Deck 4: Why Do Interest Rates Change

Question 1

When the demand for bonds ________ or the supply of bonds ________, interest rates rise.

A)increases; increases
B)increases; decreases
C)decreases; decreases
D)decreases; increases

Answer 1

decreases; increases

Question 2

Diversification benefits an investor by

A)increasing wealth.
B)increasing expected return.
C)reducing risk.
D)increasing liquidity.

Answer 2

reducing risk.

Question 3

When the demand for bonds ________ or the supply of bonds ________, bond prices fall.

A)increases; increases
B)increases; decreases
C)decreases; decreases
D)decreases; increases

Answer 3

decreases; increases

Question 4

When the price of a bond is ________ the equilibrium price, there is an excess supply of bonds and the price will ________.

A)above; rise
B)above; fall
C)below; fall
D)below; rise

Question 5

As the price of a bond ________ and the expected return ________, bonds become more attractive to investors and the quantity demanded rises.

A)falls; rises
B)falls; falls
C)rises; rises
D)rises; falls

Question 6

Factors that determine the demand for an asset include changes in the

A)wealth of investors.
B)liquidity of bonds relative to alternative assets.
C)expected returns on bonds relative to alternative assets.
D)risk of bonds relative to alternative assets.
E)all of the above.

Question 7

In a recession when income and wealth are falling, the demand for bonds ________ and the demand curve shifts to the ________.

A)falls; right
B)falls; left
C)rises; right
D)rises; left

Question 8

During business cycle expansions when income and wealth are rising, the demand for bonds ________ and the demand curve shifts to the ________.

A)falls; right
B)falls; left
C)rises; right
D)rises; left

Question 9

When the interest rate on a bond is below the equilibrium interest rate, there is excess ________ in the bond market and the interest rate will ________.

A)demand; rise
B)demand; fall
C)supply; fall
D)supply; rise

Question 10

When the demand for bonds ________ or the supply of bonds ________, interest rates fall.

A)increases; increases
B)increases; decreases
C)decreases; decreases
D)decreases; increases

Question 11

When the price of a bond is ________ the equilibrium price, there is an excess demand for bonds and the price will ________.

A)above; rise
B)above; fall
C)below; fall
D)below; rise

Question 12

When the interest rate on a bond is above the equilibrium interest rate, there is excess ________ in the bond market and the interest rate will ________.

A)demand; rise
B)demand; fall
C)supply; fall
D)supply; rise

Question 13

When the demand for bonds ________ or the supply of bonds ________, bond prices rise.

A)increases; decreases
B)decreases; increases
C)decreases; decreases
D)increases; increases

Question 14

The demand for an asset rises if ________ falls.

A)risk relative to other assets
B)expected return relative to other assets
C)liquidity relative to other assets
D)wealth

Question 15

When the interest rate on a bond is ________ the equilibrium interest rate, there is excess ________ in the bond market and the interest rate will ________.

A)below; demand; rise
B)below; demand; fall
C)below; supply; rise
D)above; supply; fall

Question 16

When the interest rate on a bond is ________ the equilibrium interest rate, there is excess ________ in the bond market and the interest rate will ________.

A)above; demand; fall
B)above; demand; rise
C)below; supply; fall
D)above; supply; rise

Question 17

When the price of a bond is above the equilibrium price, there is excess ________ in the bond market and the price will ________.

A)demand; rise
B)demand; fall
C)supply; fall
D)supply; rise

Question 18

The higher the standard deviation of returns on an asset, the ________ the asset's ________.

A)greater; risk
B)smaller; risk
C)greater; expected return
D)smaller; expected return

Question 19

The supply curve for bonds has the usual upward slope, indicating that as the price ________, ceteris paribus, the ________ increases.

A)falls; supply
B)falls; quantity supplied
C)rises; supply
D)rises; quantity supplied

Question 20

When the price of a bond is below the equilibrium price, there is excess ________ in the bond market and the price will ________.

A)demand; rise
B)demand; fall
C)supply; fall
D)supply; rise

Question 21

Factors that cause the demand curve for bonds to shift to the left include

A)a decrease in the inflation rate.
B)an increase in the volatility of stock prices.
C)an increase in the liquidity of stocks.
D)all of the above.
E)only A and B of the above.

Question 22

When people begin to expect a large run up in stock prices, the demand curve for bonds shifts to the ________ and the interest rate ________.

A)right; rises
B)right; falls
C)left; falls
D)left; rises

Question 23

When bond prices become more volatile, the demand for bonds ________ and the interest rate ________.

