Ch 16 Fiscal Policy

What two institutions did Congress create in order to increase the availability of mortgages in a secondary market?

"Fannie Mae" and "Freddie Mac"

Suppose that velocity is 3 and the money supply is $600 million. According to the quantity theory of money, nominal output equals

$1.8 billion

Which of the following best explains the difference between commodity money and fiat money?

Fiat money has no value except as money, whereas commodity money has value independent of its use as money

What is the purpose of the Taylor rule? The Taylor rule is used to

analyze and predict how the Fed targets the federal funds rate

When the Federal Open Market Committee (FOMC) decides to increase the money supply, it _____ U.S. Treasury securities. If the FOMC wishes to decrease the money supply, it _____ U.S. Treasury securities.

buys sells

Technological changes that make it possible for businesses to ditch cash include all of the following except

barter

To reduce a budget deficit,

budgetary policies such as increasing taxes and cutting expenditures can be used

If the Federal Open Market Committee (FOMC) decides to increase the money supply, it orders the trading desk at the Federal Reserve Bank of New York to

buy U.S. Treasury securities

To increase the money supply, the FOMC directs the trading desk, located at the Federal Reserve Bank of New York, to

buy U.S. Treasury securities from the public

What is the "tax wedge"?

a tax wedge is the difference between the pretax and posttax return to an economic activity. For example, a tax on interest income would decrease the posttax return to investment

Credit cards are

included in neither the M1 definition of the money supply nor in the M2 definition

Savings account balances, small-denomination time deposits, and non-institutional money market fund shares are

included only in M2

According to the quantity theory of money, if velocity does not change, when the money supply of a country increases, what will occur?

nominal GDP will increase

During the years from 2010 to 2016, the average annual growth rate of M1 was 10.3 percent, while the inflation rate as measured by the GDP deflator averaged 1.6 percent. These values are

not included in the quantity equation

Even though the federal government earned a profit on its investment in AIG, economists and policymakers who opposed the bailout were

not necessarily wrong, because it was an expensive and risky solution

Which one of the following is not a reason why businesses accept paper currency knowing that, unlike a gold coin, the paper the currency is printed on is worth very little? Paper currency is a good medium of exchange because it is ___

not valuable

Economists and policymakers might disagree over the best rule to guide monetary policy because

of differing views about the significance of inflation and unemployment

The choice of the price index the Federal Reserve uses to measure inflation can affect monetary policy because

one goal of monetary policy is price stability and, if the price index used to measure inflation is consistently wrong, monetary policies based on that information will be wrong

The figure to the right illustrates a dynamic AD-AS model. Suppose the economy is in equilibrium in the first period at point A. In the second period, the economy reaches point B. What policy would the Fed likely pursue in order to move AD2 to AD2 policy and reach equilibrium (point C) in the second period?

open market purchase of government securities

The purchases Fed Chairman Bernanke is referring to are

open market purchases of government securities

The Fed's two new policy tools are

paying interest on bank reserve holdings and paying interest on repurchase and reverse repurchase agreements

Money serves as a standard of deferred payment when

payments agreed to today but made in the future are in terms of money

When the article refers to "credit availability," it means the ability of

people to obtain credit

Money serves as a unit of account when

prices of goods and services are stated in terms of money

A "fire sale" would distort the outlook for inflation because selling at fire-sale prices

underestimates the inflation rate

If the Fed believes the inflation rate is about to increase, it should

use a contractionary monetary policy to increase the interest rate and shift AD to the left

If the Fed believes the economy is about to fall into recession, it should

use an expansionary monetary policy to lower the interest rate and shift AD to the right

Additionally, the federal funds rate is

very important for the Fed's monetary policy because the Fed uses the federal funds rate as a monetary policy target since it can control the rate through open market operations

In what ways does the federal budget serve as an automatic stabilizer for the economy?

During a recession, there is an increase in government expenditures for transfer payments and a decrease in taxes as wages and profits fall. During an expansion, there is a decrease in government expenditures for transfer payments and an increase in taxes as wages and profits rise. Both of these occur automatically and both effects help to stabilize aggregate demand.

What is fiscal policy?

Fiscal policy can be described as changes in government spending and taxes to achieve macroeconomic policy objectives

What does the report mean by "budget balances"?

Government deficit as a percentage of GDP

U.S. federal government expenditures are comprised of purchases of goods and services (defense spending plus spending on all day-to-day activities), transfer payments, interest payments, and grants to state and local governments. Which of the following statements is true?

Transfer payments are the largest component of the federal budget (about 50%) followed by defense spending (about 20%), while spending on all its day-to-day activities is the smallest component (about 8%).

Is it possible for Congress and the president to carry out an expansionary fiscal policy if the money supply does not increase?

Yes, because fiscal policy and monetary policy are separate things

In 2009, Congress and the president enacted "cash for clunkers" legislation that paid people buying new cars up to $4,500 if the traded in an older, low gas mileage car. Was this piece of legislation an example of fiscal policy?

Yes, because the primary goal of the spending program was to stimulate the national economy

The large budget deficits of $1.4 trillion in fiscal year 2009 and $1.3 trillion in fiscal year 2010 were

caused partly by the increase in government spending including spending to bail out failed financial institutions and by the deep decline in tax revenues as incomes and profits fell

Due to the American Recovery and Reinvestment Act of 2009 - the stimulus package - the effect on federal government

revenue and expenditures was highest in 2010 but both effects declined in 2011

Consider the following statement: "Real GDP is currently $17.7 trillion, and potential real GDP is $17.4 trillion. If Congress and the president would decrease government purchases by $300 billion or increase taxes by $300 billion, the economy could be brought to equilibrium at potential GDP." If government purchases were to decrease by $300 billion or if taxes were increased by $300 billion, the equilibrium level of real GDP would decrease by ___ Therefore, the statement above is ___

more than $300 billion incorrect

About ___ of the American Recovery and Reinvestment Act stimulus package took the form of increases in government expenditures, and about ___ took the form of tax cuts.

two-thirds one-third

Two examples of automatic stabilizers in the U.S. are

unemployment insurance payments and the progressive income tax system

Automatic stabilizers can reduce the severity of a recession because, during a recession

unemployment payments rise and tax collections fall, providing more spending ability to push the economy back to full employment

Suppose American Bank has $500 in deposits and $200 in reserves and that the required reserve ratio is 10 percent. In this situation, American Bank has

$50 in required reserves

Assets = +$100,000 (reserves) Liabilities = $100,000 (liabilities) If the required reserve ratio is 0.10, or 10 percent, and Wells Fargo currently has no excess reserves, the maximum loan Wells Fargo can make as result of this transaction is ___.

$90,000

Why don't more people use their savings to make loans rather than keeping the funds in bank accounts that earn very low rates of interest?

There is a risk that the borrower won't pay the money back

What is commercial lending?

This is when banks make loans to businesses

Why does a $1 increase in government purchases lead to more than a $1 increase in income and spending?

Through the government purchases multiplier, the $1 increase in government spending will lead to an increase in aggregate demand and national income, which will lead to an increase in induced spending.

What is the relationship between the federal funds rate falling and the money supply increasing?

To decrease the federal funds rate, the Fed must increase the money supply

How does lowering the target for the federal funds rate "pour money" into the banking system?

To increase the money supply, the Fed buys bonds on the open market, which increases bank reserves

What is the advantage of holding money?

Money can be used to buy goods, services, or financial assets

The Fed uses monetary policy to offset the effects of a recession (high unemployment and falling prices when actual real GDP falls short of potential GDP) and the effects of a rapid expansion (high prices and wages). Can the Fed, therefore, eliminate recessions?

