Deck 15: Financial Crises and the Economy

Question 1

Which of the following best illustrates the adverse selection problem?

A) a professional football team that consistently drafts poor players.
B) an economic agent who engages in risky behavior once a loan is received.
C) an individual who hides a pre-existing condition from a health insurer.
D) an individual who experiences a lost of income by not working while attending college.

Answer 1

an individual who hides a pre-existing condition from a health insurer.

Question 2

Assume that a firm has $100 million in real assets and $90 in real liabilities. The value of its net worth would be ________.

A) a negative $10 million.
B) $190 million.
C) $4190 billion.
D) $10 million.

Answer 2

$10 million.

Question 3

In the period from 1929 through 1933, there were successive ________ in aggregate demand and ________ in short-run aggregate supply.

A) increases; decreases
B) decreases; increases
C) decreases; no change
D) increases; increases

Answer 3

decreases; increases

Question 4

According to agency theory, a financial crisis results from ________ that disrupts the flow of funds from lender-savers to borrower-spenders.

A) an increase in asymmetric information
B) a macroeconomic shock
C) the existence of asymmetric information
D) a decrease in saving

Question 5

The risk that a borrower has a greater understanding about their potential future behavior that a potential lender is known as ________.

A) the problem of adverse selection.
B) the problem of moral hazard.
C) ornamental torsion.
D) the asymmetric innovation problem.

Question 6

When banks fail during a financial crisis, ________.

A) the removal of these weak institutions serves to strengthen the financial system
B) the elimination of competitors is likely to spark a credit boom
C) there is a loss of information that can cause the crisis to worsen
D) surviving banks resort to financial engineering to retain customers

Question 7

Prior to World War II, in the United States, financial crises occurred every ________ years or so.

A) twenty
B) seven
C) fifty
D) three

Question 8

________ refers to a decrease in the willingness of banks to lend, while an impairment of the ability of nonfinancial firms to borrow is a consequence of ________.

A) Adverse selection; moral hazard
B) Deleveraging; debt deflation
C) Fire sales; a bank panic
D) The shadow banking system; agency theory

Question 9

The risk that a borrower has more information about their previous behavior that a potential lender is known as the ________.

A) moral hazard problem.
B) adverse selection problem.
C) time-space discontinuity.
D) tertiary behavior problem.

Question 10

The analysis of asymmetric information problems is called ________.

A) adverse selection
B) microeconomics
C) cybernetics
D) agency theory

Question 11

The main objective of financial liberalization is ________.

A) to encourage financial innovation
B) to improve the allocation of financial capital
C) to discourage volatility in financial markets
D) to reduce the likelihood of a credit boom

Question 12

An early sign that financial innovation might be leading toward a financial crisis is ________.

A) deleveraging
B) a bank panic
C) a credit boom
D) debt deflation

Question 13

The failure of a major financial company is often a trigger for a financial crisis. The main reason for trouble at a single firm to become a crisis for the entire economy is that ________.

A) the central bank will suspend operations until the failed firm is restructured
B) it is unclear whether the firm's collapse will remain an isolated event
C) customers of the failed company will organize a boycott to protest their losses
D) employees and owners of the failed company reduce their spending, with adverse effects on other businesses

Question 14

The notion that lenders must select from a pool of bad credit risks, because the most undesirable borrowers are those that most actively seek out a loan is known as the________.

A) moral hazard problem.
B) ornamental torsion problem.
C) adverse selection problem.
D) asymmetric innovation problem.

Question 15

Channeling funds to individuals with productive investment opportunities is the function of ________.

A) the financial sector.
B) state and local governments.
C) the central bank.
D) state, local and federal governments.

Question 16

The adverse consequences of debt deflation are most evident ________.

A) in the expansion of credit to high-risk borrowers
B) on the balance sheets of nonfinancial businesses
C) in a sharp decline in the real interest rate
D) on the balance sheets of financial businesses

Question 17

A rapid increase in the availability of credit to previously underserved borrowers is likely ________.

A) to result from financial liberalization
B) to improve the allocation of capital
C) to confirm the merits of microcredit
D) to result from deleveraging

Question 18

Which of the following best illustrates the problem of moral hazard?

A) a professional baseball team that consistently drafts poor players.
B) an individual that is hiding a pre-existing condition from a health insurance provider.
C) an increase in the level of one's income will lead to a decrease in demand for inferior goods.
D) an economic agent that engages in risky behavior once a loan contract is signed.

Question 19

A likely consequence of deposit insurance, ceteris paribus, is ________.

