Deck 14: Expectations: the Basic Tools

Question 1

Suppose the central bank engages in contractionary monetary policy that results in lower money growth. This lower money growth will cause which of the following in the short run?

A) Lower real interest rates and lower nominal interest rates.
B) Lower real interest rates and higher nominal interest rates.
C) Higher real interest rates and higher nominal interest rates.
D) Higher real interest rates and lower nominal interest rates.
E) No change in either nominal or real interest rates.

Answer 1

Higher real interest rates and higher nominal interest rates.

Question 2

Assume that expected inflation is zero, then we know that:

A) the nominal interest rate will exceed the real interest rate.
B) the real interest rate will be zero.
C) the real interest rate will exceed the nominal interest rate.
D) the nominal and real interest rates are equal.
E) the real interest is negative.

Answer 2

the nominal and real interest rates are equal.

Question 3

Lower money growth tends to cause:

A) no change in i and r in the medium run.
B) an increase in i in the medium run and an increase in r in the medium run.
C) a decrease in i in the medium run and no change in r in the medium run.
D) an increase in i in the medium run and no change in r in the medium run.
E) no change in i in the medium run and an increase in r in the medium run.

Answer 3

a decrease in i in the medium run and no change in r in the medium run.

Question 4

Let: (1) Pt be the price of one unit of a market basket of goods (i.e., a composite commodity) in year t; (2) P e be the expected price of one unit of a market basket of goods in year t + 1; (3) u e be the
Expected rate of inflation between period t and t + 1; and (4) it be the one- year nominal interest rate. Suppose an individual borrows the equivalent of one unit of a composite commodity today. Given this information, which of the following expressions represents (i.e., is equal to) the amount of the composite commodity one must repay in one year?

A) [(1 + u e )/(1 + it)]- 1.
B) [(1 + it) P e /Pt]- 1.
C) [(1 + u e )/(1 + it)]+1.
D) (1 + u e )/(1 + it).
E) (1 + it)Pt/ P e .

Question 5

If the nominal interest rate in year t is 15%, and the expected inflation rate for year t is 3%, then the real interest rate in year t is approximately:

A) 12%.
B) 2%.
C) 3%.
D) 5%.
E) 8%.

Question 6

Suppose there is a decrease in government spending. Such a fiscal policy action will cause:

A) the natural real interest rate to rise.
B) the natural real interest rate to fall.
C) ambiguous effects on the natural real interest rate.
D) no effect on the natural real interest rate.
E) the natural real interest rate falls when the nominal rate falls.

Question 7

In the IS- LM model, an increase in expected inflation will cause which of the following?

A) An increase in output.
B) A decrease in the real interest rate.
C) An increase in the nominal interest rate.
D) All of the above.
E) None of the above.

Question 8

With a nominal interest rate of 22%, the present discounted value of $1100 to be received in one year is:

A) $796.54.
B) $690.54.
C) $901.64.
D) $646.54.
E) $851.54.

Question 9

Which of the following explains why the Great Depression did not end sooner?

A) An increase in the nominal money stock.
B) An increase in the price level.
C) The presence of deflation.
D) A relatively passive use of monetary policy.
E) Both C and D.

Question 10

Suppose the central bank pursues expansionary monetary policy. Such an action will cause:

A) the natural real interest rate to rise.
B) the natural real interest rate to fall.
C) ambiguous effects on the natural real interest rate.
D) no effect on the natural real interest rate.
E) the natural real interest rate falls when the nominal rate falls.

Question 11

Suppose households feel more optimistic about the future and decide to increase consumption. This rise in consumer confidence will cause:

A) the natural real interest rate to rise.
B) the natural real interest rate to fall.
C) ambiguous effects on the natural real interest rate.
D) no effect on the natural real interest rate.
E) the natural real interest rate falls when the nominal rate falls.

Question 12

With a nominal interest rate of 22% per year, the present discounted value of $1100 to be received in two years is:

A) $684.05.
B) $725.05.
C) $843.05.
D) $807.05.
E) $739.05.

Question 13

If the nominal interest rate is 4.6% per year, how much money can an individual borrow today if she needs to repay $300 in one year?

A) $286.81.
B) $256.81.
C) $180.81.
D) $208.81.
E) $166.81.

Question 14

When the IS curve is drawn with the nominal interest rate on the vertical axis, a reduction in the expected inflation rate will cause:

A) the IS curve to become flatter.
B) no change in the IS curve.
C) the IS curve to shift rightward.
D) the IS curve to become steeper.
E) the IS curve to shift leftward.

