Deck 27: Monetary Policy

Question 1

The discount window enables the Fed to

A)better regulate the banking system.
B)take action to change interest rates.
C)be a lender of last resort.
D)ensure the banking system's profitability.
E)control the money supply.

Answer 1

be a lender of last resort.

Question 2

One of the main liabilities on the Fed's balance sheet is reserves.Which of the following is the best definition of that item?

A)Reserves represent foreign currencies held at the Fed.
B)Reserves are deposits that banks hold at the Fed.
C)Reserves represent gold and other precious metals held at the Fed.
D)Reserves represent loans that the Fed has made to other countries.
E)None of these is an appropriate definition.

Answer 2

Reserves are deposits that banks hold at the Fed.

Question 3

Currency-the amount of coins and bills in circulation-is the main liability of the Fed.

Answer 3

True

Question 4

In an attempt to avert the worst consequences of the financial crisis of 2007 and 2008,the Fed cut the interest rate all the way to zero during the crisis,requiring that it find other ways to stimulate the economy.

Question 5

One of the basic changes that the Fed has established as a result of the financial crisis is that it no longer carries private securities.

Question 6

Which of the following represents one of the new monetary tools that the Fed has developed as a result of the recent financial crisis?

A)In the last two and a half decades,the Fed has become much less transparent about its actions.
B)The Fed is now responsible for monetary and fiscal policy.
C)The Fed has started buying private securities and making loans to private firms.
D)The Fed has become part of the Department of Treasury.
E)None of these

Question 7

The interest rate on loans banks pay when they borrow from the Fed is called

A)the discount rate.
B)the three-month CD rate.
C)the prime rate.
D)the Treasury bill rate.
E)the federal funds rate.

Question 8

As a result of the financial crisis,the Fed has now become part of the Department of the Treasury.

Question 9

As a result of the financial crisis,the Fed has begun buying securities in troubled markets,as it has been trying to provide more credit to the markets and thereby mitigate the crisis.This is known as

A)Quantitative easing.
B)FOMC.
C)Credit crunching.
D)Market deepening.
E)Market thinning.

Question 10

What happens to the Fed's balance sheet when it buys $10 billion in government securities?

A)The left-hand side of the Fed's balance sheet increases by $10 billion.
B)The left-hand side of the Fed's balance sheet decreases by $10 billion.
C)The right-hand side of the Fed's balance sheet decreases by $10 billion.
D)Both the right-hand and left-hand sides of the Fed's balance sheet decrease by $10 billion.
E)None of these.

Question 11

What do economists mean when they refer to the "size" of the Fed's balance sheet?

A)the size of the money supply it controls.
B)its ability to set fiscal policy.
C)its operating budget.
D)the sum of all the assets on its balance sheet.
E)its net worth.

Question 12

Explain the changes made by the Fed as a result of the 2007-08 financial crisis and the corresponding new types of assets it now holds.

Question 13

Currency-the amount of coins and bills in circulation-is part of the money supply.

Question 14

One of the basic changes that the Fed has established as a result of the financial crisis is that it now lends to other financial institutions that are not banks,such as the insurance giant AIG.

Question 15

In the last two and a half decades,the Fed has become much less transparent about its actions.

Question 16

One type of private security held by the Fed is commercial paper.Which of the following is the most appropriate definition of this type of private asset?

A)A public bond with very short maturity.
B)A public bond with long term maturity.
C)A private bond with very short maturity.
D)A private bond backed by the federal government.
E)None of these.

Question 17

Which of the following is $\underline{\text{not }}$ considered one of the main assets on the balance sheet of the Fed?

A)Government securities.
B)Private securities.
C)Loans to banks.
D)Currency.
E)Loans to other financial institutions.

Question 18

Which of the following policies that the Fed followed between 2002 and 2005 has been proposed as one of the reasons for the subsequent housing bust and corresponding financial crisis?

A)The Fed had interest rates that were too high during this period.
B)The Fed had interest rates that were too volatile during this period.
C)The Fed had interest rates that were too low during this period.
D)The Fed had legal reserve requirements that were too high during this period.
E)None of these.

Question 19

Describe the new tools of monetary policy of the Fed and explain the basic reasoning of the Fed to create these new ways to deal with the recent financial crisis.

