Macro Chapters 13, 14, 15, 16 & 18 TopHat

Expansionary fiscal policy will cause which of the following?

A rise in interest rates. Explanation: Expansionary fiscal policy will increase aggregate demand and in turn aggregate output. But higher aggregate output will increase money demand, which will cause interest rates to rise. Answer B is wrong; if GDP is significantly below potential, an increase in GDP will lead to increased investment. Crowding out is unlikely to have an effect that is so large that investment falls, if the economy is starting at less than potential real GDP.

Which of the following does not explain why the United States currency is valuable?

It is backed by gold

Money eliminates the need for a coincidence of wants in trading primarily through its role as a

medium of exchange

The Federal Reserve Banks are quasi-public banks which means that

they are privately owned but managed in the public interest.

When a consumer wants to compare the price of one product with another, money is functioning as a

unit of account

The functions of money serve as a

unit of account, store of value, and medium of exchange

In the short run which of the following is most responsible for the exchange rate?

Interest rates.

When the U.S. economy has a current account deficit, all of the following may be true except:

It is a bad sign since people and businesses abroad are skeptical about the U.S. economy and its potential in the future Explanation: Any large imbalance is unsustainable whether a deficit or a surplus. However, when the U.S. is in a current account deficit, people and businesses abroad are willing to lend to the U.S. residents, business and the government. It signals that they believe that the U.S. economy is a safe place to make financial investments, their saving will earn higher return than if they kept it at home, or that the U.S. is doing well economically. However, if the people and businesses abroad change their minds, they might not be willing to lend as much in the U.S. As a result, interest rates may go up. Buyers in the U.S. will not be able to import as much as before. This can affect domestic residents negatively.

In a fractional reserve banking system

banks can create money through the lending process

Banks are able to create money

because of our fractional reserve system; because of our definition of money

An increase in the money supply would cause

bond prices to rise, interest rates to fall, and an increase the quantity demanded for money.

Checkable deposits are included in

both M1 and M2

The ability to create money will ---------- as banks lend out --------- money.

increase more decrease less

Other things being equal, an expansion of commercial bank lending

increases the money supply

An increase in the money supply is likely to reduce

interest rates

The U.S. $20 dollar bill is a commodity

is an incorrect statement Explanation: U.S. dollars have one use- money but has no other value and is not used for any other purpose than money. Therefore, U.S. dollars have no intrinsic value.

An increase in investment by Americans in Canada will have which of the following immediate effects?

A decrease in the U.S. financial account surplus Explanation: Funds will flow out in order make those investments and that will reduce the current surplus in the financial account.

Assume there is only one bank and that all the people deposit all of their money into the bank. The people deposit $10 million and the bank holds 10 percent of the deposits as reserves. What is the simple money multiplier in this economy?

10 Explanation: The simple money multiplier is 1/reserves so 1/0.05 would be 20. In words, this means for every $1 put into the bank, that dollar grows to a total of $20 through the lending and borrowing of money in the economy.

From the money model above, what would be the cause and effect of the money supply shifting to the right?

A bond purchase by the Fed and a decrease in interest rates.

Which of the following will decrease the supply of money in the economy?

A customer repaying a loan. Explanation: When a borrower is paying off a loan, the bank collects the borrower's currency. If no new loans are created from this currency, then the money supply shrinks. For example, if the borrower paid $1 of the loan to the bank, then that $1 is not being lent out to another customer. Recall the simple money multiplier causes the money supply to grow. So when $1 is not loaned, then the growth that was created by the simple money multiplier does not occur. The money supply will decrease if the bank holds the $1 and does not lend it out then that $1 shrinks the economy by the amount of the simple money multiplier.

If an economy appears to be growing rapidly and inflation appears to be becoming a serious problem, which of the following fiscal policies would be appropriate?

A decrease in government spending Explanation: In an inflationary period, the problem may be too much spending. The fiscal policy to restrict spending includes decreasing government spending, increasing taxes, or decreasing transfer payments. Any of these three will have a multiplied negative effect on spending and will return the economy back to full-employment. Of the options available to you in the question, a decrease in government spending would have the effect on spending that you would want to reduce inflation. Decreasing government spending would have a multiplied negative effect on total spending, which would in turn reduces aggregate demand.

