C/HW Ch 16, 17, 14, 15

Suppose government purchases amount to $3 trillion, transfer payments amount to $1 trillion, net interest payments are $1 trillion, and tax revenue is valued at $3 trillion. (1) The government deficit is $ ___ trillion. (Enter your response as a whole number.) (2) The primary deficit is $ ___ trillion. (Enter your response as a whole number.)

(1) $2 Tril (3+1+1) - 3 = 2 (2) $1 Tril No interest: (3+1)-3 = 1

What would happen to revenue from seignorage if the inflation rate is very high? Hint: ΔM / P = π × (M / P) and assume a quickly rising price level.

All of the above: - A high inflation rate will lead to a tax on the holders of money balances. - The government will use "new money" to purchase real goods and services, possibly creating more inflation. - The revenue from seignorage will eventually decrease as it happens with any tax when the tax rate is high.

Suppose a firm has a great new​ idea: 12-hour shipping. This idea can decrease costs for many businesses and therefore result in a more efficient economy. If the entrepreneurs who create the concept cannot get funds to put their idea to​ work, a. there will be negative consequences in the shipping industry only. b. the primary negative consequence will be higher inflation. c. there will be negative consequences throughout the economy. d. there will be no negative consequences.

C. there will be negative consequences throughout the economy

Why might a central bank want to intervene in the foreign exchange market to prevent an excessive appreciation of its currency, even if it previously stated that it will allow its currency to respond to supply and demand conditions in the foreign exchange market?

Excessive appreciation of the currency may hurt exporters.

The definition of the government deficit is a matter of debate. What would be the effect on the measurement of the government deficit of considering Social Security taxes a "forced loan to the government" and benefit payments (e.g., Medicare, Social Security benefits, etc) a "repayment of principal plus interest"?

If Social Security taxes and benefits were measured as described above, then there would be no effect on the government deficit.

In recent years, the United States has experienced a sharp increase in obesity rates (in particular amongst teenagers), which is considered to increase the probability of chronic diseases like diabetes. Even if the dependency ratio is constant, what would be the effect of such a trend on the size of the government debt?

It would likely cause the size of the government debt to increase. Because higher tax payments to sustain poor health conditions.

Suppose you go to a​ bank, intending to buy a certificate of deposit with your savings. Assume that the bank offers to pay you​ 2% interest on this certificate of deposit. A customer who comes into the same bank for a car loan is likely to be charged an interest rate higher than the​ 2% that you will receive. Since the customer will be paying more than you are​ receiving, would it make sense for you to offer a loan to that individual at a higher rate than you will receive on your certificate of funds​ (but still competitively lower than the rate currently offered to the car loan​ borrower)?

No, the bank is more efficient than you at dealing with asymmetric information problems.

According to the Federal Reserve Act of 1913​ (Section 13.3):​ "In unusual and exigent​ circumstances, the Board of Governors of the Federal Reserve​ System, [...] may authorize any Federal Reserve​ bank, during such periods as the said board may​ determine, [...] to discount for any​ individual, partnership, or​ corporation, notes,​ drafts, and bills of exchange​ [...]." The Federal Reserve was highly criticized for providing liquidity to corporations and individual market participants​ (most notably in the commercial market​ paper). Which of the following does not support the conclusion that the Federal Reserve acted according to its​ mandate?

When the Federal Reserve expanded its​ lending, the economy was not experiencing unusual or exigent circumstances.

The following table shows the nominal exchange between the U.S. dollar and the euro (U.S. dollars per euro) at different points in time. The graph to the right depicts the data provided in the table. (Note that the exchange rate is quoted as dollars per euro.) (a) Over this time period, the dollar has been ___ with respect to the euro during this period. (b) From November 2009 to December 2009, the percentage change in the exchange rate was ____ % (c) From January 2010 to February 2010, the percentage change in the exchange rate was ____ %. (d) During this period, the exchange rate was relatively ____ .

[See table] (a) appreciating (b) -2.21% (c) -4.11% (d) Volatile

The situation in which a problem in one industry affects other industries is known as

a negative externality

Suppose you are about to buy a car and ask to see a vehicle history report to check previous accidents or problems reported for that car. When you are told that this information is not​ available, you decide not to buy the car. This example illustrates an adverse selection problem or "lemon" problem, where a lemon is slang for a poorly performing product. Given the information​ above, when there is a lack of​ information, transactions

are more difficult to complete because the risks involved are greater.

