Deck 17: Monetary Policy and Inflation

Question 1

What is the motivation for individuals to hold money?

A)to reduce risk
B)to provide liquidity
C)to facilitate transactions
D)all of the above

Answer 1

all of the above

Question 2

The Fed has immense power and there are no limits to the extent to which it can effectively control the economy.

Answer 2

False

Question 3

The demand for money that arises so that individuals or firms can make purchases on quick notice is called the

A)real demand for money.
B)transaction demand for money.
C)liquidity demand for money.
D)speculative demand for money.

Answer 3

liquidity demand for money.

Question 4

A decrease in the level of real GDP in the economy leads to

A)a leftward shift in the demand for money curve.
B)a rightward shift in the demand for money curve.
C)a leftward movement along the demand for money curve.
D)a rightward movement along the demand for money curve.

Question 5

Generally, when the Federal Reserve lowers interest rates, investment spending _______ and GDP _______.

A)increases; decreases
B)increases; increases
C)decreases; decreases
D)decreases; increases

Question 6

At higher interest rates the

A)money supply is higher.
B)money supply is indeterminate.
C)quantity of money demanded is higher.
D)quantity of money demanded is lower.

Question 7

The transaction demand for money comes mostly from the fact that

A)money is a store of value.
B)money is a medium of exchange.
C)money is a unit of account.
D)money has low opportunity cost.

Question 8

When the Federal Reserve increases interest rates, investment spending _______ and GDP _______.

A)increases; decreases
B)increases; increases
C)decreases; decreases
D)decreases; increases

Question 9

The demand for money that arises because holding money over short periods is less risky than holding stocks or bonds is called the

A)transactions demand for money.
B)liquidity demand for money.
C)opportunity cost demand for money.
D)speculative demand for money.

Question 10

The nominal interest rate is determined in the

A)stock market.
B)money market.
C)exchange market.
D)bond market.

Question 11

The opportunity cost of holding money is

A)heavy and awkward.
B)the probability of theft or loss.
C)the ease of conducting everyday business.
D)the return that could have been earned from holding wealth in other assets.

Question 12

An increase in the level of real GDP in the economy leads to

A)a leftward shift in the demand for money curve.
B)a rightward shift in the demand for money curve.
C)a leftward movement along the demand for money curve.
D)a rightward movement along the demand for money curve.

Question 13

At lower interest rates the

A)money supply is indeterminate.
B)money supply is lower.
C)quantity of money demanded is higher.
D)quantity of money demanded is lower.

Question 14

A decrease in the price level in the economy leads to

A)a leftward shift in the demand for money curve.
B)a rightward shift in the demand for money curve.
C)a leftward movement along the demand for money curve.
D)a rightward movement along the demand for money curve.

Question 15

Which of the following factors does NOT shift the demand curve for money?

A)changes in the interest rate
B)changes in the price level in the economy
C)changes in real income
D)changes in real GDP

Question 16

If your wealth is held as currency or in checking accounts, or other assets that you can convert to money on short notice, your assets are considered to be

A)abundant.
B)fast moving.
C)interest bearing.
D)liquid.

Question 17

Suppose that the interest rate available to you on a long-term bond is 4 percent. If you hold $1,000 of your wealth in currency instead of in the form of a bond, the annual opportunity cost is

A)$0.04.
B)$4.
C)$40.
D)$400.

Question 18

An increase in the price level in the economy leads to

A)a leftward shift in the demand for money curve.
B)a rightward shift in the demand for money curve.
C)a leftward movement along the demand for money curve.
D)a rightward movement along the demand for money curve.

Question 19

We use interest rates to measure the opportunity cost of holding money.

Question 20

In the short run when prices donʹt have enough time to change, the Federal Reserve

A)can influence the level of interest rates in the economy.
B)cannot influence the level of interest rates in the economy.
C)can influence the level of interest rates in the economy but generally will not because it would be destabilizing.
D)can only affect the amount of money in the economy.

Question 21

To decrease the money supply using the reserve requirements, what would the Fed typically do?

A)raise the reserve requirement for banks
B)reduce the reserve requirement for banks
C)make each bank voluntarily set its own reserve levels
D)let each bank get less currency from the Treasury

Question 22

If the Federal Reserve wanted to change the money supply in the economy, it would be least likely to

A)buy bonds on the open market.
B)sell bonds on the open market.
C)change the level of reserves required to be held by banks.
D)change the federal funds rate.

Question 23

An open market purchase by the Fed

A)increases the total amount of reserves in the banking system.
B)decreases the total amount of reserves in the banking system.
C)does not change the total amount of reserves in the banking system.
D)causes the reserve requirement to fall.

Question 24

Increased investment spending in the economy would be a possible result of

A)an increase in interest rates.
B)an open market purchase of bonds by the Fed.
C)an open market sale of bonds by the Fed.
D)a decrease in the money supply.

