Question 1

The opportunity cost of holding money is the:

Accepted Answer

The opportunity cost of holding money is the nominal interest rate, as it represents the foregone interest that could have been earned if the money was invested instead.

Question 2

The right of seigniorage is the right to:

Accepted Answer

Seigniorage is the profit that a government earns by issuing currency. This profit comes from the difference between the face value of the currency and the cost of producing it. Therefore, the right of seigniorage includes the right to print money.

Question 3

The ex ante real interest rate is based on _____ inflation, while the ex post real interest rate is based on _____ inflation.

Accepted Answer

The ex ante real interest rate is based on expected inflation, while the ex post real interest rate is based on actual inflation. This is because ex ante refers to predictions made before an event, while ex post refers to observations made after the event has occurred. Therefore, the ex ante real interest rate is based on expected inflation, as it is a prediction of future inflation rates. On the other hand, the ex post real interest rate is based on actual inflation, as it is calculated based on observations of past inflation rates.

Question 4

The real return on holding money is

Accepted Answer

The real return on holding money is the nominal interest rate minus the inflation rate (Fisher equation). Therefore, the answer is D, which represents the negative of the inflation rate.

Question 5

The ex post real interest rate will be greater than the ex ante real interest rate when the:

Accepted Answer

The answer of The ex post real interest rate will...

Question 6

If the nominal interest rate is 1 percent and the inflation rate is 5 percent, the real interest rate is:

Accepted Answer

The real interest rate is calculated by subtracting the inflation rate from the nominal interest rate. So, in this case, the real interest rate would be: 1% - 5% = -4%.

Question 7

The real interest rate is equal to the:

Accepted Answer

The real interest rate takes into account the effects of inflation on the nominal interest rate. It is calculated by subtracting the inflation rate from the nominal interest rate. Therefore, the correct answer is C: nominal interest rate minus the inflation rate.

Question 8

If the real interest rate declines by 1 percent and the inflation rate increases by 2 percent, the nominal interest rate implied by the Fisher equation:

Accepted Answer

According to the Fisher equation, the nominal interest rate is the sum of the real interest rate and the inflation rate. If the real interest rate declines by 1 percent and the inflation rate increases by 2 percent, the nominal interest rate increases by 1 percent (2% - 1% = 1%).

Question 9

Evidence from the past 40 years in Canada supports the Fisher effect and shows that when the inflation rate is high, the _____ interest rate tends to be _____.

Accepted Answer

The Fisher effect suggests that the nominal interest rate adjusts to expected inflation, so when inflation is high, the nominal interest rate tends to be high to maintain the real interest rate.

Question 10

If the real interest rate and real national income are constant, according to the quantity theory and the Fisher effect, a 1 percent increase in money growth will lead to rises in:

Accepted Answer

According to the quantity theory of money, an increase in the money supply leads to a proportionate increase in the price level (inflation). The Fisher effect states that changes in the expected inflation rate lead to corresponding changes in the nominal interest rate. Since the real interest rate is constant, a 1 percent increase in money growth will lead to a 1 percent increase in inflation and therefore an increase in the nominal interest rate of 1 percent (as investors will demand higher nominal interest rates to compensate for the expected increase in inflation). Therefore, choice B is the correct answer.

Question 11

If the real return on government bonds is 3 percent and the expected rate of inflation is 4 percent, then the cost of holding money is _____ percent.

Accepted Answer

The cost of holding money is the opportunity cost of not investing it, which is the sum of the real return on government bonds (3 percent) and the expected rate of inflation (4 percent), totaling 7 percent.

Question 12

When someone purchases a three-month Treasury bill, they cannot know the:

Accepted Answer

The ex post real interest rate is the actual interest rate earned after adjusting for inflation, which can only be known after the fact, once the actual inflation rate is realized.

Question 13

Using average rates of money growth and inflation in the United States over many decades, Friedman and Schwartz found that decades of high money growth tended to have _____ rates of inflation and decades of low money growth tended to have _____ rates of inflation.

Accepted Answer

Friedman and Schwartz, through their empirical research, demonstrated a direct relationship between the rate of money growth and the rate of inflation. Specifically, they found that periods of high money growth were associated with high rates of inflation, while periods of low money growth were associated with low rates of inflation. This finding supports the quantity theory of money, which posits that an increase in the money supply, if not matched by an increase in production, leads to inflation.

Question 14

The ex ante real interest rate is equal to the nominal interest rate:

Accepted Answer

The ex ante real interest rate is the nominal interest rate adjusted for expected inflation. Therefore, it is equal to the nominal interest rate minus the expected inflation rate.

Question 15

Equilibrium in the market for goods and services determines the _____ interest rate, and the expected rate of inflation determines the _____ interest rate.

Accepted Answer

Equilibrium in the market for goods and services determines the ex ante real interest rate (the interest rate adjusted for expected inflation), as it reflects the real return on investment that firms and consumers are willing to make. On the other hand, the expected rate of inflation determines the ex ante nominal interest rate, which is the interest rate without adjusting for inflation.

Question 16

"Inflation tax" means that:

Accepted Answer

Inflation tax refers to the reduction in the real value of money held by the public due to an increase in the overall price level. This is because the same amount of money can buy fewer goods and services. It is not related to tax brackets or the relationship between taxes and inflation. The option D mentions hyperinflation, which is an extreme case of inflation where the government relies on printing more money to finance its spending, leading to further inflation.

Question 17

According to the quantity theory of money, a 5 percent increase in money growth increases inflation by _____ percent. According to the Fisher equation, a 5 percent increase in the rate of inflation increases the nominal interest rate by _____ percent.

Accepted Answer

The quantity theory of money suggests that a 5% increase in money growth leads to a 5% increase in inflation. The Fisher equation states that a 5% increase in inflation results in a 5% increase in the nominal interest rate.

Question 18

According to the quantity theory of money and the Fisher equation, if the money growth increases by 3 percent and the real interest rate equals 2 percent, then the nominal interest rate will increase:

Accepted Answer

According to the Fisher equation, the nominal interest rate is the sum of the real interest rate and the inflation rate. If money growth increases by 3 percent, assuming velocity is constant, inflation will also increase by 3 percent. Therefore, the nominal interest rate will increase by the sum of the real interest rate (2 percent) and the inflation rate (3 percent), resulting in a 5 percent increase.

Question 19

In the classical model, according to the quantity theory of money and the Fisher equation, an increase in money growth increases:

Accepted Answer

According to the quantity theory of money, an increase in money growth leads to higher inflation. The Fisher equation states that the nominal interest rate is the sum of the real interest rate and expected inflation. Therefore, an increase in money growth increases expected inflation, which in turn increases the nominal interest rate.

Question 20

The inflation tax is paid:

Accepted Answer

The inflation tax is a hidden tax that is paid by all holders of money since inflation lowers the purchasing power of money. As prices rise due to inflation, the real value of money decreases, meaning that individuals can buy fewer goods and services with the same amount of money over time. This impacts everyone who holds money, including households, businesses, and government bond holders. Therefore, choice B is the correct answer.

Quiz 5: Inflation: Its Causes, Effects, and Social Costs