Suppose a given country encourages its citizens to save​ 20% of their income and allocates these funds through​ government-owned financial intermediaries. As a​ result, many elected officials get mortgages to buy expensive houses​ (and often default on their​ payments). In this​ case, funds are not being allocated to their most productive uses. A more effective way to allocate these funds would be to lend money based on ____ a. the seniority of the elected official asking for the loan. b. the expected risk and return of the projects for which the loan would be used. c. the votes received by the elected official asking for the loan. d. the effectiveness of welfare programs in the economy.

b. the expected risk and return of the projects for which the loan would be used.

A government committed to long-run fiscal discipline (i.e., low or zero budget deficits) usually conducts contractionary fiscal policy at some point to reduce the government deficit. If that action is interpreted as a commitment to long-run fiscal discipline,

consumption and investment spending will increase, which will raise aggregate demand, and long-term bond rates will decrease, allowing the government to pay back its debt.

One of the main characteristics of financial deepening, typically measured as the ratio of a money or credit aggregate to GDP is that more individuals participate in the financial​ system: more people open checking and saving​ accounts, and more firms rely on financial intermediaries as a source of funds. When financial deepening takes​ place, we expect monetary policy to be

more effective than it otherwise would​ be as more people use the financial system

One of the possible solutions to​ asset-price bubbles is the enforcement of macro-prudential regulation. Financial intermediaries have an incentive to constantly look for profitable​ opportunities, which often implies the design of new financial instruments and even the circumvention of contemporaneous regulations. When financial innovation​ occurs:

new financial instruments are​ created, which may initially be​ mismanaged, misunderstood, and difficult to properly regulate.

According to the March​ 16, 2010, FOMC​ statement: "The Committee will maintain the target range for the federal funds rate at 0 to​ 1/4 percent and continues to anticipate that economic conditions​ [...] are likely to warrant exceptionally low levels of the federal funds rate for an extended​ period." As the U.S. economy was already showing some signs of recovery by the first quarter of​ 2010, some people warned that the Federal​ Reserve's actions might increase expected inflation. (1) Which of the following is a reason why low levels of interest rates might fuel inflation​ expectations? (2) Which of the following is a policy the Federal Reserve could use to avoid inflation in the​ future?

(1) All of the above a. If the Federal Reserve keeps its policy instrument​ (i.e., the federal funds​ rate) at low levels while the output gap is​ positive, it will be effectively shifting the demand curve to the right. b. If Federal Reserve policy continues to stimulate​ demand, it can lead to subsequent shifts to the left of the​ short-run aggregate supply curve. c. According to the aggregate demand and supply​ analysis, low levels of interest rates might stimulate aggregate demand and create inflation. (2) The Federal Reserve could begin to raise the target federal funds rate.

Gustavo is a young doctor who lives in a country with a relatively inefficient legal and financial system. When Gustavo applied for a​ mortgage, he found that banks usually required collateral for up to​ 300% of the amount of the loan. (1) Why might banks require that much collateral in a financial system like​ that of Gustavo's country? (2) As a​ result of its financial system, when compared to many other​ countries, we would expect​ Gustavo's nation to​ have:

(1) An inefficient legal system implies weak property​ rights, and collateral helps banks recoup some of their loan if the borrower defaults. (2) less investment and slower economic growth.

As announced by the Obama administration, part of the 2009 fiscal stimulus package is directed to make broadband internet access available to most Americans. This type of spending should be considered as (1)____ . What will be the effect of such expenditures on the government debt burden? (2)

(1) Government investment (2) All of the above: - If the investment does not create increased productivity, then it will cause an increase in debt burden. - If taxes are increased to pay for this spending, then there will not be an additional debt burden. - If this type of investment is successful in increasing productivity, it will not create additional debt burden assuming the increased productivity raises income bey

On March 26, 2010, the Wall Street Journal reported the following: "A sudden drop-off in investor demand for U.S. Treasury notes is raising questions about whether interest rates will finally begin a march higher [...], [...] there are signs the spotlight is turning to the ability of the U.S. to finance its own budget deficit." (1) Explain the effect of higher Treasury notes interest rates on the government deficit. (2) What would be the long-run effect of distrust in the U.S. government's ability to finance its own deficit?

(1) If net interest payments increase, all else constant, the government deficit would also increase. (2) All of the above: - Tax increases may be necessary to reduce the deficit immediately to offset the inability of the government to borrow. - The government could resort to increasing the monetary base to pay for the deficit. - Investors may decide to buy fewer U.S. Treasury notes, causing the government to borrow at higher interest rates.