The Fed can only soften the magnitude of recessions, not eliminate them

Problems of credit availability would affect a homebuilder such as Hovnanian Enterprises because

most potential homeowners need mortgages to buy homes

In this statement, Keynes is discussing the important macroeconomic effect called the ___ effect

multiplier

Using bitcoins may be more attractive to individuals and firms in developing countries, such as Brazil or India, than to individuals and firms in the United States because

bitcoins would help conceal the high levels of corruption and illegal activity that take place in developing countries

As the interest rate increases,

consumption, investment, and net exports decrease; aggregate demand decreases

Consider the following statement: "The Fed has an easy job. Say it wants to increase real GDP by $200 billion. All it has to do is increase the money supply by that amount." The statement is _____ because an increase in the money supply _____ affect real GDP directly.

incorrect does not

The difference between what was expected and what actually occurred illustrates that the formulation of economic policy

relies on economic forecasting that is subject to frequent revisions and errors

With a ___, the Fed buys a security from a financial firm, which promises to buy it back from the Fed the next day.

repurchase agreement

Which of the following policy tools is the Federal Reserve least likely to use in order to actively change the money supply?

reserve requirements

The process of ___ involves creating a secondary market in which loans that have been bundled together can be bought and sold in financial markets.

securitization

Suppose that when the Fed decreases the money supply, households and firms initially hold less money than they want to, relative to other financial assets. As a result, households and firms will ___ Treasury bills and other financial assets, thereby ___ their prices, and ___ their interest rates.

sell decreasing increasing

The recessions accompanied by a financial crisis are more severe than recessions that do not involve bank crises because

severe financial crises collapse asset markets, lower real housing prices and cause a significant fall in GDP and employment

An increase in interest rates affects aggregate demand by

shifting the aggregate demand curve to the left, reducing real GDP and lowering the price level

The _____ is considered the most relevant interest rate when conducting monetary policy.

short-term nominal interest rate

When the Fed conducts monetary policy, the most relevant interest rate is the

short-term nominal interest rate

If current projections of federal spending on Social Security and Medicare are accurate, policymakers are faced with the choice of

significantly restraining spending on these programs and/or greatly increasing taxes on households and firms

The Greek government responded to the recession by cutting its budget in contrast to the typical response, which is to

spend more. Historically high overspending had weakened its economy

Policy that is specifically designed to affect aggregate supply and increase incentives to work, save, and start a business, by reducing the tax wedge is called

supply-side economics

What caused this change in the sources of mortgage finance? What would be the likely consequences of this change for the interest rates borrowers have to pay on mortgages? The primary reason for this change in the sources of mortgage finance was ___; the consequences of this change was also ___ in mortgage rates

the development of a secondary mortgage market; a decrease

Governments sometimes allow hyperinflation to occur because

when governments want to spend more than they collect in taxes, central banks increase the money supply at a rate higher than GDP growth, often resulting in hyperinflation

The effect on the economy of tax reduction and simplification is

an increase in the quantity of real GDP supplied at every price level, and a shift in the long-run aggregate supply curve

Why do banks require borrowers to submit pay stubs and tax returns when applying for a loan?

Pay stubs and tax returns allow lenders to gauge a borrower's ability to pay back the loan

Which of the following is NOT a factor that helped lead to the financial crisis of 2007-2009?

deposit insurance for commercial banks

What does the article mean by Chinese businesses being starved for credit?

Being starved for credit means Chinese businesses cannot get loans

Velocity is defined as

V = (P x Y) / M

The revenue the federal government collects from the individual income tax declines during a recession

an automatic stabilizer

If the Fed would no longer have a specific target for the money supply, it would be targeting the

federal funds rate

Hovnanian was suffering losses because

the economy was slowing down and about to head int a severe recession

The hypothetical information in the following table shows what the situation will be in 2021 if the federal government does not use fiscal policy: Year: 2020 Potential GDP: $18.0 trillion Real GDP: $18.0 trillion Price Level: 120.3 Year: 2021 Potential GDP: $18.4 trillion Real GDP: $18.0 trillion Price Level: 122.7 If congress and the president want to keep real GDP at its potential level in 2021, they should use ___, which would mean ___. If congress and the president are successful in keeping real GDP at its potential level in 2021, state whether each of the following will he higher, lower, or the same as it would have been if they had taken no action: Real GDP will be ___ Potential real GDP will be ___ The inflation rate will be ___ The unemployment rate will be ___

- an expansionary fiscal policy - increasing government spending or cutting taxes - higher - the same - higher - lower

An expansionary fiscal policy involves an increase in government purchases or an increase in taxes

An expansionary fiscal policy involves the increase of government purchases and/or a decrease in taxes in order to increase aggregate demand

Are federal expenditures higher today than they were in 1960?

As a percentage of GDP, federal expenditures have increased since 1960

The higher the tax rate, the larger the multiplier effect

FALSE

What is the difference between federal purchases and federal expenditures?

Federal purchases require that the government receives a good or service in return, whereas federal expenditures include transfer payments

Which of the following best describes the difference between crowding out in the short run and in the long run?

In the short run, an increase in government purchases may not fully crowd out private expenditures due to the stimulative effect of an increase in government purchases on aggregate demand. In the long run, most economists believe that a permanent increase in government purchases will result in complete crowding out of private expenditures

Which can be changed more quickly: monetary policy or fiscal policy?

Monetary policy can be changed more quickly than fiscal policy. Monetary policy can be changed at any of the FOMC meetings and the smaller number of individuals involved makes it easier to change policy

The federal government collected less in total individual income taxes in 1983 than in 1982. Can we conclude that Congress and the president cut individual income tax rates in 1983?

No. it could be that the economy contracted, so less income was earned and less was paid in tax

What is the long-run effect of a permanent increase in government spending?

The decline in investment, consumption, and net exports exactly offsets the increase in government spending; therefore, real GDP remains unchanged

If the short-run aggregate supply curve (SRAS) were a horizontal line, what would be the impact on the size of the government purchases and tax multipliers?

The impact of the multiplier would be larger if the SRAS curve is horizontal

Changes in taxes and spending that happen without actions by the government are called

automatic stabilizers

By repercussions, Keynes means that an initial increase in autonomous expenditures will

change production by an amount greater than the initial increase in autonomous expenditures

The figure to the right illustrates the economy using the Dynamic Aggregate Demand and Aggregate Supply Model If actual real GDP in 2006 occurs at point B and potential GDP occurs at LRAS06, we would expect the federal government to pursue a(n) ___ fiscal policy If the government's policy is successful, what is the effect of the policy on the following macroeconomic indicators? Actual real GDP ___ Potential real GDP ___ Price level ___ Unemployment ___

contractionary decreases does not change decreases increases

An attempt to reduce inflation requires ___ fiscal policy, which causes real GDP to ___ and the price level to ___.

contractionary, fall, fall

According to the statement, balancing the Budget would require

decreasing government purchases and increasing taxes

Automatic stabilizers are

government spending and taxes that automatically increase or decrease along with the business cycle

Due to the American Recovery and Reinvestment Act of 2009 (the stimulus package), from 2009 through 2011, the federal budget deficit was

greater than 8 percent of GDP but fell to less than 3 percent of GDP in 2017

Government debt is different from household debt because

households cannot tax to bring in revenue and so will default if they can't make the payments

The type of policy matters for the size of the multiplier because

households in government spending can be offset or reinforced by monetary policy, and that the impacts will be different at different phases of the business cycle

In general, we expect that people will increase their consumption

if their disposable income increases

According to the crowding-out effect, if the federal government increases spending, the demand for money and the equilibrium interest rate will ___, which will cause consumption, investment, and net exports to ___.

increase decrease

During a recession, a government's budget deficit will

increase as there are more government expenditures for income support programs and less tax revenue as income falls

What actions can Congress and the president take to move the economy back to potential GDP?

increase government spending or decrease taxes

Between the beginning of 2009 and the end of 2010, real GDP ___, while employment ___.

increased by 4.0 percent declined by 3.3 million

In terms of its effect on the long-run growth rate of real GDP, it is likely to matter more if the additional government spending involves

increased spending on highways and bridges

Over time, potential GDP ___, which is shown by the ___ curve shifting to the right.

increases long-run aggregate supply

Government debt

increases when the government runs a budget deficit, and rises during recessions and wars

Keynes appears unconcerned if government spending is wasteful because

it will still lead to an increase in production and employment

The Federal Reserve sells Treasury securities

not a fiscal policy

The federal government changes the required gasoline mileage for new cars

not a fiscal policy

The federal government increases spending on rebuilding the New Jersey shore following a hurricane

not a fiscal policy

The 2008 tax cut made it more likely that people would not respond by increasing their consumption spending because it was a

one-time tax cut that affected current, not permanent, income

Economists use the term fiscal policy to refer to changes in taxing and spending policies

only by the federal government

Expansionary fiscal policy has a ___ multiplier effect on equilibrium real GDP, and contractionary fiscal policy has a ___ multiplier effect on equilibrium real GDP.

positive negative

There may be some truth in the columnist's argument, but an economist might argue that

taxpayers in one year should not have to pay for a project that will benefit other taxpayers well into the future

Crowding out refers to

the decline in private expenditures that result from an increase in government purchases

The size of the multiplier could be affected by how close real GDP is to potential GDP because

the effects are more positive during recessions than during inflations

Who is responsible for fiscal policy?

the federal government controls fiscal policy

Why does an estimate of the size of the multiplier matter in evaluating the effects of an expansionary fiscal policy?

the larger the multiplier, the greater the effects of an expansionary fiscal policy

The government purchases multiplier can have a value greater than zero and less than 1 if

the marginal propensity to consume is negative

As the tax rate increases,

the multiplier effect decreases

In referring to "the type of fiscal policy changes in question," the author recognizes that

the tax multiplier is different from the government purchases multiplier

The goal of expansionary fiscal policy is

to increase aggregate demand

The largest and fastest-growing category of federal expenditures is

transfer payments

Since World War II, the federal government's share of total government expenditures has been between

two-thirds and three-quarters

During 2008, real GDP

decreased

A contractionary fiscal policy involves a decrease in government purchases or a decrease in taxes

A contractionary fiscal policy involves the decrease of government purchases and/or an increase in taxes in order to decrease aggregate demand

There is a strong link between changes in the money supply and inflation

in the long run

Why would inline lenders skip this step in the loan application process?

