Chapter 25

Many central banks consider price stability to be the most appropriate​ long-term goal of monetary policy. Which of the following is not a rationale for this​ view?

Deflation is a much more desirable condition than inflation.

In​ 2009, in the wake of the global financial crisis when interest rates were at their​ lowest, the U.S. government instituted a​ "cash for​ clunkers" program, and later a​ "cash for​ appliances" program. Both rebate programs were designed in part to stimulate new spending on automobiles and major appliances. What does this say about views of the health of the​ interest-rate channel during that​ time?

Despite very low interest​ rates, expenditures on consumer durables were​ weak, indicating the​ interest-rate channel was not very healthy.

Economist Franco Modigliani found that the most important transmission mechanisms of monetary policy involve consumer expenditure. Which of the following is not a channel through which monetary policy can affect consumer​ expenditure?

Expansionary monetary policy can increase the value of​ stocks, raising​ Tobin's q.

In the​ 2007-2009 recession, the value of common stocks in real terms fell by nearly​ 50%. Which of the following shows a transmission mechanism through which the decline in the stock market might have affected aggregate demand and thus contributed to the severity of the​ recession?

Falling stock prices lead to a fall in financial​ wealth, and thus consumption spending​ falls, reducing aggregate demand.

​"A decrease in​ short-term nominal interest rates necessarily implies a stance of monetary​ easing." Is this statement​ true, false, or​ uncertain? Explain your answer.

False. Monetary policy easing should be associated with changes in real interest rates and not nominal rates.

Contractionary monetary policy reduces stock​ prices, which reduce the value of financial assets and increase the probability of household financial distress. Households with less access to liquid assets spend less on consumption and residential investment. This statement describes which of the following monetary transmission​ channels?

Household liquidity effects.

Why does the credit view imply that monetary policy has a greater effect on small businesses rather than large​ firms?

Small businesses are more dependent on the availability of bank loans than large firms.

If adverse selection and moral hazard​ increase, how does this affect the ability of monetary policy to address economic​ downturns?

With increased adverse​ selection, monetary policy must be more powerful to offset the contractionary effects of adverse selection and moral hazard.

The credit market channel of monetary transmission acts primarily through the effect​ of:

asymmetric information on lending and balance sheets.

From​ mid-2008 to early​ 2009, the Dow Jones Industrial Average declined by approximately​ 50%, while real interest rates were low or were falling. What does this suggest about​ Tobin's q during the global financial​ crisis? During the global financial​ crisis, Tobin's q ... because

decreased a decline in the stock market caused the market value of firms to fall.

If nominal interest rates are​ high, the exchange rate is​ low, and asset prices are​ high, then monetary policy is best described​ as:

easy

Consider the following​ statement: "The cost of financing investment is related only to interest​ rates; therefore, the only way that monetary policy can affect investment spending is through its effects on interest​ rates." This statement is Which of the following is a correct transmission channel that shows how monetary policy can affect​ investment, without relating investment to interest​ rates? A. Expansionary monetary policy can decrease the value of​ stocks, which lowers a​ firm's net​ worth, reducing the​ firm's ability to borrow and thus decreasing investment. B. Expansionary monetary policy can increase the value of​ stocks, lowering​ Tobin's q​, and thus increasing investment. C. Expansionary monetary policy can increase the value of​ stocks, raising household​ wealth, and thus increasing consumption. D. Expansionary monetary policy can increase the value of​ stocks, raising​ Tobin's q​, and thus increasing investment.

false D. Expansionary monetary policy can increase the value of​ stocks, raising​ Tobin's q​, and thus increasing investment.

Following the global financial​ crisis, mortgage rates reached record low levels in 2011. What effect should this​ have, according to the household liquidity effect​ channel? Lower mortgage rates should lead to ... housing​ prices, which ... the value of housing wealth. This leads to a ... probability of financial​ distress, thus ... consumer durable and housing expenditure. During the same​ time, most banks raised their credit standards​ significantly, making it much more difficult to qualify for home loans and refinance existing loans. How does this alter your previous​ answer?

higher, raises, lower, increasing With higher credit​ standards, the likelihood of financial distress would remain​ elevated, resulting in no increase in consumer housing expenditure.

The Federal Reserve steadily raised interest rates during 2004 and 2005. Higher interest rates cause the value of the dollar to ... which causes net exports to ... and thus output would be expected to ... This is an example of which of the following monetary transmission​ mechanisms?

increase, decrease decrease Exchange rate effects.