A) an increase in risk-taking by banks
B) a bank panic
C) a credit boom
D) a reduction in the severity of adverse selection

Question 20

Financial institutions that cut back on their lending are engaged in ________.

A) liability management.
B) deleveraging.
C) financial innovation.
D) torsion control.

Question 21

The Great Crash on the New York Stock Exchange occurred in ________.

A) October 1929.
B) July 1776.
C) September 2001.
D) March 1933

Question 22

An asset-price bubble entails ________.

A) increasing the value of one's assets to cover liability losses.
B) an increase in asset prices above their fundamental economic value.
C) reducing the number of participants in the underlying financial derivatives market.
D) an economic skins game.

Question 23

Assume that a firm has $100 million in real assets and $90 in real liabilities. If the price level falls by ten percent, the real value of liabilities would ________.

A) fall to $81 million.
B) change, but more information must be provided to determine the exact movement.
C) remain unchanged.
D) rise to $99 million.

Question 24

When banks and other financial institutions become insolvent, ________.

A) the problem of asymmetric information becomes more acute
B) it is easier to distinguish the good creditors and borrowers from the bad
C) surviving creditors will attract borrower-spenders by lowering the real interest rate
D) the resulting increase in short-run aggregate supply will discourage investment

Question 25

The difference between the interest rate on loans to households and firms and the rate on completely safe assets is known as ________.

A) the discount rate.
B) the FICO score
C) the credit spread.
D) the prime rate.

Question 26

The main reason that many businesses fail when the price level is falling is that ________.

A) deflation causes a decline in short-run aggregate supply
B) as prices fall, businesses are unable to predict the quantity of output they will be able to sell
C) the real value of the firms assets declines in proportion to the decrease in the price level
D) falling prices mean that regular loan payments become increasingly difficult

Question 27

The decline in net worth that can result from an unanticipated decline in the price level is known as ________.

A) a credit boom.
B) deleveraging.
C) a debt deflation.
D) federal funds rationing.

Question 28

U.S. financial crises begin in a period of________.

A) rising incomes.
B) adverse selection.
C) rising uncertainty.
D) moral hazard.

Question 29

The most severe financial crisis in U.S history occurred in the years ________.

A) 2006-2008.
B) 1997-98.
C) 1929-33.
D) 1873-93.

Question 30

An increase in the general level of prices will tend to cause, other things the same ________.

A) an increase in the real value of assets
B) an increase in the real value of liabilities.
C) no change in the real value of liabilities.
D) a decrease in the real value of liabilities.

Question 31

Most likely, the stock market crash in 1929 was triggered by ________.

A) an autonomous tightening of monetary policy
B) an unexpected increase in tax rates
C) the rise of fascist political parties in Europe
D) a decline in consumer spending

Question 32

In the Great Depression, investment spending fell by ________.

A) nine-tenths of one percent.
B) nine percent.
C) ninety percent.
D) nine hundred percent.

Question 33

An individual firm is insolvent when ________.

A) its assets exceed the value of its liabilities.
B) its average costs per unit are greater than its marginal cost.
C) its average costs per unit are less than its marginal cost.
D) its liabilities exceed the value of its assets.

Question 34

Which of the following statements is correct?

A) assets plus liabilities equal net worth.
B) liabilities plus net worth equal assets.
C) assets plus net worth equal liabilities.
D) liabilities minus net worth equal assets.

Question 35

A prominent aspect of the recent Great Recession, but not of the Great Depression of the 1930s, is ________.

A) bank panics
B) mortgage defaults
C) an increase in the credit spread
D) nonconventional monetary policy

Question 36

The credit spread refers to ________.

A) the extent to which financial instruments are distributed among households at different income levels in a given society.
B) the difference between the London Inter-Bank Offered Rate (LIBOR) and the fed funds rate.
C) the price elasticity of household debt.
D) the interest-rate differential between risky bonds and U.S. Treasury bonds

Question 37

President Franklin Delano Roosevelt declared a bank holiday, closing all U.S. banks in ________.

A) July 1776.
B) October 1929.
C) March 1933
D) September 2001.

Question 38

A prominent aspect of the Great Depression of the 1930s, but not of the recent Great Recession, is ________.

A) bank panics
B) mortgage defaults
C) an increase in the credit spread
D) nonconventional monetary policy

Question 39

The Great Depression ________.

A) was largely confined to the United States.
B) was largely confined to European markets.
C) was largely confined to Asian markets.
D) was worldwide in scope.