Assume that the expenditure and tax multipliers can be estimated to be 0.75 and 0.5, respectively. Would you recommend expansionary fiscal policy based on tax cuts or increased government expenditures? Expansionary fiscal policy based on (1)__ should be recommended because this will have a larger effect on (2). (3) Suppose now there is substantial evidence that supports the hypothesis of a crowding out effect in this economy. How would this change your fiscal policy recommendation?

(1) Increase government expenditures (2) Aggregate demand (3) A continued increase in government spending may not be a good idea as there may be further cutbacks in private spending.

The Wall Street Journal printed the following on April​ 14, 2010:​ "Regulators say they are trying to improve transparency and reduce risk in the derivatives​ market" with respect to some​ senators' efforts to modify current regulations. (1) What do regulators mean by​ transparency? Increased transparency is likely to (2) _ the overall financial system by reducing asymmetric information problems. ​However, because revealing information increases costs and lowers the amount of private information financial intermediaries can use to their​ advantage, increased transparency may (3)___their profits.

(1) Making financial information available to the public (2) help (3) decrease

Consider the effect of a tax cut (if government spending remains the same) in a country with an underdeveloped financial system. Assuming individuals are forward looking (i.e., the Ricardian equivalence argument holds), what might happen to national saving in this case? (1) (2)

(1) National saving will likely decline as developing countries do not have efficient bonds or stock markets that allow individuals to buy assets to postpone current consumption. (2) They can buy an asset that could be used as a bequest for future generations.

Figure 1 above, taken from the Federal Reserve Monetary Policy Report to the Congress​ (July 21,​ 2009), shows mortgage delinquency rates from 2001 to 2009 in the United States.'' (1) Why were mortgage delinquency rates higher for subprime​ mortgages? (2) Why did adjustable rate mortgages experience higher delinquency​ rates?

(1) Subprime mortgages were made to borrowers with a lower probability of paying back their loans and more of these borrowers defaulted on their payments when the economy declined. (2) All of the above: a. Many adjustable rate mortgages were made to borrowers with lower probabilities of paying back their loans. b. Borrowers with adjustable rate mortgages experienced an increase in monthly​ payments, which may have raised payments above the​ borrower's ability to pay. c. When interest rates increased from 2004 to​ 2006, the monthly payments for borrowers with adjustable rate mortgages increased.

On November 2007 Brazil announced the discovery of huge oil reserves that could potentially transform the country into a big net exporter of oil. The increased revenues from oil exports would be expected to cause the Brazilian exchange rate to (1)____ How would this affect other Brazilian exports? Is this a desirable outcome for the country as a whole? (2)

(1) appreciate (2) The appreciation of the currency would likely cause other Brazilian exports to decrease, making this an undesirable outcome for the country as a whole

Many policymakers in developing countries have proposed implementing systems of deposit insurance like the one that exists in the United States.​ However, replicating the financial system from one nation may not be successful in other nations due to different​ economies, politics,​ histories, etc. Deposit insurance is designed to lower fears of bank runs and therefore increase public confidence in banks and deposits. ​However, because depositors may feel that the​ "safety net" of deposit insurance means they no longer need to supervise banks​ themselves, asymmetric information in the form of (1) __ may (2) ____.

(1) moral hazard (2) increase

Suppose a bottle of wine sells for $24 in California and for €12 in France. Assuming a nominal exchange rate of 0.75 euro per dollar, calculate the real exchange rate between U.S. wine and French wine. (a) The real exchange rate is ____ (b) Calculate the real exchange rate between U.S. wine and French wine if the domestic price of U.S. wine is now $10 a bottle.

(a) 1.5 (b) 0.625

The following T-account (in billions of dollars) depicts an intervention in the foreign exchange conducted by the Federal Reserve: (a) In the above case, the Federal Reserve (1)____ U.S. dollars. (b) Due to this intervention, the U.S. dollar should (2)_ .

(a) Sold (b) Depreciate

Assume that Social Security taxes remain constant, but that the number of employed people in the United States declines over time. What will happen to the size of contributions for social insurance and the government deficit in the United States?

Social insurance contributions will decrease while the size of the U.S. deficit will increase.

Assume that Social Security taxes and employment remain constant, but there is an increase in unemployment insurance benefits. What will happen to the size of contributions for social insurance and the government deficit in the United States?

