Deck 5: Understanding Interest Rates, Savings, and the Wealth Effect

Question 1

In the real world there is no such thing as "the interest rate."

Answer 1

True

Question 2

The one fundamental interest rate in the economy is known as the pure or risk-free rate of interest.

Answer 2

True

Question 3

Interest rates on securities issued by borrowers in the economy other than the government must reflect the different types and degrees of risk that investors in those securities must assume.

Answer 3

True

Question 4

The risk-free interest rate represents the"opportunity cost" of holding idle money.

Question 5

According to the classical theory of interest, the pure interest rate is determined by the interaction of the demand for and supply of money.

Question 6

For households current saving is defined as equal to the difference between current income and current consumption expenditures.

Question 7

According to the classical theory of interest, the payment of interest is considered to be a reward for waiting.

Question 8

The so-called substitution effect suggests there is a negative relationship between changes in interest rates and changes in the volume of savings.

Question 9

Retained earnings are an important measure of savings by business firms.

Question 10

The majority of funds drawn upon for investment financing by business firms come from borrowing in the money and capital markets.

Question 11

Rising business profits usually are associated with rising interest rates in the money and capital markets.

Question 12

The role of the interest rate in influencing business savings is in affecting what proportion of needed funds will be raised internally and what proportion externally.

Question 13

Most government saving is unintended and occurs infrequently.

Question 14

Interest rates are a key factor in decisions by government officials on how much to save.

Question 15

The majority of business expenditures for investment are to carry out net investment.

Question 16

Gross investment equals net investment minus replacement investment.

Question 17

The volume of net investment in the economy is closely linked to fluctuations in the nation's output of goods and services, employment and prices.

Question 18

The investment demand schedule in the classical theory of interest rates slopes downward and to the right, reflecting the declining net marginal productivity of capital as the volume of investment grows.

Question 19

According to the liquidity preference theory of interest, the interest rate is the "price" that must be paid to induce money holders to surrender a perfectly liquid asset.

Question 20

Declining interest rates result in declining bond and stock prices.

Question 21

Money demanded for transactions and precautionary purposes is dependent upon the level of and changes in interest rates.

Question 22

At low rates of interest less money is normally demanded in the economy because most investors feel bond prices must eventually rise.

Question 23

In the liquidity preference theory the nation's money supply is assumed to be interest inelastic.

Question 24

The act of increased hoarding of money by the public will result in lower interest rates, other factors held constant.

Question 25

Dishoarding of money leads to higher interest rates, ceteris paribus.

Question 26

Contraction of a nation's money supply by its central bank will, ceteris paribus, result in higher interest rates.

Question 27

Expansion of the money supply by the central bank should lower interest rates provided the demand for money does not fall; if the demand for money does decline, interest rates will rise.

Question 28

The liquidity preference theory of interest is essentially a long run, not a short run, theory of interest rate determination.

Question 29

In the loanable funds theory of interest consumer demand for credit is assumed to be relatively elastic with respect to changes in the rate of interest.

Question 30

In the loanable funds theory the demand for loanable funds in the business sector falls as interest rates increase.

Question 31

According to the income effect, a rise in interest rates may cause individuals to save more in an effort to reach their savings goal more rapidly.

Question 32

For an individual or family heavily in debt a rise in interest rates will stimulate a greater amount of savings because of the wealth effect.

Question 33

In the loanable funds theory of interest, the supply of savings curve is assumed to be highly interest elastic.

Question 34

Positive hoarding of money takes place when the demand for money is less than the supply.

Question 35

Changes in net investment by business are closely linked to fluctuations in a nation's output of goods and services, employment and prices. In fact, substantial cutbacks in inventory investment and long-term capital spending occur on average every 3 to 4 years in the U.S., usually precipitating a period of inflation.

Question 36

The Classical theorists believed that the demand for investment capital is negatively related to the rate of interest: when interest rates are low, more funds are required while higher interest rates decrease the demand for investment capital.

Question 37

The Classical theory of interest assumes that interest rates are the principal determinant of the quantity of savings and that the demand for borrowed funds comes primarily from consumers and government.

Question 38

According to the Liquidity Preference theory of interest, at a point above the equilibrium rate of interest, the supply of money exceeds the quantity demanded and some households, businesses and units of government will try to dispose of unwanted money balances by purchasing bonds.

Question 39

The pure or risk-free rate of interest is a component of all interest rates in the economy. The closest approximation of this in the real world is the yield to maturity on U.S. Treasury bills.

Question 40

According to the liquidity effect, an increase in the nation's money supply with money demand unchanged would cause interest rates to rise due to increased inflation.

Question 41

The rational expectations view suggests that new information made available to market investors will tend to cause interest rates to fall temporarily below their equilibrium values, but rates will rapidly move back toward equilibrium.

Question 42

According to the rational expectations view of interest rates, the forecasting of rates requires knowledge of the public's current set of interest rate expectations.

Question 43

Foreign demand for loanable funds is relatively insensitive to interest-rate differentials between the U.S. and the rest of the world.

Question 44

The increased foreign supply of loanable funds to U.S. credit markets stems in part from commercial banks in Western Europe and the Pacific Rim.

Question 45

The foreign supply of loanable funds to the U.S. credit markets is positively related to U.S.-foreign interest rate differentials.

