Question 1

Keynesian monetary analysis relies on changes in interest rates to bring about changes in investment, consumption, and the prices of other assets.

Accepted Answer

Keynesian monetary analysis emphasizes the role of interest rates in stimulating or dampening economic activity. By lowering or raising interest rates, central banks can influence the cost of borrowing for firms and individuals, which in turn can affect their willingness to invest and spend. This can have ripple effects throughout the economy, leading to changes in employment, output, and inflation. Therefore, changes in interest rates are a key tool for Keynesian policymakers.

Question 2

Classical economists believed that changes in the supply of money translated into changes in the price level.

Accepted Answer

Classical economists, such as Adam Smith and David Ricardo, believed in the quantity theory of money, which states that changes in the supply of money have a direct and proportional effect on the price level.

Question 3

Keynes argued that fiscal policy, not monetary policy, is needed to get an economy out of the liquidity trap.

Accepted Answer

Keynes believed that in a liquidity trap, interest rates are so low that they cannot be lowered further and do not incentivize enough borrowing and investment. Therefore, government spending and investment must be increased through fiscal policy to stimulate the economy.

Question 4

Keynes believed that monetary policy had no effect on the economy, whether the problem was a mild recession or a depression.

Accepted Answer

Keynes believed that monetary policy could have an effect on the economy, particularly in a depression, but he emphasized the importance of fiscal policy (government spending and taxation) in addressing economic downturns.

Question 5

When a country finds itself in a liquidity trap, monetary policy can be ineffective.

Accepted Answer

In a liquidity trap, interest rates are already near zero and the demand for investment and consumption is low, making monetary policy ineffective as further reductions in interest rates will not boost spending.

Question 6

The quantity theory of money and the equation of exchange provide good short-run explanations of the effects of the money supply on the larger economy.

Accepted Answer

The quantity theory of money and the equation of exchange provide good long-run explanations of the effects of the money supply on the larger economy. In the short run, other factors such as changes in expectations, interest rates, and real economic shocks can also affect the economy.

Question 7

According to Keynesian monetary theory, when the money supply decreases, interest rates increase and investment and output decrease.

Accepted Answer

Keynesian monetary theory posits that when the money supply decreases, interest rates increase as there is less money available for borrowing. This increase in interest rates then leads to a decrease in investment by businesses and a subsequent decrease in output.

Question 8

In the quantity theory of money, V stands for the volume of money.

Accepted Answer

V stands for the velocity of money in the quantity theory of money.

Question 9

Keynes favored using fiscal policy to stimulate aggregate demand to move the economy toward full employment.

Accepted Answer

Keynes believed that fiscal policy, which involves government spending and taxation, could be used to increase demand in the economy and reduce unemployment. This is often referred to as Keynesian economics.

Question 10

In the short run, Keynesian monetary analysis suggests that changes in the money supply change interest rates, leading to a change in investment and a change in aggregate demand that in turn changes income, employment, and output.

Accepted Answer

This is a correct statement in Keynesian monetary analysis.

Question 11

Keynesians argue that fiscal policy is required in depressions because the liquidity trap can render monetary policy ineffective.

Accepted Answer

Keynesians believe that in a depression, monetary policy may become ineffective as interest rates approach zero and people become reluctant to spend or invest. In such a scenario, fiscal policy, such as government spending or tax cuts, can help stimulate economic activity. This is why they advocate for its use in economic downturns.

Question 12

The quantity theory suggests that any increase in the money supply leads to a proportionate increase in the price level.

Accepted Answer

This is the basic premise of the quantity theory of money. An increase in the money supply, all else being equal, will lead to an increase in aggregate demand, which in turn will lead to an increase in prices.

Question 13

According to classical economics and the quantity theory of money, any change in the money supply will affect prices.

Accepted Answer

According to classical economics and the quantity theory of money, any increase or decrease in the money supply will lead to a corresponding increase or decrease in the price level. This is because when the money supply increases, there is more money chasing the same amount of goods and services, leading to a rise in prices. Similarly, when the money supply decreases, there is less money chasing the same amount of goods and services, leading to a fall in prices.

Question 14

Keynes defined the liquidity trap as a situation in which, once interest rates decrease, individuals spend their money rather than holding onto it.

Accepted Answer

Keynes defined the liquidity trap as a situation in which, despite low interest rates, individuals and businesses still prefer to hold onto their money rather than spend it or invest it, because of a pessimistic outlook on the economy.

Question 15

Monetarists believe that the economy will return to full employment in the long run on its own.

Accepted Answer

Monetarists argue that the economy will self-correct and return to full employment in the long run, mainly through the adjustment of prices and wages. They believe that government interventions, such as fiscal policies, can be destabilizing and lead to inflation.

Question 16

Because classical economists assumed long-run full employment, as well as a slowly changing technology and monetary institutional system, both the velocity and the aggregate output in the equation of exchange are fixed.

Accepted Answer

Classical economists believed that in the long run, full employment would be reached and that there would be slow changes in technology and the monetary system. Therefore, both velocity and aggregate output were assumed to be fixed in their equation of exchange.

Question 17

The velocity of money is equal to the GDP divided by the price level.

Accepted Answer

The velocity of money is equal to the GDP divided by the money supply, not the price level. It measures how frequently units of currency are used to purchase domestically-produced goods and services within a given time period.

Question 18

The quantity theory does not provide useful explanations for short-run fluctuations in the economy.

Accepted Answer

The quantity theory of money focuses on the long-run relationship between money supply and prices, and assumes that other factors such as technology and productive capacity are constant. Therefore, it is not sensitive to short-run fluctuations in the economy.

Question 19

According to the classical money transmission mechanism, if the money supply increases, individuals will start to spend money, since they are holding excess cash and they cannot control the money supply.

Accepted Answer

According to the classical money transmission mechanism, an increase in the money supply leads to a decrease in interest rates, which leads to an increase in spending by individuals and an increase in borrowing by firms. This is known as the "liquidity effect." Therefore, individuals are expected to spend more money when there is an increase in the money supply.

Question 20

The equation of exchange applies only in the short run.

Accepted Answer

The equation of exchange, which relates money, output, velocity, and prices, is a theoretical framework that applies in both the short and long run. In the short run, changes in the money supply can have a more significant impact on inflation and economic output, while in the long run, changes in the money supply tend to have a greater impact on prices.

Quiz 13: Monetary Policy