Deck 26: Monetary Policy

Question 1

A decrease in the interest rate, other things being equal, causes a(n):

A) upward movement along the demand curve for money.
B) downward movement along the demand curve for money.
C) rightward shift of the demand curve for money.
D) leftward shift of the demand curve for money.

Answer 1

B

Question 2

Which of the following explains why the demand for money curve has an inverse relationship between the interest rates and the quantity of money demanded?

A) As the interest rate rises, the opportunity cost of holding money rises, and people respond by converting cash or checking account balances into interest-bearing financial investments.
B) As the interest rate rises, people find it advantageous to borrow money, which increases the quantity of money demanded.
C) As the interest rate falls, the opportunity cost of holding money rises, and people respond by converting cash or checking account balances into interest-bearing financial investments.
D) As the interest rate rises, the demand for money curve shifts outward to the right.

Answer 2

A

Question 3

When the interest rate falls,

A) the opportunity cost of holding money rises.
B) people shift out of holding interest-yielding bonds into holding money.
C) the quantity of money people will hold decreases.
D) investment spending decreases.

Answer 3

B

Question 4

People learn to hold a specific quantity of money for the groceries, theater tickets, gasoline, clothes, film, and other items they habitually purchase. This behavior is representative of the:

A) precautionary demand.
B) speculative demand.
C) transactions demand.
D) volatility demand.

Question 5

Keynes called money people hold to make routine day-to-day purchases the:

A) transactions demand for holding money.
B) precautionary demand for holding money.
C) speculative demand for holding money.
D) store of value demand for holding money.

Question 6

Speculative demand for money is a(n):

A) positive function of prices.
B) inverse function of prices.
C) positive function of interest rates.
D) inverse function of interest rates.

Question 7

The opportunity cost of holding money balances increases when:

A) the inflation rate decreases.
B) the interest rate increases.
C) the interest rate decreases.
D) GDP is far from full employment.

Question 8

Keynesians identify three principal motives for demanding money. They are the:

A) transactions demand, precautionary demand, and liquidity motive.
B) transactions demand, precautionary demand, and convertibility motive.
C) transactions demand, speculative demand, and volatility motive.
D) transactions demand, speculative demand, and precautionary demand.

Question 9

Which of the following statements is true ?

A) The speculative demand for money at possible interest rates gives the demand for money curve its upward slope.
B) There is an inverse relationship between the quantity of money demanded and the interest rate.
C) According to the quantity theory of money, any change in the money supply will have no effect on the price level.
D) The transactions demand for money is used as an insurance agent against unexpected needs.

Question 10

Keynes called the money people hold in order to pay unforeseen or unexpected expenses the:

A) transactions demand for holding money.
B) precautionary demand for holding money.
C) speculative demand for holding money.
D) store of value demand for holding money.

Question 11

Other things being equal, an increase in the rate of interest causes a(n):

A) upward movement along the demand for money curve.
B) downward movement along the demand for money curve.
C) rightward shift of the demand for money curve.
D) leftward shift of the demand for money curve.

Question 12

The demand for money curve shows that there is an inverse relationship between the quantity of money demanded and the:

A) quantity of money supplied.
B) gross domestic product (GDP).
C) price level.
D) interest rate.

Question 13

If at the prevailing interest rate the quantity of money demanded is $2 trillion, and the supply of money is $1.5 trillion, then which of the following is true ?

A) There is a shortage of money, and consequently interest rates must fall in order to achieve an equilibrium in the money market.
B) There is a surplus of money, and consequently interest rates must fall in order to achieve an equilibrium in the money market.
C) There is shortage of money, and consequently interest rates must rise in order to achieve an equilibrium in the money market.
D) There is a surplus of money, and consequently interest rates must rise in order to achieve an equilibrium in the money market.

Question 14

Which type of demand for money causes the demand for money curve to slope downward?

