Practice Problems: M&B

A decrease in the discount rate does not normally lead to an increase in borrowed reserves​ because: A.the equilibrium interest rate will still fall below the discount rate. B.there is often a time lag between a decrease in the discount rate and the market reaction to it. C.a decrease in the discount rate usually leads to an increase in nonborrowed reserves. D.setting the discount rate below the equilibrium rate is forbidden by​ law, since a clear arbitrage opportunity would exist.

A

Both the portfolio choice and​ Keynes's theories of the demand for money suggest that as the relative expected return on money​ falls, demand for it will fall. Why would the portfolio choice approach predict that money demand is unaffected by changes in interest​ rates? A.A rise in interest rates leads to an increase in the implicit interest paid on checkable​ deposits, so the relative expected return on money only falls by a small amount. B.A rise in interest rates leads to a lower relative expected return on money and hence a lower demand for money. C.Velocity is unpredictable because interest​ rates, which have large​ fluctuations, affect the demand for money and hence velocity. D.None of the above are correct.

A

Does inflation targeting help reduce the​ time-inconsistency of discretionary​ policy? A.​Yes, it is a mechanism of​ self-discipline, which effectively ties the hands of policymakers to commit to a policy path. B.​Yes, it decreases the transparency of monetary policy strategy and hence the​ public's expectations of inflation. C.No, inflation targeting decreases the accountability of monetary policymakers. D.​No, there is no direct relationship between inflation targeting and solving the​ time-inconsistency problem.

A

If the Fed has an​ interest-rate target, why will an increase in the demand for reserves lead to a rise in the money​ supply? A.The Fed will conduct open market purchases. B.The Fed will conduct open market sales. C.The Fed will increase reserve requirements. D.The Fed will increase the discount rate.

A

The​ short-run aggregate supply curve slopes upward because an increase in output relative to potential​ output: A.creates tight labor and product markets that cause inflation to rise. B.leads to unstable markets and higher inflation. C.causes markets to have excess​ supplies, putting upward pressure on inflation. D.induces aggregate demand to​ increase, increasing inflation.

A

Why would a central bank be concerned about​ persistent, long-term budget​ deficits? A.It may increase inflation​ expectations, making it harder to keep inflation anchored at a​ low, stable level. B.It always leads to decreases in government​ spending, which lowers output and increases unemployment. C.The government may decide to finance the deficit by issuing​ bonds, which increases its debt and inflation level. D.Policymakers may decide to reduce the deficit by monetizing the​ debt, leading to large decreases in the monetary base.

A

​"If f ​increases, then the Fed can keep output constant by reducing the real interest rate by the same amount as the increase in financial​ frictions." Is this statement​ true, false, or​ uncertain? Explain your answer. A.False. The Fed would need to reduce the real interest rate by a little bit less than the change in f to keep output constant. B.True. The Fed can keep output constant by reducing the real interest rate by the same amount as the increase in financial frictions. C.Uncertain. It depends on whether the​ Fed's distaste for inflation​ (characterized by the parameter lambdaλ​) equals zero or not.

A

​"If prices and wages are perfectly​ flexible, then gammaγ ​= 0 and changes in aggregate demand have a smaller effect on​ output." Is this statement​ true, false, or​ uncertain? Explain your answer. A.False. As prices and wages become more​ flexible, γ becomes​ larger, and thus for a given aggregate demand​ shock, the effects on output are smaller. B.False. When prices and wages are perfectly​ flexible, γ becomes​ smaller, and thus for a given aggregate demand​ shock, the effects on output are always larger. C.True. When γ ​= 0, the​ short-run aggregate supply curve becomes​ steeper, and thus the effects of changes in aggregate demand on output are smaller. D.Uncertain. The effect on output caused by changes in aggregate demand also depends on the size of the output gap.

A

​"The Fed decreased the fed funds rate in late​ 2007, even though inflation was increasing. This demonstrates a violation of the Taylor​ principle." Is this statement​ true, false, or​ uncertain? Explain your answer. A.False. It was the autonomous component of the fed funds rate that was decreased through an autonomous monetary policy easing. The​ Fed's distaste for inflation did not change and remained positive. B.True. Under the Taylor​ principle, the fed funds rate should have been raised by more than any rise in expected inflation. C.Uncertain. Although the responsiveness of the real interest rate to the inflation rate​ declined, which could be a violation of the Taylor​ principle, the real interest rate increased.

A

​"The depreciation of the dollar from December 2008 to December 2009 had a positive effect on aggregate demand in the​ U.S." Is this statement​ true, false, or​ uncertain? Explain your answer. A.True, since a cheaper dollar increases net​ exports, a component of aggregate demand. B.​False, since the​ dollar's value in foreign exchange markets has no bearing upon aggregate demand. C.False, since a dollar depreciation harms U.S. competitiveness in world markets. D.​Uncertain, since many other variables were changing at the same time.