During and after the global financial​ crisis, the Fed reduced the fed funds rate to nearly zero. At the same​ time, the stock market fell dramatically and housing market values declined sharply. Comment on the effectiveness of monetary policy in this period through the wealth channel Monetary policy effects through the wealth channel were ... during the global financial crisis​ because:

ineffective though real interest rates were​ low, stock and housing values declined​ sharply, which decreased aggregate demand.

During and after the global financial​ crisis, the Fed provided banks with large amounts of liquidity.​ Banks' excess reserves increased​ sharply, while credit extended to households and firms decreased sharply. Comment on the effectiveness of the bank lending channel during this time. The bank lending channel was ... during the global financial crisis​ because:

ineffective the increased reserves did not translate into higher lending because of perceived credit risks by lending banks.

It is dangerous to always associate the easing or tightening of monetary policy with a fall or a rise in​ short-term nominal interest rates because Which of the following is not one of the four basic policy​ lessons:

movements in nominal interest rates do not always correspond to movements in real interest rates. Monetary policy is ineffective in reviving a weak economy if​ short-term interest rates are already near zero.

One of the classic features of the global financial crisis is the failure of​ high-profile investment banks and financial​ firms, such as Lehman​ Brothers, Bear​ Stearns, and AIG. These firms experienced sharp contractions in the value of their balance sheets due to risky asset holdings. Which of the following schematics correctly identifies how this would affect the​ economy, as it relates to the balance sheet​ channel?

r↑ → Ps↓ → firms' net worth↓ → adverse selection↑, moral hazard↑ → lending↓ → I↓ → Yad↓

In the late​ 1990s, the stock market was rising​ rapidly, the economy was​ growing, and the Federal Reserve kept interest rates relatively low. Identify the correct schematic that explains how this policy stance would affect the economy as it relates to the Tobin q transmission mechanisms.

r↓ → Ps↑ → q↑ → I↑ → Yad↑

If an expansionary monetary policy leads to a house price bubble that fuels strong consumer​ spending, this is an example of According to​ Tobin's q​ theory, expansionary monetary policy will lead to an increase in investment spending because

the wealth effect. the market value of firms rises relative to the replacement cost of capital.

Expansionary monetary policy increases stock prices and thus the net worth of firms. As net worth​ rises, adverse selection and moral hazard problems are​ reduced, and thus bank lending​ increases, which increases investment. This statement describes which of the following monetary transmission​ channels?

Balance sheet channel.

Lars​ Svensson, a deputy governor of the Swedish central​ bank, proclaimed that when an economy is at risk of falling into​ deflation, central bankers should be​ "responsibly irresponsible" with monetary expansion. What does this​ mean? How does being​ "responsibly irresponsible" relate to the monetary transmission​ mechanism? When central bankers are​ "responsibly irresponsible" with monetary​ expansion, they create stimulus through the ... channel, which ... aggregate demand and ... the risk of deflation

Central banks should commit to strong but temporary inflationary policies that are designed to raise inflation expectations. interest-rate, increases, decreases

Which of the following is a true statement about the effect of monetary policy on interest​ rates?

Changes in​ short-term nominal interest rates do not always indicate the stance of monetary policy.

How can the​ interest-rate channel still function when​ short-term nominal interest rates are at the​ zero-lower bound?

If the central bank commits to a higher inflation​ policy, it can raise inflation​ expectations, thereby lowering real interest​ rates, even when the nominal interest rate is zero.

Suppose that the nominal interest rate is near​ zero, and the economy is in a recession. Which of the following is a correct statement about the effectiveness of monetary​ policy?

Monetary policy can still be highly effective because it can work through channels other than the interest rate

Which of the following does not support the credit view of monetary​ policy?

The real interest rate can be used to stimulate​ spending, even when the nominal rate is zero.

​"If countries fix their exchange​ rate, the exchange rate channel of monetary policy does not​ exist." Is this statement​ true, false, or​ uncertain? Explain your answer.

True. When countries fix their exchange​ rate, they must use monetary policy to affect the interest rate in order to maintain the exchange rate.

Using a​ schematic, show how the Great Depression demonstrates the unanticipated price level channel.

Unanticipated P↓ → firms' real net worth↓ → adverse selection↑, moral hazard↑ → lending↓ → I↓ → Yad↓

​"Considering that consumption is nearly​ 2/3 of total​ GDP, this means that the interest​ rate, wealth, and household liquidity channels are the most important monetary policy channels in the​ U.S." Is this statement​ true, false, or​ uncertain? Explain your answer.

Uncertain. There are other channels that could have a greater effect on investment than those from monetary policy changes.