Deck 27: Information Problems and Channels for Monetary Policy

Question 1

Why are savers often unwise in lending to borrowers who are willing to pay very high interest rates?

A)Very high interest rates are against the law in many states.
B)The high tax rates on interest income make high-interest rate loans unappealing to lenders.
C)Borrowers will usually pay very high interest rates only when inflation is high, which makes the real interest rate on such loans low.
D)Adverse selection and moral hazard problems reduce the likelihood of repayment on high-interest rate loans.

Answer 1

Adverse selection and moral hazard problems reduce the likelihood of repayment on high-interest rate loans.

Question 2

Large firms find external funds to be more costly than internal funds because

A)they must pay taxes on external funds but not on internal funds.
B)external funds must be raised in financial markets, whereas internal funds may be raised from banks.
C)legally a portion of external funds must be distributed to shareholders, whereas all internal funds may be used for investment projects.
D)outside investors require a higher return to compensate them for having to obtain information about the firms.

Answer 2

outside investors require a higher return to compensate them for having to obtain information about the firms.

Question 3

In the basic AD-SRAS model, the assumption is made that

A)bank loans are imperfect substitutes for other forms of finance.
B)all sources of finance are perfect substitutes.
C)the real interest rate overstates the cost of funds to borrowers.
D)the real interest rate understates the cost of funds to borrowers.

Answer 3

all sources of finance are perfect substitutes.

Question 4

A favorable shock to productivity may raise investment by

A)increasing firms' internal funds.
B)reducing government spending, which would otherwise crowd out investment spending.
C)causing interest rates to fall as the economy expands.
D)reducing taxes on corporate profits.

Question 5

Why are banks able to offer funds more cheaply to many borrowers than can financial markets?

A)Banks tend to be willing to settle for lower profits than are other lenders.
B)Banks are less regulated than are financial markets, which lowers banks' costs of operating.
C)Banks specialize in gathering information on the creditworthiness of borrowers and monitoring borrowers' activities.
D)Financial markets are generally uninterested in making loans to small borrowers, because small borrowers usually cannot afford to pay the rates charged large corporations and other large borrowers.

Question 6

As a result of asymmetric information

A)small firms are better able to secure external financing than are large firms.
B)investment spending may fall in a recession even if true investment opportunities do not change.
C)short-run fluctuations in output are smaller than they would otherwise be.
D)fluctuations in the amount of internal funds have large effects on the investment in plant and equipment carried out by mature firms.

Question 7

A majority of lending from savers to borrowers takes place through

A)financial intermediaries.
B)stock and bond markets.
C)direct lending by the government.
D)private transactions among friends and relatives.

Question 8

Economists have found that the greater is a borrower's net worth compared to the borrower's desired level of capital investment

A)the larger is the gap between the cost of external and internal financing.
B)the smaller is the gap between the cost of external and internal financing.
C)the larger is the borrower's tax liability.
D)the smaller is the borrower's tax liability.

Question 9

For large firms economists have found that

A)internal funds are a cheaper source of funds than are external funds.
B)external funds are a cheaper source of funds than are internal funds.
C)internal and external funds cost firms about the same.
D)direct loans from the federal government are the largest source of funds.

Question 10

What did President George H. W. Bush and his advisers believe was causing the weakness in the U.S. economy in the fall of 1991?

A)A credit crunch
B)High inflation
C)Low interest rates
D)A large federal budget deficit

Question 11

In which of the following years did the Fed move quickly when signs of a credit crunch appeared?

A)Only 1991
B)Only 1991 and 1998
C)Only 1998 and 2001
D)1991, 1998, and 2001

Question 12

When a borrower's net worth is high,

A)the cost of its internal funds will be high.
B)the cost of its internal funds will be low.
C)the cost of its external funds will be high.
D)information costs are less likely to constrain capital spending.