Question 46

According to the long-run view of interest rates in the Classical Theory future interest rates should average lower than today's interest rates due to population aging.

Question 47

If domestic savings rise, less foreign savings will be needed to support domestic living standards according to the textbook.

Question 48

One of the essential contributions of the money and capital markets is to direct the savings of older individuals into the hands of younger individuals who desire to improve their current standard of living by borrowing.

Question 49

If the number of younger workers declines and the proportion of older wage earners and retirees continue rising, the U.S. and other leading industrialized economies should experience a rise in expected per-capital real income, resulting in an acceleration of current consumption and less saving in the long run, according to the textbook.

Question 50

Equilibrium in the economy requires that planned saving equals planned consumption.

Question 51

Equilibrium in the money market requires the money supply be equal to the amount of hoarding demand.

Question 52

Equilibrium in the loanable funds market requires that the supply of savings equal the difference between money demand and the amount of investment demand.

Question 53

Equilibrium in the foreign currency markets means that the U.S. dollar establishes a stable price vis-à-vis the British pound, but not necessarily with other foreign currencies.

Question 54

According to the Rational Expectations Theory, interest rates follow predictable patterns that can be used to earn excess profits.

Question 55

Rational expectations theorists argue that rate hedging is preferable to rate forecasting because guessing the public's expectations is too difficult.

Question 56

Current research suggests that past interest rate movements are not significantly related to current rates of return on bonds and stock.

Question 57

According to the Rational Expectations Theory, if the market expects more government borrowing, rates will rise.

Question 58

The speculative demand for money states that investors speculate when interest rates are high.

Question 59

When U.S. interest rates decline relative to foreign interest rates, capital flows out of the United States to seek the higher rates available abroad.

Question 60

When U.S. interest rates rise relative to interest rates prevailing overseas, a large-scale sell-off of U.S. bonds and stocks usually occurs as both U.S. and foreign investors buy more securities outside the U.S. in foreign markets, according to the textbook.

Question 61

According to the textbook, predicting interest rates in one nation based on those prevailing in another with a significant rate of accuracy is fairly easy to do.

Question 62

According to the textbook, interest rates in one country can no longer be viewed as separate and independent from interest rates in other countries.

Question 63

As long as projects are mutually exclusive, NPV and IRR yield the same results.

Question 64

The risk-free rate is a component of all interest rates.

Question 65

Households are savers in the economy, while businesses are not.

Question 66

The wealth effect was very strong during the stock market and housing booms of the late 1990s when the personal savings rate went negative as households consumed more than their income. This effect has sense reversed itself due to the recent credit crisis.

Question 67

When a family's overall wealth increases, their consumption expenditures increase because their need for additional savings to meet their savings target is reduced is referred to as the wealth effect.

Question 68

The speculative motive stems from uncertainty about the future prices of bonds.

Question 69

The cautionary motive for holding money arises because we live in an uncertain world and cannot predict exactly what our expenditures or even our income will be in the future.

Question 70

The transaction motive for holding money represents the demand for money to purchase goods and services in more than one year.

Question 71

In the real world there are thousands of interest rates, but there is no such thing as "the interest rate."

Question 72

The cautionary motive for holding money arises because we live in a certain world and can predict exactly what our expenditures and our income will be in the future.

Question 73

When U.S. interest rates decline relative to foreign interest rates, capital flows into the United States to seek the higher rates than are available abroad.

Question 74

According to the Rational Expectations Theory, if the market expects more government borrowing, rates will decline.

Question 75

The increased foreign supply of loanable funds to U.S. credit markets stems in part from the Federal Reserve lowering the prime interest rate.

Question 76

Which of the following statements describes a role performed by the rate of interest in the economy?

A) Facilitates that current savings will flow into investment to promote economic growth
B) Allocates the available supply of credit, generally providing loanable funds to projects bearing the highest expected returns
C) Brings the nation's money supply into balance with the demand for money
D) Serves as a tool of government economic policy
E) All of the above represent roles of the rate of interest in the economy

Question 77

Which of the following statements concerning the "pure" rate of interest is true?

A) It represents the true opportunity cost of holding idle money
B) A rate of interest approximated by the yield to maturity on long-term U.S. government bonds
C) Rate of interest at which the government can borrow
D) Determined according to the classical theory of interest by the interplay of the supply of savings and the demand for investment capital
E) All of the above are true

Question 78

The theory which argues that the risk-free interest rate is determined by the interaction of the supply of savings (coming mainly from households) and the demand for investment capital (principally from business) is known as the:

A) Classical Theory of Interest Rates
B) Liquidity Preference Theory of Interest Rates
C) Loanable Funds Theory of Interest
D) Efficient Markets Theory
E) None of the above

Question 79

The theory which argues that the risk-free interest rate is determined by the interaction of the demand for money and the nation's supply of money is known as the:

A) Classical Theory of Interest Rates
B) Liquidity Preference Theory of Interest Rates
C) Loanable Funds Theory of Interest
D) Efficient Markets Theory
E) None of the above

Question 80

The theory which argues that the risk-free interest rate is determined by the interaction of the demand for credit and the nation's supply of credit is known as the:

A) Classical Theory of Interest Rates
B) Liquidity Preference Theory of Interest Rates
C) Loanable Funds Theory of Interest
D) Efficient Markets Theory
E) None of the above