A) speculative demand
B) precautionary demand
C) transactions demand
D) foreign-exchange demand

Question 15

Keynes called the money people hold in order to buy bonds, stocks, or other nonmoney financial assets the:

A) transactions demand for holding money.
B) precautionary demand for holding money.
C) speculative demand for holding money.
D) unit of account demand for holding money.

Question 16

Keynes argued that the downward slope of the demand for money curve depends on the:

A) equation of exchange.
B) rate of interest.
C) federal funds rate.
D) discount rate.

Question 17

The demand curve for money:

A) shows the amount of money balances that individuals and businesses wish to hold at various levels of private investment.
B) reflects the open market operations policy of the Federal Reserve.
C) shows the amount of money that households and businesses wish to hold at various rates of interest.
D) indicates the amount that consumers wish to borrow at a given interest rate.

Question 18

The quantity of money demanded to satisfy transactions needs:

A) is intended for unexpected expenditures.
B) increases with the level of real GDP.
C) decreases with the level of real GDP.
D) is unrelated to either national income or the interest rate.

Question 19

In Keynes's view, an excess quantity of money demanded causes people to:

A) sell bonds and the interest rate rises.
B) buy bonds and the interest rate falls.
C) buy bonds and the interest rate rises.
D) increase speculative balances.

Question 20

One reason that people hold money is to pay for unexpected car repairs and other unpredictable expenses. This motive for holding money is called:

A) transactions demand.
B) precautionary demand.
C) speculative demand.
D) noncyclical demand.

Question 21

Which of the following policies would be most likely to reduce the rate of inflation?

A) sale of government bonds by the Federal Reserve
B) a reduction in the discount rate
C) an increase in the size of the federal budget deficit
D) a reduction in the required reserves imposed on the banking system

Question 22

Exhibit 16-1 Money market demand and supply curves

Starting from an equilibrium at E₁ in Exhibit 16-1, a leftward shift of the money supply curve from MS₁ to MS₂ would cause an excess:

A) demand for money, leading people to sell bonds.
B) demand for money, leading people to buy bonds.
C) supply of money, leading people to sell bonds.
D) supply of money, leading people to buy bonds.

Question 23

If the Fed wants to raise interest rates, then it can use its open market operations to:

A) increase the money supply.
B) decrease the money supply.
C) increase money demand.
D) decrease money demand.

Question 24

An increase in the money supply is represented by a(n):

A) rightward shift of the downward-sloping money supply curve.
B) upward shift of the money supply curve.
C) rightward shift of the money supply curve.
D) increase in the rate of interest.

Question 25

Which of the following policies could the Fed use to lower the interest rate?

A) a tax cut
B) selling government securities
C) raising the discount rate
D) reducing the required reserve ratio

Question 26

When the Fed increases the money supply, interest rates:

A) rise.
B) fall.
C) are unaffected.
D) rise and then fall.

Question 27

Exhibit 16-3 Money market demand and supply curves

In Exhibit 16-3, assume an equilibrium with an interest rate of 15 percent and the money supply at $100 billion. The Fed uses its policy tools to move the economy to a new equilibrium at E₂ with money supply of $150 billion and an interest rate of 10 percent. This change could be the result of a(n):

A) open market sale of securities by the Fed.
B) higher discount rate set by the Fed.
C) higher required-reserve ratio set by the Fed.
D) open market purchase of securities by the Fed.

Question 28

Which of the following is the objective of expansionary monetary policy?

A) an increase in employment
B) a decrease in employment
C) an increase in the velocity of money
D) an increase in prices proportional to the rise in the money supply

Question 29

Assume the Fed decreases the money supply and the demand for money curve is fixed. In response, people will:

A) sell bonds, thus driving up the interest rate.
B) buy bonds, thus driving down the interest rate.
C) buy bonds, thus driving up the interest rate.
D) sell bonds, thus driving down the interest rate.

Question 30

When the Fed reduces the money supply, it will cause a decrease in aggregate demand because:

A) real rates will rise, lowering business investment and consumer spending.
B) the dollar will depreciate on the foreign exchange market, leading to an increase in net exports.
C) lower interest rates will cause the value of assets (for example, stocks) to rise.
D) the national debt will increase, causing consumers to reduce their spending.