A

​"The federal funds rate can sometimes be below the interest rate paid on​ reserves." Is this statement​ true, false, or​ uncertain? Explain your answer. A.True. This may happen because nonbank financial​ institutions, which cannot earn interest on​ reserves, participate in the federal funds market. B.False. Banks would prefer earning a​ risk-free interest rate rather than loaning excess reserves in the more risky federal funds market at an equivalent or lower rate. C.Uncertain. It depends on the stigma associated for a bank to borrow directly from the Fed.

A

​"When the stock market​ rises, investment is​ increasing." Is this statement​ true, false, or​ uncertain? Explain your answer. A.False. The buying and selling of stocks represents transfers of existing​ assets, and new production does not occur. B.False. When the stock market​ rises, less borrowing is likely to​ occur, thus decreasing investment. C.True. The buying and selling of stocks will increase​ income, so new production must occur. D.Uncertain. Investment spending is most likely influenced by emotional waves of optimism or pessimism and not changes in the stock market.

A

"Interest rates can be measured more accurately and quickly than reserve​ aggregates; hence an interest rate is preferred to the reserve aggregates as a policy​ instrument." Do you agree or​ disagree? A.Agree. Policymakers care only about nominal interest rates when making policy decisions and do not use the money supply or its aggregates in making decisions. B.Disagree. The measurement of real interest rates requires estimates of expected​ inflation, and it is not true that real interest rates are necessarily measured more accurately and quickly than the money supply. C.Disagree. Nominal interest rates are measured more accurately and quickly than the money​ supply; therefore,​ interest-rate targets are not necessarily better than​ money-supply targets. D.Agree. Although nominal interest rates are measured more accurately and quickly than the money​ supply, the​ interest-rate variable that is of more concern to policymakers is the real interest rate.

B

Following the global financial crisis in​ 2008, assets on the Federal​ Reserve's balance sheet increased​ dramatically, from approximately​ $800 billion at the end of 2007 to​ $3 trillion in 2011. Many of the assets held are​ longer-term securities acquired through various loan programs instituted as a result of the crisis. In this​ situation, how could reverse repos​ (matched sale-purchase​ transactions) help the Fed reduce its assets held in an orderly​ fashion, while reducing potential inflationary problems in the​ future? A.Reverse repos serve as a temporary open market sale in which the Federal Reserve temporarily sells assets to further increase its balance​ sheet, thus increasing the money supply and lowering​ short-term interest rates. B.Reverse repos serve as a temporary open market sale in which the Federal Reserve temporarily sells assets to reduce its balance​ sheet, thus decreasing the money supply and raising​ short-term interest rates. C.Reverse repos serve as dynamic open market operations that are intended to permanently reduce the Federal​ Reserve's balance​ sheet, thus limiting fluctuations in the money supply. D.In this​ situation, the Fed should engage in repurchase agreements​ (a repo) rather than reverse​ repos, as this would further expand reserves and the monetary base.

B

If households and firms believe the economy will be in a recession in the​ future, will this necessarily cause a​ recession, or have any impact on output at​ all? A.While such pessimistic expectations can reduce autonomous​ investment, these beliefs cannot affect equilibrium output to the point where a recession is likely. B.If these beliefs are strong​ enough, it could reduce autonomous investment to a point where equilibrium output decreases​ significantly, leading to a recession. C.Such emotional​ beliefs, or animal​ spirits, are based on rational expectations and therefore are an accurate predictor of the economy. D.These expectations may create uncertainty in an​ economy; however, they are irrational and will have no impact on output at all.

B

Why did Keynes think that money demand is affected by changes in interest​ rates? A.Money demand is not affected because interest rates do not fluctuate very often. B.A rise in interest rates leads to a lower relative expected return on money and hence a lower demand for money. C.A rise in interest rates leads to an increase in the implicit interest paid on checkable​ deposits, so the relative expected return on money only falls by a small amount. D.None of the above are correc

B

Would it be problematic for a central bank to have a primary goal of maximizing economic​ growth? A.Yes, because this may result in structural changes in the economy that could lead to an increase in inflation. B.Yes comma because this could lead to imbalances in the economy that could lead to bubbles and financial crises.Yes, because this could lead to imbalances in the economy that could lead to bubbles and financial crises. nothing C.​No, by maximizing economic​ growth, a central bank can effectively achieve its goal of high employment and price stability. D.No, because this could balance the economy and prevent bubbles and financial crises from occurring.

B

​"If the demand for reserves did not​ fluctuate, the Fed could pursue both a reserves target and an​ interest-rate target at the same​ time." Is this statement​ true, false, or​ uncertain? Explain your answer. A.False. A reserves target and​ interest-rate target can never have the same policy outcome. B.True. The target interest rate would have a set level of reserves that would only change if the Fed desired. C. True. The nominal interest rate and the real interest rate would have to be the same. D.Uncertain. There is not enough information about how the interest rate would be set.