Online lenders skip this step because gathering and reviewing information on borrowers is costly

Which one of the following is not a function of money?

Open market operations

If the marginal propensity to consume equals 0.60, the tax rate equals 0.10, and the marginal propensity to import equals 0.05, what is the value of the government purchases multiplier? The government purchases multiplier is equal to ___

1 / [ 1 - ( MPC ( 1 - t ) - MPI ] [ 1 - ( 0.60 ( 1 - 0.10 ) - 0.05 ) ] [ 1 - ( 0.60 ( 0.90 ) - 0.05 ) ] [ 1 - ( 0.54 - 0.05 ) ] [ 1 - 0.49 ] 0.51 1 / 0.51 = 1.96

If the required reserve ration is 0.10, the maximum increase in checking account deposits that will result from an increase in bank reserves of $10,000 is ___.

10,000 / 0.10 = 100,000

The United States is divided into ___ Federal Reserve Districts. The Federal Reserve Bank's Board of Governors consists of ___ members appointed by the president of the U.S. to 14-year, non-renewable terms. One of the board members is appointed to a ___ year, renewable term as the chairman.

12 7 4

According to the Taylor Rule, what is the federal funds target rate under the following conditions? - Equilibrium real federal funds rate equals 3% - Target rate of inflation equals 3% - Current inflation rate equals 2% - Real GDP is 2% below potential real GDP The federal funds target rate equals _____%

3.5

Assuming a fixed amount of taxes and a closed economy and that the marginal propensity to consume equals 0.75, calculate the value of the following multipliers. Be sure to use a negative sign (-) to show if a multiplier has a negative value. The government purchases multiplier equals: ___ (1 / 1 - MPC) = (1 / 1 - 0.75) The tax multiplier equals: ___ [ (-MPC) / (1 - MPC) ] = [ (-0.75) / (1 - 0.75) ] The balanced budget multiplier equals: ALWAYS 1

4 -3 1

If the money supply is growing at a rate of 4 percent per year, real GDP (real output) is growing at a rate of 2 percent per year, and velocity is growing at 3 percent per year instead of remaining constant, what will the inflation rate be?

4 - 2 = 2 2 + 3 = 5%

If the money supply is growing at a rate of 4 percent per year, real GDP (real output) is growing at a rate of 2 percent per year, and velocity is constant, what will the inflation rate be?

4 - 2 = 2%

Suppose the reserve requirement is 15%. What is the effect on total checkable deposits in the economy if bank reserves increase by $40 billion?

40 / 0.15 = $267 billion increase

During the expansion and deflation of the housing bubble, new home sales rose by

60 percent between January 2000 and July 2005 and then fell by 80 percent between July 2005 and May 2010

There are ___ members of the Board of Governors, who the President of the United States appoints to ___. One of the Board members is appointed Chairman for ___.

7, 14-year nonrenewable terms, 4-year renewable term

What did President Trump mean by a "strong dollar"?

A "strong dollar" is when it takes more units of a foreign currency to buy a dollar

Which of the following were important developments in the mortgage market that took place during the 1970s?

A and B ONLY - Fannie Mae and Freddie Mac began to act as intermediaries between investors and home buyers - Banks began to resell mortgages on the secondary market rather than holding them in their portfolios

Why did the Fed help JP Morgan Chase buy Bear Stearns?

A and C only - Failure to Bear Stearns would lead to a larger investment bank failure - Commercial banks would be reluctant to lend to investment banks

The long-run growth rate of real GDP depends primarily on

A and C only - the growth rate of labor productivity as measured by the growth in real GDP per hour worked - the growth in the number of hours worked

Consider the following list of arguments about changing to a flat tax; A. There would be a reduction in paperwork and the compliance cost of the tax system B. The complexities in the current tax code allow the government to pursue other policy goals C. A change in the tax code would result in a more unequal distribution of income because the marginal tax rate on high-income taxpayers would be reduced D. There are potential increases in labor supply, savings, and investment from a lower marginal tax rate Which two out of the above list of arguments would you advance in favor of a flat tax? Which two out of the above list of arguments would you advance against a flat tax?

A and D B and C

In a fractional reserve banking system, what is the difference between a "bank run" and a "bank panic?"

A bank run involves one bank; a bank panic involves many banks

Consider the following choices and determine the correct definition for the monetary rule

A monetary rule is a plan for increasing the money supply at a constant rate regardless of the prevailing economic condition

Distinguish among money, income, and wealth

A person's money is the currency held and the checking account balance, income is the earning and wealth is equal to value of assets minus all debts

What is banking panic?

A situation in which many banks experience runs at the same time

Why would a strong dollar make it hard for U.S. firms to compete?

A strong dollar raises the cost of U.S. goods to buyers in foreign countries

Changes in interest rates affect aggregate demand. Which of the following is affected by changes in interest rates and, as a result, impacts aggregate demand?

A. Consumption of durable goods B. Business investment projects C. The value of the dollar

How do investment banks differ from commercial banks?

A. Investment banks do not take deposits E. Investment banks generally do not lend to households

How does a budget deficit act as an automatic stabilizer and reduce the severity of a recession?

ALL OF THE ABOVE - Consumers spend more than they would in the absence of social insurance programs, like unemployment - During recessions, tax obligations fall due to falling wages and profits - Transfer payments to households increase

Increased government debt can lead to higher interest rates and, as a result, crowding out of private investment spending. In terms of borrowing (debt-spending), what will offset the effect of crowding out in the long run so that government debt poses less of a problem to the economy?

ALL OF THE ABOVE - Debt-spending on education - Debt-spending on research and development - Debt-spending on highways and ports

What are the gains to be had from simplifying the tax code?

ALL OF THE ABOVE - Resources from the tax preparation industry freed up for other endeavors - Greater clarity of the decisions made by households and firms - Increased efficiency of households and firms

The decline in housing prices that began in 2006 led to rising defaults among which borrowers?

ALL OF THE ABOVE - borrowers with adjustable-rate mortgages - borrowers who had made only small down payments - alt-A and subprime borrowers

To determine if these values are consistent with the quantity equation, additional information would be needed about

ALL OF THE ABOVE - the level of real GDP - the price level and velocity of money - the size of the money supply

The simple deposit multiplier equals

ALL OF THE ABOVE - the ratio of the amount of deposits created by banks to the amount of new reserves - the formula used to calculate the total increase in checking account deposits from an increase in bank reserves - the inverse, or reciprocal, of the required reserve ratio

Which of the following was the Fed's objective in using "quantitative easing" and Operation Twist"?

ALL OF THE ABOVE - to keep interest rates on 10-year Treasury notes low - to increase aggregate demand - to keep interest rates on mortgages low

Which of the following is not a correct comparison between an expansionary monetary policy in the basic aggregate demand and aggregate supply model and in the dynamic aggregate demand and aggregate supply model?

ALL OF THE ABOVE ARE CORRECT STATEMENTS ABOUT THE TWO MODELS - if the economy is below full employment, expansionary monetary policy will cause an increase in the price level in both models - In the dynamic model, expansionary policy would be used when demand does not grow sufficiently; in the basic model, expansionary policy would be used when demand falls - the dynamic model assumes that potential GDP is constantly growing while the basic model assumes that it is static

Which of the following statements is correct?