A)increases; rises
B)increases; falls
C)decreases; falls
D)decreases; rises

Question 24

An increase in the expected rate of inflation will ________ the expected return on bonds relative to that on ________ assets, and shift the ________ curve to the left.

A)reduce; financial; demand
B)reduce; real; demand
C)raise; financial; supply
D)raise; real; supply

Question 25

When the federal government's budget deficit increases, the ________ curve for bonds shifts to the ________.

A)demand; right
B)demand; left
C)supply; left
D)supply; right

Question 26

During an economic expansion, the supply of bonds ________ and the supply curve shifts to the ________.

A)increases, left
B)increases, right
C)decreases, left
D)decreases, right

Question 27

Higher expected interest rates in the future ________ the demand for long-term bonds and shift the demand curve to the ________.

A)increase; left
B)increase; right
C)decrease; left
D)decrease; right

Question 28

When the expected inflation rate decreases, the demand for bonds ________, the supply of bonds ________, and the interest rate ________.

A)increases; increases; rises
B)decreases; decreases; falls
C)increases; decreases; falls
D)decreases; increases; rises

Question 29

When bond prices become less volatile, the demand for bonds ________ and the interest rate ________.

A)increases; rises
B)increases; falls
C)decreases; falls
D)decreases; rises

Question 30

When prices in the stock market become more uncertain, the demand curve for bonds shifts to the ________ and the interest rate ________.

A)right; rises
B)right; falls
C)left; falls
D)left; rises

Question 31

During a recession, the supply of bonds ________ and the supply curve shifts to the ________.

A)increases, left
B)increases, right
C)decreases, left
D)decreases, right

Question 32

When stock prices become less volatile, the demand curve for bonds shifts to the ________ and the interest rate ________.

A)right; rises
B)right; falls
C)left; falls
D)left; rises

Question 33

When the expected inflation rate increases, the demand for bonds ________, the supply of bonds ________, and the interest rate ________.

A)increases; increases; rises
B)decreases; decreases; falls
C)increases; decreases; falls
D)decreases; increases; rises

Question 34

When people begin to expect a large stock market decline, the demand curve for bonds shifts to the ________ and the interest rate ________.

A)right; falls
B)right; rises
C)left; falls
D)left; rises

Question 35

Lower expected interest rates in the future ________ the demand for long-term bonds and shift the demand curve to the ________

A)increase; left.
B)increase; right.
C)decrease; left.
D)decrease; right.

Question 36

Factors that cause the demand curve for bonds to shift to the left include

A)an increase in the inflation rate.
B)an increase in the liquidity of stocks.
C)a decrease in the volatility of stock prices.
D)all of the above.
E)none of the above.

Question 37

When bonds become less widely traded, and as a consequence the market becomes less liquid, the demand curve for bonds shifts to the ________ and the interest rate ________.

A)right; rises
B)right; falls
C)left; falls
D)left; rises

Question 38

A decrease in the expected rate of inflation will ________ the expected return on bonds relative to that on ________ assets.

A)reduce; financial
B)reduce; real
C)raise; financial
D)raise; real

Question 39

When bonds become more widely traded, and as a consequence the market becomes more liquid, the demand curve for bonds shifts to the ________ and the interest rate ________.

A)right; rises
B)right; falls
C)left; falls
D)left; rises

Question 40

An increase in expected inflation causes the supply of bonds to ________ and the supply curve to shift to the ________.

A)increase, left
B)increase, right
C)decrease, left
D)decrease, right

Question 41

An increase in the expected rate of inflation causes the demand for bonds to ________ and the supply for bonds to ________.

A)fall; fall
B)fall; rise
C)rise; fall
D)rise; rise

Question 42

Figure 4.1
In Figure 4.1, the most likely cause of the increase in the equilibrium interest rate from i₁ to i₂ is

A)an increase in the price of bonds.
B)a business cycle boom.
C)an increase in the expected inflation rate.
D)a decrease in the expected inflation rate.

Question 43

Figure 4.2
In Figure 4.2, one possible explanation for the increase in the interest rate from i₁ to i₂ is

A)an increase in economic growth.
B)an increase in government budget deficits.
C)a decrease in government budget deficits.
D)a decrease in economic growth.
E)a decrease in the riskiness of bonds relative to other investments.

Question 44

The economist Irving Fisher, after whom the Fisher effect is named, explained why interest rates ________ as the expected rate of inflation ________.

A)rise; increases
B)rise; stabilizes
C)rise; decreases
D)fall; increases
E)fall; stabilizes

Question 45

The loanable funds framework is easier to use when analyzing the effects of changes in ________, while the liquidity preference framework provides a simpler analysis of the effects from changes in income, the price level, and the supply of ________

A)expected inflation; bonds.
B)expected inflation; money.
C)government budget deficits; bonds.
D)the supply of money; bonds.