Question 31

Exhibit 16-1 Money market demand and supply curves

Beginning from an equilibrium at E₁ in Exhibit 16-1, a decrease in the money supply from $150 billion to $100 billion causes people to:

A) sell bonds and drive the price of bonds down.
B) sell bonds and drive the price of bonds up.
C) buy bonds and drive the price of bonds down.
D) buy bonds and drive the price of bonds up.

Question 32

When the Fed decreases the money supply, interest rates:

A) rise.
B) fall.
C) are unaffected.
D) rise and then fall.

Question 33

Assume a fixed demand for money curve and the Fed increases the money supply. The result is a temporary:

A) excess quantity of money demanded.
B) excess quantity of money supplied.
C) new equilibrium interest rate.
D) decrease in the demand for loans.

Question 34

Exhibit 16-3 Money market demand and supply curves

As shown in Exhibit 16-3, assume the money supply curve shifts rightward from MS₁ to MS₂ and the economy is operating along the intermediate segment of the aggregate supply curve. The result will be a:

A) higher investment, lower real GDP, and lower price level.
B) lower investment, lower real GDP, and lower price level.
C) higher investment, higher real GDP, and higher price level.
D) higher interest rate and no effect on real GDP or the price level.

Question 35

Starting from a position of macroeconomic equilibrium at below the full-employment level of real GDP, an increase in the money supply will:

A) raise interest rates, prices, and reduce real GDP.
B) raise interest rates, lower prices, and leave real GDP unchanged.
C) raise interest rates, lower prices, and leave real GDP unchanged.
D) lower interest rates, raise prices, and increase real GDP.

Question 36

The Keynesian mechanism through which monetary policy affects the price level, real GDP, and employment depends on the impact of the:

A) interest rate on savings.
B) inflation on investment.
C) interest rate on investment.
D) interest rate on bond prices.

Question 37

Suppose that the current money market equilibrium has an interest rate of 5 percent and a quantity of $2 trillion. Suppose that at a 6 percent interest rate, the quantity of money demanded is $1.5 trillion, while at a 4 percent interest rate it is $2.5 trillion. If the Fed makes an open-market purchase of $50 billion, and the money multiplier is 10, what will be the new money market equilibrium?

A) An interest rate of 6 percent and a quantity of $1.5 trillion.
B) An interest rate of 5 percent and a quantity of $2 trillion.
C) An interest rate of 4 percent and a quantity of $2.5 trillion.
D) The new money market equilibrium cannot be determined from the information given.

Question 38

Exhibit 16-1 Money market demand and supply curves

As shown in Exhibit 16-1, assume the money supply curve shifts leftward from MS₁ to MS₂ and the economy is operating along the intermediate segment of the aggregate supply curve. The result will be a:

A) higher investment, lower real GDP, and lower price level.
B) lower investment, lower real GDP, and lower price level.
C) higher investment, higher real GDP, and higher price level.
D) higher interest rate and no effect on real GDP or the price level.

Question 39

In Keynes's view, an excess quantity of money supplied causes people to:

A) sell bonds and the interest rate rises.
B) buy bonds and the interest rate falls.
C) buy bonds and the interest rate rises.
D) increase speculative balances.

Question 40

Suppose that the current money market equilibrium features an interest rate of 5 percent and a quantity of $2 trillion. If the Fed raises the discount rate, which of the following is most likely to be the new money market equilibrium?

A) An interest rate of 6 percent and a quantity of $1.5 trillion.
B) An interest rate of 5 percent and a quantity of $2 trillion.
C) An interest rate of 4 percent and a quantity of $2.5 trillion.
D) An interest rate of 3 percent and a quantity of $3 trillion.

Question 41

Exhibit 16-4 Aggregate demand and supply model

In Exhibit 16-4, which one of the following actions could the Fed use to shift the AD curve from AD₁ to AD₂?