Question 15

Suppose the central bank engages in contractionary monetary policy that results in lower money growth. This lower money growth will cause which of the following in the medium run?

A) Lower real interest rates and lower nominal interest rates.
B) Lower real interest rates and higher nominal interest rates.
C) Higher real interest rates and higher nominal interest rates.
D) Higher real interest rates and lower nominal interest rates.
E) No change in real interest rates and lower nominal interest rates.

Question 16

Which of the following must occur for the nominal interest rate to be equal to the real interest rate?

A) Expected inflation is equal to the nominal interest rate.
B) Expected inflation is equal to the real interest rate.
C) The nominal and real interest rates can never be equal.
D) Expected inflation is equal to zero.
E) Expected inflation is equal to twice the real interest rate.

Question 17

Suppose the nominal interest rate is zero. In this situation, the present discounted value of a finite sequence of future payments is equal to which of the following:

A) the sum of zero.
B) the square of the sum of all payments.
C) the sum of all the payments divided by the rate of inflation.
D) the sum of all payments.
E) the average value of each payment.

Question 18

When individuals make decisions about how much money and bonds to hold, which of the following variables will portfolio holders consider?

A) The nominal interest rate only.
B) The expected inflation rate only.
C) Both the nominal and real interest rates.
D) The real interest rate only.
E) Either the real interest rate or the expected inflation rate.

Question 19

If the nominal interest rate falls, and the expected inflation rate rises, we know that the real interest rate:

A) will decrease.
B) will decrease, but only if the decrease in the nominal rate is smaller than the increase in expected inflation.
C) cannot be defined.
D) will increase.
E) will increase, but only if the decrease in the nominal rate is greater than the increase in expected inflation.

Question 20

In the medium run, which of the following expressions will represent the nominal interest rate?

A) rn.
B) gY+ gm.
C) rn - ne.
D) rn + gm.
E) rn + nT.

Question 21

Suppose the central bank engages in expansionary monetary policy that results in higher money growth. This higher money growth will cause which of the following in the medium run?

A) Lower real interest rates and lower nominal interest rates.
B) Lower real interest rates and higher nominal interest rates.
C) Higher real interest rates and higher nominal interest rates.
D) Higher real interest rates and lower nominal interest rates.
E) No change in real interest rates and higher nominal interest rates.

Question 22

Which of the following statements about the nominal interest rate (i) is correct?

A) It is the interest rate measured in terms of goods.
B) It is always less than the real interest rate.
C) It is the type of interest rate typically reported in the financial pages of newspapers.
D) It is equal to the expected rate of inflation.
E) It is equal to the real interest rate minus the rate of inflation.

Question 23

The Fisher effect summarises the effects of:

A) inflation on the real interest rate in the medium run.
B) inflation on the real interest rate in the short run.
C) inflation on the nominal interest rate in the short run.
D) inflation on the natural real interest rate in the short run.
E) inflation on the nominal interest rate in the medium run.

Question 24

From 1929 to 1932, U.S. output growth was:

A) consistently negative.
B) negative in the first few years, and then mostly positive in the remaining years.
C) negative in the first few years, and then zero in the remaining years.
D) consistently near zero.
E) consistently positive.

Question 25

Because the nominal interest rate is always positive, the discount factor is always:

A) zero.
B) one.
C) negative.
D) greater than one.
E) less than one.

Question 26

An increase in the nominal interest rate, all else held constant, will always cause which of the following?

A) The demand for money to decrease.
B) The expected inflation rate to decrease.
C) The real interest rate to decrease.
D) The demand for money to increase.
E) The inflation rate to decrease.

Question 27

With a constant nominal interest rate equal to i, the present discounted value of $1.00 to be received 6 years from today is equal to:

A) 1 + i.
B) 1/(1 + i)6.
C) i6.
D) 6(1 + i).
E) (1 + i)6.

Question 28

During the first few years of the Great Depression:

A) both nominal and real interest rates remained constant.
B) nominal interest rates increased, but real interest rates decreased.
C) nominal interest rates decreased, but real interest rates increased.
D) both nominal and real interest rates increased.
E) both nominal and real interest rates decreased.

Question 29

Suppose you are told that the nominal interest rate is greater than the real interest rate. Given this information, we would be able to conclude that:

A) expected inflation must be positive.
B) either the nominal or real interest rate must be negative.
C) expected inflation must be negative.
D) deflation must be occurring.
E) both the nominal and real interest rates must be negative.

Question 30

A consol bond promises to pay $1500 each year, forever, starting next year. If the nominal interest rate is 6%, the present discounted value of this consol is:

A) $20000.00.
B) $15000.00.
C) $24000.00.
D) $25000.00.
E) $18000.00.

