Question 1

When the central bank has lowered or raised interest rates, this occurs only because the central bank's bond traders are:
A) Conducting open-market operations to ensure revenue is generated.
B) Conducting open-market operations to cover their positions.
C) Conducting open-market operations to ensure that the money supply is increased.
D) Conducting open-market operations to ensure that the equilibrium interest rate equals x percent.

Accepted Answer

The central bank conducts open-market operations to ensure that the equilibrium interest rate equals the desired level. Lowering interest rates will increase the money supply and stimulate economic growth, while raising interest rates will reduce inflationary pressures. Bond traders are responsible for implementing these monetary policies through the purchase or sale of government bonds in the open market. Their goal is to achieve the central bank's target interest rate. A and B are incorrect because bond traders do not conduct open-market operations for their own revenue or to cover their positions. C is not entirely accurate because increasing the money supply is only one potential goal of open-market operations, not the sole reason for adjusting interest rates.

Question 2

Describe the process in the money market by which the interest rate reaches its equilibrium value if it starts above equilibrium.

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Question 3

Explain why the interest rate is the opportunity cost of holding currency. What is the benefit of holding currency?

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Question 4

Briefly discuss the theory of liquidity preference.

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Question 5

If asset markets are driven by the "animal spirits" of investors, then
A) those markets reflect rational behaviour.
B) those markets reflect irrational behaviour.
C) the efficient markets hypothesis is correct.
D) the stock market exhibits informational efficiency.

Accepted Answer

The concept of "animal spirits" suggests that asset markets are driven more by emotions and psychology than rational analysis. This implies that investors may make decisions based on factors other than available information, leading to irrational behavior in asset markets.

Question 6

When the government cuts personal income taxes, for instance, it increases households' take home pay. As a result:
A) Households will save all of this additional income, and spend little or nothing on consumer goods.
B) Households will save some of this additional income, but will also spend some of it on consumer goods.
C) Households will not save any of this additional income, but will spend all of it on the stock market.
D) Households will neither save the additional income nor spend it on consumer goods.

Accepted Answer

Households will likely save some of the additional income, but they will also spend some of it on consumer goods. The amount that they save versus spend will depend on their personal financial situation and priorities. However, economic theory suggests that household spending will increase overall, as consumers have more disposable income to use on goods and services.

Question 7

The crowding-out effect is caused by
A) an increase in the money supply increases the demand for goods and services, and thus crowds out investment.
B) an increase in government purchases reduces the demand for goods and services, and thus crowds out investment.
C) an increase in consumer income increases the demand for goods and services, and thus crowds out investment.
D) an increase in government purchases increases the demand for goods and services, and thus crowds out investment.

Accepted Answer

The crowding-out effect occurs when increased government spending leads to higher interest rates, which reduces private investment. This happens because government borrowing can increase demand for loanable funds, raising interest rates and making it more expensive for businesses to borrow and invest.

Question 8

In 2009, Professor Mankiw wrote an article in the New York Times suggesting negative interest rates. The logic is that consumers would spend more money. The additional spending would:
A) increase aggregate demand and act as a boost to the economy.
B) decrease aggregate demand and act as a boost to the economy.
C) increase aggregate demand and slow down the economy.
D) decrease aggregate demand and slow down the economy.

Accepted Answer

Negative interest rates would encourage consumers to spend rather than save, therefore increasing demand for goods and services. This boost in demand would stimulate economic growth and potentially lead to a decrease in unemployment.

Question 9

Suppose that the government spends more on replacing old school buildings with new ones. What does this do to aggregate demand? Please cite the presence of the multiplier effect, the crowding-out effect and taxes.

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Question 10

In addition to the multiplier and crowding-out effects, a tax change is a determinant of the size of the shift in the aggregate demand curve. Why would perceptions about whether the tax change is permanent or temporary affect the size of the shift?

Accepted Answer

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Question 11

The response of monetary policy to a change in fiscal policy is an example of a more general phenomenon: the use of _______________ to steady aggregate demand and, as a result, production and employment.
A) macroeconomic policies.
B) active stabilization policies.
C) financial policies.
D) research-led policies.

Accepted Answer

The use of monetary policy to stabilize aggregate demand after a change in fiscal policy is an example of active stabilization policies. These are macroeconomic policies aimed at reducing the volatility of production, employment, and prices in the short run. Financial policies are a subset of macroeconomic policies that focus specifically on financial markets and institutions. Research-led policies are not a category of macroeconomic policies.

Question 12

Use the money market to explain the interest-rate effect and its relation to the slope of the aggregate demand curve.

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Question 13

The multiplier effect means that aggregate demand curve will shift by a larger amount than the increase in _____________.
A) consumer spending.
B) budget revenues.
C) government spending.
D) the aggregate supply.

