Deck 30: Financial Crises, Panics, and Unconventional Monetary Policy

Question 1

The bursting of the stock market bubble was one of the contributing factors to the 2008 crisis.

Answer 1

True

Question 2

Government regulations that deal with financial crises tend to become less effective over time.

Answer 2

True

Question 3

Having a precommitment strategy gives the Fed the ability to alter the Fed funds rate when needed.

Answer 3

False

Question 4

What would likely have the most severe immediate effect on an economy?

A)A significant drop in exports
B)The Fed's infusing reserves into the economy
C)An aggregate demand shock
D)A failure of the financial sector

Question 5

Structural stagnationists argue that unconventional monetary policy tools were necessary to restore order in the banking system.

Question 6

During the 2008/09 recession, the Fed bailed out 25 percent of banks to keep them solvent.

Question 7

The Fed followed a precommitment policy when it promised to keep short-term interest rates low for a period of time after the 2008/09 U.S. recession.

Question 8

Which of the following described the attitude of most economists toward the U.S.-based automobile sector during the 2008 recession?

A)It needed to receive subsidies from the government in order to produce hybrid cars.
B)It should be taken over by the Federal Government.
C)If their industry failed, it would not take the rest of the economy down with it.
D)It needed to be bailed out, just like the financial sector was bailed out.

Question 9

Extrapolative expectations work when prices are rising, but not when prices decline.

Question 10

Liquidity is:

A)having assets that can be readily converted into cash.
B)having liabilities that can be readily converted into cash.
C)sufficient assets to cover long-run liabilities.
D)sufficient liabilities to cover long-run assets.

Question 11

When a central bank is acting as a lender of last resort, it is:

A)buying long-term Treasury bonds and selling short-term Treasury notes.
B)buying Treasury bills directly from the public.
C)providing banks with Treasury bills for free.
D)providing banks with liquidity to meet their obligations.

Question 12

According to the efficient market hypothesis, rational people will not recognize that asset prices are rising too quickly.

Question 13

A financial bailout might make better sense on economic grounds than a bailout of the automotive industry because:

A)automobile companies are less deserving than financial companies.
B)the automobile industry is smaller than the financial industry.
C)the finance industry is necessary for other industries to function.
D)the automobile industry brings problems on itself.

Question 14

One of the roles of the Fed is to be the lender of last resort.

Question 15

The following is an example of the moral-hazard problem: Homebuyers do not properly evaluate the risks involved in buying a home, because they are assuming the government will bail them out of a bad mortgage as it has done before.

Question 16

Why are financial-sector crises scarier than collapses in other sectors of the economy?

A)The financial sector is the biggest sector.
B)Financial-sector crises happen more often than collapses in other sectors.
C)Most people work in the financial sector.
D)If the financial sector fails, it can bring the whole economy down with it.

Question 17

Leveraging can encourage herding behavior.

Question 18

According to structural stagnationists there is an argument to be made that the Fed should return to standard monetary policy.

Question 19

An important role of central banks during a financial crisis is:

A)passing new bank regulations.
B)acting as the lender of last resort.
C)closing banks.
D)eliminating bank reserves.

Question 20

What role do almost all economists agree the central bank has in a financial crisis?

A)Contractionary fiscal policy to reduce leverage
B)Lender of last resort
C)Expansionary fiscal policy to reduce herding
D)No role

Question 21

Mortgage-backed securities are financial instruments:

A)that are highly risky.
B)that are extremely safe.
C)whose value depends on the value of mortgages.
D)that are highly leveraged, but which offer high returns.

Question 22

Potential homebuyers expect house prices to continue to rise, which causes others to believe that they will rise even faster. This is an example of:

A)imperfect expectations.
B)heightened expectations.
C)extrapolative expectations.
D)irrational expectations.

Question 23

Asset price bubbles are not sustainable because:

A)people realize that leverage really doesn't work mathematically.
B)invariably the government steps in to burst the asset price bubble.
C)investors eventually run out of assets with which to purchase the good.
D)they do not reflect an increase in the real productive value of the asset.

Question 24

Suppose the people in my town hear a rumor that their local bank is in trouble and all rush to withdraw money from the bank. This is referred to as:

A)leverage.
B)a moral hazard problem.
C)a bad precedent problem.
D)a bank run.

Question 25

When there are unsustainable rapidly rising prices of some type of financial asset, such as stocks, we refer to this as a(n):

A)liquidity trap.
B)asset price bubble.
C)bad-precedent problem.
D)moral-hazard problem.

