Deck 17: Optimal Monetary Policy

Question 1

If the central bank targets the interest rate,it

A)must decrease interest rates in response to an increase in money demand.
B)can lead to runaway inflation if maintained too rigidly.
B)rules out the possibility of runaway inflation.
D)Both a and c
E)Both b and c

Answer 1

B

Question 2

The FOMC meets approximately eight times per year and at these meetings they

A)set a target federal funds interest rate.
B)set a target money supply.
C)set a target employment target.
D)All of the above
E)None of the above

Answer 2

A

Question 3

According the principle of time inconsistency,the most important element of policy making is

A)predictability.
B)transparency.
C)credibility.
D)judgment

Answer 3

C

Question 4

Briefly discuss an argument for Central Bank Independence.When looking across countries,has Central Bank independence been successful? Explain.

Question 5

Assuming the central bank follows a money supply target,then an increase in the demand for money

A)will shift the position of the LM schedule away from the predicted level even if the target level of the money supply is achieved.
B)will shift the position of the LM schedule toward the predicted level as long as the target level of the money supply is achieved.
C)may or may not shift the position of the LM schedule away from the predicted level even if the target level of the money supply is achieved.
D)None of the above

Question 6

If velocity is highly unstable,then targeting the money supply

A)will be effective in stabilizing the LM curve and interest rates.
B)has the same effects as targeting interest rates.
C)will be ineffective in stabilizing aggregate demand.
D)none of the above.

Question 7

Does targeting the money supply become more or less effective if money demand is highly interest rate elastic? Use a graph to explain your intuition.

Question 8

Intermediate targeting the money supply is preferable if there is a(n)

A)increase in the severity of supply shocks.
B)unstable money demand function.
C)low interest elasticity of money demand.
D)difficulty in the measurement of money demand.
E)none of the above.

Question 9

Under what conditions is a money-stock target considered superior to an interest-rate target? Under what conditions is an interest-rate target preferred to a money-stock target?

Question 10

If the financial innovations such as ATM machines make money demand less elastic than it was before,then

A)the LM curve will become steeper.
B)the LM curve will become flatter.
C)both the IS and LM curves will become flatter.
D)the LM curve will shift to the left.

Question 11

According to the Taylor rule,how should monetary policy and interest rates change in response to a situation in which actual output exceeds the natural rate of output? In what sense is the Taylor rule consistent with Keynesian stabilization policy? Explain.

Question 12

What is the FOMC? Who votes on the FOMC? How often does it meet? What is the outcome of their meetings?

Question 13

"The independence of the Fed leaves it unaccountable for its actions." Do you agree or disagree with this statement?

Question 14

After two decades with inflationary rates that exceeded the Organization for Economic Co-operation and Development average and with output growth rates that fell short of that average,the New Zealand government adopted a very strict form of inflation targeting in 1990.Explain the New Zealand experiment and its strict form of inflation targeting.

Question 15

If the great majority of shocks to our system arise from unpredictable shocks to money demand,the preferred tactic of monetary policy is targeting

A)reserves.
B)interest rates.
C)M2.
D)reserves plus currency.

Question 16

The best case for intermediate targeting on monetary aggregates is where the

A)LM schedule is flat and the money demand function is stable.
B)IS schedule is flat and the level of investment is stable.
C)LM schedule is steep and the money demand function is stable.
D)IS schedule is steep and the money demand function is stable.

Question 17

According to the theory of time inconsistency,why are rules preferable to discretion? Does it make a difference if you are talking about this in a model with rational expectations or not?

Question 18

Which of the following statements is (are)correct? Regardless of whether the LM curve is vertical or upward sloping,

A)a money stock target is superior to an interest rate target when the uncertainty facing the policymaker concerns the IS schedule.
B)an interest rate target is always superior to a money stock target when the uncertainty facing the policymaker concerns the IS schedule.
C)both a money stock target or interest rate target provide the same results when the uncertainty facing the policymaker concerns the IS schedule.
D)a money stock target is never superior to an interest rate target when the uncertainty facing the policymaker concerns the IS schedule.

Question 19

According to the Taylor rule,if actual output is greater than the natural rate of output,then the Fed should

A)decrease inflation.
B)increase interest rates.
C)conduct open market sales.
D)decrease interest rates.
E)Both a and b

Question 20

Discuss the merits of a money growth rule versus an inflation target rule.Which was preferred by Monetarists? Which is the most widely used today,and why?

