a strict "money growth rule" of 3% (that is, they keep at 3% no matter what), what happens if velocity growth ( ) drops? A) Inflation, real growth, and nominal wage growth all decrease. B) Inflation increases, but real growth and nominal wage growth decrease. C) Inflation and nominal wage growth decrease, but real growth increases. D) Inflation, real growth, and nominal wage growth all increase.
a
If the Fed reacts to a series of negative real shocks by raising money growth every time: A) the inflation rate will increase over time. B) the inflation rate will decrease over time. C) deflation will occur. D) the inflation rate will remain unchanged.
a
If the value of a bank's liabilities is greater than its assets, there is a: A) solvency crisis. B) liquidity crisis. C) liability crisis. D) profitability crisis.
a
If you are a married man, you can expect: A) more in Social Security benefits than a single man. B) less in Social Security benefits than a single man. C) the same in Social Security benefits as a single man. D) more than a single man only if your wife worked.
a
In a progressive tax system, if a person moves from one income bracket to a higher income bracket: A) both the marginal tax rate and average tax rate will be higher. B) both the marginal tax rate and average tax rate will be lower. C) the marginal tax rate will be lower and the average tax rate will be higher. D) the marginal tax rate will be higher and the average tax rate will be lower.
a
In the AD-AS model, an increase in money growth will cause the growth rate of real GDP to increase in: A) the short run only. B) the long run only. C) both the short run and the long run. D) neither the short run nor the long run.
a
In the short run, a monetary contraction leads to increased unemployment because: A) wages and prices are sticky. B) wages and prices are flexible. C) wages are sticky, while prices are flexible. D) wages are flexible, while prices are sticky.
a
M1 is equal to currency plus: A) checkable deposits. B) total reserves held at the Federal Reserve. C) savings deposits. D) small-time deposits.
a
On average, U.S. households with income in the bottom 20% pay: A) less than 5% of their incomes in federal income tax. B) between 5% and 15% of their incomes in federal income tax. C) between 15% and 25% of their incomes in federal income tax. D) more than 25% of their incomes in federal income tax.
a
Open market operations involve the Federal Reserve: A) buying and selling government bonds. B) lending reserves directly to banks. C) providing reserves to banks through auction. D) competing with investment banks for treasury securities.
a
The Federal Reserve typically affects the real rate of interest in: A) the short run only. B) the long run only. C) both the short run and the long run. D) neither the short run nor the long run.
a
The debt-to-GDP ratio has roughly doubled since the Great Recession of 2007-2008. A) True B) False
a
The interest rate that the Fed has the most control over is the: A) Federal Funds rate. B) mortgage loan rate. C) long-term government bond rate. D) prime rate.
a
The multiplier effect is the: A) subsequent consumer spending that increases AD from expansionary fiscal policy. B) subsequent consumer spending that increases AD from contractionary fiscal policy. C) increase in GDP from an increase in the money supply and decrease in taxes. D) increase in GDP from increased consumer savings and private investment.
a
The national debt held by the public increases when the federal government runs a deficit. A) True B) False
a
U.S. currency has the words "Federal Reserve Note" on it. A) True B) False
a
What is the difference between disinflation and deflation? A) Disinflation is a slower increase in prices, whereas deflation is a decrease in prices. B) Deflation is a slower increase in prices, whereas disinflation is a decrease in prices. C) The Fed can engineer disinflation, but not deflation. D) There is no difference between disinflation and deflation.
a
What is the reserve requirement? A) the legal minimal percentage of deposits required to be held in reserve by banks B) the percentage of reserves that is held only on amounts greater than $50 million C) the amount of reserves that the Fed wants to inject at a given time D) the amount of reserves needed for the Fed to provide a given increase in the money supply
a
What primary benefit can a temporary investment tax credit have? A) It can accelerate capital outlays in an economic downturn. B) It can encourage workers to work extra hours. C) It can encourage consumers to save more. D) It can encourage firms to hire more workers.