Question 40

Assume that a firm has $100 million in real assets and $90 in real liabilities. If the price level rise by ten percent, the real value of its assets would ________.

A) fall.
B) rise.
C) change, but more information must be provided to determine their exact movement.
D) remain unchanged.

Question 41

The practice of approving mortgages in order to sell them as mortgage-backed securities is known as ________.

A) originate-to-distribute
B) principal-agent engineering
C) predatory lending
D) a credit default swap

Question 42

Which of the following is among the possible reasons that the 2007-2009 financial crisis did not result in an economic depression?

A) new lending programs by the central bank
B) privatization of Fannie Mae and Freddie Mac
C) a substantial increase in exports to China
D) rapid foreclosure of "underwater" properties

Question 43

Subprime borrowers ________.

A) are those individuals who owe more on their mortgage than the value of their home
B) possess a relatively low FICO score.
C) rely on mortgage-backed securities to support their mortgage applications.
D) are those with an income level below the value of their mortgage.

Question 44

During the Great Depression, as real interest rates rose, good credit risks were less likely to seek loans. This process illustrates the phenomenon of ________.

A) adverse selection.
B) moral hazard.
C) poor monetary policy.
D) debt deflation.

Question 45

How is a financial crisis like a power blackout?

Question 46

Hedge funds, investment banks, and other non-depository financial firms are known as ________.

A) the shadow banking system
B) repurchasers
C) subprime lenders
D) CDOs

Question 47

Instruments which provide payments to holders of bonds in the event of default are known as ________.

A) collateralized bond obligations.
B) tertiary payment devices.
C) credit default swaps.
D) mortgage-backed securities.

Question 48

From 1995-2007, the Irish economy________.

A) suffered from severe unemployment, famine and labor migration.
B) witnessed a boom in the real economy, but suffered through a collapse in asset prices.
C) enjoyed one of the highest growth rates in the world.
D) suffered through a period of prolonged deflation.

Question 49

A haircut (in finance) is ________.

A) the payment of a block of funds as part of a refinancing arrangement.
B) the percentage by which the value of collateral exceeds the value of the loan
C) the issue of equities rather than debt in acquiring access to money capital.
D) the immediate end of lending to subprime borrowers.

Question 50

Describe the role of uncertainty at the beginning of and in the unfolding of a financial crisis.

Question 51

Monetary policy in the United States is primarily the responsibility of ________.

A) the President and Congress.
B) the Federal Reserve System.
C) the U.S. Treasury.
D) the Comptroller of the Currency.

Question 52

What are the effects of a financial crisis on short-run aggregate supply? How might long-run aggregate supply be affected?

Question 53

Which of the following is among the possible reasons that the 2007-2009 financial crisis did not result in an economic depression?

A) tax cuts
B) elimination of nonessential government spending
C) rapid prosecution of predatory lenders
D) closure of the shadow banking system

Question 54

How can improvements in statistical analysis of financial data cause the amount of information in financial markets to decline?

Question 55

If the value of a home falls below the amount owed on the mortgage for that property, the house is said to be ________.

A) underwater.
B) collateralized.
C) swamped.
D) in short sale.

Question 56

The worst weekly decline in U.S. stock market history occurred during the week beginning with ________.

A) March 20, 1933.
B) December 7, 1941.
C) September 12, 2001.
D) October 6, 2008.

Question 57

The financial innovation of numerical credit scoring contributed to the ________.

A) "democratization of credit"
B) reduction of loan-to-value ratios
C) "depersonalization of credit"
D) reduction of information asymmetries

Question 58

The rate targeted by the Federal Reserve System as it conducts monetary policy is the ________.

A) discount rate.
B) prime rate.
C) Treasury bill rate.
D) fed funds rate.

Question 59

Which of the following is among the possible reasons that the 2007-2009 financial crisis did not result in an economic depression?

A) the declaration of a bank holiday by the nation's President
B) international policy coordination
C) strict reliance on conventional monetary policy
D) government spending restraint

Question 60

A $100 million loan with a haircut of four percent requires collateral valued at ________.

A) $104 million
B) $96 million
C) $4 million
D) $400,000

Question 61

The key objective of purchases by the Federal Reserve of over $1 trillion worth of debt issued by private firms was ________.

A) to avoid the bankruptcy of the issuing firms
B) to manage expectations
C) to prevent such firms from being acquired by foreign companies
D) to stimulate spending by firms and households

Question 62

Asset-price bubbles ________.