Question 26

If a financial asset is liquid, it is:

A)considered to be a safe asset with no chance of being deleveraged.
B)an online asset and has no physical piece of paper associated with it.
C)a highly desirable asset.
D)an asset that can easily be converted into cash.

Question 27

I buy 100 shares of stock at $2 a share, with $100 of my own money. I borrow another $100 at 10 percent interest. The share price stays constant at $2. My rate of return is approximately:

A)2 percent.
B)0 percent.
C)−5 percent.
D)−10 percent.

Question 28

Leverage is best defined as:

A)the practice of buying an asset with borrowed money.
B)using friends inside the banking industry to secure loans.
C)the ability of people without income to secure mortgages.
D)low interest rates at the beginning of the term of a loan that later rise.

Question 29

A bank that is liquid:

A)has assets that can be readily converted into cash and money.
B)has sufficient assets to cover its long-term liabilities.
C)can sell short-term bonds to buy long-term bonds.
D)is diversified in its holdings of financial assets.

Question 30

The 2008 financial crisis was caused largely by:

A)a run on banks and other financial institutions.
B)a bursting of the automobile market bubble.
C)a bursting of the housing market bubble.
D)by the inability of the government to issue Treasury bonds.

Question 31

Solvency is having:

A)assets that can be readily converted into cash.
B)liabilities that can be readily converted into cash.
C)sufficient assets to cover long-run liabilities.
D)sufficient liabilities to cover long-run assets.

Question 32

I invest $100 in a stock and borrow 90 percent of the $100 at 10 percent. The stock price rises by 20 percent. The rate of return on my investment is:

A)10 percent.
B)90 percent.
C)110 percent.
D)100 percent.

Question 33

The two main causes of an asset price bubble are:

A)herding and leverage.
B)herding and budget deficits.
C)budget surpluses and leverage.
D)herding and budget surpluses.

Question 34

Extrapolative expectations are expectations that:

A)are consistent with trending expectations.
B)a trend will reverse.
C)are consistent with economists' expectations.
D)a trend will continue.

Question 35

Which type of expectations can lead to an asset price bubble?

A)Extrapolative
B)Efficient
C)Real
D)Inverted

Question 36

Why could leverage lead to an asset price bubble?

A)It allows investors to take advantage of disinflation.
B)It takes advantage of insiders who help outsiders.
C)It increases the ability of people to purchase financial instruments.
D)It takes advantage of extrapolative expectations.

Question 37

In which two markets did an asset bubble form that led to a financial crisis in 2008?

A)Housing and mortgage-backed securities
B)Housing and automobiles
C)Mortgage-backed securities and tulips
D)South Sea Company and tulips

Question 38

When the Fed loaned to banks using banks' long-run assets such as mortgages as collateral, it was:

A)loosening its regulations of bank.
B)providing banks with liquidity.
C)giving banks assets.
D)conducting standard monetary policy.

Question 39

A company borrows money to supplement its current funds and uses it to buy more financial assets. This is what referred to as:

A)diversification.
B)leverage.
C)quantitative easing.
D)herding.

Question 40

If housing prices are rising by 20 percent per year, you can borrow money at 5 percent per year, and you are sure housing prices will continue to rise in the future, you would be wise to:

A)not buy a house because it will leave you in debt.
B)buy as many houses as you can.
C)buy a house if you need a house.
D)sell your house to get out of debt.

Question 41

The efficient market hypothesis suggests that:

A)while individuals can be irrational, collectively they will not.
B)because individuals are rational, collectively they are also rational.
C)irrationality must a part of every economic model.
D)asset price bubbles are efficient.

Question 42

The efficient market hypothesis suggests that:

A)Congress is unable to pass effective laws.
B)the Fed will be unable to pop an asset price bubble.
C)asset price bubbles are a normal part of an economy.
D)asset price bubbles won't occur.

Question 43

Suppose you work in investments for a financial institution, and other banks are making a fortune with Irish goldmines. The fact that you are more likely to move to invest in Irish goldmines just because you see other banks doing so is called:

A)the law of diminishing control.
B)leverage.
C)herding.
D)diversification.

Question 44

Which of the following does not explain why the Glass-Steagall regulations lost their effectiveness?

A)Over time, nonbank financial firms were able to borrow directly from the public, rather than having to borrow from commercial banks.
B)The Federal Reserve created regulations that ran counter to what the government was trying to do.
C)With the advent of new financial instruments, regulated banks lost business to unregulated institutions, and credit began to flow through unregulated systems.
D)As regulations became too successful, people wanted to eliminate these regulations in order to pursue the magic of the free market.