a
When consumers spend all of their tax rebate checks, what takes place in the economy? A) Aggregate demand shifts to the right. B) Aggregate demand shifts to the left. C) The LRAS curve shifts left. D) Inflation decreases.
a
Which asset would you classify as being most liquid? A) demand deposits B) small-time deposits C) a home D) gold bullion
a
With free trade, the domestic price of a good must be equal to the world price of a good. A) True B) False
a
A central bank can always keep an economy at its long-run growth rate by exactly offsetting any shock to aggregate demand. A) True B) False
b
An increase in government spending causes: A) the aggregate demand curve to shift to the left. B) the aggregate demand curve to shift to the right. C) an upward movement along the aggregate demand curve. D) a downward movement along the aggregate demand curve.
b
Federal government grants to state governments can: A) increase saving rather than spending. B) make states dependent on the federal government. C) cause state-level government layoffs. D) immediately end a recession.
b
Fiscal policy is most desirable if the economy returns to its long-run equilibrium immediately after a shock occurs. A) True B) False
b
If a tariff decreases domestic consumption of a good from 230 million units to 150 million units and raises the domestic price by $1.50, given a linear domestic demand curve and a perfectly elastic world supply curve, what is the value of the unexploited gains from trade caused by decreased domestic consumption? A) $45 million B) $60 million C) $80 million D) $120 million
b
If an increase in government spending of $100 million causes an increase in aggregate spending of less than $100 million, we call this phenomenon: A) crowding in. B) crowding out. C) the multiplier. D) the Ricardian effect.
b
If the average reserve ratio in the banking system is 25% and the Fed increases bank reserves by $20,000, then the change in the money supply will be equal to $100,000. A) True B) False
b
If the federal government spends 12% of GDP and collects revenues of 10% of GDP, what is the deficit as a percentage of GDP? A) 1% B) 2% C) 11% D) 12%
b
In a recession, automatic stabilizers cause: A) an increase in tax revenues and a decrease in government spending. B) a decrease in tax revenues and an increase in government spending. C) an increase in both tax revenues and government spending. D) a decrease in both tax revenues and government spending.
b
In the short run, a negative real shock will cause output growth to: A) increase. B) decrease. C) remain unchanged. D) become more difficult to predict.
b
Monetary policy is more effective at combating real shocks than AD shocks. A) True B) False
b
Money market mutual funds are more liquid than savings deposits. A) True B) False
b
Other things equal, will an individual tax rebate or a cut in tax rates provide the largest stimulus? A) an individual tax rebate B) a cut in tax rates C) They will both produce the same amount of stimulus. D) Neither will provide any stimulus.
b
Social Security benefits have become more generous over time. A) True B) False
b
Social Security taxes account for the largest source of U.S. federal government receipts today. A) True B) False
b
The Fed loaned money to J. P. Morgan and AIG because it was concerned about: A) moral hazard on the part of these banks. B) systemic risk, should these banks fail. C) the liquidity of these banks. D) the market demands being placed on these banks.
b
The Social Security payment system began issuing Social Security checks: A) at the end of World War II. B) in 1940. C) during the Great Depression. D) in 1913.
b
The alternative minimum tax is only assessed on high-income families. A) True B) False
b
The crowding out effect refers to an increase in private spending that leads to a decrease in government spending. A) True B) False
b
The earned income tax credit makes the U.S. federal income tax: A) more regressive. B) more progressive. C) flatter. D) irrelevant to most taxpayers except for the rich.
b
The implementation lag is likely to be: A) longer for changes in government spending than for changes in taxation. B) shorter for changes in government spending than for changes in taxation. C) indefinitely long for both changes in government spending and changes in taxation. D) similar in length for both changes in government spending and changes in taxation.
b
The interest rate commercial banks charge each other on overnight loans is called the: A) prime rate. B) Federal Funds rate. C) discount rate. D) Treasury bill rate.
