Question 1

A rise in the money supply __________ the natural rate of interest.

Accepted Answer

The natural rate of interest is determined by real factors such as productivity and thrift, not by monetary factors like the money supply.

Question 2

A rise in government expenditure __________ the natural rate of interest.

Accepted Answer

An increase in government expenditure is likely to lead to higher demand for goods and services, which can put upward pressure on prices. This, in turn, can lead to higher inflation expectations, causing lenders to demand higher interest rates to compensate for the eroding value of their money. As a result, the natural rate of interest is likely to rise.

Question 3

Monetarists believe in a relatively unstable __________ curve, and thus recommend a monetary policy targeting the __________.

Accepted Answer

Monetarists argue for the importance of controlling the money supply to manage economic stability, aligning with the choice that suggests targeting the money supply. They typically view the LM (liquidity preference-money supply) curve as more stable than the IS (investment-savings) curve, but their policy recommendations focus on controlling the money supply rather than directly targeting interest rates.

Question 4

Keynesians believe in a relatively stable __________ curve, and thus recommend a monetary policy targeting the __________.

Accepted Answer

Keynesians believe in a stable LM curve, which shows the relationship between interest rates and the level of income. Therefore, they recommend a monetary policy targeting the interest rate (which is represented on the LM curve) rather than the money supply (which is represented on the IS curve).

Question 5

The quantity of money demanded increases at every combination of GDP and interest rate. If the Fed holds to an unchanged interest rate target, the interest rate __________ and GDP __________.

Accepted Answer

The answer of The quantity of money demanded increases at...

Question 6

When the economy is at full employment __________ interest rates are __________ by an expansionary monetary policy if inflationary expectations are generated.

Accepted Answer

When the economy is at full employment, expansionary monetary policy can lead to inflationary expectations, which may prevent real interest rates from changing as nominal rates adjust for inflation.

Question 7

"A drop in the money supply lowered output in the short run, but left output unaffected in the long run." This statement implies that the price level __________ in the long run, causing the interest rate to __________.

Accepted Answer

In the long run, a drop in the money supply leads to a decrease in the price level, which in turn causes the interest rate to fall as the real money supply increases.

Question 8

"A rise in the money supply raised output in the short run, but left output unaffected in the long run." This statement implies that the price level __________ in the long run, causing the interest rate to __________.

Accepted Answer

In the long run, an increase in the money supply leads to a proportional increase in the price level (inflation) without affecting the real output, according to classical economic theory. As prices rise, the demand for money for transactions purposes increases, leading to an increase in interest rates.

Question 9

"A rise in government expenditures raised output in the short run, but left output unaffected in the long run." This statement implies that the price level __________ in the long run, causing the interest rate to __________.

Accepted Answer

According to the theory of the long-run neutrality of money, an increase in government expenditures can boost output in the short run due to increased demand. However, in the long run, this effect dissipates as prices adjust upwards, leading to higher inflation. This inflation can prompt central banks to raise interest rates to control inflation, hence the price level rises, causing the interest rate to rise as well.

Question 10

Suppose that IS and LM intersect at full-employment output. A rightward shift of LM will be followed by a __________ price level that shifts LM to the __________ in a return to full employment.

Accepted Answer

A rightward shift of the LM curve, which represents a situation where money supply increases or interest rates decrease leading to higher investment and income, initially moves the economy away from full employment by increasing output beyond the full-employment level. This increase in output leads to higher demand for goods and services, which puts upward pressure on prices. As prices rise, the real money supply (which is the nominal money supply adjusted for price level) decreases because the money does not go as far when prices are higher. This decrease in the real money supply shifts the LM curve back to the left as it requires higher interest rates to equilibrate the money market at the higher price level, eventually returning the economy to full employment but at a higher price level.

Question 11

The quantity of money demanded suddenly increases at every combination of GDP and interest rate. If the Fed holds to an unchanged money supply target, the interest rate __________ and GDP __________.

Accepted Answer

An increase in money demand leads to an increase in the interest rate, as individuals and firms compete for a limited supply of loanable funds. The rise in the interest rate decreases investment spending, ultimately leading to a decrease in GDP.

Question 12

The quantity of money demanded decreases at every combination of GDP and interest rate. If the Fed holds to an unchanged money supply target, the interest rate __________ and GDP __________.

Accepted Answer

The answer of The quantity of money demanded decreases at...

Question 13

The natural rate of interest is a __________ rate that __________ inflationary expectations.

Accepted Answer

The natural rate of interest is a real rate that excludes inflationary expectations. This is because the natural rate refers to the rate that is consistent with the economy being in long-run equilibrium, and inflationary expectations are a short-term phenomenon that can fluctuate. By using the real rate, policymakers can get a better sense of the underlying economic conditions and adjust policy accordingly.

Question 14

Suppose that IS and LM intersect at full-employment output. A rightward shift of IS will be followed by a __________ price level that shifts LM to the __________ in a return to full-employment.

Accepted Answer

A rightward shift of the IS curve, which represents an increase in investment and/or consumption, leads to higher demand in the economy. This increased demand typically results in a rising price level. As prices rise, the real money supply decreases (because the value of money falls), making money more expensive and interest rates higher. This mechanism shifts the LM curve to the left, as it represents a decrease in the liquidity of money at each level of income, moving the economy back to full-employment equilibrium but at a higher price level.