Question 46

When the economy slips into a recession, normally the demand for bonds ________, the supply of bonds ________, and the interest rate ________.

A)increases; increases; rises
B)decreases; decreases; falls
C)increases; decreases; falls
D)decreases; increases; rises

Question 47

When the economy enters into a boom, normally the demand for bonds ________, the supply of bonds ________, and the interest rate ________.

A)increases; increases; rises
B)decreases; decreases; falls
C)increases; decreases; rises
D)decreases; increases; rises

Question 48

When the inflation rate is expected to increase, the real cost of borrowing declines at any given interest rate; as a result, the ________ bonds increases and the ________ curve shifts to the right.

A)demand for; demand
B)demand for; supply
C)supply of; demand
D)supply of; supply

Question 49

Factors that can cause the supply curve for bonds to shift to the left include

A)an expansion in overall economic activity.
B)a decrease in expected inflation.
C)an increase in government deficits.
D)only A and C of the above.

Question 50

In Keynes's liquidity preference framework, individuals are assumed to hold their wealth in two forms:

A)real assets and financial assets.
B)stocks and bonds.
C)money and bonds.
D)money and gold.

Question 51

Figure 4.1
In Figure 4.1, the most likely cause of the increase in the equilibrium interest rate from i₁ to i₂ is a(n)________ in the ________.

A)increase; expected inflation rate
B)decrease; expected inflation rate
C)increase; government budget deficit
D)decrease; government budget deficit

Question 52

When the inflation rate is expected to increase, the expected return on bonds relative to real assets falls for any given interest rate; as a result, the ________ bonds falls and the ________ curve shifts to the left.

A)demand for; demand
B)demand for; supply
C)supply of; demand
D)supply of; supply

Question 53

Figure 4.1
In Figure 4.1, the most likely cause of a decrease in the equilibrium interest rate from i₂ to i₁ is

A)an increase in the expected inflation rate.
B)a decrease in the expected inflation rate.
C)a business cycle expansion.
D)a combination of both A and C of the above.

Question 54

When comparing the loanable funds and liquidity preference frameworks of interest rate determination, which of the following is true?

A)The liquidity preference framework is easier to use when analyzing the effects of changes in expected inflation.
B)The loanable funds framework provides a simpler analysis of the effects of changes in income, the price level, and the supply of money.
C)In most instances, the two approaches to interest rate determination yield the same predictions.
D)All of the above are true.
E)Only A and B of the above are true.

Question 55

A decrease in the expected rate of inflation causes the demand for bonds to ________ and the supply of bonds to ________.

A)fall; fall
B)fall; rise
C)rise; fall
D)rise; rise

Question 56

Figure 4.2
In Figure 4.2, one possible explanation for the increase in the interest rate from i₁ to i₂ is a(n)________ in ________.

A)increase; the expected inflation rate
B)decrease; the expected inflation rate
C)increase; economic growth
D)decrease; economic growth

Question 57

Factors that can cause the supply curve for bonds to shift to the right include

A)an expansion in overall economic activity.
B)a decrease in expected inflation.
C)a decrease in government deficits.
D)all of the above.
E)only A and B of the above.

Question 58

In his liquidity preference framework, Keynes assumed that money has a zero rate of return; thus, when interest rates ________ the expected return on money falls relative to the expected return on bonds, causing the demand for money to ________.

A)rise; fall
B)rise; rise
C)fall; fall
D)fall; rise

Question 59

Figure 4.2
In Figure 4.2, one possible explanation for a decrease in the interest rate from i₂ to i₁ is

A)an increase in government budget deficits.
B)an increase in expected inflation.
C)a decrease in economic growth.
D)a decrease in the riskiness of bonds relative to other investments.

Question 60

When the federal government's budget deficit decreases, the ________ curve for bonds shifts to the ________.

A)demand; right
B)demand; left
C)supply; left
D)supply; right

Question 61

When the growth rate of the money supply increases, interest rates end up being permanently lower if

A)the liquidity effect is larger than the other effects.
B)there is fast adjustment of expected inflation.
C)there is slow adjustment of expected inflation.
D)the expected inflation effect is larger than the liquidity effect.

Question 62

A higher level of income causes the demand for money to ________ and the interest rate to ________

A)decrease; decrease.
B)decrease; increase.
C)increase; decrease.
D)increase; increase.

Question 63

Milton Friedman contends that it is entirely possible that when the money supply rises, interest rates may ________ if the ________ effect is more than offset by changes in income, the price level, and expected inflation.