Question 13

In comparing the actions of the Fed in the fall of 1998 with its actions in the fall of 1991, we can say that

A)in both instances the Fed moved quickly to raise interest rates in the face of an expected increase in inflation.
B)in both instances the Fed moved quickly to cut interest rates in the face of signs of a credit crunch.
C)the Fed moved more quickly in 1998 than in 1991 to cut interest rates in the face of signs of a credit crunch.
D)the Fed failed in both cases to take action in the face of signs of a credit crunch.

Question 14

What did President Bush's advisers believe should be done about the weakness in the U.S. economy in the fall of 1991?

A)They argued in favor of an expansionary fiscal policy.
B)They argued in favor of waiting for the effects of falling prices.
C)They argued in favor of an expansionary monetary policy.
D)They argued in favor of waiting for economic recovery in Japan and Europe to increase demand for U.S. products.

Question 15

If banks become more willing to make loans, the aggregate demand curve will

A)shift to the left, and the real interest rate will fall.
B)shift to the left, and the real interest rate will rise.
C)shift to the right, and the real interest rate will fall.
D)shift to the right, and the real interest rate will rise.

Question 16

All else being equal, increases in firms' net worth result in

A)increases adverse selection problems.
B)increases moral hazard problems.
C)increases in capital investment spending.
D)a greater gap between the cost of internal and external financing.

Question 17

For breakdowns in lending by financial institutions to affect the volume of funds flowing from savers to borrowers,

A)financial institutions must charge lower interest rates than other lenders.
B)financial institutions must charge higher interest rates than other lenders.
C)alternative sources of funds to borrowers must be imperfect substitutes for loans from financial institutions.
D)financial institutions must be subject to less regulation than other lenders.

Question 18

The main reason that markets for finance do not resemble simple auction markets, such as the market for wheat, is that

A)markets for finance tend to be dominated by a few large lenders.
B)because of asymmetric information, savers must spend resources to learn about borrowers.
C)markets for finance are much more closely regulated by the government than are other markets.
D)simple auction markets usually suffer from excess demand for their products.

Question 19

One reason that investment spending tends to decline during recessions is that

A)interest rates tend to rise, reducing the expected future profitability of investment projects undertaken with borrowed funds.
B)many firms experience a decline in internal funds.
C)government spending tends to rise, which crowds out investment spending.
D)many firms experience an increase in taxes, reducing the expected future profitability of investment projects.

Question 20

The key reason why loans from financial institutions and other forms of borrowing are not perfect substitutes is that

A)information problems exist in financial markets.
B)banks are legally required to offer loans at rates below those prevailing in the bond market.
C)the tax treatment of loans from financial institutions is different from the tax treatment of loans obtained in the bond market.
D)financial institutions have great difficulty in evaluating the creditworthiness of all but the largest borrowers.

Question 21

If banks become less willing to lend, which category of spending is likely to be most affected?

A)Consumer durables
B)Consumer nondurables
C)Net exports
D)Government purchases

Question 22

In financial panics in the United States in the nineteenth and early twentieth centuries

A)interest rates rose and stock prices fell in financial markets.
B)interest rates fell and stock price rose in financial markets.
C)interest rates and stock prices both fell in financial markets.
D)interest rates and stock prices both rose in financial markets.

Question 23

The effect of a decline in the money supply on the economy differs from the effect of a decline in the willingness of banks to lend in that a decline in the money supply will lead to

A)a decline in output, whereas a decline in the willingness of banks to lend will lead to an increase in output.
B)an increase in the price level, whereas a decline in the willingness of banks to lend will lead to a decrease in the price level.
C)an increase in the real interest rate, whereas a decline in the willingness of banks to lend will lead to a decrease in the real interest rate.
D)a decrease in the price level, whereas a decline in the willingness of banks to lend will lead to an increase in the price level.

Question 24

An increase in borrower net worth will shift the aggregate demand curve

A)and the money demand curve to the left.
B)and the money demand curve to the right.
C)to the left, and the money demand curve to the right.
D)to the right, and the money demand curve to the left.