Question 15

The quantity of money demanded increases at every combination of GDP and interest rate. If the Fed holds to an unchanged interest rate target, the interest rate __________ and GDP __________.

Accepted Answer

When the Fed holds to an unchanged interest rate target, it adjusts the money supply to meet the demand at that interest rate, keeping the interest rate unchanged. GDP remains unchanged in this scenario because the question does not specify any direct action affecting GDP, such as fiscal policy or a change in investment or consumption behavior due to the interest rate policy.

Question 16

Suppose that IS and LM intersect at full-employment output. A leftward shift of LM will be followed by a __________ price level that shifts LM to the __________ in a return to full employment.

Accepted Answer

A leftward shift of the LM curve indicates a decrease in the money supply or an increase in money demand, leading to higher interest rates and lower output. To return to full employment, the price level must fall, which increases the real money supply and shifts the LM curve back to the right.

Question 17

Starting from full employment output, fiscal policy will be completely crowded out in real terms, even with __________ LM curve, so long as prices are __________.

Accepted Answer

The answer of Starting from full employment output, fiscal policy...

Question 18

Suppose that IS and LM intersect at full-employment output. A leftward shift of IS will be followed by a __________ price level that shifts LM to the __________ in a return to full employment.

Accepted Answer

A leftward shift of the IS curve indicates a decrease in investment or consumption, leading to lower output and income. This would typically result in lower demand for goods and services, putting downward pressure on prices. As prices fall, the real money supply (money supply adjusted for price level) increases because the value of money goes up when prices go down. This increase in the real money supply would shift the LM curve to the right, as more money is available to support economic activity at lower interest rates, helping the economy return to full employment.

Question 19

"A drop in government expenditures lowered output in the short run, but left output unaffected in the long run." This statement implies that the price level __________ in the long run, causing the interest rate to __________.

Accepted Answer

In the long run, the economy adjusts to changes in government expenditures through changes in the price level and interest rates. A drop in government expenditures would initially lower output, leading to a decrease in the demand for money, which in turn causes the price level to fall. As the price level falls, the real value of money increases, leading to lower interest rates. This adjustment process ensures that output returns to its natural level in the long run, unaffected by the initial drop in government expenditures.

Question 20

When the economy is at full employment __________ interest rates are __________ by an expansionary monetary policy if inflationary expectations are generated.

Accepted Answer

When the economy is at full employment, the central bank cannot use expansionary monetary policy to increase output and employment without generating inflationary expectations. The expansionary monetary policy involving an increase in money supply and decrease in interest rates will lead to an increase in aggregate demand, which will increase prices in the long run. Therefore, nominal interest rates are increased to discourage borrowing and reduce aggregate demand.

Quiz 25: Money and Economic Stability in the ISLM World

A rise in the money supply __________ the natural rate of interest.

A rise in government expenditure __________ the natural rate of interest.

Monetarists believe in a relatively unstable curve, and thus recommend a monetary policy targeting the .

Keynesians believe in a relatively stable curve, and thus recommend a monetary policy targeting the .

The quantity of money demanded increases at every combination of GDP and interest rate. If the Fed holds to an unchanged interest rate target, the interest rate and GDP .

When the economy is at full employment interest rates are by an expansionary monetary policy if inflationary expectations are generated.

"A drop in the money supply lowered output in the short run, but left output unaffected in the long run." This statement implies that the price level in the long run, causing the interest rate to .

"A rise in the money supply raised output in the short run, but left output unaffected in the long run." This statement implies that the price level in the long run, causing the interest rate to .

"A rise in government expenditures raised output in the short run, but left output unaffected in the long run." This statement implies that the price level in the long run, causing the interest rate to .

Suppose that IS and LM intersect at full-employment output. A rightward shift of LM will be followed by a price level that shifts LM to the in a return to full employment.

The quantity of money demanded suddenly increases at every combination of GDP and interest rate. If the Fed holds to an unchanged money supply target, the interest rate and GDP .

The quantity of money demanded decreases at every combination of GDP and interest rate. If the Fed holds to an unchanged money supply target, the interest rate and GDP .

The natural rate of interest is a rate that inflationary expectations.

Suppose that IS and LM intersect at full-employment output. A rightward shift of IS will be followed by a price level that shifts LM to the in a return to full-employment.

The quantity of money demanded increases at every combination of GDP and interest rate. If the Fed holds to an unchanged interest rate target, the interest rate and GDP .

Suppose that IS and LM intersect at full-employment output. A leftward shift of LM will be followed by a price level that shifts LM to the in a return to full employment.

Starting from full employment output, fiscal policy will be completely crowded out in real terms, even with LM curve, so long as prices are .

Suppose that IS and LM intersect at full-employment output. A leftward shift of IS will be followed by a price level that shifts LM to the in a return to full employment.

"A drop in government expenditures lowered output in the short run, but left output unaffected in the long run." This statement implies that the price level in the long run, causing the interest rate to .

When the economy is at full employment interest rates are by an expansionary monetary policy if inflationary expectations are generated.