A) raise the legal reserve requirement
B) lower the discount rate
C) lower the federal funds rate
D) sell government securities

Question 42

Exhibit 16-5 Money, investment and product markets

In Exhibit 16-5, if the interest rate falls from i₁ to i₂, investment spending will:

A) increase, and aggregate demand will shift from AD₁ to AD₂.
B) decrease, and aggregate demand will shift from AD₂ to AD₁.
C) remain the same, and aggregate demand will shift from AD₂ to AD₃.
D) increase, and aggregate demand will shift from AD₂ to AD₁.

Question 43

The Keynesian cause-and-effect sequence predicts that an increase in the money supply will cause interest rates to:

A) fall, boosting investment and shifting the AD curve rightward, leading to an increase in real GDP.
B) fall, cutting investment and shifting the AD curve leftward, leading to a decrease in real GDP.
C) rise, cutting investment and shifting the AD curve rightward, leading to an increase in real GDP.
D) rise, boosting investment and shifting the AD curve rightward, leading to an increase in real GDP.

Question 44

An increase in the supply of money will lead to ____ in equilibrium real GDP and ____ in equilibrium price level.

A) an increase; an increase
B) an increase; a decrease
C) a decreases; an increase
D) a decrease; a decrease

Question 45

If the economy is inflationary, the Fed would most likely:

A) encourage banks to provide loans by buying government securities.
B) encourage banks to provide loans by raising the discount rate.
C) encourage banks to provide loans by selling government securities.
D) restrict bank lending by selling government securities.

Question 46

Exhibit 16-5 Money, investment and product markets

In Exhibit 16-5, a shift in aggregate demand from AD₁ to AD₂:

A) cannot raise real GDP because the economy is at full employment.
B) cannot raise real GDP because the aggregate supply curve is upward sloping at GDP₂.
C) will raise real GDP because the economy is operating below the full-employment level.
D) will cause the interest rate to increase from i₂ to i₁.

Question 47

Exhibit 16-6 Money, investment and product markets

In Exhibit 16-6, if the interest rate falls from i₁ to i₂, then:

A) the quantity demanded of investment increases from I₁ to I₂ and investment spending shifts the aggregate demand curve from AD₂ to AD₁, decreasing the level of real GDP.
B) the quantity demanded of investment increases from I₁ to I₂ and investment spending shifts the aggregate demand curve from AD₁ to AD₂, increasing the level of real GDP.
C) the quantity demanded of investment decreases from I₂ to I₁ and investment spending shifts the aggregate demand curve from AD₁ to AD₂, decreasing the level of real GDP.
D) the quantity demanded of investment decreases from I₂ to I₁ and investment spending shifts the aggregate demand curve from AD₂ to AD₁, increasing the level of real GDP.

Question 48

According to monetarists, which of the following would be most important for the control of inflation?

A) a steady increase in federal expenditures
B) the imposition of price controls
C) keeping the growth rate of the money supply low and steady
D) a steady increase in the size of the budget deficit

Question 49

Discuss the determinants of the equilibrium interest rate. What can the Fed do to change the interest rate?

Question 50

Exhibit 16-4 Aggregate demand and supply model

In Exhibit 16-4, which one of the following actions could the Fed use to shift the AD curve from AD₁ to AD₂?

A) raise the legal reserve requirement
B) raise the discount rate
C) lower the federal funds rate
D) buy government securities

Question 51

Exhibit 16-5 Money, investment and product markets

In Exhibit 16-5, a shift in aggregate demand from AD₂ to AD₃:

A) increases real GDP, and lowers the price level.
B) decreases real GDP, and lowers the price level.
C) increases real GDP, and raises the price level.
D) decreases real GDP, and raises the price level.

Question 52

According to Keynesians, an increase in the money supply will have its greatest impact on GDP when the aggregate demand curve intersects:

A) the vertical portion of the aggregate supply curve.
B) the upward sloping portion of the aggregate supply curve.
C) the horizontal portion of the aggregate supply curve.
D) either the upward sloping or the vertical portions of the aggregate supply curve.