Which of the following best describes the cause-effect chain of contractionary monetary policy?

A decrease in the money supply will raise the interest rate, decrease investment spending, and decrease aggregate demand and GDP.

Which event would cause the dollar to appreciate against the euro, if everything else remains the same?

An increase in interest rates in the U.S. Explanation: The dollar will appreciate if relative interest rates in the U.S. versus Europe increase. The dollar will also appreciate if prices in the U.S. decline relative to Europe.

Which of the following groups serve on the Federal Open Market Committee (select all that apply)?

All members of the Board of Governors Five of the regional Federal Reserve Bank presidents Explanation: The FOMC consists of all 7 members of the board of governors, the New York Fed president, and 4 of the regional bank presidents on a rotating basis.

Which of the following explains why purchasing power parity does not hold?

All of the above are reasons why purchasing power parity does not hold. Not all goods are traded. Shipping costs could explain differences in exchange rates. There may be import taxes or restrictions which alter prices. Explanation: For purchasing power parity to hold, goods need to move freely between borders without taxes or shipping costs. Also, purchasing power parity only applies for tradeable goods, where exchange rates are relevant. The price indexes, however, include non-tradeable goods as well.

Which event would cause the dollar to depreciate against the peso if everything else remains the same?

An increase in prices in the U.S. Explanation: The value of a currency will depreciate if its relative prices increase or its relative interest rates decrease. Also, as income increases the country's imports will increase causing the currency value to decrease. The opposite is then true if the countries income decreases. An increase in interest rates in the U.S. makes the dollar more attractive and would increase the value of the dollar.

Compare two situations:Year 1. Real GDP increases, and at the same time, interest rates increase.Year 2. Real GDP increases, and at the same time, interest rates decrease. What is a possible explanation of the difference?

An increase in spending may have caused the increase in GDP in year 1; an increase in the money supply may have caused the increase in GDP in year 2. Explanation: A rise in interest rates and GDP must have been caused by something that increased income without increasing the money supply. This would result in higher interest rates. An increase in planned spending might have caused this. In the year 2 scenario, expansionary monetary policy reduces interest rates and can increase real GDP.

Which of the following statements is true?

Bond prices and the interest rate are inversely related

Which of the following groups would prefer monetary policy to ameliorate a recession, as opposed to fiscal policy?

Borrowers Explanation: Expansionary monetary policy lowers interest rates while expansionary fiscal policy raises interest rates. Borrowers prefer low interest rates and lenders prefer high interest rates.

Which of the following reasons make monetary policy preferable to fiscal policy in inflation?

Both A and B A shorter implementation lag There is no limit on how high the interest rate can go up.

Which of the following enables a country to fix its currency to another currency?

Buying domestic currency or selling foreign currency to assure a stable exchange rate Buying and selling foreign government bonds to assure a stable exchange rate Selling domestic currency or buying foreign currency to assure a stable exchange rate Explanation: Governments fix their currency by buying bonds from other countries, whereby they sell their own currency and buy foreign currency. Governments can also sell foreign currency and buy domestic currency to keep their currency stable.

What monetary policy would intend to hold down inflation?

Decrease the money supply to shift the aggregate demand curve leftward

Which of the following best describes the immediate effect of an increase in U.S. tariffs on goods and services manufactured abroad? The balance of trade

Deficit will decrease Explanation: The initial effect would be to decrease imports and that would reduce the trade deficit.

From the money model above and starting at point FFR1, Ms1, which point would be the new (interest rate, quantity of money), from an increase in RGDP and purchase of T-bills by the FED.

FFR1, Ms2

The paper money used in the United States is

Federal Reserve Notes

Assume that we are currently producing less than the potential level of GDP. Which of the following is a valid argument for active use of monetary policy instead of fiscal policy?

Fiscal policy may cause crowding out of investment Explanation: Fiscal policy may cause crowding out of investment when the economy is nearing full employment. If the government is concerned with the amount of investment and long-run economic growth, the desired policy might be to use an increase in the money supply to lower interest rates to increase investment.