Question 25

Which of the following countries did not suffer a banking crisis during the early 1930s?

A)Canada
B)United States
C)France
D)Germany

Question 26

Which of the following countries suffered a banking crisis during the early 1930s?

A)Germany
B)Canada
C)United Kingdom
D)Japan

Question 27

A financial panic will result in

A)a rightward shift in the SRAS curve.
B)a leftward shift in the SRAS curve.
C)a rightward shift in the AD curve.
D)a leftward shift in the AD curve.

Question 28

A decline in borrower net worth

A)raises information costs, but increases the ability of households and firms to borrow.
B)reduces information costs and increases the ability of households and firms to borrow.
C)raises information costs and reduces the ability of households and firms to borrow.
D)reduces information costs and reduces the ability of households and firms to borrow.

Question 29

A decline in borrower net worth will result in

A)lower output, but a higher price level.
B)a lower price level, but higher output.
C)lower output and a lower price level.
D)higher output and a higher price level.

Question 30

Credit controls are

A)actions by banks to deny loans to risky borrowers.
B)attempts by the Fed to control credit by manipulating the money supply.
C)regulatory restrictions on bank lending.
D)attempts by credit card issuers to screen out bad credit risks.

Question 31

An increase in borrower net worth will result in

A)higher output and a higher real interest rate.
B)higher output, but a lower real interest rate.
C)lower output and a lower real interest rate.
D)lower output, but a higher real interest rate.

Question 32

If banks become less willing to make loans, the aggregage demand curve

A)will shift to the left, and the money demand curve will shift to the right.
B)and the money demand curve will both shift to the left.
C)will shift to the right, and the money demand curve will shift to the left.
D)and the money demand curve will both shift to the right.

Question 33

During the financial panic of the early 1930s

A)the public converted large amounts of currency to bank deposits.
B)the spread between interest rates on safe and risky securities widened sharply.
C)spending by large firms declined relative to spending by households and small firms.
D)banks shifted large amounts of funds from government securities to loans.

Question 34

Credit controls were removed in July 1980 because they had

A)proved to have little impact on economic activity.
B)resulted in sharp increases in interest rates.
C)raised the inflation rate.
D)produced a recession.

Question 35

A credit crunch

A)is an increase by consumers in the default rate on loans.
B)is a decline in either the ability or the willingness of banks to lend at any particular interest rate.
C)is a reduction in the money supply by the Fed.
D)is an increase in the discount rate by the Fed.

Question 36

Which of the following was NOT part of the program of credit controls imposed by the Fed in March 1980?

A)Banks were requested to reduce their acquisition of funds from nondeposit sources.
B)A ceiling was placed on the interest rates paid on Treasury securities.
C)A surcharge of 3% was placed on some discount borrowing by large banks.
D)A special reserve requirement of 15% was placed on new money market mutual fund assets.

Question 37

An increase in the willingness of banks to lend will result in

A)a lower real interest rate, whereas an increase in the money supply will lead to a higher real interest rate.
B)a lower real interest rate as will an increase in the money supply.
C)a higher real interest rate as will an increase in the money supply.
D)a higher real interest rate, whereas an increase in the money supply will lead to a lower real interest rate.

Question 38

Research has shown that the countries that suffered a banking crisis during the early 1930s

A)had smaller declines in the money supply than did countries that did not suffer a banking crisis.
B)had larger declines in output and employment than did countries that did not suffer a banking crisis.
C)had smaller declines in output and employment than did countries that did not suffer a banking crisis.
D)were located exclusively in Europe.

Question 39

One reason why financial panics in the United States in the nineteenth and early twentieth centuries resulted in less bank lending is that

A)depositors converted significant amounts of bank deposits to currency.
B)banks shifted from loans to purchases of U.S. government securities as the yields on these securities rose sharply.
C)the U.S. government restricted bank lending in order to free funds to cover its budget deficits.
D)companies shifted from bank loans to the bond market as rates on bonds dropped below rates charged by banks.