A) impact the macroeconomy only when they burst
B) are easily recognized by market participants
C) always involve overly optimistic expectations
D) are unlikely to occur when credit is readily available

Question 63

Why is responding to a financial crisis by bailing out financial institutions more effective than direct support of nonfinancial businesses?

Question 64

The Troubled Asset Relief Program ________.

A) led to the creation of the Federal Reserve System.
B) helped contribute to the stock market crash of 2006-2007.
C) shifted non-performing assets off the balance sheet of the Federal Deposit Insurance Corporation onto the balance sheet of Fannie Mae and Freddie Mac.
D) authorized the Treasury to by mortgages from troubled financial institutions.

Question 65

The expectations channel of monetary transmission takes the view that ________.

A) decreasing the federal funds rate will lead to a reduction in the discount rate.
B) if economic agents believe that the price of an individual asset will rise in the future, they will buy that asset today, contributing to its eventual price increase.
C) if households expect an increase in prices in the future, they will engage in spending today.
D) households will increase their spending today if they believe that the monetary authorities are committed to maintaining low interest rates.

Question 66

Asset-price bubbles ________.

A) are a relatively recent phenomenon.
B) end with an increase in asset prices.
C) have been a feature of market economies for centuries.
D) are likely to be prevented by advances in computer technology and telecommunications.

Question 67

In the event that nominal interest rates cannot be lowered further, the Federal Reserve might rely on________.

A) federal government fiscal policy.
B) targeting the fed funds rate.
C) quantitative easing.
D) targeting the inflation rate.

Question 68

How did international policy coordination contribute to the avoidance of an economic depression in 2008 - 2010?

Question 69

Central bank lending to bail out troubled firms is known as ________, while allowing troubled firms to conceal the true value of their assets is called ________.

A) crony capitalism; larceny
B) liquidity provision; regulatory forbearance
C) securitization; nonconventional monetary policy
D) subprime lending; regulatory arbitrage

Question 70

Following the collapse of its housing and stock markets around 1990, the Japanese government ________.

A) effectively managed the crisis, limiting the damage to the Japanese economy.
B) took only limited action in response to the crisis.
C) was able to rely on private initiatives in quickly reversing the course of GDP in the 1990s.
D) fixed the value of the yen to the Euro and pursued an aggressive monetary policy.

Question 71

The Economic Recovery Act of 2008 included a temporary increase in the federal deposit insurance ceiling from $100,000 to $250,000. The likely objective was to ________.

A) boost bank profitability
B) increase the money supply
C) discourage withdrawals from banks
D) bail out the Federal Deposit Insurance Corporation (FDIC)

Question 72

Credit-driven bubbles ________.

A) occur exclusively within the financial sector
B) are more likely to be identified by central bank officials than by market participants
C) are best contained with a policy of high real interest rates
D) are harder to identify than expectations-driven bubbles

Question 73

What is meant by the expectations channel of monetary transmission? How does it relate to the credit channel?

Question 74

The most important component of the Economic Recovery Act passed by the Bush Administration was ________.

A) the creation of the Federal Reserve discount window.
B) the establishment of the Troubled Asset Relief Program (TARP).
C) the decrease in taxes for the wealthiest one percent of all Americans.
D) the creation of the Federal Reserve.

Question 75

The current chairman of the Board of Governors of the Federal Reserve System is ________.

A) Alan Greenspan.
B) Barack Obama.
C) Ben Bernanke.
D) Nancy Pelosi.

Question 76

Which of the following is a distinctive feature of a credit-driven asset-price bubble?

A) asset-price increases that are "justified" by projections of future value
B) a weakening of lending standards
C) an increase in the number and variety of market participants
D) The affected assets are financial stocks or bonds issued by companies in the financial sector.

Question 77

The zero-lower-bound problem eliminates the ability of the central bank to use which of the following in implementing policy?

A) open market operations.
B) discount lending
C) the federal funds rate
D) the required reserve ratio.

Question 78

Attempts by a central bank to increase bank deposits without a decrease in nominal interest rates are referred to as ________.

A) quantitative easing
B) credit channeling
C) open market operations
D) liquidity provision

Question 79

Compared to the central bank response to the financial crisis in 2007-2009, the response to the Great Depression of the 1930s may be characterized as ________, while the response of Japan's central bank to the banking crisis in the early 1990s merits the label ________.

A) hasty; sluggish
B) intrusive; tenacious
C) complacent; indulgent
D) corrupt; technocratic

Question 80

Fiscal policy involves the manipulation of ________.

A) U.S. interest rates.
B) wages and prices.
C) federal government spending and tax revenues.
D) the supply of money.