Question 1

The reason inflation spiralled in Canada in the 1970s can be attributed to ________.
A)the central bank not following the Taylor Principle
B)the OPEC oil embargo
C)changing policies at the federal government level
D)an aggressive central bank policy buying bonds

Accepted Answer

A

Question 2

Higher inflation results from higher interest rates due to ________.
A)the Taylor principle
B)the Taylor rule
C)the slope of the monetary policy curve
D)the Fisher equation

Accepted Answer

A

Question 3

Explain the relationship between Bank of Canada's overnight rate and the real interest rate.

Accepted Answer

Because prices are sticky-changes in monetary policy will not have an immediate effect on inflation and expected inflation. As a result, when the Bank of Canada lowers the overnight interest rate, real interest rates fall; and when the Bank of Canada raises the overnight rate, real interest rates rise.

Question 4

The Taylor Principle differs from the Taylor rule because ________.
A)it does not provide a rule for how monetary policy should react to conditions in the economy
B)the Taylor principle relates to real interest rates and the Taylor rule pertains to nominal interest rates
C)the Taylor principle is exclusively used by the Bank of Canada while the Taylor rule is used by the U.S. Fed
D)the Taylor rule relates to inflation rates while the Taylor principle is applied to real interest rates

Accepted Answer

The Taylor Principle is a concept within the broader Taylor Rule framework. It specifically states that central banks should adjust nominal interest rates by more than one-for-one in response to inflation to stabilize the economy. This principle does not provide a specific rule or formula for policy action; instead, it offers guidance on the direction and magnitude of interest rate adjustments in response to inflation. The Taylor Rule, on the other hand, is a more comprehensive guideline that suggests how central banks should set short-term interest rates based on deviations of actual inflation rates from target inflation rates and actual GDP from potential GDP.

Question 5

Tightening monetary policy refers to ________.
A)higher real interest rates
B)higher nominal interest rates
C)lower real interest rates
D)lower nominal interest rates

Accepted Answer

Tightening monetary policy involves reducing the money supply and raising interest rates in order to decrease inflationary pressure. This results in higher real interest rates, as nominal interest rates are adjusted for inflation.

Question 6

An increase in the interest rate due to Taylor principle changes result in ________.
A)a movement up the monetary policy curve
B)a movement down the monetary policy curve
C)an upward shift of the monetary policy curve
D)a downward shift of the monetary policy curve

Accepted Answer

An increase in the interest rate due to Taylor principle changes implies that central banks are giving more weight to inflation in setting their policy rate. This leads to a movement up the monetary policy curve, indicating that higher interest rates are required to achieve the same level of inflation.

Question 7

If the central bank did not follow the Taylor principle so that the real interest rate fell when inflation rose, ________.
A)inflation would increase
B)the nominal interest rate would not change
C)expected inflation would be equal to zero
D)output would remain unchanged

Accepted Answer

According to the Taylor principle, when inflation rises, the central bank should increase nominal interest rates by more than the increase in inflation in order to keep the real interest rate positive and prevent inflation from spiraling out of control. If the central bank did not follow this principle and allowed the real interest rate to fall when inflation rose, it would not provide a sufficient disincentive for borrowing and spending, which would lead to increased demand for goods and services and push up prices, causing inflation to increase further.

Question 8

If the monetary policy rule is given by r = 1.0 + 0.5p, then 1.0 represents ________.
A)the autonomous component of the real interest rate set by the central bank
B)the responsiveness of the real interest rate to the inflation rate
C)the nominal rate as described by the Taylor principle
D)none of the above

Accepted Answer

The value of 1.0 represents the autonomous component of the real interest rate set by the central bank, which is independent of the inflation rate. The coefficient of 0.5 represents the responsiveness of the real interest rate to changes in the inflation rate. The Taylor principle refers to the idea that nominal interest rates should increase by more than the increase in the inflation rate in order to maintain a stable economy, and is not directly related to the value of 1.0 in this monetary policy rule.

Question 9

If the central bank did not follow the Taylor principle ________.
A)inflation would spiral out of control
B)it could rely on autonomous monetary policy changes
C)it could rely on non-conventional monetary policy tools
D)B and C only

Accepted Answer

The Taylor principle is based on the idea that a central bank should raise interest rates in response to inflation to prevent it from spiraling out of control. If the central bank does not follow this principle, inflation could indeed become uncontrollable. Choices B and C may be possible solutions for a central bank that cannot follow the Taylor principle, but they do not negate the potential consequences of not following it.

Question 10

The Bank of Canada conducts monetary policy by ________.
A)setting the overnight interest rate
B)buying and selling bonds in open market operations
C)changing the tax rate to influence aggregate demand
D)changing the exchange rate to influence aggregate demand

Accepted Answer

The answer of The Bank of Canada conducts monetary policy...

Question 11

If the monetary policy rule is given by r = 1.0 + 0.5p, then r represents ________.
A)the autonomous component of the real interest rate set by the central bank
B)the responsiveness of the real interest rate to the inflation rate
C)the real interest rate that is sent by the central bank
D)none of the above

Accepted Answer

The equation given shows that r, the real interest rate sent by the central bank, is a function of the inflation rate (p). The coefficient of 0.5 indicates the responsiveness of the real interest rate to changes in the inflation rate. The constant term of 1.0 represents the autonomous component of the real interest rate, which is set by the central bank independent of changes in the inflation rate. Therefore, r represents the real interest rate set by the central bank.