ALL OF THE ABOVE ARE TRUE - changes in the federal funds rate usually will result in changes in both short-term and long-term interest rates on financial assets - the effect of a change in the federal funds rate on long-term interest rates is usually smaller than it is on short-term interest rates - a majority of economists support the Fed's choice of the interest rate as its monetary policy target, but some economists believe the Fed should concentrate on the money supply instead

Which of the following is a monetary policy response to the economic recession of 2007-2009 and the accompanying financial crisis?

ALL OF THE ABOVE WERE RESPONSES - The Fed provided loans directly to corporations by purchasing commercial paper - The Fed purchased large amounts of mortgage-backed securities - The Fed expanded the eligibility for discount loans to firms other than commercial banks

Which of the following is NOT a function of money?

Acceptability

Which of the following is a monetary policy tool used by the Federal Reserve Bank?

All of the above - Decreasing the rate at which banks can borrow money from the Federal Reserve - Increasing the reserve requirement from 10 percent to 12.5 percent - Buying $500 million worth of government securities, such as Treasury bills

Which of the following is true with respect to hyperinflation?

All of the above - It can be hundreds - even thousands - of percentage points per year - It is caused by central banks increasing the money supply at a rate much greater than the growth rate of real GDP. - In the presence of hyperinflation, firms and households avoid holding money.

Which of the following is true with respect to Irving Fisher's quantity equation, M x V = P x Y?

All of the above - V = Average number of times a dollar is spent on goods and services - M = M1 definition of the money supply - P = the GDP deflator - V = (P x Y) / M

The use of money

All of the above - eliminates the double coincidence of wants - reduces the transaction costs of exchange - allows for greater specialization

The M1 measure of the money supply includes which of the following components?

All of the above - holdings of traveler's checks - Checking account deposits in banks - Currency in circulation

In the figure to the right, when the money supply increased from MS1 to MS2, the equilibrium interest rate fell from 4% to 3%. Why?

All of the above - increased demand for Treasury securities drives down their interest rate - increased demand for Treasury securities drives up their prices - Initially, firms hold more money than they want relative to other financial assets

Which of the following conditions make a good suitable for use as a medium of exchange?

All of the above conditions must be met - The good should be of standardized quality, so that any two units are identical - The good must be acceptable to (that is, usable by) most buyers and sellers - The good should be durable, valuable relative to its weight, and divisible

What is meant by Professor Spencer's statement "this printing of money 'will keep the [deflation] wolf from the door'"?

An increase in the money supply that exceeds the rate of growth of GDO will increase the price level

The economic definition of money is:

Any asset that people are generally willing to accept in exchange for goods and services

Are federal purchases higher today than they were in 1960?

As a percentage of GDP, federal purchases have decreased since 1960

Consider the figures below and determine which is the best description of what causes the shift from AD1 to AD2

BOTH A AND B - Example A shows a contractionary monetary policy. The price level and real GDP both fall - Example B shows an expansionary monetary policy. The price level and real GDP both rise

Based on the European Central Bank's statement do you expect that the inflation rate is above or below the ECB's inflation target? Briefly explain.

Below, because the ECB's use of this non-standard monetary policy is intended to increase the money supply

The figure to the right shows a breakdown of the M1 definition of the money supply in 2017. Which area corresponds to the amount of checking account deposits?

C (largest portion)

Look carefully at the following list. a. the coins in your pocket b. the funds in your checking c. the funds in your savings account d. the traveler's check that you have left over from a trip e. your Citibank Platinum Card Which of the things above are NOT included in the M1 definition of the money supply?

C & E

What is inflation targeting?

Committing the central bank to achieve an announced level of inflation

Why would deflation cause "shoppers to hold back," and what does Evans-Pritchard mean when he says, "Once this psychology gains a grip, it can gradually set off a self-feeding spiral that is hard to stop"?

Consumers delay purchases, expecting prices to fall more, and the lack of demand causes prices to fall further

If the economy is at full employment, what economic variables will conventional tax cuts or stimulus spending not affect much? What variables might these policies affect?

Conventional tax cuts and stimulus spending will not have much effect on real GDP and unemployment, but will affect inflation

In the definition of the money supply, where do credit cards belong?

Credit cards are not included in the definition of the money supply

What is meant by crowding out?

Crowding out is a decline in private expenditures as a result of increases in government purchases

Which of the following is not a Federal Reserve district?

Denver

Briefly explain whether you agree or disagree with the following statement: "Assets are things of value that people own. Liabilities are debts. Therefore, a bank will always consider a checking account deposit to be an asset and a car loan to be a liability."

Disagree. Checking accounts represent something that the bank owes to the owner of the account. It is a bank liability.

Do you agree or disagree with the following statement? "I recently read that more than half of the money issued by the government is actually held by people in foreign countries. If that's true, then the United States is less than half as wealthy as the government statistics indicate."

Disagree. Money is currency plus checking deposits. Wealth is the value of assets minus debts

Does judging whether a deficit is excessive depend in part on whether the country is in a recession?

During a recession, the deficit is higher as tax revenue falls and spending increases making an existing deficit even bigger

What is the "shadow banking system"?

Financial firms that raise money from investors and provide it to borrowers

The figure to the right illustrates the dynamic AD-AS model Suppose the economy is in equilibrium in the first period at point (A). In the second period, the economy reaches point (B). We would expect the federal government to pursue what type of policy in order to move AD2 to AD2 policy and reach equilibrium (point C) in the second period? ___ If the federal government's policy is successful, what is the effect on the following macroeconomic indicators? Actual real GDP: ___ Potential real GDP: ___ Price level: ___ Unemployment: ___

Expansionary fiscal policy OR increase government spending increases does not change increases decreases

A simplified tax code would reduce economic efficiency by increasing the number of decisions households and firms make solely to reduce their tax payments

FALSE

During 2005, the FOMC was concerned that the inflation rate would begin to accelerate due to the continued boom in the housing market, so the Fed started decreasing the target for the federal funds rate.

False

For the Fed to succeed in reducing the severity of business cycles, it must act precisely when a recession or an acceleration of inflation can be seen in the economic data

False

If the Fed decides to carry out an expansionary monetary policy because it believes aggregate demand will not increase enough to keep the economy at potential GDP, the inflation rate will most likely be lower than it would have been without the policy.

False

Evaluate the following statement: Banks use deposits to make consumer loans to households and commercial loans to businesses. Banks will loan out every penny of their deposits in order to make a profit.

False. Banks must hold a fraction of their deposits as vault cash or with the Federal Reserve

For more than 20 years, the Fed has used the federal funds rate as its monetary policy target. It has not targeted money supply at the same time because the

Fed cannot target both at the same time: It has to choose between targeting an interest rate and targeting the money supply

In 2017, one article in the Wall Street Journal had the headline: "Federal Reserve Expected to Deliver Rate Increase." What rate was the headline likely referring to? Who is able to borrow and lend at that rate? Why does the Fed's actions to increase or decrease the rate you identified above attract so much attention?

Federal funds rate Banks are able to borrow and lend from each other at that rate This rate ultimately has a substantial effect on many other interest rates

Suppose that Congress changes the law to require all firms to accept paper currency in exchange for whatever they are selling. All of the following are correct except:

Firms lose since they don't have the convenience of credit cards

What is the difference between federal government purchases (spending) and federal government expenditures?

Government purchases are included in government expenditures

The term "crowding out" refers to a situation where:

Government spending increases interest rates and decreases private investment

Which of the following equations explains the reasoning behind this statement?

Growth rate of real GDP = Growth rate of hours worked + Growth rate of labor productivity

Which of the following equations links real GDP growth to its two determinants?

Growth rate of real GDP = Growth rate of hours worked + Growth rate of labor productivity

What does Holtz-Eakin mean by "policies that genuinely augment the supply side of the economy"?

He means policies that increase potential GDP by increasing the desire to work, save, invest, and start a business

In addition to the Federal Reserve Bank, what other economic actors influence the money supply?

Households, firms, and banks

What is a "classic type of run"?

May depositors simultaneously decide to withdraw their money from a bank

Which of the following statements about the federal debt is correct?

If the debt becomes very large relative to the economy, then the government may have to raise taxes to high levels or reduce other types of spending to make the interest payments on the debt

What changes should they make if they decide a contractionary fiscal policy is necessary?

In this case, Congress and the president should enact policies that decrease government spending and increase taxes

A newspaper article contains the statement: "Income is only one way of measuring wealth" Do you agree that income is a way of measuring wealth?