Question 45

Structural stagnationists believe:

A)the efficient market hypothesis is operational at all times.
B)people can be irrational at times.
C)people are generally irrational.
D)the efficient market hypothesis is never operational.

Question 46

Which of the following was not a contributing factor to the housing market boom of the 2000s?

A)Low interest rates
B)Mortgages with no or little money down
C)The merging of large banks giving them more assets
D)Scant concern given to people's ability to meet the mortgage payment

Question 47

Structural stagnationists believe expansionary monetary policy in the early 2000s:

A)was channeled into asset prices.
B)created far too much inflation.
C)required contractionary fiscal policy.
D)was entirely ineffective in affecting the economy.

Question 48

Deposit insurance is:

A)private insurance by depositors to guarantee against a bank run that would affect deposits.
B)government insurance that promised to reimburse individuals for loss in the value of deposits.
C)a regulation that limits how much an individual can deposit at a single bank to avoid bank runs.
D)a Federal Reserve Bank regulation that covered deposits by individuals against losses.

Question 49

Which of the following was not a direct contributor to the booming housing market in the 2000s?

A)People were expecting housing prices to keep on rising.
B)People could get mortgages with little or no money down.
C)Lending standards became loose.
D)Contractionary policy was passed in 2001.

Question 50

Initially, policy makers were not concerned about the financial crisis because:

A)conventional economic theory was telling them they did not have to worry about such an event occurring.
B)no other comparable crisis had happened before in history.
C)fiscal policy would kick in to stabilize the economy.
D)banks and other financial institutions had convinced policy makers that they would take care of any type of crisis.

Question 51

To offset the moral hazard problem created by the FDIC, the government:

A)created securities to spread the risks.
B)created the Federal Reserve Bank.
C)separated banks from other financial institutions.
D)required individuals to pay a portion of the insurance costs.

Question 52

In the 1970s and 1980s, savings banks invented NOW accounts to get around financial regulations. This is an example of:

A)a moral hazard problem.
B)deleveraging.
C)the law of diminishing control.
D)quantitative easing.

Question 53

The FDIC is an example of:

A)the Glass-Steagall Act
B)a Federal Reserve Bank tool.
C)risk premium.
D)deposit insurance.

Question 54

The Glass-Steagall Act was set up to:

A)regulate financial institutions after the Savings and Loan Crisis the 1980s.
B)give the federal government the sole responsibility in carrying out fiscal policy to regulate the economy.
C)establish banking regulations and deposit insurance as a result of the 1930s crisis.
D)regulate the derivatives market as a result of the 2008 crisis.

Question 55

Whenever a regulatory system is set up, individuals or firms being regulated will figure out ways to get around these regulations. This is referred to as the law of:

A)diminishing returns.
B)unintended consequences.
C)diminishing control.
D)demand.

Question 56

The government has bailed out homeowners who are in danger of foreclosure. Furthermore, future homeowners may deduce that the government will again bail them out in the case of future economic turmoil. The government inadvertently has created what is known as:

A)deleveraging.
B)the law of diminishing control.
C)moral hazard.
D)herding.

Question 57

Which of the following is not an example of moral hazard?

A)Investment banks use 40-1 leverage, knowing that if the market collapses, the government will come to the rescue.
B)Domestic automobile companies fail to design high-quality fuel-efficient cars, hoping that the government will save them if oil prices skyrocket.
C)A backcountry skier takes an excessively dangerous run, knowing that local rescue crews will come to his aid if he gets in an accident.
D)Insurance companies stopped offering insurance policies in New Orleans after a major hurricane, knowing the government will offer subsidies to draw people back.

Question 58

Which is not a measure instituted to offset the moral hazard problem created by the FDIC?

A)Established strict regulations of banks
B)The creation of the Federal Reserve Bank
C)Separating banks from other financial institutions
D)Require financial transactions essential to the economy to remain in banks

Question 59

Which of the following describes the law of diminishing control?

A)The Federal Reserve Bank cannot impact excess reserves and the money supply.
B)Financial institutions have few ways to assess the solvency of borrowers.
C)After regulations are enacted, institutions find ways around the regulations.
D)As people engage in leverage, they have less and less control over the price of the asset.

Question 60

Moral hazard is a problem that arises when:

A)people are required to bear the negative consequences of their actions.
B)people don't have to bear the negative consequences of their actions.
C)people benefit from the negative actions of others.
D)government discourages companies from taking risks.

Question 61

Which of the following is not one of the unconventional monetary policy tools used by the Fed?