Question 31

Suppose the economy is initially operating at the natural level of output. Now, suppose the central bank raises the inflation target by 3%. Given this information, we would expect that:

A) the real interest rate will increase by less than 3% in the medium run.
B) the real interest rate will decrease by less than 3% in the medium run.
C) the real interest rate will decrease by exactly 3% in the medium run.
D) the real interest rate will not change in the medium run.
E) the real interest rate will increase by exactly 3% in the medium run.

Question 32

Suppose households feel less optimistic about the future and decide to reduce consumption. This fall in consumer confidence will cause:

A) the natural real interest rate to rise.
B) the natural real interest rate to fall.
C) ambiguous effects on the natural real interest rate.
D) no effect on the natural real interest rate.
E) the natural real interest rate falls when the nominal rate falls.

Question 33

Suppose the central bank pursues contractionary monetary policy. Such an action will cause:

A) the natural real interest rate to rise.
B) the natural real interest rate to fall.
C) ambiguous effects on the natural real interest rate.
D) no effect on the natural real interest rate.
E) the natural real interest rate rises when the nominal rate rises.

Question 34

Data on real and nominal interest rates of ten- year Australian T- Bond show that, over the past forty years:

A) the real rate has always been less than the nominal rate.
B) the nominal rate has always been less than the real rate.
C) the nominal rate has varied, but the real rate has not.
D) the real rate has varied, but the nominal rate has not.
E) whenever the nominal rate rises, the real rate falls, and vice versa.

Question 35

Suppose the economy is initially operating at the natural level of output. Now, suppose the central bank raises the inflation target by 2.5%. Given this information, we would expect that:

A) the nominal interest rate will increase by more than 2.5% in the medium run.
B) the nominal interest rate will increase by exactly 2.5% in the medium run.
C) the nominal interest rate will fall by exactly 2.5% in the medium run.
D) the nominal interest rate will fall by less than 2.5% in the medium run.
E) the nominal interest rate will not change in the medium.

Question 36

Assume that the inflation rate is positive. Given this information, which of the following is always true?

A) The nominal interest rate must be greater than the real interest rate.
B) The real interest rate is negative.
C) The real interest rate is greater than the nominal interest rate.
D) The nominal interest rate must be equal to the real interest rate.
E) The real interest rate is positive.

Question 37

Suppose there is an increase in government spending. Such a fiscal policy action will cause:

A) the natural real interest rate to rise.
B) the natural real interest rate to fall.
C) ambiguous effects on the natural real interest rate.
D) no effect on the natural real interest rate.
E) the natural real interest rate falls when the nominal rate falls.

Question 38

Suppose the Reserve Bank of Australia pursues contractionary monetary policy. This policy move will tend to cause:

A) no change in i in the medium run and an increase in r in the medium run.
B) a decrease in i in the medium run and a decrease in r in the medium run.
C) a decrease in i in the medium run and no change in r in the medium run.
D) an increase in i in the medium run and no change in r in the medium run.
E) no change in i in the medium run and a decrease in r in the medium run.

Question 39

Suppose that the nominal interest rate and expected inflation rate both increase by 3%. These equal increases in the nominal interest rate and expected inflation rate will cause:

A) an increase in the real interest rate.
B) a decrease in government spending.
C) a decrease in money demand.
D) a decrease in investment.
E) a decrease in the real interest rate.

Question 40

When expected inflation is equal to the nominal interest rate, which of the following is correct?

A) The real interest rate is higher than the nominal interest rate.
B) The real interest rate is positive.
C) The real interest rate is zero.
D) The real interest rate is negative.
E) None of the above.

Question 41

Which of the following best defines the real interest rate (r)?

A) The amount of goods we must give up next year in order to consume more goods today.
B) The amount of goods we must give up today in order to have more dollars next year.
C) The amount of dollars we must give up next year in order to consume more goods today.
D) The amount of dollars we must give up today in order to consume more goods today.
E) The amount of dollars we must give up next year in order to have more dollars today.

Question 42

Suppose the central bank engages in expansionary monetary policy that results in higher money growth. This higher money growth will cause which of the following in the short run?

A) Lower real interest rates and lower nominal interest rates.
B) Lower real interest rates and higher nominal interest rates.
C) Higher real interest rates and higher nominal interest rates.
D) Higher real interest rates and lower nominal interest rates.
E) No change in either nominal or real interest rates.

Question 43

The present discounted value of a future payment becomes smaller when:

A) the payment itself decreases.
B) the real interest rate decreases.
C) the payment itself increases.
D) the nominal interest rate decreases.
E) the payment is made sooner rather than later.