Income is yearly earnings and it doesn't measure wealth which is the value of personal assets less all debts

If Irving Fisher was correct in his prediction about the value of velocity, then the quantity equation can be written to solve for the inflation rate as follows:

Inflation rate = Growth rate of the money supply = growth rate of real output

Which of the following is a monetary policy target used by the Fed?

Interest rate

Consider the figure to the right. An increase in government spending shifted the aggregate demand curve from AD1 to AD2. As a result, both price level and real GDP increased. What can be said, however, about the increase in real GDP

It increased by less than indicated by a multiplier with a constant price level

Under these circumstances, was the Chinese paper currency a commodity money or a fiat money?

It is a commodity money because it has value as recycled paper

What is the Taylor rule?

It is a rule that links the Fed's target for the federal funds rate to the current inflation rate, real equilibrium federal funds rate, inflation gap and output gap

Which of the following would be the least desirable candidate to be a good medium of exchange?

Milk

Which of the following is included in M2 but not M1?

Money market deposit accounts in banks

What do economists mean by the demand for money?

It is the amount of money - currency and checking account deposits - that individuals hold

The Taylor rule for federal funds rate targeting does which of the following?

It links the Fed's target for the federal funds rate to economic variables

How would such a large quantity of Confederate dollars have affected the value of the Confederate currency?

It would have generated high inflation and therefore decreased the value of the Confederate currency

Is the real world deposit multiplier greater than, less than, or equal to the simple deposit multiplier?

Less. The simple deposit multiplier is a model with assumptions that keep it higher than the real-world multiplier

What are the largest asset and the largest liability of a typical bank?

Loans are the largest asset and deposits are the largest liability of a typical bank

What is a "subprime mortgage," and would a subprime borrower be likely to pay a higher or a lower interest rate than a borrower with a better credit history?

Loans granted to borrowers with flawed credit histories; a higher interest rate

A policy of lowering the tax rate on dividends and capital gains to increase investment is intended to result in:

Long run supply side effects

Which of the following is NOT a monetary policy goal of the Federal Reserve bank (the Fed)?

Low prices

Why would a cut in the Selic rate be an appropriate policy action at a time when the inflation rate was falling and the economy was struggling?

Lowering the Selic rate would decrease other interest rates, which would increase aggregate demand and stimulate the economy

Which one of the following is not the formula for the quantity theory of money?

M x Y = P x V

The Federal Reserve uses two definitions of the money supply, M1 and M2, because

M1 is a narrow definition focusing more on liquidity, whereas M2 is a broader definition of the money supply

Suppose you decide to withdraw $100 in currency from your checking account. What is the effect on M1? Ignore any actions the bank may take as a result of your having withdrawn the $100.

M1 remains unchanged

Jill makes a deposit into her savings account at the local bank with $100 in cash. As a result of this transaction,

M1 will decrease by $100

The M2 definition of the money supply includes

M1, savings accounts, small time deposits, and money markets

Which of the following is not a correct statement about M2?

M2 is the best definition of money as a medium of exchange

Suppose you withdraw $1,000 from a money market mutual fund and deposit the funds in your bank checking account. How will this action affect M1 and M2?

M2 will not be affected, but M1 will increase

Which of the following is one of the unprecedented actions of the Fed?

Making loans to primary dealers and holders of mortgage-backed securities

Why might investors in a money market mutual fund, for example, be more likely to "rush to the exits" if they heard bad news about the fund's investments, than would bank depositors if they received bad news about their bank's investments?

Money market mutual funds are not protected by deposit insurance, as commercial banks' deposits are through the Federal Deposit Insurance Corporation (FDIC).

What did Geithner mean by the "non-bank financial system"?

Money market mutual funds, hedge funds, and other financial firms that raise money from investors and provide it to firms and households.

Suppose you deposit $1,000 cash into your checking account. By how much will the total money supply increase as a result when the required reserve ratio is 0.50? The change in the money supply is:

Money multiplier = 1 / 0.5 = 2 Total money supply = 2 x 1000 = 2000 Money supply increase = 2000 - 1000 = 1000 Change in money supply = $1,000

What is the disadvantage of holding money?

Money, in the form of currency or checking account deposits, earns either no interest or a very low rate of interest

Which one of the following is not one of the policy tools the Fed uses to control the money supply?

Moral suasion

Which of the following is not a correct comparison between a contractionary monetary policy in the basic aggregate demand and aggregate supply model and in the dynamic aggregate demand and aggregate supply model?

NONE OF THE ABOVE ARE CORRECT STATEMENTS ABOUT THE TWO MODELS - the static model assumes that potential GDP is constantly growing while the dynamic model assumes that it is static - in the dynamic model, contractionary policy would be used when demand grows too slowly; in the basic model, expansionary policy would be used when demand increases - if the economy is above full employment, contractionary monetary policy will cause a decrease in the price level in the static but not the dynamic model

Does the Fed's dual mandate require it to attain a zero percent unemployment rate? Briefly explain.

No, because even when the economy is at full employment, there is still a natural rate of unemployment

If online lenders find that borrowers are defaulting on loans at higher than expected rates, can they offset the problem by charging higher interest rates on the loans? Briefly explain.

No, because only the most high-risk borrowers will accept loans, meaning the borrower is more likely to default

Does the Fed's dual mandate require it to attain a zero percent inflation rate? Briefly explain.

No, because price stability is sufficient

Does the merchant's ability to arrange a barter deal with a customer indicate that the Indian economy doesn't actually require money to function efficiently? Briefly explain

No, restoring to barter means that each trade required a doubly coincidence of wants for trade to occur

Is cooling off rapid increases in stock prices part of the Fed's dual mandate?

No, this is not part of the Fed's dual mandate of price stability and high employment

Consider the figure to the right. Can the Fed achieve a $900 billion money supply (MS) AND a 5% interest rate (point C)?

No. The Fed cannot target both the money supply and the interest rate simultaneously

Do the goods Medemoiselle Zelie received as payment fulfill the four functions of money?

No. The goods are not a store of value

After September 11, 2001, the federal government increased military spending on wars in Iraq and Afghanistan. Is this increase in spending considered fiscal policy?

No. The increase in defense spending after that data was designed to achieve homeland security objectives.

Suppose the economy is in equilibrium in the first period at point A. In the second period, the economy reaches point B. What policy would the Fed likely pursue in order to move AD2 to AD2 policy and reach equilibrium (point C) in the second period? (What policy will increase the price level and increase actual real GDP?)

Open market purchase of government securities

If the Federal Reserve is late to recognize a recession and implements an expansionary policy too late, the result could be an increase in inflation during the beginning of the next phase. Even though the goal had been to reduce the severity of the recession, the poor timing caused another problem: inflation. This is an example of what type of policy?

Procyclical policy

What is this non-standard monetary policy of net asset purchases called?

Quantitative easing

Which of the following equations explains why the relationship indicated by the equation holds?

Real GDP = Number of hours worked x (Real GDP / Number of hours worked)

Which of the following is not an issue with using active monetary policy to reduce business cycles?

Real GDP and employment changes from monetary policy actions can move in a countercyclical manner

Which one of the following is not one of the monetary policy goals of the Fed?

Reduce income inequality

The formula for the simple deposit multiplier is

Simple deposit multiplier = 1 / RR

Why would securitization give mortgage borrowers access to a deeper pool of capital?

Since banks could resell mortgages to investors, they had access to more funds than just their own deposits

Why would deposit insurance provide the banking system with protection against runs?

Since most depositors are insured, it is less likely that panicked buyers will simultaneously withdraw funds

What is meant by supply-side economics?

Supply-side economics refers to the use of taxes to increase incentives to work, save, invest, and start a business in order to increase long-run aggregate supply

Few economists believe the federal government should attempt to balance its budget every year

TRUE

The Federal Reserve is divided into two bodies:

The Board of Governors and 12 regional districts

Which of the following gave the Fed a dual mandate?

The Employment Act of 1946

Which of the following best explains how the Federal Reserve acts to help prevent banking panics?

The Fed acts as a lender of last resort, making loans to banks so that they can pay off depositors

Which tool is the most important?

The Fed conducts monetary policy principally through open market operations

Why would the Fed intentionally use contractionary monetary policy to reduce real GDP?

The Fed intends to reduce inflation, which occurs if real GDP is greater than potential GDP

Which of the following statements is true about the Fed's monetary policy targets?