b
The largest source of revenue for the U.S. federal government is: A) the corporate income tax. B) the individual income tax. C) excise taxes, such as taxes on gasoline and alcohol. D) Social Security and Medicare taxes.
b
The money multiplier is greater than 1 because most banks keep more than 100% of any increase in bank deposits as reserves. A) True B) False
b
The world's largest bank customer is: A) the Federal Reserve. B) the U.S. Treasury. C) the FDIC. D) the SEC.
b
To fight a recession, the federal government can: A) increase taxes. B) increase its spending. C) increase interest rates. D) decrease the discount rate.
b
When a central bank reacts the same way to a shock every time, it is likely using: A) policy discretion. B) a policy rule. C) a bandwagon policy. D) a wait-and-see policy.
b
When the Fed responds to a negative spending shock by increasing the money supply, it is using: A) a policy rule. B) a discretionary policy. C) its political power. D) its credibility.
b
Which does NOT serve as means of payment in the United States? A) paper bills and coins B) mutual funds C) checking or debit account D) savings deposits
b
Which is NOT an automatic stabilizer? A) greater access to credit B) defense spending C) progressive tax system D) welfare programs
b
(Figure: Monetary Policy) Refer to the figure. Assume that the economy is initially at point Y in the graph. If the Fed takes the appropriate action with monetary policy, but banks are slow to lend, then: A) the Fed action would be magnified and the economy would move to point X. B) the Fed action would be nullified and the economy would remain at point Y. C) the Fed action would be partially effective and the economy would move to point Z. D) the LRAS curve would shift to the left.
c
(Table: Multiple Deposit Expansion) Refer to the table. For the multiple deposit expansion process described in this table, if all banks hold only the required reserves, what is the money multiplier in this country? A) 8 B) 10 C) 12.5 D) 5
c
A significant decrease in the rate of inflation is called: A) deflation. B) credible inflation. C) disinflation. D) quantitative easing.
c
Although the Federal Reserve may increase the monetary base, the larger monetary aggregates (M1 and M2) and thus aggregate demand won't increase very much in response if: A) the interest rate is too high. B) the tax rate is too high. C) banks are slow to lend. D) the economy is in recession.
c
An illiquid bank is one that: A) borrows in the market for federal funds. B) borrows at the discount window. C) has more short-term liabilities than short-term assets. D) has more long-term assets than liabilities.
c
An increase in government spending growth will cause the LRAS curve to: A) shift inward. B) shift outward. C) remain unchanged. D) first shift outward and then shift inward.
c
Fiscal policy includes federal government policy on: A) government spending only. B) taxes only. C) both government spending and taxes. D) neither government spending nor taxes.
c
Holding reserves is costly for banks because: A) it forces banks to pay for ATMs. B) it leads to the risk of bank robberies. C) it leads to fewer profits. D) the Fed charges banks interest on required reserves.
c
How many regional banks compose the Federal Reserve System? A) 4 B) 10 C) 12 D) 16
c
If Ricardian equivalence is correct, any tax cut will cause consumer spending to: A) increase. B) decrease. C) remain unchanged. D) change in an unpredictable manner.
c
If the average reserve ratio in the banking system is 20% and the Fed increases bank reserves by $100,000, what will be the total potential increase in the money supply? A) $100,000 B) $120,000 C) $500,000 D) $2 million
c
If the government increases its spending, financing methods that can cause crowding out include: A) raising taxes only. B) selling bonds only. C) both raising taxes and selling bonds. D) neither raising taxes nor selling bonds.
c
The Fed could have popped the bubble of the housing boom in the 2000s by: A) lending directly to homeowners. B) regulating the stock markets more. C) reducing the growth rate of the money supply. D) doing nothing.
c
The primary tools of fiscal policy are: A) money supply and money demand. B) government expenditure and money supply. C) government expenditure and taxation. D) taxation and interest rates.