A strong dollar increases ______________ and reduces ______________.

Imports; exports Explanation: As the dollar strengthens, it takes more foreign currency to buy the dollar, causing the price of exports to rise, and the price of imports to decline.

A decrease in the interest rate will cause a(n)

Increase in the amount of money held as an asset

The simple money multiplier will ______________ as the required reserve ratio ______________

Increase, decreases Explanation: as the required reserve ratio gets smaller or decreases, banks have excess reserves and can create more loans. This means the simple money multiplier must increase. This also causes the quantity of money in the economy to increase.

According to the advocates of crowding out, an increase in government spending will cause the demand for money to ______________, then interest rates to ______________, which in turn causes investment spending to ______________.

Increase, increase, decrease Explanation: An increase in federal spending would have a multiplied positive effect on total spending. This means that people are spending more and will demand more money. As the demand for money increases, interest rates will rise. With higher interest rates, the cost of borrowing money for investment will be higher, so investment will fall. This is part of the explanation of the "crowding out" phenomenon.

Contractionary monetary policy will likely be accompanied by a(n) ______________ in interest rates and that change in interest rates will cause a(n) ______________ in the value of the dollar.

Increase; increase Explanation: Restrictive monetary policy will result in an increase in interest rates, which will increase the demand for the dollar and that will increase the value of the dollar.

All of the following explain why the U.S. trade deficit with Germany would expand, except ______________.

Increased interest rates in Europe Explanation: As interest rates in Europe increase, the Euro will gain value as money flows into Europe. The dollar will therefore decline in value, which increases exports and decreases imports. Each one of the other changes would increase the value of the dollar and thus increase imports and decrease exports.

Which of the following accurately refers to "crowding in"?

Increased investment in response to expansionary fiscal policy. Explanation: When the federal budget deficit is increased there are two effects; which one dominates will determine whether crowding out or crowding in occurs.An increased deficit means that government spending has increased or taxes have decreased. The stimulus to spending is a positive one and will cause more investment as real GDP increases. The increased deficit also means that interest rates will increase, raising the cost of investment. Thus, investment will fall. If the latter effect is larger than the first, we will have crowding out. Investment spending decreases. If the first is larger, we have crowding in, that is, an increase in investment.

A temporary income tax cut will be ______________ effective as a fiscal policy than a permanent change ______________.

Less; because future income is not affected Explanation: A tax cut that is permanent increases current disposable income and future disposable income. Both current and future income affect current consumption. A temporary tax cut only affects current disposable income and thus has a smaller effect on consumption. The effect on future income is the relevant explanation, not the effects of the tax change on the deficit.

The demand for money will shift to the right as a result of (multiple answers are accepted)

an increase in GDP

Credit cards are part of

Neither M1 nor M2 Explanation: Credit cards are not money. Credit cards are a means of transferring money. The credit card firm pays for your purchase and then you pay the credit card company the money it used to pay for your purchase.

An economy is producing at a level of output that is equal to the full-employment level of output. Prices of a fundamental resource, such as oil, decrease significantly. What would be the best monetary policy?

No monetary or fiscal policy would be required. Explanation: There is a trade-off. Two problems (higher unemployment and higher inflation) have been created. Either policy will make one of the problems worse.

Assume that the economy is currently producing a level of real GDP above the full employment level of real GDP, and the government lowers taxes as part of a new economic policy. Which of the following monetary policies should the Federal Reserve undertake if it wants to encourage the economy to go to a full employment level of output?

Raise the federal funds rate target Explanation: If the economy is already producing above the full employment level of real GDP, there is already upward pressure on prices. A tax decrease will shift aggregate demand out putting further upward pressure on prices. To offset this pressure, the federal reserve needs to reduce aggregate demand. One way to do so is to raise the federal funds rate target.

Ways the U.S. can reduce its current account deficit include the following, except:

Reduce exports to international countries by eliminating free trade agreements Explanation: Smaller exports means the trade balance, which is exports minus imports, will fall further. This would make the current account deficit larger.

When the Federal Reserve announces that it is increasing the federal funds rate, we would expect to see banks do which of the following?