B

​"Since inventories can be costly to​ hold, firms' planned inventory investment should be​ zero, and firms should acquire inventory only through unplanned inventory​ accumulation." Is this statement​ true, false, or​ uncertain? Explain your answer. A.True. Firms will earn more by purchasing securities and thus should not hold excess inventory. B.False. Firms may prefer to hold excess inventory to meet unpredictable consumer demands. C.False. If the cost of real borrowing is​ low, firms should increase their inventory holdings to increase future profits. D.Uncertain. The mpc is required to determine whether holding the additional inventory is worth the cost.

B

Describe how​ (if at​ all) the IS​ curve, MP​ curve, and AD curve are affected in the following ​situation: The new Federal Reserve chair begins to care more about fighting inflation.The new Federal Reserve chair begins to care more about fighting inflation. A.The IS and AD curves shift to the left, and the MP curve does not shift.The IS and AD curves shift to the left, and the MP curve does not shift. nbsp B.None of the curves are affected.None of the curves are affected. C.The IS curve is not affected, the MP curve becomes steeper, and the slope of the AD curve becomes flatter.The IS curve is not affected, the MP curve becomes steeper, and the slope of the AD curve becomes flatter. D.The economy moves along the IS curve, the MP curve shifts down, and the net effect on the AD curve cannot beThe economy moves along the IS curve, the MP curve shifts down, and the net effect on the AD curve cannot be definitely determined. E.The AD curve shifts to the left, the MP curve becomes flatter, and the slope of the IS curve becomes steeper.

C

During an expansin​, how would you expect velocity to typically behave over the business​ cycle? A.Velocity will not change because real GDP will rise and restrictive policy will be implemented.not change because real GDP will rise and restrictive policy will be implemented. B. Velocity will decline comma since it will become less convenient for purchases to be paid for with cash or checks.decline, since it will become less convenient for purchases to be paid for with cash or checks. C.Velocity will increase comma since the money supply will be less expansionary comma and nominal GDP will rise.increase, since the money supply will be less expansionary, and nominal GDP will rise. D.The change in velocity will be unpredictable because of high inflation and price fluctuations.

C

How is an autonomous tightening or easing of monetary policy different than a change in the real interest rate due to a change in the current inflation​ rate? A.Tightening or easing of monetary policy may cause a change in the responsiveness of the real interest rate to the inflation​ rate, not in its autonomous component. B.Tightening or easing of monetary policy is reflected as a movement along the monetary curve rather than an upward or downward shift of the curve. C.With a tightening or easing of monetary​ policy, some projected changes in monetary policy independent of the current inflation rate may occur. D.Autonomous tightening or easing of monetary policy is based on a change in the nominal interest​ rate, not the real interest rate.

C

What is the advantage of quantitative easing as an alternative to conventional monetary policy when​ short-term interest rates are at the zero​ lower-bound? A.Quantitative easing always causes an increase in economic activity through greater loans and monetary expansion.Quantitative easing always causes an increase in economic activity through greater loans and monetary expansion. B.Banks hold the extra liquidity received from quantitative easing as excess reserves and hence decrease their risks.Banks hold the extra liquidity received from quantitative easing as excess reserves and hence decrease their risks. C.Purchases of longer minus term securities could reduce longer minus term interest rates and hence lead to an expansion.Purchases of longer−term securities could reduce longer−term interest rates and hence lead to an expansion. D.Purchases of intermediate securities could further decrease the money supply and hence lead to an increase inPurchases of intermediate securities could further decrease the money supply and hence lead to an increase in borrowing.

C

What is the key assumption underlying the​ Fed's ability to control the real interest​ rate? A.It is the real interest​ rate, not the nominal​ rate, that determines the level of equilibrium output. B.The real interest rate is the nominal interest rate minus expected inflation. C.Because inflation is relatively sticky in the short​ run, when the Federal Reserve changes the federal funds​ rate, it implies similar changes in real interest rates. D.Nominal interest rates should be increased by more than any rise in expected inflation to stabilize inflation.

C

​"A central bank with a dual mandate will achieve lower unemployment in the long run than a central bank with a hierarchical mandate in which price stability takes​ precedence." Is this statement true or​ false? Explain your answer. A.True. The​ short-run Phillips curve shows an inverse relationship between inflation and unemployment. B.True. Inflation targeting only allows a central bank to focus on inflation. C.False. There is no​ long-run trade-off between inflation and unemployment. D.False. Inflation targeting still allows central banks to constantly adjust for unemployment concerns.