Question 44

Which of the following will not cause a decrease in the present value of a sequence of payments?

A) An increase in a future expected payment.
B) A decrease in a future expected payment.
C) An increase in the current interest rate.
D) A decrease in the current payment.
E) An increase in expected future interest rates.

Question 45

What is the relationship among the nominal interest rate, the natural real interest rate, and money growth in the medium run? Explain. Based on your answer, what effect will a decrease in target inflation have on the nominal interest rate and the natural real interest rate in the medium run? Explain.

Question 46

First, explain what the nominal interest rate represents. Second, explain what the real interest rate represents.

Question 47

Suppose government officials report that the expected inflation rate is negative. Given this information, you would be able to conclude that:

A) the real interest rate is greater than zero.
B) the real interest rate is less than the nominal interest rate.
C) the real interest rate can be any of the above, depending on the absolute value of the negative expected inflation rate.
D) the real interest rate is negative.
E) the real interest rate is equal to the nominal interest rate.

Question 48

With a nominal interest rate of 3.5% per year, the present discounted value of $850 to be received in 8 years is:

A) $950.50.
B) $874.50.
C) $748.50.
D) $645.50.
E) $1122.50.

Question 49

Because expected inflation is typically positive, we know that:

A) the nominal interest rate is generally less than the real interest rate.
B) the real interest rate rate is approximately equal to zero.
C) the nominal interest can be negative.
D) the real interest rate is generally less than the nominal interest rate.
E) the nominal and real interest rates are generally equal.

Question 50

Suppose output is growing at 3% and the nominal money stock is growing at 0%. Also assume that the economy has reached its medium- run equilibrium. Given this information, we know with certainty that:

A) inflation is greater than 3%.
B) inflation is equal to 3%.
C) deflation occurs.
D) inflation is positive.
E) the real interest rate is equal to the nominal interest rate.

Question 51

Explain what the Fisher effect/Fisher hypothesis represents.

Question 52

To what extent can the central bank affect the real interest rate in the medium run? Explain.

Question 53

For this question, assume that the nominal interest rate does not change. In this situation, a decrease in expected inflation will cause:

A) an increase in investment.
B) an increase in the real interest rate.
C) a decrease in the real interest rate.
D) an increase in consumption.
E) an increase in money demand.

Question 54

Discuss how a manager of a mining company would use the expected present discounted value to make decisions on whether to purchase machines and equipments to develop a new mine.

Question 55

Suppose there is an increase in government spending. Such a fiscal policy action will cause:

A) the natural level of output to rise.
B) the natural level of output to fall.
C) ambiguous effects on the natural level of output.
D) no effect on the natural level of output.
E) the natural level of output rises when the natural real interest rate falls.

Question 56

Assume that the nominal interest rate is equal to 0. Use this information and the information about the payments provided below, rank the following three sequences of payments according to their present value.

A) B > A > C
B) A > C > B
C) C > B > A
D) A > B > C
E) None of the above.

Question 57

Using the IS- LM model, graphically illustrate and explain what effect an increase in target inflation will have on output, the nominal interest rate, and the real interest rate in the short run.

Question 58

Which of the following is true of the LM curve when the nominal interest rate is on the vertical axis?

A) The LM curve becomes downward sloping.
B) The LM curve becomes steeper.
C) A change in expected inflation will have no effect on the position of the LM curve.
D) A decrease in the expected inflation rate will make the LM curve shift down.
E) A decrease in the expected inflation rate will make the LM curve shift up.

Question 59

To reduce the nominal interest rate in the medium run, what type of policy should the central bank pursue? Explain.

Question 60

To reduce the nominal interest rate in the short run, what type of policy should the central bank pursue? Explain.

Question 61

What are the determinants of the nominal interest rate in the medium run? Based on your answer, to what extent can monetary policy affect the nominal interest rate in the medium run? Briefly explain. And finally, to what extent can fiscal policy affect the nominal interest rate in the medium run? Briefly explain.

Question 62

Discuss the demand- side factors and the role of deflation in contributing to the Great Depression in Australia.

Question 63

Explain the difference in the interest rate that enters into the IS relation and the LM relation. What is the link between these two interest rates in the IS- LM model?

Question 64

Explain whether it is possible for the nominal interest rate to increase while the real interest rate simultaneously decreases.

Question 65

First, discuss what is meant by the "natural real interest rate". Second, explain what effect each of the following will have on the natural real interest rate: (1) a decrease in government spending; and (2) an increase in the inflation target.