c
The tax rebate of 2008 had a relatively small impact because taxpayers primarily used the rebate to: A) purchase their annual Christmas gifts. B) take vacations. C) reduce their debts. D) increase their savings.
c
The top 1% of all income earners pay about _____ of all federal taxes in the United States. A) 1% B) 10% C) 25% D) 50%
c
The two lowest marginal tax brackets in the United States are: A) 5% and 10%. B) 7% and 15%. C) 10% and 15%. D) 15% and 25%.
c
Under a flat tax: A) the marginal tax rate is zero, but the average tax rate is one. B) people with higher incomes pay less tax dollars. C) the average tax rate is the same for people with different income levels. D) the amount of tax payment is the same for people with different income levels.
c
When expansionary fiscal policy subsequently increases income and consumer spending, the subsequent increase in AD is called the _____ effect. A) expansionary B) secondary C) multiplier D) crowding out
c
When the Fed increases the money supply to counteract a negative real shock: A) growth usually returns to the level it was before the shock. B) half of the increase is seen in growth and half in inflation. C) inflation increases a lot and growth increases a little. D) growth remains stuck at the level of the negative real shock.
c
Which is a reasonable cause for the formation of the housing bubble in the 2000s? A) high market confidence B) credible monetary policy C) low Federal Funds rate D) the Fed's use of a monetary policy rule
c
Which is the MOST credible monetary policy action? A) The central bank makes policy actions in secret to avoid speculation. B) The central bank attempts to confuse the public by changing its policy stance frequently. C) The central bank announces its policy in public and sticks with the policy over time. D) The central bank does nothing to the economy regardless of any economic shock.
c
The U.S. corporate income tax rate is: A) one of the lowest in the world. B) near average but on the low side for rich countries. C) near average but on the high side for rich countries. D) one of the highest in the world.
d
The discount rate is the interest rate that banks: A) charge borrowers with the lowest credit risk. B) charge borrowers with the highest credit risk. C) pay when borrowing from other banks. D) pay when borrowing directly from the Fed.
d
The income tax is a tax on all of the following, except: A) labor income. B) interest income. C) dividends and capital gains. D) welfare benefits.
d
Together, Social Security, defense, Medicare, and Medicaid make up approximately _____ of the U.S. federal budget. A) one-quarter B) one-third C) one-half D) two-thirds
d
Under which scenario would expansionary fiscal policy work BEST? A) when two real shocks have occurred B) when the economy is at equilibrium in the long run C) when the economy has had a large negative supply shock D) when AD is low compared with the long-run equilibrium position of the economy
d
What strict rule did Milton Friedman believe would provide for greater price stability? A) GDP should not go above 5%. B) Unemployment should never be above 10%. C) Inflation should stay below 3% a year. D) Money supply should grow by 3% annually.
d
When a major negative aggregate demand shock hits the economy, a central bank can "maintain market confidence" by: A) raising the Federal Funds rate. B) buying stocks in the stock market. C) selling Treasury securities in the open market. D) promising to increase the growth rate of money if the economy worsens further.
d
Which is NOT a reason so much U.S. currency circulates in other countries? A) Several countries use the U.S. dollar as their official currency. B) The U.S. dollar is frequently used in drug trafficking. C) Dollars hold their value in unstable countries. D) The Federal Reserve makes loans to other countries.
d
Which is NOT a tool that the Federal Reserve can use to influence AD? A) open-market operations B) lending to banks and other financial institutions C) changes in reserve requirements and the interest rate paid on reserves D) printing money
d
Which of the following is the smallest component of U.S. federal government spending? A) defense B) Social Security C) unemployment and welfare D) interest payments on government debt
d
Which statement does NOT limit the effectiveness of fiscal policy? A) Changes in private spending offset the effects of government spending or taxation. B) The size of government is small in comparison with the economy as a whole. C) Fiscal policy is subject to long and uncertain lags. D) Government spending and taxes have little effect on aggregate demand.
d