C

​"If nominal GDP​ rises, velocity always​ rises." Is this statement​ true, false, or​ uncertain? A.True. If nominal GDP​ rises, the money supply decreases and hence velocity will always rise. B.False. If nominal GDP​ rises, the money supply will rise proportionately and hence velocity will remain constant. C.False. If the money supply increases by a greater amount than nominal​ GDP, velocity will decline. D.Uncertain. It depends on whether nominal GDP increases because of an increase in P or an increase in Y.

C

According to​ Keynes's analysis of the speculative demand for​ money, which of the following shows that velocity will undergo substantial fluctuations and thus cannot be treated as​ constant? A.Keynes believed that changes in​ people's expectations about what the normal level of interest rates are will cause money demand and hence velocity to fluctuate. B.Since Keynes believed velocity is affected by interest rates and interest rates fluctuate a​ lot, velocity will as well. C.Keynes believed that money demand and hence velocity are affected by interest rates. D.All of the above are correct. E.None of the above are correct.

D

In​ Keynes's analysis of the speculative demand for​ money, what will happen to money demand if people suddenly decide that the normal level of the interest rate has​ declined? Why? A.Money demand will increase because people will want to borrow more money. B.Money demand will stay the same because the speculative component of the demand for money is viewed as insensitive to interest rates. C.Money demand will increase because as interest rates​ fall, the price of bonds falls. The relative decrease in the expected return on bonds makes money more attractive. D.Money demand will decrease because as interest rates​ fall, the price of bonds rises. The relative increase in the expected return on bonds makes money less attractive.

D

When comparing the monetary base to M1 on the grounds of controllability and​ measurability, why would you prefer the monetary base as an intermediate​ target? A.The monetary base is measured more accurately and quickly. B.The monetary base is more directly influenced by the tools of the Fed. C.The Fed can calculate data on the monetary base from its own balance sheet​ data, while it constructs M1 numbers from surveys of​ banks, which take some time to collect and are not always that accurate. D.All of the above are correct.

D

Why is paying interest on reserves an important tool for the Federal Reserve to manage​ crises? A.It allows for fluctuations in the federal funds​ rate, making monetary policy more flexible. B.It allows the Fed to increase the money supply to support excessive demand for goods and services. C.It allows the Fed to increase the effective tax on​ deposits, thereby increasing economic efficiency. D.It allows the Fed to increase its lending as much as it wants without reducing the federal funds rate.

D

Why is the composition of the​ Fed's balance sheet a potentially important aspect of monetary policy during a​ crisis? A.A consistent composition of the​ Fed's balance sheet provides transparency and certainty for markets and households in making decisions about the future. B.Providing liquidity to financial organizations adds reserves to the general banking system and reduces risk. C.When the Fed provides liquidity to a particular segment of the credit​ market, it can freeze the market and hence decrease inflation. D.The Fed can influence interest rates and provide more targeted liquidity.

D

You often read in the newspaper that the Fed has just lowered the discount rate. Does this signal that the Fed is moving to a more expansionary monetary​ policy? Why or why​ not? A.Yes. The Fed usually uses the discount rate to manipulate the money supply. B.No. The Fed usually lowers the discount rate to signal contractionary policy. C.Yes. The Fed usually uses the discount rate to signal the future of monetary policy. D.No. The Fed usually lowers the discount rate when market rates fall regardless of the direction of monetary policy.

D

​"Since financial crises can impart severe damage to the​ economy, a central​ bank's primary goal should be to ensure stability in financial​ markets." Is this statement​ true, false, or​ uncertain? Explain your answer. A.True. If financial market stability is​ maintained, then funds are channeled to the most productive investment​ opportunities, thus leading to an expansion in economic activity. B.False. Price stability should always be the primary goal of any central bank. C.True. If financial market stability had been​ pursued, the​ 2007-2009 recession would have been prevented. D.Uncertain. Although stability in financial markets is an important​ goal, focusing on other goals such as stabilizing​ employment, output, or even​ short-term movements in the business cycle may be more important to the economy.

D

If higher inflation is​ bad, then why might it be advantageous to have a higher inflation​ target, rather than a lower target closer to​ zero? A.A higher inflation target leads to increased communication with the public and thus reduces uncertainty. B.It is easier to stabilize the economy with a higher inflation target than a target closer to zero. C.Central banks are more accountable with a higher inflation​ target, thus solving the​ time-inconsistency problem. D.A higher inflation target is less binding than a target closer to zero.

D`

What methods have​ inflation-targeting central banks used to increase communication with the public and increase the transparency of monetary policy​ making? A.​Inflation-targeting central banks have used brochures with fancy​ graphics, boxes, and other​ eye-catching design elements to engage the​ public's interest. B.Inflation-targeting central banks have frequent communications with the government. C.​Inflation-targeting central banks take the opportunity to make public speeches on their monetary policy strategy. D.Only B and C are correct. E.All of the above are correct.

E