Question 21

The Taylor rule relates

A)inflation rates to unemployment rates.
B)the federal funds rate to inflation and output rates.
C)differences in the federal funds rate from its target to differences in inflation and unemployment from its target.
D)differences in the federal funds rate from its target to differences in inflation and unemployment from its target.
E)All of the above

Question 22

In today's Fed,its primary strategy is to

A)target the federal funds rate in the short-run,target inflation in the long-run.
B)target inflation
C)target the money supply.
D)target the federal funds rate in the short-run,balance inflation and output goals in the long-run.

Question 23

An index constructed by Alberto Alesina and Lawrence Summers measuring central bank independence for a sample of industrialized countries during the late 1980s notes that the

A)most countries have completely independent central banks.
B)countries with less independent central banks had lower inflation rates.
C)the most independent central banks were those of Switzerland and Germany,followed by the U.S.Federal Reserve.
D)there has been a trend away from central bank independence among countries
E)both c and d

Question 24

The voting members of the Open Market Committee are

A)the 7 Governors of the Federal Reserve System.
B)the 12 presidents of the Federal Reserve Banks.
C)the 7 Governors and the Chairman of the Council of Economic Advisors.
D)the 7 Governors and 5 of the presidents of the 12 regional Federal Reserve Banks.

Question 25

If money demand does not depend on the interest rate then

A)the LM curve if vertical and fiscal policy is ineffective.
B)the LM curve is horizontal and fiscal policy is ineffective.
C)the LM curve is horizontal and horizontal has no effect on output.
D)the LM curve is vertical and monetary policy is ineffective.

Question 26

Which of the following is not considered an ultimate target that the monetary authority attempts to control?

A)Growth in real GDP
B)The rate of unemployment
C)The rate of inflation
D)The money supply

Question 27

On October 6,1979,the Federal Reserve abandoned the strategy of targeting the Federal funds rate and focused on target ranges for growth in the monetary aggregates.Since that time,the Federal Reserve

A)has never deviated from that strategy.
B)gave up on interest rate targeting.
C)deviated from target ranges for growth in the monetary aggregates when inflation and unemployment were high.
D)None of the above

Question 28

Which of the following statements is (are)correct? Over the past 20 years,the Federal Reserve

A)has only targeted monetary aggregates.
B)has varied between an emphasis on interest rate control and targeting of monetary aggregates.
C)has only emphasized control of the interest rate.
D)None of the above

Question 29

Monetary policy decisions,such as the target growth rate in the money supply or the target level for interest rates,are set by the

A)president and congress.
B)Federal Reserve Board of Governors.
C)Shadow Open Market Committee.
D)presidents of the Federal Reserve banks.
E)Federal Open Market Committee (FOMC).

Question 30

The Federal funds rate

A)is the interest rate on borrowing from the Federal Reserve.
B)measures the volume of reserves.
C)is the interest rate charged on loans from one bank to another.
D)is the interest rate charged on all commercial loans.

Question 31

A change in monetary policy has a larger effect on aggregate demand the

A)flatter the LM curve.
B)the less elastic money demand.
C)more elastic money demand.
D)steeper the IS curve.
E)the steeper the LM curve.

Question 32

An argument against inflation targeting is that

A)the Fed does not completely control inflation.
B)it rules out stabilization policy.
C)puts too much emphasis on low inflation.
D)All of the above

Question 33

The money-stock target is preferable when uncertainty is the result of unpredictable shifts in which of the following?

A)expectations in future profitability
B)Residential construction investment
C)the money multiplier
D)Both a and b
E)All of the above

Question 34

Relative to fiscal policy,monetary policy

A)has fewer harmful side effects.
B)requires much more time to implement.
C)is more closely controlled by Congress.
D)is much more independent of the political process.

Question 35

If money demand does not depend upon income,then

A)monetary policy cannot have any effect upon the economy.
B)monetary policy will only affect the level of the price level.
C)monetary policy will only affect interest rates.
D)monetary policy will have a larger impact on income.

Question 36

Assuming the Federal Reserve is targeting the interest rate,a decrease in money demand will

A)shift the LM schedule to the right.
B)shift the LM schedule to the left.
C)shift the IS schedule to the right.
D)not shift the LM schedule.
E)none of the above.

Question 37

Assuming that the central bank is following a money stock targeted,an exogenous rise in investment demand

A)causes income to rise but the money stock has to be increased to accommodate the expansion.
B)has to be accommodated with open market purchases to expand the money stock.
C)increases income,money demand,and lowers the interest rate.
D)increases income and money demand and lowers the interest rate.
E)none of the above.

Question 38

A variable that the Federal Reserve focuses on because it has a direct link to the variables the Fed is ultimately concerned about is known as a(n)

A)median target.
B)short-term target.
C)immediate target.
D)intermediate target.