Reduce their loans because they have fewer reserves due to the Fed's open market sales. Explanation: When the Fed increases the federal funds rate, it sells bonds. Banks and the nonbank public buy these bonds by sending the Fed a check. This reduces the amount of reserves banks have and so banks need to reduce their lending to achieve the required reserve ratio.

Consider the following quote: "Over one and a half million people were laid off from jobs following the doubling of oil prices in 1979." What was the policy dilemma faced by monetary and fiscal policy makers?

Rising prices and rising unemployment Explanation: The policy dilemma is rising prices and rising unemployment. If policy is used to stimulate the economy, inflation will rise further. If policy is used to slow the economy down, unemployment will rise. If tax and spending policy is used to increase supply, it is likely that spending will increase before supply, thus causing more inflation.

What do people and businesses abroad do with all the money U.S. residents send them in exchange for the goods and services we import? All of these except for:

Sell their international government bonds to U.S. Explanation: The money they receive from the U.S., beyond the money they send back to the U.S. for exports, could be kept as currency or deposited in bank accounts in international banks. People and businesses abroad want to find a good place for the proceeds of their exports and save it by often buying stocks and bonds that have a higher return. They also buy real estate that increases in value over time.

Which of the following make(s) the conduct of discretionary policy difficult?

The Fed implements policy now that will affect the economy in the future The Fed has to make forecasts about the future based on current data The Fed is uncertain about how large the effect of a policy change will be

Which of the following are false?

The demand for money is upward sloping The demand for money is vertical. The supply of money is the positive relationship between the quantity supplied of money and the interest rate. Banks can create money by printing Federal Reserve Notes The US money multiplier rises during recessions. The demand for money is the inverse relationship between the interest rate and the opportunity cost of holding money.

The most commonly used monetary policy instrument is _________.

The federal funds rate and open market operations Explanation: The FOM considers open market operations and changes in the federal funds rate to be the most important and routinely makes changes to these, but rarely changes the required reserve ratio. The discount rate tends to move along with the federal funds rate but discount loans are rarely used except during financial crises.

Which of the following is not a sufficient reason for the preference of fiscal policy over monetary policy in a recession?

The implementation lag.

What three features of an economy are the most influential in exchange rate determination?

The interest rate, the GDP growth rate, and purchasing power parity.

What is the opportunity cost of holding currency? (multiple answers are accepted)

The interest that could have been earned if the currency was in the bank. Explanation: By holding currency, you do not earn interest. Therefore, by holding currency, the cost is what you give up, which would be the interest rate.

Which is the most accurate sequence of events when the Fed buys T-Bills?

The money supply is increased, which decreases the interest rate, and causes investment spending, output, and employment to increase

Which of the following occurs when monetary authorities raise the excess reserves of commercial banks?

The money supply is increased, which decreases the interest rate, and causes investment spending, output, and employment to increase

Which of the following varies directly with the interest rate?

The opportunity cost of holding money

Which of the following statements comparing the lags of monetary and fiscal policy is accurate?

The policy-making lag for fiscal policy is longer than monetary policy. Explanation: Fiscal policy generally requires approval by Congress, a process which can take quite a long time. Even after the policy has been approved by Congress, it takes time for the actual changes in spending to take place.

Assume the economy faces high unemployment but stable inflation. Which combination of government policies is most likely to reduce unemployment?

The purchase of government securities in the open market and an increase in government spending.

An economy is producing at a level of output that is equal to the full-employment level of output. Prices of a fundamental resource, such as oil, increase significantly. What would be the best monetary policy?

There is no obviously correct policy, unless you can specify your goals. Explanation: There is a trade-off. Two problems (higher unemployment and higher inflation) have been created. Either policy will make one of the problems worse.

Once decisions have been made to use monetary policy and fiscal policy to solve a problem, it will take more time for monetary policy to have an effect on real GDP and the inflation rate than would an increase in government spending.

True Explanation: Monetary policy will take longer, because monetary policy works by changing the money supply, which starts a long process. The change in the money supply changes interest rates, which changes investment spending, which changes total spending. Fiscal policy works to change total spending directly in the case of changes in government spending and almost directly in the case of changes in taxes.