Question 20

The buying and selling government securities is the traditional role of central banks as they go about doing open market operations.

Question 21

Throughout history,higher money growth has been associated with

A)disinflation.
B)stable economic growth.
C)deflation.
D)higher inflation.
E)longer economic expansions.

Question 22

A line depicting the relationship between the quantity of money demanded and the interest rate is

A)negatively sloped.
B)positively sloped.
C)horizontal.
D)vertical.
E)horizontal at high interest rates and vertical at low interest rates.

Question 23

Open market sales will

A)increase money supply.
B)increase money demand.
C)decrease money supply.
D)decrease money demand.
E)decrease money supply and the quantity of money demanded.

Question 24

According to current U.S.monetary policy,the Fed

A)adjusts the interest rate so it intersects money supply and the chosen money demand.
B)adjusts the money supply so it intersects money demand at the chosen interest rate.
C)adjusts the money demand so it intersects the chosen money supply and interest rate.
D)adjusts money demand,money supply,and the interest rate to be in line with the chosen target inflation rate.
E)adjusts the interest rate so it intersects money demand and the chosen money supply.

Question 25

As a result of the financial crisis,from 2007 to 2009,the size of the Fed's balance sheet more than doubled.

Question 26

Assume the Fed has complete control over the money supply.If the demand for money were greater than the supply of money,we would expect

A)a decrease in the quantity of money demanded and a decrease in the rate of interest.
B)a decrease in the quantity of money demanded and an increase in the rate of interest.
C)an increase in the quantity of money supplied,a decrease in the quantity of money demanded,and an increase in the rate of interest.
D)an increase in the quantity of money demanded and a decline in the rate of interest.
E)a decrease in the quantity of money supplied,a decrease in the quantity of money demanded,and an increase in the rate of interest.

Question 27

The demand for money is

A)negatively related to real GDP.
B)positively related to the interest rate.
C)negatively related to the volume of transactions.
D)independent of the interest rate.
E)negatively related to the interest rate and positively related to the volume of transactions.

Question 28

When the rate of interest increases,

A)the opportunity cost of money increases,and the quantity of money demanded increases.
B)the opportunity cost of money decreases,and the quantity of money demanded declines.
C)the demand for money is unaffected.
D)the opportunity cost of money decreases,and the quantity of money demanded increases.
E)the opportunity cost of money increases,and the quantity of money demanded declines.

Question 29

When the rate of interest falls,

A)the opportunity cost of money increases,and the quantity of money demanded declines.
B)the opportunity cost of money increases,and the quantity of money demanded increases.
C)the demand for money is unaffected.
D)the opportunity cost of money decreases,and the quantity of money demanded declines.
E)the opportunity cost of money decreases,and the quantity of money demanded increases.

Question 30

Explain why increases or decreases in the monetary base will eventually lead to increases or decreases in the money supply.

Question 31

When the Fed increases the federal funds rate,

A)all other interest rates are unaffected.
B)money demand is unaffected.
C)all other interest rates increase.
D)all other interest rates decrease.
E)money demand increases.

Question 32

When the Fed increases the interest rate,

A)money supply is unaffected.
B)money demand is unaffected.
C)money demand shifts left,and money supply shifts right.
D)money demand shifts left,and money supply is unaffected.
E)money demand and money supply shift left.

Question 33

If the Fed has fixed the interest rate,

A)it must conduct open market sales when money demand increases.
B)the money demand will not change.
C)money supply and money demand will not change.
D)it must conduct open market sales when money demand decreases.
E)the money supply will not change.

Question 34

If banks start paying higher interest rates on checking accounts,we would expect,assuming everything else held equal,

A)the demand for money to become more sensitive to changes in the interest rate.
B)the demand for money to become horizontal.
C)the relationship between interest rates and the demand for money to be unaffected.
D)the demand for money to become less sensitive to changes in the interest rate.
E)a decrease in the supply of money.

Question 35

Economists refer to the sum of all currency plus reserves on the Fed's balance sheet liabilities as

A)aggregate demand.
B)implicit power.
C)the Fed's operating budget.
D)the monetary base.
E)the Fed's net worth.