Question 25

What would be a way for the Federal Reserve to stimulate a sluggish economy?

A)print more money
B)buy government bonds on the open market
C)sell more government bonds
D)encourage the stock market

Question 26

The quantity of money demanded will increase as interest rates increase.

Question 27

Both increases in the price level and increases in real GDP will decrease the demand for money.

Question 28

What would be a way for the Federal Reserve to slow down the economy when it is growing too quickly or is inflationary?

A)print more money
B)buy back government bonds on the open market
C)sell more government bonds
D)encourage the stock market

Question 29

The most commonly used tool in monetary policy is

A)changes in required reserve ratios.
B)changes in the discount rate.
C)open market operations.
D)express lending transactions.

Question 30

By raising the discount rate, the Federal Reserve _______ banks from borrowing more reserves.

A)encourages
B)discourages
C)prohibits
D)short-changes

Question 31

From time to time, the Federal Reserve buys back government bonds from the private sector through a process called

A)bond recall procedures.
B)open market purchases.
C)backflip bond investments.
D)voluntary redemption procedures.

Question 32

The one organization that has the power to change the total amount of reserves in the banking system is the

A)Congress.
B)Executive Branch of the Federal Government.
C)U.S. Treasury.
D)Federal Reserve System.

Question 33

From time to time, the Federal Reserve sells various quantities of government bonds to the private sector through a process called

A)bond recall procedures.
B)backflip bond investments.
C)open market sales.
D)voluntary redemption procedures.

Question 34

What three factors affect the demand for money?

Question 35

Decreased investment spending in the economy would be a possible result of

A)a decrease in interest rates.
B)an open market purchase of bonds by the Fed.
C)an open market sale of bonds by the Fed.
D)an increase in the money supply.

Question 36

Selling government bonds through open market operations allows the Federal Reserve to

A)decrease money in the treasury.
B)decrease the money supply in the private sector.
C)receive discounts on future sales.
D)receive a high rate of interest on the bonds.

Question 37

If your assets are highly liquid, this means you can make transactions on short notice.

Question 38

How can the Federal Reserve actually increase the money supply?

A)by delaying transfer of money among banks
B)by raising the discount rate
C)by printing more money
D)by purchasing more government bonds in the open market

Question 39

Explain the three different types of money demand.

Question 40

To increase the money supply using the reserve requirements, what would the Fed typically do?

A)increase the reserve requirement for banks
B)reduce the reserve requirement for banks
C)make each bank set its own reserve levels
D)let each bank get more currency from the Treasury

Question 41

The assumption that the Fed would continue to increase interest rates caused the dollar to appreciate. For the U.S. economy, an appreciating dollar reflects

A)a rise in exchange rates, decreasing net exports and GDP.
B)a rise in exchange rates, increasing net exports and GDP.
C)a fall in exchange rates, decreasing net exports and GDP.
D)a fall in exchange rates, increasing net exports and GDP.

Question 42

An open market sale of bonds by the Federal Reserve will lead to an increase of reserves in banks.

Question 43

An increase in the discount rate will

A)decrease the money supply.
B)not affect the money supply.
C)increase the money supply.
D)have an unclear effect on the money supply.

Question 44

A decrease in the discount rate

A)reduces the cost of borrowing from the Fed.
B)signals the Fedʹs desire to decrease the money supply.
C)signals the Fedʹs desire to reduce lending to commercial banks.
D)increases the cost of reserves borrowed from the Fed.

Question 45

Summary of the article:
In Surprise Move, Fed Signals Pivot to Normal Policy
By Sewell Chan
New York Times
February 18, 2010
In February 2010, the Fed raised the discount rate for the first time in over a year, signaling that the era of low
interest rates necessitated by the recession and financial crisis will gradually end. Despite this quarter percent
increase, the Fed also indicated that the discount rate would remain ʺexceptionally lowʺ for an ʺextended
periodʺ due to the slow economic recovery. The increase widens the spread between the discount rate and
the federal funds rate, a move the Fed states should encourage banks to use the discount window ʺonly as a
backup source of fundsʺ. The Fed also has eventual plans to reduce the money supply by extracting some of
the extra reserves it added to the economy to assist banks during the financial crisis.
In an attempt to reassure the market, the Fed emphasized that it was not suddenly moving in a new
direction. In its statement announcing the interest rate increase, the Fed also stated that ʺthe modifications are
not expected to lead to tighter financial conditions for households and businesses and do not signal any
change in the outlook for the economy or for monetary policy.ʺ
Even with the reassurances, some early signs of investor concern about further interest rate increases
emerged. Following the Fedʹs announcement, stock futures fell, 10-year Treasury note yields rose, and the
dollar experienced a slight appreciation in value.
What impact would the Fedʹs raising the interest rate have on any inflationary pressure in the economy?