Social insurance contributions will remain constant; however, the size of the U.S. government deficit will increase.

As the effects of the​ 2007-2009 financial crisis became more​ pervasive, legislators and policymakers debated about the role played by the Federal Reserve as a regulatory agency. While the Federal Reserve argued for more regulatory oversight of the financial​ system, some policymakers wanted to remove these powers from the Federal Reserve claiming it failed to act as a proper regulator. Using the concept of asymmetric​ information, which of the following is an argument used as criticism of the Federal​ Reserve?

The Federal Reserve failed to act as a proper financial system regulator and as a consequence many firms were allowed to accept too much risk and had to be​ "rescued" later.

In November 2021, following an election in which his party had lost, Argentina's President announced that the country would shortly reach an agreement with the International Monetary Fund (IMF) to pay back US$17 billion in debt it owed to the IMF. In the sovereign bond market, the following likely occurred:

The risk on Argentinean debt​ fell, its yield​ fell, and its price rose.

Microcredit programs usually target a group of women and assign funds to them under the condition that decisions about the use of funds are made by all women in the group. Microcredit loans usually lend to borrowers in extremely poor​ nations, yet in general have higher repayment rates than​ "regular" loans made by financial intermediaries. Why might this​ be?

The moral hazard problem is greatly reduced by providing strong incentives to maintain a good relationship with the group by making loan payments.

According to the​ FDIC, thirty banks failed or were assisted during​ 2008: six were based in​ California, two in​ Florida, and five in Nevada. The New York Times printed in 2007 that Nevada​ (-36.1%), Florida​ (-30.8%), and California​ (-21.3%) were amongst the top five states where home sales dropped​ (in parenthesis) the most between the fourth quarter of 2005 until the fourth quarter of 2006.​ (​Source: http://www.nytimes.com/2007/02/16/business/16home.html​) Which of the following explains how real estate market conditions in these areas can explain almost​ 50% of bank failures in​ 2008?

These areas experienced the largest decline in housing sales. When housing sales and prices​ fall, it reduces the value of real​ estate, which increases the probability that there will be mortgage defaults. Loan defaults reduce bank assets and make it more difficult for a bank to remain solvent.

Figure 1 above from the Federal Reserve Monetary Policy Report to the Congress​ (July 21,​ 2009), shows the gross issuance of mortgage backed securities​ (MBS) in the United States between 2007 and the second quarter of 2009. Which of the following does not occur with the changes in the gross issuance of MBS in the United States during this​ period? a. In March​ 2007, gross issuance of MBS in the United States reached its​ peak, which coincided with the deterioration of the real estate market. b. When home prices declined and foreclosures​ increased, the gross issuance of MBS also​ decreased, as these securities became more risky assets to hold. During the most virulent phase of the housing​ crisis, there were almost no MBS issued​ (late 2008-early​ 2009). c. After the Federal Reserve and the U.S. Treasury provided liquidity and restored confidence in the financial​ market, trading resumed in the market for MBS and the volume increased during the first quarter of 2009. d. All of the above

d. All of the above

Which of the following effects on the economy could occur if the Federal Reserve uses monetary policy to burst a wrongfully identified​ asset-price bubble?

d. All of the above - Investment and consumption expenditures would be expected to​ decline, while unemployment would increase. - Some weak sectors of the economy might suffer from increased interest​ rates, which might create a recession. - To burst the bubble the Federal Reserve would need to raise interest​ rates, decreasing access to funds.

Most legal systems assume that it is better not to incarcerate a guilty individual than to incarcerate an innocent person​ (i.e., if you are making a​ mistake, at least choose the least bad​ one). As central banks can potentially make a mistake when bursting​ asset-price bubbles, which of the following support the​ statement: ​ "it is worse to burst a bubble when it was not necessary then not bursting a bubble when it was needed​ to."

d. All of the above - because central banks have many policy tools to counteract the effect of a price bubble​ burst, it is usually considered wiser to leave bubbles alone and eventually act if needed. - The worst mistake would be to burst a bubble when it was not necessary because the central bank may impose harm to the economy when it was not necessary. - Most central banks are quite conservative with respect to taking actions against​ asset-price bubbles since they cannot guarantee a price bubble has occurred.

Suppose that the Federal Reserve cannot convince the public of its commitment to fight inflation in the United States in the near future. What would be the effect on the expected appreciation of the U.S. dollar? Based on this information, the dollar would be expected to (1)___ in the future.

depreciate