A)fall; liquidity
B)fall; risk
C)rise; liquidity
D)rise; risk

Question 64

If the Fed wants to permanently lower interest rates, then it should raise the rate of money growth if

A)there is fast adjustment of expected inflation.
B)there is slow adjustment of expected inflation.
C)the liquidity effect is smaller than the expected inflation effect.
D)the liquidity effect is larger than the other effects.

Question 65

Figure 4.3
In Figure 4.3, an increase in the interest rate from i₂ to i₁ can be explained by

A)a decrease in money growth.
B)an increase in money growth.
C)a decline in the price level.
D)an increase in the expected price level.

Question 66

A decline in the expected inflation rate causes the demand for money to ________ and the demand curve to shift to the ________

A)decrease; right.
B)decrease; left.
C)increase; right.
D)increase; left.

Question 67

Figure 4.3
In Figure 4.3, the factor responsible for the decline in the interest rate is

A)a decline in the price level.
B)a decline in income.
C)an increase in the money supply.
D)a decline in the expected inflation rate.

Question 68

Figure 4.4
Figure 4.4 illustrates the effect of an increased rate of money supply growth. From the figure, one can conclude that the liquidity effect is ________ than the expected inflation effect and interest rates adjust ________ to changes in expected inflation.

A)smaller; quickly
B)larger; quickly
C)larger; slowly
D)smaller; slowly

Question 69

Figure 4.4
Figure 4.4 illustrates the effect of an increased rate of money supply growth. From the figure, one can conclude that the

A)Fisher effect is dominated by the liquidity effect and interest rates adjust slowly to changes in expected inflation.
B)liquidity effect is dominated by the Fisher effect and interest rates adjust slowly to changes in expected inflation.
C)liquidity effect is dominated by the Fisher effect and interest rates adjust quickly to changes in expected inflation.
D)Fisher effect is smaller than the expected inflation effect and interest rates adjust quickly to changes in expected inflation.

Question 70

If the Fed wants to permanently lower interest rates, then it should lower the rate of money growth if

A)there is fast adjustment of expected inflation.
B)there is slow adjustment of expected inflation.
C)the liquidity effect is smaller than the expected inflation effect.
D)the liquidity effect is larger than the other effects.

Question 71

When the growth rate of the money supply is increased, interest rates will rise immediately if the liquidity effect is ________ than the other effects and if there is ________ adjustment of expected inflation.

A)larger; rapid
B)larger; slow
C)smaller; slow
D)smaller; rapid

Question 72

A lower level of income causes the demand for money to ________ and the interest rate to ________

A)decrease; decrease.
B)decrease; increase.
C)increase; decrease.
D)increase; increase.

Question 73

A decline in the price level causes the demand for money to ________ and the demand curve to shift to the ________

A)decrease; right.
B)decrease; left.
C)increase; right.
D)increase; left.

Question 74

If the liquidity effect is smaller than the other effects, and the adjustment of expected inflation is slow, then the

A)interest rate will fall.
B)interest rate will rise.
C)interest rate will initially fall but eventually climb above the initial level in response to an increase in money growth.
D)interest rate will initially rise but eventually fall below the initial level in response to an increase in money growth.

Question 75

A rise in the price level causes the demand for money to ________ and the demand curve to shift to the ________

A)decrease; right.
B)decrease; left.
C)increase; right.
D)increase; left.

Question 76

When the growth rate of the money supply decreases, interest rates end up being permanently lower if

A)the liquidity effect is larger than the other effects.
B)there is fast adjustment of expected inflation.
C)there is slow adjustment of expected inflation.
D)the expected inflation effect is larger than the liquidity effect.

Question 77

When the growth rate of the money supply is decreased, interest rates will rise immediately if the liquidity effect is ________ than the other effects and if there is ________ adjustment of expected inflation.

A)larger; rapid
B)larger; slow
C)smaller; slow
D)smaller; rapid

Question 78

Figure 4.3
In Figure 4.3, the decrease in the interest rate from i₁ to i₂ can be explained by

A)a decrease in money growth.
B)an increase in money growth.
C)a decline in the expected price level.
D)only A and B of the above.

Question 79

Holding everything else constant, an increase in the money supply causes

A)interest rates to decline initially.
B)interest rates to increase initially.
C)bond prices to decline initially.
D)both A and C of the above.
E)both B and C of the above.

Question 80

Holding everything else constant, a decrease in the money supply causes

A)interest rates to decline initially.
B)interest rates to increase initially.
C)bond prices to increase initially.
D)both A and C of the above.
E)both B and C of the above.