Question 40

In some financial panics, an unanticipated drop in the price level led to declining investment because the lower price level

A)resulted in higher nominal interest rates.
B)raised the real value of firms' debt obligations.
C)reduced the real value of consumers' financial wealth.
D)reduced the real value of expected future profits.

Question 41

The balance sheet channel describes ways in which interest rate changes resulting from monetary policy affect

A)the portfolio decisions of households.
B)the portfolio decisions of businesses.
C)borrowers' net worth.
D)lenders' net worth.

Question 42

In the bank lending channel, an expansionary monetary policy will in the short run

A)increase the real interest rate.
B)decrease the real interest rate.
C)leave the real interest rate unaffected.
D)have an ambiguous effect on the real interest rate.

Question 43

The credit crunch at the beginning of the 1990-1991 recession is attributable to

A)banks' concern about the strength of borrowers' balance sheets.
B)the imposition of credit controls by the federal government.
C)disintermediation brought about by rising interest rates.
D)a shift by depositors from bank deposits to other investments.

Question 44

The new Keynesian view of the effect of monetary policy on output stresses the effects of monetary policy on

A)the net worth of borrowers.
B)the willingness of banks to make loans.
C)the ability of banks to make loans.
D)interest rates.

Question 45

In the bank lending channel, an expansionary monetary policy will shift to the right

A)only the money supply line.
B)only the money supply line and the aggregate demand curve.
C)only the money supply line and the money demand curve.
D)the money supply line, the money demand curve, and the aggregate demand curve.

Question 46

In the bank lending channel, an expansionary monetary policy

A)will lead to a greater increase in output than in the money channel.
B)will not affect the real interest rate.
C)will result in increased spending only for firms and households dependent for credit on bank loans.
D)will lead to a larger budget deficit than in the money channel.

Question 47

Which of the following statements is correct?

A)Because in practice few borrowers are bank-dependent, the bank lending channel is of little real-world importance.
B)In the money channel, an expansionary monetary policy may cause a leftward shift in the AD curve.
C)In the bank lending channel, an expansionary monetary policy can increase output in the short run even if it results in an increase in the real interest rate.
D)In the money channel, an expansionary monetary policy affects the money supply curve but not the money demand curve.

Question 48

In the bank lending channel, an important reason for output increases in the short run after an expansionary monetary policy is that

A)the funds directly available for households and firms to spend will increase.
B)prices will increase, making increased production more profitable for firms.
C)the increase in government spending from an expansionary monetary policy increases output through the multiplier effect.
D)the ability of banks to make loans will increase.

Question 49

In the money channel, an expansionary monetary policy will in the short run

A)increase the real interest rate.
B)decrease the real interest rate.
C)leave the real interest rate unaffected.
D)have an ambiguous effect on the real interest rate.

Question 50

In the money channel, loans by financial institutions

A)are central to understanding the impact of monetary policy on output.
B)play no special role in the money supply process.
C)are considered poor substitutes for other sorts of borrowing.
D)are considered important only during recessions.

Question 51

Disintermediation involves

A)an increase in regulatory restrictions on bank lending.
B)a shift by depositors from bank deposits to other investments.
C)an increase in borrowing from banks at the expense of alternative sources of funds.
D)a decrease in interest rates following an expansion in the money supply.

Question 52

During a credit crunch

A)banks typically lower interest rates to attract new borrowers.
B)small-business investment increases relative to large-business investment.
C)banks typically hold much smaller portions of their portfolios in loans.
D)housing investment increases relative to large-business investment.

Question 53

Analysts have attempted to model the impact of monetary policy on net worth by emphasizing

A)the impact of lower interest rates on business spending on fixed investment.
B)the impact of lower interest rates on household spending on housing and durable goods.
C)the liquidity of balance sheet positions as a determinant of business and household spending.
D)the greater variability of business spending compared to household spending.