Question 53

According to Keynesian economists, which of the following is not a consequence of increasing the money supply?

A) a lower interest rate
B) greater investment
C) lower real GDP
D) higher real GDP

Question 54

Exhibit 16-6 Money, investment and product markets

In Exhibit 16-6, if the Fed believes the economy is at AD₃, how might it engineer a decline in the price level?

A) By decreasing the money supply, the interest rate falls, investment rises, and aggregate demand falls, causing the price level to fall.
B) By decreasing the money supply, the interest rate rises, investment rises, and aggregate demand rises, causing the price level to fall.
C) By decreasing the money supply, the interest rate rises, investment falls, and aggregate demand falls, causing the price level to fall.
D) By increasing the money supply, the interest rate rises, investment rises, and aggregate demand falls, causing the price level to fall.

Question 55

Exhibit 16-5 Money, investment and product markets

In Exhibit 16-5, when the money supply increases from MS₁ to MS₂, the equilibrium interest rate:

A) decreases from i₁ to i₂, decreasing investment spending from I₂ to I_1.
B) increases from i₂ to i₁, increasing investment spending from I₁ to I₂.
C) increases from i₂ to i₁, decreasing investment spending from I₂ to I₁.
D) decreases from i₁ to i₂, increasing investment spending from I₁ to I₂.

Question 56

Exhibit 16-4 Aggregate demand and supply model

In Exhibit 16-4, which one of the following actions could the Fed use to shift the AD curve from AD₃ to AD₂?

A) Lower the legal reserve requirement.
B) Lower the discount rate.
C) Lower the federal funds rate.
D) Sell government securities.

Question 57

According to Keynesians, an increase in the money supply will have its least impact on GDP when the aggregate demand curve intersects:

A) the horizontal portion of the aggregate supply curve.
B) the vertical portion of the aggregate supply curve.
C) the upward sloping portion of the aggregate supply curve.
D) either the horizontal or upward sloping portion of the aggregate supply curve.

Question 58

According to the monetarists, which of the following is true?

A) Instability in the money supply is the primary cause of economic instability.
B) A reduction in the money supply will cause consumers to increase spending.
C) A reduction in the money supply will cause a proportional reduction in wages and prices, leaving output unchanged.
D) A rapid growth rate of the money supply will lead to a rapid growth rate of real GDP.

Question 59

Exhibit 16-6 Money, investment and product markets

In Exhibit 16-6, an increase in the money supply from MS₁ to MS₂ causes:

A) interest rates to fall from i₁ to i₂ and the quantity demanded of investment to decrease from I₂ to I₁.
B) interest rates to fall from i₁ to i₂ and aggregate demand to shift from AD₂ to AD₁.
C) interest rates to fall from i₁ to i₂ and the quantity demanded of investment to increase from I₁ to I₂.
D) interest rates to rise from i₂ to i₁ and the quantity demanded of investment to remain the same.

Question 60

The Keynesian cause-and-effect sequence predicts that a decrease in the money supply will cause interest rates to:

A) fall, boosting investment and shifting the AD curve rightward, leading to an increase in real GDP.
B) fall, boosting investment and shifting the AD curve rightward, leading to a decrease in real GDP.
C) rise, cutting investment and shifting the AD curve leftward, leading to a decrease in real GDP.
D) rise, boosting investment and shifting the AD curve rightward, leading to an increase in real GDP.

Question 61

The quantity theory of money of the Classical economists says that a change in the money supply will produce a:

A) proportional change in the price level.
B) greater than proportional change in the price level.
C) less than proportional change in the price level.
D) wide variation in the velocity of money.

Question 62

The velocity of money is the:

A) rate at which the price index for consumer goods rises.
B) multiple by which an increase in government expenditures will cause output to expand.
C) average number of times a dollar is used to buy goods and services included in GDP.
D) number of times a dollar is taken out of the country during a year.