Question 12

The monetary policy (MP)curve indicates the relationship between ________.
A)the overnight rate and the real interest rate
B)the overnight rate and the inflation rate
C)the inflation rate and the expected inflation rate
D)the real interest rate the central bank sets and the inflation rate

Accepted Answer

The monetary policy curve illustrates the relationship between the real interest rate set by the central bank and the inflation rate, showing how central banks adjust interest rates in response to changes in inflation to achieve their monetary policy objectives.

Question 13

If the monetary policy rule is given by r = 1.0 + 0.5p, then 0.5 represents ________.
A)the autonomous component of the real interest rate set by the central bank
B)the responsiveness of the real interest rate to the inflation rate
C)the nominal rate as described by the Taylor principle
D)none of the above

Accepted Answer

The coefficient 0.5 represents the responsiveness of the real interest rate (r) to changes in the inflation rate (p). As the inflation rate increases, the central bank raises the real interest rate to counteract inflationary pressures.

Question 14

The upward slope of the MP curve indicates that ________.
A)the central bank lowers real interest rates when inflation rises
B)the central bank raises real interest rates when inflation falls
C)the central bank raises nominal interest rates when inflation rises
D)the central bank raises real interest rates when inflation rises

Accepted Answer

The upward slope of the MP (Monetary Policy) curve indicates that the central bank raises real interest rates when inflation rises. This is because higher interest rates make borrowing more expensive, which reduces consumption and slows down the growth of the economy. As a result, inflation rates tend to fall. Conversely, lower interest rates encourage borrowing and consumption, which boosts economic growth but can also lead to higher inflation rates.

Question 15

Central banks aim to ________.
A)keep inflation stable
B)keep expected inflation equal to zero
C)reduce inflation to zero
D)A and B only

Accepted Answer

Central banks aim to keep inflation stable, not necessarily at zero, as moderate inflation is often considered healthy for an economy. Reducing inflation to zero or keeping expected inflation at zero are not typical goals.

Question 16

In the 1970s , the inflation rate in Canada reach levels over ________ percent.
A)2
B)5
C)10
D)12

Accepted Answer

The inflation rate in Canada did reach levels over 10 percent in the 1970s, particularly during the period known as the "Great Inflation" from 1974 to 1981. Options A, B, and D are too low considering the severity of inflation during this period.

Question 17

Explain the relationship between real and nominal interest rates when inflation is expected to remain unchanged in the short run.

Accepted Answer

The answer of Explain the relationship between real and nominal...

Question 18

The Bank of Canada controls the overnight rate by ________.
A)varying the settlement balances it provides to the banking system
B)dictating terms of the LVTS
C)managing government savings
D)borrowing from the provincial government

Accepted Answer

The Bank of Canada controls the overnight rate by varying the settlement balances it provides to the banking system. By adjusting the amount of settlement balances, the Bank can influence the supply of funds available for lending and borrowing between banks, which in turn affects the overnight interest rate that banks charge each other.

Question 19

Because prices are sticky in the short-run, when the Bank of Canada raises the overnight rate, ________.
A)nominal interest rates fall
B)real interest rates rise
C)inflation falls
D)real interest rates fall

Accepted Answer

When the Bank of Canada raises the overnight rate, it increases the cost of borrowing for banks, which in turn raises the cost of borrowing for individuals and businesses. This reduces the demand for credit and spending, leading to a decrease in the level of aggregate demand and lower inflationary pressures. However, in the short run, prices are sticky, meaning that they do not adjust immediately to changes in demand or supply. As a result, nominal interest rates may not fall immediately, but real interest rates (which adjust for inflation) will rise. This can lead to a contraction in the economy, as higher real interest rates reduce investment and consumption, and lower inflationary pressures.

Question 20

Because prices are slow to move in the short-run, when the Bank of Canada lowers the overnight rate, ________.
A)nominal interest rates rise
B)real interest rates fall
C)inflation falls
D)real interest rates rise

Accepted Answer

When the Bank of Canada lowers the overnight rate, short-term nominal interest rates tend to fall, but prices are slow to adjust, so inflation remains relatively stable in the short-run. This leads to a decline in real interest rates, as inflation-adjusted returns on investments decrease.

Quiz 22: The Monetary Policy and Aggregate Demand Curves

The reason inflation spiralled in Canada in the 1970s can be attributed to ________.

Higher inflation results from higher interest rates due to ________.

Explain the relationship between Bank of Canada's overnight rate and the real interest rate.

The Taylor Principle differs from the Taylor rule because ________.

Tightening monetary policy refers to ________.

An increase in the interest rate due to Taylor principle changes result in ________.

If the central bank did not follow the Taylor principle so that the real interest rate fell when inflation rose, ________.

If the monetary policy rule is given by r = 1.0 + 0.5p, then 1.0 represents ________.

If the central bank did not follow the Taylor principle ________.

The Bank of Canada conducts monetary policy by ________.

If the monetary policy rule is given by r = 1.0 + 0.5p, then r represents ________.

The monetary policy (MP) curve indicates the relationship between ________.

If the monetary policy rule is given by r = 1.0 + 0.5p, then 0.5 represents ________.

The upward slope of the MP curve indicates that ________.

Central banks aim to ________.

In the 1970s , the inflation rate in Canada reach levels over ________ percent.

Explain the relationship between real and nominal interest rates when inflation is expected to remain unchanged in the short run.

The Bank of Canada controls the overnight rate by ________.

Because prices are sticky in the short-run, when the Bank of Canada raises the overnight rate, ________.

Because prices are slow to move in the short-run, when the Bank of Canada lowers the overnight rate, ________.