Question 54

In the money channel, the main way in which an expansionary monetary policy increases output in the short run is by

A)lowering the real interest rate, which increases spending by households and firms.
B)directly increasing the funds available for households and firms to spend.
C)increasing the ability of banks to make loans.
D)increasing the funds available for government spending.

Question 55

In the money channel, an expansionary monetary policy will shift to the right

A)only the money supply line.
B)only the money supply line and the aggregate demand curve.
C)only the money supply line and the money demand curve.
D)the money supply line, the money demand curve, and the aggregate demand curve.

Question 56

Which of the following occurs as a result of an increase in the money supply in the bank lending channel view, but does not occur in the money lending channel view?

A)An increased availability of bank loans
B)A rightward shift in the MD curve
C)A high level of output
D)A rightward shift in the AD curve

Question 57

In the money channel view of how changes in the money supply affect output and the real interest rate in the short run,

A)other financial assets are considered to be poor substitutes for bank loans by many borrowers.
B)banks are passive intermediaries, meeting the public's demand for money by supplying deposits.
C)credit crunches have a very important role to play.
D)interest rates do not necessarily bring the volume of funds desired to be lent by savers into equilibrium with the volume of funds desired to be borrowed by borrowers.

Question 58

Increases in interest rates

A)reduce borrowers' net worth.
B)reduce lenders' net worth.
C)increase the present value of borrowers' assets.
D)raise the cost to businesses of internal funding.

Question 59

Why did many economists suspect a credit crunch occurred in the fall of 1998?

A)Interest rates rose sharply.
B)The U.S. economy entered a recession.
C)Banks curtailed lending to risky borrowers.
D)Investment spending declined dramatically.

Question 60

The bank lending channel

A)emphasizes the role of interest rates in the money supply process.
B)emphasizes the importance of borrowers' net worth to the decision of lenders to grant loans.
C)emphasizes the behavior of bank-dependent borrowers.
D)is another name for the money channel.

Question 61

From 1929 to 1933 expenditures on fixed investment, consumer durable goods, and housing all declined in constant dollars by at least

A)5%.
B)10%.
C)25%.
D)50%.

Question 62

The strength of housing markets in many countries in the 2000s was attributed to

A)low interest rates worldwide.
B)coordinated cross-national planning restrictions.
C)tighter monetary policy by most major central banks.
D)purely domestic factors.

Question 63

When households and businesses have to sell illiquid assets to meet current obligations, they are said to be experiencing

A)disintermediation.
B)financial distress.
C)moral hazard.
D)adverse selection.

Question 64

If the bank lending channel is correct, a credit crunch in bank lending should

A)lower interest rates.
B)be felt disproportionately by borrowers for whom transactions costs of nonbank finance are the highest.
C)increase the money supply.
D)lead to disintermediation.

Question 65

A general unwillingness of banks to lend

A)results in monetary policy being ineffectual in the bank lending channel.
B)results in monetary policy being ineffectual in the balance sheet channel.
C)results in monetary policy being ineffectual in the money channel.
D)does not result in monetary being ineffectual in the bank lending, balance sheet, or money channels.

Question 66

The finding that bank loans decline and the volume of commercial paper issued increases when the Fed contracts the level of bank reserves appears to indicate that

A)the impact of contractionary monetary policy comes mainly from its effect on interest rates.
B)during these episodes borrowers who are able to do so switch toward nonbank sources of financing.
C)changes in credit demand must be responsible.
D)during these episodes savers must convert bank deposits into commercial paper purchases.

Question 67

Which of the following statements is correct?

A)The bank lending channel does not reject the idea that monetary policy can affect output by changing interest rates.
B)The bank lending channel argues that monetary policy affects output only through its effect on banks' portfolio decisions regarding loans and securities.
C)The bank lending channel argues that monetary policy affects output only through its effect on the public's portfolio decisions regarding money and nonmoney assets.
D)The bank lending channel has been unable to explain the movements in bank lending observed in the 1980s and 1990s.

