Deck 16: The Influence of Monetary and Fiscal Policy on Aggregate Demand

Question 1

An increase in the interest rate reduces the quantity of goods and services demanded, because borrowing is less expensive.

Answer 1

False

Question 2

If a country's central bank contracts the money supply, the aggregate demand curve shifts to the left.

Answer 2

True

Question 3

When the central bank contracts the money supply, the interest rate rises to bring the money market into equilibrium and reduces the quantity of goods and services demanded for any given price level.This

A)shifts the aggregate demand curve to the right.
B)shifts the aggregate demand curve to the left.
C)shifts the aggregate supply curve to the right.
D)shifts the aggregate supply curve to the left.

Answer 3

shifts the aggregate demand curve to the left.

Question 4

According to the theory of liquidity preference, if the interest rate is above the equilibrium level, the quantity of money people want to hold is less than the quantity the central bank has created, and this surplus of money puts upward pressure on the interest rate.

Question 5

Originally developed by John Maynard Keynes in the 1930s, the theory of liquidity preference holds that the interest rate adjusts to bring money supply and money demand into balance.

Question 6

If a country's central bank increases the money supply, the aggregate demand curve shifts to the left.

Question 7

As the interest rate falls, people become more willing to hold money until, at the equilibrium interest rate, people are happy

A)to demand the central bank issues more money.
B)to hold exactly the amount of money the central bank has supplied.
C)to demand less than the amount of money the central bank has supplied.
D)to demand more than the amount of money the central bank has supplied.

Question 8

Although many factors determine the quantity of money demanded, the one emphasized by the theory of liquidity preference is the interest rate.

Question 9

An increase in the interest rate raises the opportunity cost of holding money.There is an incentive, therefore, for people to exchange cash holdings for interest bearing deposits and this, as a result

A)increase the money supply.
B)reduces the interest rate.
C)increases the quantity of money demanded.
D)reduces the quantity of money demanded.

Question 10

When the interest rate falls

A)the opportunity cost of holding money rises.
B)people shift out of holding interest yielding assets and hold more of their wealth in the form of money.
C)the quantity of money people will hold decreases.
D)investment spending decreases.

Question 11

A monetary expansion would reduce interest rates, stimulate investment spending and

A)expand the money supply.
B)decrease aggregate demand.
C)expand aggregate demand.
D)expand aggregate supply.

Question 12

The opportunity cost of holding money is the

A)cost incurred to change other assets into money.
B)time cost of accessing funds.
C)value of the goods and services a person is able to obtain with the money.
D)interest a person could have earned by holding other forms of wealth instead.

Question 13

The equilibrium interest rate occurs in the money market where the

A)quantity of money available is zero.
B)the maximum quantity of funds has been borrowed and loaned.
C)the money supply is equal to the money demanded.
D)the quantity of money demanded is zero.

Question 14

An increase in the interest rate reduces the quantity of goods and services demanded.As a result

A)the demand for domestic goods increases.
B)the demand for foreign goods declines.
C)the demand for residential and business investment goods increases.
D)the demand for residential and business investment goods declines.

Question 15

According to the theory of liquidity preference, if the interest rate is below the equilibrium level, the quantity of money people want to hold is more than the quantity the central bank has created, and this shortage of money puts upward pressure on the interest rate.

Question 16

More reflective of current central bank policy is to treat the money supply, rather than the interest rate, as its policy instrument.

Question 17

At higher interest rates

A)the price of goods and services are reduced.
B)the price of borrowing and the interest rates are reduced.
C)the cost of borrowing and the return on savings are greater.
D)the cost of borrowing and the return on savings are reduced.

Question 18

The equilibrium interest rate is the rate at which the quantity of money demanded exactly balances the quantity of money supplied.

Question 19

John Maynard Keynes's liquidity preference theory suggests that the interest rate is determined by

A)the supply of and demand for loanable funds.
B)aggregate supply and aggregate demand.
C)the commercial banks.
D)the supply of and demand for money.

Question 20

When the government cuts spending, aggregate demand will fall, this will depress production and employment in the short run

Question 21

Explain why the interest rate is the opportunity cost of holding currency.What is the benefit of holding currency?

Question 22

The multiplier effect means that aggregate demand curve will shift by a larger amount than the increase in

A)consumer spending.
B)budget revenues.
C)government spending.
D)the aggregate supply.