Question 39

In the United States,the strategy of monetary policy

A)has not changed even as the economic environment has varied.
B)has been to target interest rates.
C)has been to target the money supply.
D)None of the above

Question 40

The primary tool utilized by the Federal Reserve today in conducting monetary policy is

A)the discount rate.
B)reserve requirements.
C)open market operations.
D)selective credit controls.

Question 41

Which of the following statements is (are)correct?

A)Not all economists believe that time inconsistency problems are important for real world monetary policy.
B)Time inconsistency problems cannot explain higher inflation in the post-war era.
C)Time inconsistency problems exist in contexts other than monetary policy.
D)Both a and c
E)All of the above

Question 42

The Taylor rule specifies

A)a constant relationship between interest rates and output.
B)a constant relationship between interest rates,output,and inflation.
C)a flexible relationship between interest rates,output,and inflation.
D)a fixed relationship between inflation and output.
E)none of the above.

Question 43

Throughout the 1980s,the Federal Reserve

A)primarily targeted M1.
B)primarily targeted M2.
C)returned to targeting the federal funds rate.
D)began targeting inflation.

Question 44

Monetarists are in favor of

A)inflation targeting.
B)interest rate targeting.
C)output targeting.
D)nominal income targeting.
E)money growth targeting.

Question 45

If the Federal Reserve "pegs" the interest rate,then in the IS-LM framework,the LM schedule

A)is vertical.
B)becomes horizontal.
C)slopes upward to the right.
D)slopes downward and the left.

Question 46

If the Fed has the discretion to choose its policy and announces a low inflation policy,then

A)the public is likely to discount this claim because the Fed has an incentive to change their policy in the future.
B)the public is likely to believe this claim because the Fed has no incentive to change their policy in the future.
C)the Fed will always cheat and increase inflation in the future.
D)the Fed will have to keep inflation lower in the future or they will be voted out of office.
E)none of the above.

Question 47

Assume that the Federal Reserve replaces the money stock with the interest rate as an intermediate target.Then,

A)the range for the target interest rate would be chosen to hit the inflation rate,unemployment rate,and growth rate of the economy.
B)if the Treasury bill rate fell temporarily below the target range,the Open Market Desk would sell securities in the open market until the Treasury bill rate rose to the target range.
C)if the Treasury bill rate rose above the target range,the Open Market Desk would purchase Treasury bills or other government securities.
D)All of the above

Question 48

Policy is conducted via a rule if policymakers

A)use monetary and fiscal policy only when the political situation dictates it.
B)set monetary and fiscal policy according to multiple but predetermined goals.
C)a free to respond to unexpected changes in economic conditions.
D)announce in advance how they will respond to changes in economic conditions.

Question 49

Assume that targeted inflation is 1 percent.According to the Taylor rule,the federal funds rate is:

A)equal to 2 percent if inflation and output are at their target level.
B)equal to 6 percent if inflation is 3 percent,output is at its target level and the Fed's targeted federal funds rate is 2 percent.
C)equal to 4 percent if inflation is 2 percent ,output is 2 percent above its target level and the Fed's targeted federal funds rate is 2 percent.
D)none of the above are correct.

Question 50

If the central bank targets the money stock,then a negative shock to money demand will

A)shift the LM schedule to the right and income will rise above the target level.
B)shift the LM schedule up and income will fall below the target level.
C)not shift the LM schedule and,therefore,will not displace income from the target level.
D)None of the above

Question 51

Inflation targeting is one policy that attempts to deal with the problem of:

A)dollarization.
B)time inconsistency.
C)the tradeoff between inflation and unemployment.
D)the liquidity trap.
E)none of the above.

Question 52

Unlike a money supply target,an inflation rate target

A)will always stabilize income better.
B)will stabilize income better if velocity is unstable.
C)still allows the Fed unlimited discretion.
D)eliminates the need for a central bank.

Question 53

Policy is conducted via discretion if policymakers

A)announce and achieve a constant money supply.
B)announce and achieve a constant interest rate.
C)are free to respond to changes in economic conditions on a case-by-case basis.
D)announce in advance how they will respond to changes in economic conditions.

Question 54

Assume that the money stock is the intermediate target and money demand is totally interest- inelastic.Then,the

A)LM schedule will be horizontal.
B)LM curve schedule would be vertical.
C)IS curve would be horizontal.
D)None of the above

Question 55

According to the Taylor rule,when inflation and/or output is above its target,then:

A)the federal funds rate must be negative.
B)the federal funds rate must be above its target.
C)the federal funds rate must be above inflation.
D)none of the above are correct.

Question 56

Which of the following statements is false?

A)Stabilization policy cannot be conducted by rule.
B)Politics can serve as a deterrent to discretionary monetary policy.
C)Monetary policy in the US is currently discretionary.
D)Time consistency is a particularly problem when using discretionary policy.