Question 68

Since World War II, contractionary monetary policy changes have had

A)a larger impact on the output of small manufacturing firms than on the output of large manufacturing firms.
B)a larger impact on the output of large manufacturing firms than on the output of small manufacturing firms.
C)about the same negative impact on the output of both large and small manufacturing firms.
D)about the same positive impact on the output of large and small manufacturing firms.

Question 69

In the balance sheet channel, an expansionary monetary policy will shift to the right

A)only the money supply line.
B)only the money supply line and the aggregate demand curve.
C)only the money supply line and the money demand curve.
D)the money supply line, the money demand curve, and the aggregate demand curve.

Question 70

To determine whether a home is affordable, most homebuyers focus on

A)the price of the home.
B)cost of servicing the mortgage compared to take-home pay.
C)interest rates.
D)how much the home price has changed in recent years.

Question 71

An increase in the money supply can reduce the probability of financial distress by

A)directly increasing the funds available to households and businesses.
B)lowering the prices of U.S. Treasury securities.
C)allowing the federal government to reduce its budget deficit.
D)raising stock prices and the value of liquid financial assets.

Question 72

In the balance sheet channel, an expansionary monetary policy

A)will lead to a greater increase in output than in the money channel.
B)will not affect the real interest rate.
C)will result in increased spending only for firms and households dependent for credit on bank loans.
D)will lead to a larger budget deficit than in the money channel.

Question 73

Which of the following pieces of advice is an advocate of the bank lending channel most likely to give to officials in an emerging market economy?

A)Focus on the development of financial markets because they will be the chief sources of funds to business.
B)Make sure that financial institutions are developed along with financial markets.
C)Keep interest rates low to enable young, growing enterprises to borrow in financial markets.
D)Use credit controls to deal with excessive bank lending.

Question 74

Bank lending channel advocates are skeptical of Milton Friedman and Anna Schwartz's explanation of the role of banking panics in explaining the Great Depression, because they believe Friedman and Schwartz failed to take into account the effect of the banking panics on

A)the supply of money.
B)interest rates.
C)the availability of bank loans.
D)consumer confidence.

Question 75

Because the Carter credit controls of 1980 were unexpected and imposed by the government, we can conclude that

A)the subsequent decline in demand for bank loans most likely caused the 1980 recession.
B)the subsequent decline in bank loans was the result of a shift in bank loan supply that was independent of any shift in bank loan demand.
C)the subsequent decline in the supply of bank loans was most likely caused by the 1980 recession.
D)the controls led to an increase in the demand for money.

Question 76

The decline in the price level following the 1929 stock market crash may have reduced household spending on durable goods and houses because the decline

A)resulted in higher nominal interest rates.
B)led the government to increase its spending, which crowded out spending by households.
C)increased the real value of outstanding household debt.
D)led to an offsetting decline in nominal wages.

Question 77

A decline in bank lending during a recession

A)indicates that a credit crunch is occurring.
B)indicates that the demand for bank loans has declined.
C)will generally result in higher real interest rates.
D)might be the result of a credit crunch or a decline in the demand for bank loans.

Question 78

Monetary policy can have substantial effects on the economy even when nominal interest rates are very low

A)since real rates are what affects borrowing and spending decisions.
B)by improving borrower and bank balance sheets.
C)by reducing transactions costs.
D)only when the policy is substantial.

Question 79

In the balance sheet channel, when households have high levels of liquid assets relative to their liabilities, they are more willing to invest in consumer durable goods or housing because

A)they estimate the likelihood of financial distress to be low.
B)they are able to borrow at lower interest rates.
C)they can make these purchases without having to borrow.
D)they are likely to be middle-aged, when most purchases of consumer durable goods and houses are made.

Question 80

In the balance sheet channel, an expansionary monetary policy will in the short run

A)increase the real interest rate.
B)decrease the real interest rate.
C)leave the real interest rate unaffected.
D)have an ambiguous effect on the real interest rate.