The Fed is forced to choose between the interest rate and the money supply as its monetary policy target

Nobel Iaureate Milton Friedman and his followers belong to a school of though known as monetarism. What do monetarists argue the Fed should target?

The Fed should target the money supply, not the interest rate, and that it should adopt the monetary growth rule

In response to the severity of the financial crisis, the Fed started to rapidly reduce the target range for the federal funds rate in September 2007 and, from December 2008 to December 2015, held the target between 0% and 0.25%. Which of the following statements is true?

The Fed successfully held the actual federal funds within that target range over the seven-year period by conducting open market operations to increase or decrease bank reserves quickly

What can we expect from the Federal Reserve Bank if it seeks to move the economy in the direction of long-run macroeconomic equilibrium? If the Fed's policy is successful, what is the effect on the following indicators? Actual real GDP: Potential real GDP: Price Level: Unemployment:

The Fed will pursue a contractionary monetary policy decreases does not change decreases increases

Country X is a small developing economy. The budget deficit of the government has been rising sharply in the last few years. The government spends a large amount of money to keep unprofitable public sector firms running. It also extends lavish salaries and retirement benefits to government employees. With low tax revenue, the government has restored to financing its deficit by issuing bonds. This was expected to lead to an increase in the price level. As the value of the currency declined, the velocity of money in the country was also expected to rise. However, while the velocity of money barely increased, the price level in the economy increased disproportionately. Which of the following can most reasonably be inferred from the above information?

The GDP of country X is likely to be declining

In what sense do you think the Brazilian economy was "struggling" when this article was published?

The cut in the Selic rate suggests that Brazilian real GDP was below its potential

How do the banks "create money"?

When there is an increase in checking account deposits, banks gain reserves and make new loans, and the money supply expands

What is the difference between the federal budget deficit and federal government debt?

The federal budget deficit is the year-to-year short fall in tax revenues relative to government spending (T < G + TR), financed through government bonds. The federal government debt is the accumulation of all past deficits

As the figure to the right indicates, the Fed can affect both the money supply and interest rates. However, in recent years, the Fed targets interest rates in monetary policy more often than it does the money supply. Which interest rate does the Fed target?

The federal funds rate

According to the quantity theory of money, inflation results from which of the following?

The money supply grows faster than real GDP.

How does the quantity theory provide an explanation about the cause of inflation?

The quantity equation shows that if the money supply grows at a faster rate than real GDP, then there will be inflation.

Explain whether you agree with this argument: If the Fed actually ever carried out a contractionary monetary policy, the price level would fall. Because the price level has not fallen in the United States over an entire year since the 1930s, we can conclude that the Fed has not carried out a contractionary policy since the 1930s.

The statement is false. A contractionary policy could results in a lower rate of inflation rather than a fall in the price level

During the German hyperinflation of the 1920s, many households and firms in Germany were hurt economically; however, people with debt actually benefitted some from the hyperinflation.

True

If coins could have been easily used to purchase goods and services in other areas, the coins would also have some intrinsic value

True

Two government-sponsored enterprises that stand between investors and banks that grant mortgages are the Federal National Mortgage Association and the Federal Home Loan Mortgage Corporation.

True

We can say that loans are funded by deposits because deposits give banks financial capital, which can be loaned out so banks can make a profit

True

When is it considered "good policy" for the government to run a budget deficit?

When borrowing is used for long-lived capital goods

When Congressman Brady stated that Woodrow Wilson use "federalism" to convince Congress to pass the Federal Reserve Act, he meant that

Wilson created a Federal Reserve System composed of 12 district banks under the supervision of a board in Washington

Does the government create money by printing currency?

Yes, but banks create the majority of the money supply by making loans

An article in the Wall Street Journal in 2017 about Venezuela notes that: "The economy has shrunk by an estimated 27% since 2013. The International Monetary Fund says inflation this year will hit 720%." Are these facts related? Briefly explain.

Yes, high inflation diminishes the ability of the Venezuelan currency to function as money, leading to lower output growth

Is there a connection between the Chinese central bank imposing a higher required reserve ratio on banks and Chinese businesses being starved for credit? Briefly explain.

Yes, higher required ratios require banks to keep more capital as reserves instead of making loans

Is there a connection between these countries experiencing worsening budget balances while also experiencing increasing debt-to-GDP ratios? Briefly explain.

Yes, holding GDP constant, worsening budget balances lead to larger debt-to-GDP ratios because debt is the sum of annual government budget deficits

Are such increases a concern for the Fed? Briefly explain.

Yes, rapidly rising stock prices could be a concern for the Fed because it has a goal of stable financial markets

Is there an economic connection between the president's desire for a weaker dollar and his desire that the Federal Reserve keep interest rates low? Briefly explain.

Yes, when the Federal Reserve keeps interest rates low, it makes the dollar weaker because investing in the United States is less attractive

Suppose you decide to withdraw $100 in cash from your checking account. Which one of the following choices accurately shows the effect of this transaction on your bank's balance sheet?

Your bank's balance sheet shows a decrease in reserves by $100 and a decrease in deposits by $100

The events that led to the financial crisis include

a burst in a housing bubble in 2006 which led to mortgage defaults, and a disruption of the financial system resulting from the creation of complex packaging of mortgages

Congress and the president enact a temporary cut in payroll taxes.

a discretionary fiscal policy

If the government cuts taxes in order to increase aggregate demand, the action is called

a discretionary fiscal policy

What is price deflation?

a fall in the price level

Which of the following is not one of the monetary policy goals of the Federal Reserve ("the Fed")?

a high foreign exchange rate of the U.S. dollar relative to other currencies

According to the Taylor Rule, if the Fed reduces its target for the inflation rate, the result will be

a higher target federal funds rate

A pro to a business of ditching cash is

a reduced risk of robbery

Identify each of the following as: - part of an expansionary fiscal policy - part of a contractionary fiscal policy - not part of fiscal policy a. The corporate income tax rate is increased b. Defense spending is increased c. The Federal Reserve lowers the target for the federal funds rate d. Families are allows to deduct all their expenses for daycare from their federal income taxes e. The individual income tax rate is decreased

a. part of a contractionary fiscal policy b. not part of fiscal policy c. not part of fiscal policy d. not part of fiscal policy e. part of an expansionary fiscal policy

President Trump was assuming that in 2017, the economy was

able to create more jobs and expand without increasing the inflation rate

The government would want the economy to contract when real GDP is

above potential GDP and the price level is rising

The over-65 population is increasing so rapidly because

after WWII, there was a "baby boom", but after 1965 birthrates fell

If something is to be considered as money, it has to fulfill ___

all four functions

If the Fed itself admits that there are many obstacles in the way of effective monetary policy, why does it still engage in active monetary policy rather than use a monetary growth rule, as suggested by Milton Friedman and his followers? Policymakers at the Fed believe that

although it is not perfect, active monetary policy is still a stabilizing force in the economy

The total the federal government pays out for unemployment insurance decreases during an expansion

an automatic stabilizer

According to an article in the New York Times, and official at the Bank of Japan has the following explanation of why monetary policy was not pulling the country out of recession: "Despite recent major increases in the money supply, he said, the money stays in banks." In the quote, when the official says "the money stays in banks," he is referring to _____ in the reserves in banks. But the real problem was that banks were not _____ the reserves. The reason for this may have been a lack of _____

an increase lending borrowers

The U.S. penny is made primarily of zinc. There have been several times in recent years when zinc prices have been high and it has cost the U.S. Treasury more than one cent to manufacture a penny. There are currently about 1.4 billion pennies in circulation. Economist Francois Velde of the Federal Reserve Bank of Chicago has proposed making the current penny worth 5 cents. The effect of this proposal would cause ___ the value of M1 Is this change likely to have much impact on the economy?

an increase in NO

In the securitization process,

banks grant loans to households and bundle the loans into securities that are then sold to investors

Reserve requirements are changed infrequently because

banks set long-term policy decisions, loan decisions, and deposit decisions based on the reserve requirement

The Fed now needs to rely on these two new policy tools to change the federal funds rate because

banks were not loaning out excess reserves

What is "quantitative easing"? Quantitative easing involved the Fed's

buying longer term Treasury securities that are not usually involved in open market operations

An initial decrease in a bank's reserves will decrease checkable deposits

by an amount greater than the decrease in reserves

A central bank can "create money" by buying bonds because

by increasing the banks' reserves, banks can make loans which increase checking account balances, and these are part of the money supply.