A)An increase in interest rates decreases the money demand, which could slow increases in the price level.
B)An increase in interest rates increases the money supply, which could cause the price level to increase.
C)An increase in interest rates decreases the exchange rate, which causes net exports to rise, generating inflation.
D)An increase in interest rates increases real GDP, which creates inflation in an economy.

Question 46

Recall the Application about the Fedʹs expanded involvement in the economy following the financial
crisis in 2008 to answer the following question(s).
Recall the Application. During 2008, the value of the Fedʹs total assets

A)fell by over $2 trillion.
B)remained virtually unchanged.
C)became negative.
D)more than doubled.

Question 47

Recall the Application about the Fedʹs expanded involvement in the economy following the financial
crisis in 2008 to answer the following question(s).
Recall the Application. Prior to the financial crisis, the Fed primarily held as assets.

A)mortgage-backed securities
B)cash
C)corporate stocks and bonds.
D)Treasury securities

Question 48

In practice, the Federal Reserve keeps the discount rate close to the _______ rate in order to avoid large swings in borrowed reserves by banks.

A)inflation
B)six-month Treasury bill
C)federal funds
D)prime

Question 49

A change in the reserve requirement is used infrequently by the Fed because it

A)is disruptive to the banking system.
B)does not influence the money supply.
C)does not affect bank reserves.
D)does not affect the money multiplier.

Question 50

When the Federal Reserve buys bonds on the open market, it decreases the money supply.

Question 51

Recall the Application about the Fedʹs expanded involvement in the economy following the financial
crisis in 2008 to answer the following question(s).
Recall the Application. Prior to the financial crisis in 2008, the Fedʹs traditional method of conducting monetary policy to expand the money supply was

A)purchasing Treasury securities.
B)purchasing mortgage-backed securities.
C)lowering reserve requirements.
D)raising the discount rate.

Question 52

When the Federal Reserve decreases the money supply, it generally does so by purchasing bonds.

Question 53

A decrease in the discount rate will

A)decrease the money supply.
B)not affect the money supply.
C)increase the money supply.
D)have an unclear effect on the money supply.

Question 54

Summary of the article:
In Surprise Move, Fed Signals Pivot to Normal Policy
By Sewell Chan
New York Times
February 18, 2010
In February 2010, the Fed raised the discount rate for the first time in over a year, signaling that the era of low
interest rates necessitated by the recession and financial crisis will gradually end. Despite this quarter percent
increase, the Fed also indicated that the discount rate would remain ʺexceptionally lowʺ for an ʺextended
periodʺ due to the slow economic recovery. The increase widens the spread between the discount rate and
the federal funds rate, a move the Fed states should encourage banks to use the discount window ʺonly as a
backup source of fundsʺ. The Fed also has eventual plans to reduce the money supply by extracting some of
the extra reserves it added to the economy to assist banks during the financial crisis.
In an attempt to reassure the market, the Fed emphasized that it was not suddenly moving in a new
direction. In its statement announcing the interest rate increase, the Fed also stated that ʺthe modifications are
not expected to lead to tighter financial conditions for households and businesses and do not signal any
change in the outlook for the economy or for monetary policy.ʺ
Even with the reassurances, some early signs of investor concern about further interest rate increases
emerged. Following the Fedʹs announcement, stock futures fell, 10-year Treasury note yields rose, and the
dollar experienced a slight appreciation in value.
What impact does the Fedʹs raising the interest rate have on the money supply and on the price level?

A)An increase in interest rates raises the money supply and eventually reduces prices.
B)An increase in interest rates reduces the money demand which will slow the growth in prices.
C)An increase in interest rates lowers the money supply and raises the money demand, which will neutralize price increases.
D)An increase in interest rates will increase investment spending and GDP, which will lower prices.

Question 55

The federal funds rate is the interest rate that

A)the Fed charges to banks that borrow from it.
B)banks charge the Fed for using their reserves.
C)the Fed pays on bank reserves.
D)banks charge each other for borrowed money.

Question 56

The rate of interest charged to commercial banks by the Fed for loans is called the _______ rate.

A)federal funds
B)discount
C)prime
D)commercial paper

Question 57

Recall the Application about the Fedʹs expanded involvement in the economy following the financial
crisis in 2008 to answer the following question(s).
According to the Application, in 2010 the Fed

A)the Fed ended its support of the mortgage market.
B)the Fed converted all its assets to cash.
C)held over $1 trillion in mortgage-backed securities.
D)stopped trading in Treasury securities.

Question 58

In addition to lowering the discount rate to increase the money supply, the Fed could also

A)purchase bonds on the open market and raise reserve requirements.
B)sell bonds on the open market and raise reserve requirements.
C)purchase bonds on the open market and lower reserve requirements.
D)sell bonds on the open market and lower reserve requirements.