Question 36

The Fed prefers to focus on the interest rate rather than growth in the money supply because

A)it does not like to conduct open market operations.
B)the money supply is too unpredictable.
C)it makes inflation more predictable.
D)money demand is too volatile.
E)it is easier to fix the interest rate than maintain growth in the money supply.

Question 37

Increases or decreases in the monetary base eventually become corresponding increases or decreases in the money supply.

Question 38

All else held equal,an increase in the amount of transactions (goods and services purchased)in the economy results in

A)a decrease in the demand for money.
B)a steeper demand-for-money curve.
C)an increase in the demand for money.
D)an increase in the quantity demanded of money.
E)no change in the demand for money.

Question 39

If the Fed determines the amount of money in circulation,the interest rate is determined by the

A)required reserve ratio.
B)currency to deposit ratio.
C)money multiplier.
D)monetary base.
E)demand for money.

Question 40

Assume the Fed has complete control over the money supply.If the demand for money were less than the supply of money,we would expect

A)an increase in the quantity of money demanded and a decline in the rate of interest.
B)a decrease in the quantity of money demanded and an increase in the rate of interest.
C)a decrease in the quantity of money supplied,a decrease in the quantity of money demanded,and an increase in the rate of interest.
D)a decrease in the quantity of money demanded and a decrease in the rate of interest.
E)an increase in the quantity of money supplied,a decrease in the quantity of money demanded,and an increase in the rate of interest.

Question 41

Explain why the interest rate is the opportunity cost of holding money.

Question 42

The money demand curve does not tend to move around much.

Question 43

Because it emphasizes the fact that the process involves the purchase of certain types of private securities,the Fed uses the following related term to refer to quantitative easing.

A)A liquidity trap.
B)Credit easing.
C)Zero interest measures.
D)Liquidity easing.
E)None of these.

Question 44

A constant money growth rule

A)leads to higher inflation.
B)keeps interest rates stable.
C)prevents the demand for money from shifting.
D)does not work well because the demand for money is too volatile.
E)works better than an interest rate rule because the demand for money is too volatile.

Question 45

If the interest rate on bank CDs increases,the opportunity cost of holding money increases.

Question 46

The main instrument of monetary policy at central banks around the world is the

A)money supply.
B)overnight interest rate.
C)discount rate.
D)prime rate.
E)reserve requirement.

Question 47

If the Fed wants to fix the interest rate,how does it guarantee that money demand will equal money supply?

Question 48

The Fed changes the federal funds rate by

A)directing banks to charge each other a new rate.
B)asking banks to charge each other a new rate.
C)asking Congress to make the change.
D)increasing or decreasing the supply of reserves in the overnight market.
E)directing banks to charge consumers a new rate.

Question 49

Use a supply and demand for money diagram to show why,if the Fed is interested in lowering the federal funds rate by a certain amount,the interest sensitivity of the demand for money function will determine the extent of the open market operation,that is,by how much the money supply will have to increase.

Question 50

The interest rate is the opportunity cost of holding money.

Question 51

A situation in which further increases in the money supply (liquidity)do not lower interest rates is known as

A)a liquidity trap.
B)an asymptotic limit.
C)credit crunch.
D)a Fed's failure.
E)None of these.

Question 52

What is a liquidity trap?

A)A situation in which banks stop lending to one another.
B)A situation in which further increases in the money supply result in smaller reductions in the interest rate until the interest rate approaches zero.
C)A situation in which the Fed no longer has the capacity to provide liquidity to the system.
D)A situation in which the interest rate gets so high that consumers and companies no longer can afford to obtain credit.
E)None of these.

Question 53

Assuming everything else held constant,suppose there is an increase in the demand for money.
(A)Use a supply and demand diagram to show what will happen to the equilibrium interest rate if the supply of money is fixed.
(B)If there was an increase in money demand and the interest rate was fixed,what would happen to the money supply? Explain how the change in money supply would come about.

Question 54

If money demand is very volatile,the preferred policy is to target the interest rate instead of the money supply.

Question 55

If money demand increases,wealth must have increased.

Question 56

A situation in which a zero interest rate has been reached,and yet the Fed continues to increase the money supply by increasing reserves,is known as

A)a liquidity trap.
B)an asymptotic limit.
C)quantitative easing.
D)a liquidity expansion.
E)None of these.