A con to a business of ditching cash is

cash is the only medium of exchanged used by some

William McChesney martin, who was Federal Reserve chairman from 1951 to 1970, was once quoted as saying, "The role of the Federal Reserve is to remove the punchbowl just as the party gets going." When he said "to remove the punchbowl," he meant to engage in _____ policy In terms of the economy, "just as the party gets going" refers to a situation in which real GDP _____ potential GDP, which will result in _____ the inflation rate

contractionary is greater than an increase in

A "premature tightening" of the "pace of purchases" would slow down the economic recovery because this action would be

contractionary, reducing lending and economic activity

The most important role of the Federal Reserve in today's U.S. economy is

controlling the money supply to pursue economic objectives

One-time tax rebates, such as those in 2001 and 2008, increase consumption spending by less than a permanent tax cut because one-time rebates increase

current income

A higher required reserve ratio ___ the value of the simple deposit multiplier

decreases

An increase in the amount of excess reserves that banks keep ___ the value of the real-world deposit multiplier.

decreases

In the figure to the right, the opportunity cost of holding money ___ when moving from point A to point B on the money demand curve.

decreases

Which of the following is the largest liability of a typical bank?

deposits

The Fed expects that controlling that one interest rate would allow it to meet its goals for inflation and unemployment because lower short-term interest rates

encourage lending and stimulate economic activity

Congress passed legislation to create the Federal Reserve System in 1913 in order to

end the instability created by bank panics by acting as a lender of last resort

Whenever banks gain reserves and make new loans, the money supply ___; and whenever banks lose reserves, and reduce their loans, the money supply ___.

expands contracts

The Fed's strategy of increasing the money supply and lowering interest rates in order to increase real GDP is called

expansionary monetary policy

The interest rate that banks charge each other for overnight loans is called the

federal funds rate

The short-term interest rate the article is referring to is the

federal funds rate

To affect economic variables such as real GDP or the price level, the monetary policy target the Federal Reserve has generally focused on is the

federal funds rate

By raising the discount rate, the Fed leads banks to make ___ loans to households and firms, which will ___ checking account deposits and the money supply

fewer decrease

The U.S. dollar can best be described as

fiat money

The Federal Reserve _____ attempted to use this non-standard monetary policy of net asset purchases you identified above.

has

Since 1950, the annual inflation rate int he U.S.

has typically been positive, but it has also varied substantially, peaking around 1980, and becoming negative for several months in early 2009 due to the effects of the Great Recession

What does Feldstein mean by a "behavioral response" to tax cuts? The behavioral response will be that people in

higher tax brackets will experience an increase in taxable income and thus will work more

Very high rates of inflation are called

hyperinflation

___ is caused by central banks increasing the money supply at a rate far in excess of the growth rate of real GDP.

hyperinflation

While Paul Volcker was chairman, the Fed did not target both the rate of inflation and interest rates because

if the Fed targets interest rates, they have to accept that inflation will fluctuate significantly, and Volcker's goal was to reduce inflation

The Federal Reserve releases transcripts of its Federal Open Market Committee (FOMC) meetings only after a five-year lag in order to preserve the confidentiality of the discussions. When the transcripts of the FOMC's 2008 meetings were released, one member of the Board of Governors was quoted as saying in an April 2008 meeting, "I think it is very possible that we will look back and say, particularly after the Bear Stearns episode, that we have turned the corner in terms of the financial disruption." This member's analysis turned out to be The member's prediction may have seemed reasonable at the time because

incorrect. The economic situation worsened throughout 2008 there was a crisis atmosphere in April 2008, and once the crisis was resolved, it was reasonable to expect things to improve

Budget deficits automatically ___ during recessions and ___ during expansions

increase decrease

With an expansionary monetary policy, investment, consumption, and net exports all _____, which results in the aggregate demand curve shifting to the _____, increasing real GDP and the price level

increase right

If you move $100 from your savings account to your checking account, then M1 will ___ and M2 will ___

increase by $100 remain the same

In the figure to the right, which of the following events is most likely to cause a shift in the money demand (MD) curve from MD1 to MD2 (point A to Point C)?

increase in real GDP or increase in the price level

Cuts in marginal tax rates will

increase marginal net-of-tax income, increase the supply of labor and increase total taxes as people work longer hours

All of the following are factors that make growth rates that high more difficult to achieve today except - increased immigration - rising number of disabled people - an aging population - a slower birth rate

increased immigration

When the central bank commits to conducting policy in a manner that achieves the goal of holding inflation to a publicly announced level, it is using

inflation targeting

If the Fed is too slow to react to a recession and applies an expansionary monetary policy only after the economy begins to recover, then

inflation will be higher than if the Fed had not acted

An investment blog said about Fed Chair Janet Yellen, "She is arguably the world's most powerful woman, and perhaps the most powerful person in the world. Can you name anybody with more might"? This assessment

is generally accepted by economists because of the influence the Fed chair has on monetary policy and the effect monetary policy has on inflation, employment, and financial stability

The cyclically adjusted budget deficit

is measured as if the economy were at potential real GDP

The financial firms of the shadow banking system were

more vulnerable than commercial banks to bank runs because they were more highly leveraged than commercial banks

The federal funds rate

is the rate that banks charge each other for short-term loans of excess reserves

A countercyclical policy is one that

is used to attempt to stabilize the economy

The Fed uses policy targets of interest rate and/or money supply because

it can affect the interest rate and the money supply directly and these in turn can affect unemployment, GDP growth, and the price level

The government bailout was controversial because

it was expensive, and other companies suffered through bankruptcy and failure

The federal government bailed out AIG because

it was the largest insurance company in the nation and the government feared the repercussions of a failure of AIG

If a tax cut has supply-side effects, then

it will affect both aggregate demand and aggregate supply

If the economy moves into recession, monetarists argue that the Fed should

keep the money supply growing at a constant rate

Startups and small businesses might be more likely than large corporations to rely on banks for funding because

large corporations have more ways to obtain funding than do startups and small businesses

As a result of crowding out in the short run, the effect on real GDP of an increase in government spending is often

less than the increase in government spending

The reference to "a broader spectrum of interest rates" means that the Fed began to focus on

longer term Treasury rates and mortgage rates

A "fire sale" in perishable foods is selling those goods at extremely ___ prices

low

When interest rates on Treasury bills and other financial assets are low, the opportunity cost of holding money is ___, so the quantity of money demanded will be ___.

low high

If the RBI ignored the fire sale in perishable foods it might be led to set its target interest rate at the wrong level because actual inflation would be

lower

If the Taylor rule was changed to have a higher coefficient on the output gap, then during a recession the federal funds rate would be

lower, because more weight would be given to the output gap

Why is the Fed sometimes said to have a "dual mandate"? The Fed is said to have a "dual mandate" because

maintaining price stability and high employment are the two most important goals of the Fed that are explicitly mentioned int he Employment Act of 1946

When sellers are willing to accept money in exchange for goods and services, money is acting as a

medium of exchange

Milton Friedman would have liked the Fed to follow a monetary rule where the

money supply is increased every year by a percentage rate equal to the long-run growth rate of real GDP

What is fiat money?

money that is authorized by a central bank and that does not have to be exchanged for gold or some other commodity money

As interest rates decline, stocks become a _____ attractive investment relative to bonds, which causes the demand for stocks and their prices to _____

more rise

The amount of U.S. currency in circulation is much higher than the amount held by the U.S. population because

more than half of the currency is held outside the borders of the United States

A baseball fan with a Mike Trout baseball card wants to trade it for a Giancarlo Stanton baseball card, but everyone the fan knows who has a Stanton card doesn't want a Trout card Economists characterize this problem as a failure of the

principle of a double coincidence of wants

A former Federal Reserve official argued that at the Fed, "the objectives of price stability and low long-term interest rates are essentially the same objective." This is true because

stable prices make it easier to plan for the future, so expectations can be stable, which makes it less costly to make loans

Congress broadened the Fed's responsibility since

the 1930s as a result of the Great Depression

Support for a monetary rule of the kind advocated by Friedman declined since 1980 because

the Fed's performance since 1980 has been excellent even without a formal inflation target

What is "Operation Twist"? "Operation Twist" refers to

the Fed's program to purchase $400 billion in long-term Treasury securities while selling an equal amount of shorter-term Treasury securities