Accepted Answer

The multiplier effect refers to the concept that an increase in government spending will lead to a greater increase in total spending in the economy, because the initial spending leads to further rounds of spending by recipients, creating a ripple effect. Therefore, the aggregate demand curve will shift by a larger amount than the increase in government spending.

Question 14

Explain the logic according to liquidity preference theory by which an increase in the money supply changes the aggregate demand curve.

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Question 15

Different theories of the interest rate are useful for different purposes. When thinking about the short-run determinants of interest rates, it is best to keep in mind:
A) the loanable funds theory.
B) the liquidity preference theory.
C) the classical economic theory.
D) the price level theory.

Accepted Answer

The liquidity preference theory provides a framework for understanding short-term fluctuations in interest rates by emphasizing the demand for money and the preference for liquidity. The loanable funds theory focuses more on long-term interest rate determination based on savings and investment. The classical economic theory is not as relevant to short-run interest rate fluctuations, and the price level theory is more related to inflation than interest rates.

Question 16

Explain how a transfer payment like unemployment benefit acts as an automatic stabilizer.

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Question 17

What is the difference between monetary policy and fiscal policy?

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Question 18

Different theories of the interest rate are useful for different purposes. When thinking about the long-run determinants of interest rates, it is best to keep in mind:
A) the loanable funds theory.
B) the liquidity preference theory.
C) the classical economic theory.
D) the price level theory.

Accepted Answer

The loanable funds theory is most useful for understanding the long-run determinants of interest rates, as it focuses on the interaction of the supply and demand for funds over time. The liquidity preference theory is more useful for understanding short-term fluctuations in interest rates based on changes in individuals' preferences for money holdings. The classical economic theory and the price level theory are not as directly related to understanding the determinants of interest rates.

Question 19

A tax change is a determinant of the size of the shift in the aggregate demand curve. The shift in aggregate demand curve will be affected by
A) households' perceptions about whether the tax change is on income or on goods.
B) households' perceptions about whether the tax change is local or national.
C) households' perceptions about whether the tax change is good or bad.
D) households' perceptions about whether the tax change is permanent or temporary.

Accepted Answer

Household perceptions about whether the tax change is permanent or temporary can significantly affect their spending behavior, which in turn will affect the size of the shift in the aggregate demand curve. If households perceive a tax change to be permanent, they are more likely to adjust their consumption behavior, leading to a larger shift in the aggregate demand curve. If they perceive the tax change to be temporary, their consumption behavior may not change as much, leading to a smaller shift. The other options are not relevant determinants of the size of the shift in the aggregate demand curve.

Question 20

Suppose that consumers become pessimistic about the future health of the economy. What will happen to aggregate demand and to output? What might a government have to do to keep output stable?

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Quiz 34: The Influence of Monetary and Fiscal Policy on Aggregate Demand

When the central bank has lowered or raised interest rates, this occurs only because the central bank's bond traders are:

Describe the process in the money market by which the interest rate reaches its equilibrium value if it starts above equilibrium.

Explain why the interest rate is the opportunity cost of holding currency. What is the benefit of holding currency?

Briefly discuss the theory of liquidity preference.

If asset markets are driven by the "animal spirits" of investors, then

When the government cuts personal income taxes, for instance, it increases households' take home pay. As a result:

The crowding-out effect is caused by

In 2009, Professor Mankiw wrote an article in the New York Times suggesting negative interest rates. The logic is that consumers would spend more money. The additional spending would:

Suppose that the government spends more on replacing old school buildings with new ones. What does this do to aggregate demand? Please cite the presence of the multiplier effect, the crowding-out effect and taxes.

In addition to the multiplier and crowding-out effects, a tax change is a determinant of the size of the shift in the aggregate demand curve. Why would perceptions about whether the tax change is permanent or temporary affect the size of the shift?

The response of monetary policy to a change in fiscal policy is an example of a more general phenomenon: the use of _______________ to steady aggregate demand and, as a result, production and employment.

Use the money market to explain the interest-rate effect and its relation to the slope of the aggregate demand curve.

The multiplier effect means that aggregate demand curve will shift by a larger amount than the increase in _____________.

Explain the logic according to liquidity preference theory by which an increase in the money supply changes the aggregate demand curve.

Different theories of the interest rate are useful for different purposes. When thinking about the short-run determinants of interest rates, it is best to keep in mind:

Explain how a transfer payment like unemployment benefit acts as an automatic stabilizer.

What is the difference between monetary policy and fiscal policy?

Different theories of the interest rate are useful for different purposes. When thinking about the long-run determinants of interest rates, it is best to keep in mind:

A tax change is a determinant of the size of the shift in the aggregate demand curve. The shift in aggregate demand curve will be affected by

Suppose that consumers become pessimistic about the future health of the economy. What will happen to aggregate demand and to output? What might a government have to do to keep output stable?