Question 57

The Fed can fix the interest rate or the money supply,but not both at the same time.Please explain.

Question 58

There is a positive relationship between interest rates and the money supply.

Question 59

The policy by which the central bank keeps the growth of the money supply constant is referred to as a

A)constant money growth rule.
B)constant interest rate rule.
C)constant money demand rule.
D)Taylor rule.
E)Fisher rule.

Question 60

Given that the money demand function is not stable,why does the Fed think it is best to fix interest rates instead of growth in the money supply?

Question 61

The nominal interest rate in the economy cannot go below zero,so at some point increases in reserves will stop lowering the interest rate.

Question 62

Quantitative easing refers to the change in

A)interest rates.
B)the amount of money supply.
C)stock prices.
D)the number of loans instead of their sizes.
E)None of these.

Question 63

Once a zero interest rate has been reached,even though continuing to increase the money supply will not lower the interest rate,the process can stimulate the economy.

Question 64

QE2 occurred in 2007 to bail out major U.S.banks.

Question 65

If the inflation rate is equal to the target inflation rate,then the Fed

A)does not have to change monetary policy as long as the rate of inflation remains constant.
B)will only change monetary policy if it wants to change the target inflation rate.
C)will change monetary policy if it feels that aggregate demand is too high or low.
D)does not have to worry about changing monetary policy.
E)will change monetary policy only if it believes that potential GDP is changing.

Question 66

Explain why interest rates cannot go negative.

Question 67

Quantitative easing is one way to stimulate the economy when the interest rate hits zero.

Question 68

A situation in which the interest rate gets so high that consumers and companies no longer can afford to obtain credit is known as a liquidity trap.

Question 69

The policy of quantitative easing aims at reducing the interest rate.

Question 70

Which of the following would cause the Fed to raise interest rates?

A)An increase in imports
B)An increase in consumer confidence
C)An increase in saving
D)An increase in taxes
E)A decrease in exports

Question 71

Quantitative easing increases all the following except

A)interest rates.
B)reserves.
C)the monetary base.
D)the money supply.
E)the size of the Fed's balance sheet.

Question 72

Quantitative easing in 2009 and 2010 was criticized for its likely effect on

A)bringing down GDP growth.
B)raising the unemployment rate further.
C)causing high inflation.
D)raising the value of the U.S.dollar against other currencies.
E)lowering interest rates further.

Question 73

In 2009,QE1 involved

A)cutting some interest rates to below zero.
B)the bailing out of major banks.
C)the federal government's increased spending and tax cuts.
D)the Fed's purchase of mortgage backed and long-term government securities.
E)no action.

Question 74

The "Goldilocks economy" is one in which

A)real GDP is below potential GDP.
B)real GDP is equal to potential GDP.
C)real GDP is equal to potential GDP,and inflation is equal to the target rate.
D)inflation is equal to the target rate.
E)inflation is lower than the target rate.

Question 75

Which of the following statements best describes what it means for the Fed to manage aggregate demand?

A)If real and potential GDP were equal,the Fed would change interest rates even if the rate of inflation equaled the target rate of inflation.
B)The Fed changes interest rates only if the rate of inflation is deviating from the target rate of inflation.
C)If real and potential GDP were not equal,the Fed would change interest rates in order to prevent a deviation between the rate of inflation and the target rate of inflation.
D)The Fed changes interest rates only if the rate of inflation is higher than the target rate of inflation.
E)If real and potential GDP were not equal,the Fed would change interest rates only in those cases that would prevent the rate of inflation from rising above the target rate of inflation.

Question 76

Nominal interest rates sometimes go negative.

Question 77

Explain the controversy surrounding the effectiveness of quantitative easing.

Question 78

The interest rate effectively hit zero in the U.S.in December 2008.

Question 79

Which of the following would cause the Fed to raise interest rates even though the rate of inflation is equal to the target rate?

A)An increase in household wealth
B)An increase in potential GDP
C)An increase in imports
D)A reduction in government purchases
E)A reduction in business confidence

Question 80

A liquidity trap is a situation in which further increases in the money supply result in smaller reductions in the interest rate until the interest rate approaches zero.