Because of this,

the M1 monetary aggregate is a poor measure of the U.S. money supply

From an understanding of the multiplier process, explain why an increase in the tax rate would decrease the size of the government purchases multiplier. The value of the government purchases multiplier would decrease in the formula for the multiplier ___ Similarly, explain why a decrease in the marginal propensity to import would increase the size of the government purchases multiplier. The value of the government purchases multiplier would decrease because in the formula for the multiplier the denominator is ___

the MPC is multiplied by (1 - t) 1 - [MPC x (1 - t) - MPI]

An asset would be usable as a medium of exchange for all of the following reasons except:

the asset should be a commodity that has intrinsic value

A business that "ditches cash" means

the business no longer accepts currency as payment

When the Federal Reserve sells Treasury securities in the open market,

the buyers of these securities pay for them with checks and bank reserves fall

Which of the following events was an important cause of the 2007-2009 recession?

the collapse of a housing bubble

The consumer price index (CPI) might yield a rate of inflation different from that found using the core PCE price index because

the core PCE does not measure food and energy prices, which are measured by the CPI

Government policies that could have been said to have been subsidizing cheap loans included

the creation of a secondary mortgage market through Fannie Mae and Freddie Mac, and the low interest rates following the 2001 recession

A double coincidence of wants refers to

the fact that for a barter trade to take place between two people, each person must want what the other one has

The interest rate on German government bonds became negative when

the inflation rate exceeded the nominal interest rate

The federal funds rate is

the interest rate that banks charge each other for overnight loans

Two economists at the Federal Reserve Bank of Cleveland note that "estimates of potential GDP are very fluid, [which] suggests there is considerable error in our current measure." They conclude that "this lack of precision should be recognized when policy recommendations are made using a Taylor-type rule." The Federal Reserve Bank of Cleveland economists made this argument based on

the likelihood the potential output or the natural rate of unemployment cannot be accurately measured

If the price level decreases,

the money demand curve shifts to the left

If real GDP increases,

the money demand curve shifts to the right

Which of these variables are the main monetary policy targets of the Fed?

the money supply and the interest rate

If the FOMC orders the trading desk to sell Treasury securities

the money supply curve will shift to the left, and the equilibrium interest rate will rise

Economists believe that the smaller the tax wedge for any economic activity, such as working, saving, investing, or starting a business,

the more of that economic activity that will occur

The number of new workers directly affects

the number of hours worked

The central bank of a country controls the money supply, which equals the currency held by

the public plus their checking account balances

One of the goals of the Federal Reserve is price stability. For the Fed to achieve this goal,

the rate of inflation should be low, such as 1% to 3%, and should be fairly consistent

The Fed gave up targeting the money supply because

the relationship between monetary aggregates and other economic variables was becoming unreliable

Which of the following refers to the minimum fraction of deposits banks that are required by law to keep as reserves?

the required reserve ratio

When the Federal Reserve purchases Treasury securities in the open market,

the sellers of such securities deposit the funds in their banks and bank reserves increase

The national debt is best measured as

the total value of U.S. Treasury securities outstanding

All of the following may help explain the slow adoption of bitcoin except

the vast majority of consumers may not care that bitcoins provide no record of their transactions

Investors were willing to buy bonds with a negative interest rate because

they believed there was no chance that the government would default

How can investment banks be subject to liquidity problems? Investment banks can be subject to liquidity problems because

they often borrow short term, sometimes as short as overnight, and invest the funds in longer-term investments

The quantity theory of money is better able

to explain the inflation rate in the long run

When congress established the Federal Reserve in 1913, its main responsibility was

to make discount loans to banks suffering from large withdrawals by depositors

Which of the following are categories of federal government expenditures?

ALL OF THE ABOVE - interest on the national debt - transfer payments - grants to state and local governments

Which of the following is not a correct comparison between an expansionary fiscal policy in the basic aggregate demand and aggregate supply model and in the dynamic aggregate demand and aggregate supply model?

All of the above are correct statements about the two models - If the economy is below full employment, expansionary fiscal policy will cause an increase in the price level in both models - The dynamic model assumes that potential GDP is constantly growing while the basic model assumes that it is static - In the dynamic model, expansionary policy would be used when demand does not grow sufficiently; in the basic model, expansionary policy would be used when demand falls

Suppose that at the same time Congress and the president pursue an expansionary fiscal policy, the Federal Reserve pursues an expansionary monetary policy. How might an expansionary monetary policy affect the extent of crowding out in the short run?

An expansionary monetary policy would decrease interest rates and thus reduce the extent of crowding out

If the federal budget deficit turns out to be smaller than expected, is it likely that economic growth was higher or lower than expected? Briefly explain.

Higher than expected, because government spending on transfer payments likely fell

Suppose that the economy is currently at potential GDP, and the federal budget is balanced. If the economy moves into recession, what will happen to the federal budget?

If the budget is balanced at potential GDP and the economy moves into recession, then there will be a budget deficit as government expenditures increase and tax revenues decrease

If Congress and the president decide an expansionary fiscal policy is necessary, what changes should they make in government spending or taxes?

In this case, Congress and the president should enact policies that increase government spending and decrease taxes

Briefly explain whether an expansionary fiscal policy will cause each of the following variables to increase or decrease: Real GDP The unemployment rate The price level

Increase real GDP by increasing aggregate demand Decrease the unemployment rate by increasing production Increase the price level because more is demanded

Which of the following is not a correct comparison between a contractionary fiscal policy in the basic aggregate demand and aggregate supply model and in the dynamic aggregate demand and aggregate supply model?

None of the above are correct statements about the two models - If the economy is above full employment, contractionary fiscal policy will reduce the inflation rate in the basic but not the dynamic model - In the dynamic model, contractionary policy would be used when demand grows too slowly; in the basic model, expansionary policy would be used when demand increases - The basic model assumes that potential GDP is constantly growing while the dynamic model assumes that it is static

How important is it to pay off this debt?

Not very important if the debt is at a sustainable level, and the interest payments are relatively constant

The actual change in real GDP resulting from an increase in government purchases or a cut in taxes will be less than the simple multiplier effect indicates.

TRUE

What is the cyclically adjusted budget deficit or surplus?

The cyclically adjusted budget deficit or surplus is the deficit or surplus in the federal government's budget if the economy were at potential GDP

Why would the CBO's forecast of future levels of GDP and employment matter for its forecasts of future federal budget deficits?

These forecasts affect the amount of tax revenue and the amount of government spending on transfer payments

Why do few economists argue that it would be a good idea to balance the federal budget every year?

To keep a balanced budget during a recession, taxes would have to increase and government expenditures would have to decrease, which would further reduce aggregate demand and deepen the recession

An "excessive" budget deficit in this context is

a relatively large budget deficit as a percentage of GDP beyond the European Union's deficit and debt rules

The increase in the number of people age 65 or older will result in ___ in federal spending on Social Security and Medicare as a percentage of GDP.

an increase

Borrowing is a bad idea to pay for ___ but a good idea to pay for ___

current expenses long-lived capital goods

In the context of what was happening in the economy in 1929, President Hoover was ___ in saying that, in 1932, nothing was more necessary than balancing the federal government's budget

incorrect

The U.S. federal government raises revenue from individual and corporate income taxes, social insurance taxes, and other sources (including excise taxes, tariffs, and payments to cut timber on federal lands) The largest share of federal revenues comes from

individual income taxes (about 44%), followed by social insurance taxes (about 35%) and corporate income taxes (about 13%)

Some economists argue that because increases in government spending crowd out private spending, increased government spending will reduce the long-run growth rate of real GDP. This is most likely to happen if the private spending being crowded out is ___

investment spending

The federal government would not want to increase its spending, even if the result were to increase real GDP and employment in the short run, if

it would lead to a greater federal deficit and an increase in the national debt

The federal government's day-to-day activities include running federal agencies like the Environmental Protection Agency, the FBI, the National Park Service, and the Immigration and Customs Enforcement. Spending on these types of activities make up

less than 10 percent of federal government expenditure

In the short run, increases in federal spending will increase real GDP and employment if

the economy is producing at less than its potential output and has some cyclical unemployment

Another infrastructure project in northern California funded in part by ARRA funds involved expanding the Caldecott Tunnel between the cities of Oakland and Orinda. A spokesperson for the California state agency in charge of the project mentioned that the Caldecott tunnel project would have a "ripple effect" on employment. The ripple effect meant that

the job creation would spread to other industries and eventually to the whole economy due to the consumption of the construction workers