Question 63

According to the equation of exchange, if M = 200, P = 100, and Q = 10, the V is:

A) 20.
B) 2.
C) 10.
D) 5.

Question 64

If the money supply is $250 billion and nominal GDP is $1 trillion, the velocity of money is:

A) 0.25.
B) 0.40.
C) 2.50.
D) 4.00.

Question 65

Suppose nominal GDP equaled $10,988 billion while the M2 money supply was $6,063 billion. What was the velocity of the M2 money stock?

A) 0.45
B) 0.55
C) 1.81
D) 2.36

Question 66

Given the strict quantity theory of money, if the quantity of money doubled, prices would:

A) fall by half.
B) double.
C) remain constant.
D) increase somewhat but less than double.

Question 67

The equation of exchange states that:

A) money supply multiplied by real output equals velocity.
B) velocity multiplied by money supply equals the selling price times the quantity of actual output.
C) money supply divided by velocity equals nominal GDP.
D) money supply divided by velocity equals real GDP.

Question 68

If nominal GDP is $7 trillion, and the money supply is $2 trillion, then what is the velocity of money?

A) 14.
B) 7.
C) 3.5.
D) 2.

Question 69

According to the quantity theory of money, which one of the following economic variables would change in response to an increase in the money supply?

A) prices
B) real income
C) velocity
D) employment

Question 70

Since classical economists believe that both V and Q are constants for an economy in short-run equilibrium, the equation of exchange becomes a theory in which:

A) the quantity of money explains prices.
B) the quantity of money explains velocity.
C) the quantity of money explains real GDP.
D) changes in M cause changes in V.

Question 71

According to the quantity theory of money, a 10 percent increase in the money supply leads to a 10 percent increase in:

A) velocity.
B) unemployment.
C) the price level.
D) real GDP.

Question 72

According to the quantity theory of money, if M's growth is lower than Q's, then:

A) V falls.
B) V rises.
C) P rises.
D) P falls.

Question 73

Given the strict quantity theory of money, if the quantity of money were decreased by 50 percent, prices would:

A) fall by 50 percent.
B) rise by 50 percent.
C) increase by 100 percent.
D) decrease by 100 percent.

Question 74

Causality is clear and mechanical with the quantity theory of money. If M increases because:

A) V and Q are variable, the price level, P, increases.
B) V and Q are variable, the price level, P, decreases.
C) V and Q are constant, the price level, P, increases.
D) V and Q are constant, the price level, P, decreases.

Question 75

If the velocity of the M1 money supply is 4 and nominal GDP is $200 billion, the stock of money in circulation must be:

A) $25 billion.
B) $50 billion.
C) $100 billion.
D) $800 billion.

Question 76

According to classical economists,

A) prices are rigid.
B) both V and Q are variable for an economy in short-run equilibrium.
C) changes in M cause changes in V.
D) the velocity of money is constant.

Question 77

The velocity of money is:

A) money supply divided by prices.
B) spending divided by output.
C) required monetary reserves divided by income.
D) GDP divided by the money supply.

Question 78

The Monetarist transmission mechanism through which monetary policy affects the price level, real GDP, and employment depends on the:

A) indirect impact of changes on the interest rate.
B) indirect impact of changes on profit expectations.
C) direct impact of changes in fiscal policy on aggregate demand.
D) direct impact of changes in the money supply on aggregate demand.

Question 79

"Monetary instability has been the major cause of economic instability in this country. Expansion in the money supply has been the source of every major inflation. Every major recession has been either caused or perpetuated by monetary contraction." Who among the following would most likely adhere to this view?

A) Monetarists.
B) Keynesians.
C) Demand-side economists.
D) Quantity theorists.

Question 80

Monetarists reject using discretionary monetary policy as an effective stabilization tool because they believe:

A) if the money supply grows at a rate equal to the economy's long-run rate of economic growth, then the economy will be unstable.
B) that changes in the money stock do not affect output or prices.
C) the Fed will miss its money supply targets and make the economy worse.
D) monetary policy can stimulate aggregate demand, but it cannot affect inflation.