The benefit of the current account deficit involves all of the following except:

We end up investing too little in our U.S. domestic economy using the loans from the people and businesses abroad Explanation: There is no indication that we are investing too little. In fact, we are able to invest more as a result.

"An increase in the budget deficit can be beneficial for the economy," said a member of Congress during the November budget debates. Could this statement be true?

Yes Explanation: An increase in the budget deficit will benefit the economy when the economy is in a recession. An increase in government spending or a decrease in taxes will cause growth in total spending.

On a diagram where the interest rate and the quantity of money demanded are shown on the vertical and horizontal axes respectively, the demand for money can be represented by

a downward sloping line or curve from left to right.

An increase in the demand for money would cause

a fall in bond prices, an increase in interest rates and no change the supply of money.

The effectiveness of monetary policy is limited by the

all of the above the location of the investment demand function. the slope of the investment demand function. being able to put off interest-sensitive spending decisions.

If the economy were encountering a severe recession, proper monetary and fiscal policies would call for

buying government securities, reducing the reserve ratio, reducing the discount rate, reducing interest paid on reserves held at Fed banks, and a budgetary deficit.

The largest component of the money supply (M1) is

checkable deposits

Money supply M1 does not include the currency held by

commercial banks

The Federal Reserve System was set up to be a ______________ and politically ______________ institution.

decentralized; independent Explanation: In order to pass the Federal Reserve Act, Congress structured the reserve system so that it was dispersed across the country and so that leadership would not be easily controlled by one location or group. Board members are appointed for 14-year terms to reduce the political pressure to make politically popular but unwise decisions.

If the Fed is trying to make the interest rates go down, its objective is to

decrease unemployment

During the Great Recession of 2007-2009, interest rates

decreased to about zero, and investments also declined sharply.

One major advantage of money serving as a medium of exchange is that it allows society to

escape the complications of barter

We hold more money when the interest rate

falls because it has a low opportunity cost

Store owners in the U.S. accept dollars for the purchase of goods and services. Every day, you have woken up and believed that the exchange of dollars for goods and services could occur because

money is a medium of exchange

Monetary policy is thought to be

more effective in controlling demand-pull inflation than in moving the economy out of a recession.

The goldsmith's ability to create money came from the discovery that

paper money in the form of gold receipts was rarely redeemed for gold

A lower real interest rate typically induces consumers to

purchase more goods that are bought using credit.

An increase in interest rates causes the

quantity demanded of money to decrease Explanation: An increase in interest rates increases the opportunity cost of holding currency. As the cost of holding currency increases and the benefits do not change, the quantity demanded of money will fall.

According to the Taylor rule, if the inflation gap is zero and real GDP rises by one percent above potential GDP, then the Fed should

raise the federal funds rate by half of a percentage point

If the Fed wants to reduce the monetary multiplier, it should

raise the required reserve ratio

The newspaper headline in December, 2019, that the Fed took no action on the federal funds rate indicates that

there appears to be no or little risk of inflation.

When the federal reserve announces that it is increasing the federal funds rate, it is actually going to ___________.

sell bonds in the open market until the federal funds rate rises to the new target Explanation: The Fed announces a new federal funds rate and then makes it happen by buying or selling bonds to influence interest rates. When the fed sells bonds, bond prices fall and interest rates rise.

The Federal Reserve could reduce the money supply by

selling government bonds in the open market. raising the discount rate.

A newspaper report that the Federal Reserve will lower the discount rate again this year says that the Fed is trying to

stimulate the economy

The supply of money is vertical because it is assumed that

the Fed has the ultimate control of the money supply.

The Federal Funds Rate is

the bank to bank overnight lending rate of at least 1 million dollars. the rate that a bank pays another bank when it borrows money on the federal funds market.

To maintain current interest rates, the Fed would buy government bonds in the open market when

the demand for money increases

The interest rate that the Fed charges banks for loans to them through the traditional channel is called

the discount rate

The discount rate is

the rate that a bank pays the Fed when it borrows from the Fed.

The prime rate is

the rate that banks charge their most preferred customers.