Question 59

Which action could the Fed use to decrease the money supply?

A)an open market purchase
B)an increase in the required reserve ratio
C)a tax increase
D)a decrease in the discount rate

Question 60

An increase in the discount rate

A)reduces the cost of reserves borrowed from the Fed.
B)signals the Fedʹs desire to increase the money supply.
C)signals the Fedʹs desire to lend increased reserves to banks.
D)increases the cost of reserves borrowed from the Fed.

Question 61

The prime rate is the interest rate at which banks can borrow from the Fed.

Question 62

Based on the model of the money market, if prices in the economy decrease, the equilibrium interest rate should

A)stay the same.
B)increase.
C)decrease.
D)increase to the same extent that the supply of money increases.

Question 63

If the quantity of money demanded exceeds the quantity of money supplied, then the

A)interest rate stays the same.
B)interest rate will increase.
C)interest rate will decrease.
D)effect on the interest rate is indeterminate.

Question 64

Recall the Application about the reasons why interest rates rise during an economic recovery to answer
the following question(s). Although higher interest rates are often associated with lower output, interest
rates often start to rise when an economy recovers from a recession and when an economy grows quickly.
As an example, in 2005, a year in which real GDP grew very rapidly,interest rates on 3 -month Treasury
bills rose from 2.3 percent at the beginning of the year to 3.9 percent by the end of the year.
According to this Application, one reason why interest rates rise during an economic recovery is

A)the Fed increases the money supply to stimulate the economy.
B)the Fed decreases the money supply to avoid overheating the economy.
C)the Fed decreases the money demand to offset the increase in money supply.
D)the Fed increases the money demand to balance the increase in money supply.

Question 65

Banks can obtain funds to make loans by borrowing reserves from other banks through the federal funds market.

Question 66

Based on the model of the money market, when real GDP increases, the equilibrium interest rate should

A)stay the same.
B)increase.
C)decrease.
D)increase to the same extent that the supply of money increases.

Question 67

If the Federal Reserve is interested in conducting contractionary policy, what types of policies should it consider?

Question 68

If the Federal Reserve conducts an open market sale, the

A)interest rate will not change.
B)interest rate will increase.
C)interest rate will decrease.
D)money supply is increased.

Question 69

If the Federal Reserve conducts an open market purchase, the

A)interest rate will not change.
B)interest rate will increase.
C)interest rate will decrease.
D)money supply is decreased.

Question 70

The Federal Reserve influences the level of interest rates in the short run by changing the

A)demand for money through open market operations.
B)demand for money through changes in reserve requirements.
C)supply of money through open market operations.
D)supply of money through changes in stock market operations.

Question 71

Recall the Application about the reasons why interest rates rise during an economic recovery to answer
the following question(s). Although higher interest rates are often associated with lower output, interest
rates often start to rise when an economy recovers from a recession and when an economy grows quickly.
As an example, in 2005, a year in which real GDP grew very rapidly,interest rates on 3 -month Treasury
bills rose from 2.3 percent at the beginning of the year to 3.9 percent by the end of the year.
According to this Application, one reason why interest rates rise during an economic recovery is

A)the demand for money increases, while the supply of money remains fixed.
B)the demand for money decreases, while the supply of money increases.
C)the demand for money remains fixed, while the supply of money increases.
D)the demand for money increases, while the supply of money increases.

Question 72

How would the Fedʹs reduction of the reserve ratio requirement affect the money supply?

Question 73

Equilibrium in the money market occurs when

A)the quantity of money demanded equals the quantity of money supplied.
B)the quantity of money demanded is less than the quantity of money supplied.
C)the quantity of money demanded is more than the quantity of money supplied.
D)the interest rate equals the money supply.

Question 74

If the Federal Reserve raises the discount rate, banks will be inclined to borrow additional reserves and the money supply will increase.

Question 75

How would the Fedʹs changing the discount rate affect the money supply?

Question 76

Based on the model of the money market, when real income decreases, the equilibrium interest rate should

A)stay the same.
B)increase.
C)decrease.
D)increase to the same extent that the supply of money increases.

Question 77

The _______ determines the supply of money.

A)Congress
B)President
C)Federal Reserve
D)banking system

Question 78

How would the Fedʹs sale of government bonds on the open market affect the money supply?

Question 79

Based on the model of the money market, if the Federal Reserve increases the reserve requirement, the equilibrium interest rate should

A)stay the same.
B)increase.
C)decrease.
D)increase to the same extent that the demand for money increases.

Question 80

If the quantity of money demanded is less than the quantity of money supplied, then the

A)interest rate stays the same.
B)interest rate will increase.
C)interest rate will decrease.
D)effect on the interest rate is indeterminate.