A)Precommitment strategy
B)Quantitative easing
C)Operation twist
D)Dodd-Frank Act

Question 62

The purpose of the Dodd-Frank Wall Street Reform Act was to:

A)encourage banks to engage in more risk-taking.
B)give banks the choice to report their holdings.
C)force banks to limit their risk-taking.
D)limit what stocks and mutual funds that investors could choose.

Question 63

The graph below shows what happens when the Fed implements:

A)operation twist.
B)credit easing.
C)quantitative easing.
D)precommitment policies.

Question 64

The recent regulation that was designed to limit risk-taking by banks by requiring them to report their holdings is called the:

A)Glass-Steagall Act.
B)Dodd-Frank Wall Street Reform and Consumer Protection Act.
C)Troubled Asset Relief Program.
D)Federal Deposit Insurance Act.

Question 65

Which of the following would not fall under the description of unconventional monetary policy by the Federal Reserve?

A)Accepting lower quality assets as collateral for loans
B)Opening lending facilities to noncommercial banks
C)Directly purchasing short-term bonds from money market mutual funds
D)Lowering the reserve requirement for banks

Question 66

Buying financial assets from banks and other financial institutions in order to stimulate the economy is referred to as:

A)money easing.
B)operation twist.
C)quantitative easing.
D)precommitment policy.

Question 67

A policy buying a wide range of financial assets from banks and other financial institutions in order to stimulate the economy is called:

A)precommitment policy.
B)operation twist.
C)money easing.
D)quantitative easing.

Question 68

All of the following are examples of the law of diminishing control that followed banking regulations put in place after the Great Depression except:

A)banks created new instruments to circumvent the law.
B)financial business migrated to unregulated institutions.
C)depositors demanded financial institutions be responsible for their financial decisions.
D)politicians were pressured to dismantle the regulations.

Question 69

If a firm or an industry is considered too big to fail, it is

A)unwise to regulate it because the regulation will slow growth.
B)wise to regulate it because the regulation will make it smaller.
C)wise to regulate it because of the moral hazard problem.
D)unwise to regulate it because it is too big.

Question 70

Which of the following would not address the moral hazard problem?

A)Establish strict regulations of the banks
B)Design systems so that necessary financial transactions stayed within regulated banks
C)Allow the government to take over the policy-making decisions of the Federal Reserve
D)Separate banks from other financial institutions

Question 71

A general principle of regulation is:

A)do not offset the moral hazard problem.
B)set as few bad precedents as possible.
C)let banks fail regardless of the effect on the economy.
D)the need to reduce regulations over time.

Question 72

Quantitative easing refers to:

A)a gradual reduction in interest rates by the Federal Reserve.
B)looser restrictions on banks' investments in derivatives.
C)a gradual reduction in marginal tax rates.
D)nonstandard monetary policy designed to extend credit in the economy.

Question 73

Which of the following would have the impact shown in the accompanying graph?

A)Operation twist
B)Money easing
C)Quantitative easing
D)Precommitment policy

Question 74

Purchasing long-term government bonds from private financial corporations for the purpose of changing the quality of assets held by the Fed is called:

A)credit easing.
B)operation twist.
C)quantitative easing.
D)precommitment policy.

Question 75

To avoid the law of diminishing control, the government could:

A)treat regulation as a one-time event that is not predictable.
B)leave the regulations the way they are.
C)let the Federal Reserve decide the regulations and implement the regulations.
D)change the regulations when it is appropriate to do so.

Question 76

Quantitative easing involves all of the following except:

A)higher long-term interest rates.
B)higher asset prices.
C)Lower long-term interest rates.
D)Purchasing longer-term bonds.

Question 77

The aim of unconventional monetary policy tools is to:

A)stimulate the economy in coordination with fiscal policy.
B)slow down liquidity and increase interest rates.
C)boost liquidity and reduce interest rates when credit channels are clogged.
D)increase the value of the dollar.

Question 78

When the Fed is changing the quality of the assets it holds, this is called:

A)quantitative easing.
B)operation twist.
C)credit easing.
D)precommitment policy.

Question 79

Which of the following did not contribute to the law of diminishing control?

A)New financial institutions and instruments
B)Political pressure to reduce regulations
C)New monetary policy tools
D)Regulations covered fewer financial instruments

Question 80

The main difference between quantitative easing and credit easing is that:

A)quantitative easing changes the mix of the Fed's holdings, credit easing does not.
B)credit easing changes the quality of the Fed's holdings, quantitative easing does not.
C)credit easing shifts long-term interest rates down while quantitative easing shifts them up.
D)There is no difference since both add credit to the economy.