Question 23

When the government cuts personal income taxes, for instance, it increases households' take home pay.As a result

A)households will save all of this additional income, and spend little or nothing on consumer goods.
B)households will save some of this additional income, but will also spend some of it on consumer goods.
C)households will not save any of this additional income, but will spend all of it on the stock market.
D)households will neither save the additional income nor spend it on consumer goods.

Question 24

The response of monetary policy to a change in fiscal policy is an example of a more general phenomenon: the use of _______________ to steady aggregate demand and, as a result, production and employment.

A)macroeconomic policies
B)active stabilization policies
C)financial policies
D)Research led policies

Question 25

Describe the process in the money market by which the interest rate reaches its equilibrium value if it starts above equilibrium.

Question 26

The crowding out effect is caused by

A)an increase in the money supply, which increases the demand for goods and services, and thus crowds out investment.
B)an increase in government purchases, which reduces the demand for goods and services, and thus crowds out investment.
C)an increase in consumer income, which increases the demand for goods and services, and thus crowds out investment.
D)an increase in government purchases, which increases the demand for goods and services, and thus crowds out investment.

Question 27

When the central bank has lowered or raised interest rates, this occurs only because the central bank's bond traders are

A)conducting open market operations to ensure revenue is generated.
B)conducting open market operations to cover their positions.
C)conducting open market operations to ensure that the money supply is increased.
D)conducting open market operations to ensure that the equilibrium interest rate equals x percent.

Question 28

In addition to the multiplier and crowding out effects, a tax change is a determinant of the size of the shift in the aggregate demand curve.Why would perceptions about whether the tax change is permanent or temporary affect the size of the shift?

Question 29

Suppose that consumers become pessimistic about the future health of the economy.What will happen to aggregate demand and to output? What might a government have to do to keep output stable?

Question 30

If asset markets are driven by the "animal spirits" of investors, then

A)those markets reflect rational behaviour.
B)those markets reflect irrational behaviour.
C)the efficient markets hypothesis is correct.
D)the stock market exhibits informational efficiency.

Question 31

Briefly discuss the theory of liquidity preference.

Question 32

Explain the logic according to liquidity preference theory by which an increase in the money supply changes the aggregate demand curve.

Question 33

Different theories of the interest rate are useful for different purposes.When thinking about the short run determinants of interest rates, it is best to keep in mind

A)the loanable funds theory.
B)the liquidity preference theory.
C)the classical economic theory.
D)the price level theory.

Question 34

What is the difference between monetary policy and fiscal policy?

Question 35

Different theories of the interest rate are useful for different purposes.When thinking about the long run determinants of interest rates, it is best to keep in mind

A)the loanable funds theory.
B)the liquidity preference theory.
C)the classical economic theory.
D)the price level theory.

Question 36

Use the money market to explain the interest rate effect and its relation to the slope of the aggregate demand curve.

Question 37

In 2009, Professor Mankiw wrote an article in the New York Times suggesting negative interest rates.The logic is that consumers would spend more money.The additional spending would

A)increase aggregate demand and act as a boost to the economy.
B)decrease aggregate demand and act as a boost to the economy.
C)increase aggregate demand and slow down the economy.
D)decrease aggregate demand and slow down the economy.

Question 38

Explain how a transfer payment like the unemployment insurance benefit acts as an automatic stabilizer.

Question 39

Suppose that the government spends more on replacing old school buildings with new ones.What does this do to aggregate demand? Please cite the presence of the multiplier effect, the crowding out effect and taxes.

Question 40

A tax change is a determinant of the size of the shift in the aggregate demand curve.The shift in the aggregate demand curve will be affected by

A)households' perceptions about whether the tax change is on income or on goods.
B)households' perceptions about whether the tax change is local or national.
C)households' perceptions about whether the tax change is good or bad.
D)households' perceptions about whether the tax change is permanent or temporary.

Question 41

Keynes thought that the behaviour of the economy in the short run was influenced by what he called "animal spirits." By this he meant that business people sometimes felt good about the economy, and carried out lots of investment, and at other times felt bad about the economy, and so cut back on their investment spending.Explain how such fluctuations in investment would lead to fluctuations in real GDP and prices.