Question 1

Monetary policy is used to stabilize the economy by changing factors that shift the:
A) AD curve.
B) SRAS curve.
C) LRAS curve.
D) aggregate demand, short-run aggregate supply, and LRAS curves.

Accepted Answer

Monetary policy is specifically designed to shift the AD curve. Changes in interest rates, money supply, and other monetary variables affect consumer and business spending, ultimately influencing the level of aggregate demand in the economy. Shifting the AD curve can help to stabilize the economy by reducing inflation and unemployment. Although changes in monetary policy can also impact the SRAS and LRAS curves indirectly, their primary target is the AD curve.

Question 2

In the case of a negative shock to aggregate demand, the central bank should:
A) decrease the rate of growth of the money supply to control inflation.
B) increase the rate of growth of the money supply to restore spending growth.
C) decrease the rate of growth of the price level to keep real growth high.
D) do nothing.

Accepted Answer

A negative shock to aggregate demand indicates a decrease in spending that can lead to an economic recession. To counter this, the central bank may increase the rate of growth of the money supply to encourage spending and promote economic growth. However, this action must be taken cautiously to avoid inflationary pressures.

Question 3

Which is a limitation of monetary policy in stabilizing the economy?
A) Central banks have too much control over the money supply.
B) Most central bank policymakers are controlled by the government.
C) Monetary policy is subject to uncertain lags.
D) Central banks have no discretion over policy tools.

Accepted Answer

Monetary policy is subject to uncertain lags, which means that the effects of policy changes may take several months or even years to impact the economy. This can reduce the effectiveness of monetary policy in stabilizing the economy, as the central bank may not be able to quickly respond to economic fluctuations. Additionally, while central banks do have some control over the money supply, they are still limited by factors such as the demand for money and the actions of commercial banks. Central bank policymakers may also be influenced by government officials, but this is not necessarily a limitation of monetary policy itself. Central banks do have discretion over policy tools, such as setting interest rates or conducting open market operations, but these tools may not be effective in all economic situations.

Question 4

If the Fed adheres to a strict "money growth rule" of 3% (that is, they keep $\vec { M }$ at 3% no matter what), what happens if velocity growth ( $\vec { v }$
) drops?
A) Inflation, real growth, and nominal wage growth all decrease.
B) Inflation increases, but real growth and nominal wage growth decrease.
C) Inflation and nominal wage growth decrease, but real growth increases.
D) Inflation, real growth, and nominal wage growth all increase.

Accepted Answer

If velocity growth drops while money supply growth is fixed at 3%, the overall nominal GDP growth will decrease, leading to lower inflation, real growth, and nominal wage growth.

Question 5

To offset the effect of negative growth in money velocity ( $\vec { v }$ ), the central bank should:
A) decrease the growth rate of the money supply.
B) increase the growth rate of the money supply.
C) apply a policy that stabilizes the growth in money velocity.
D) apply a policy that reduces the growth in money velocity.

Accepted Answer

To offset negative growth in money velocity, the central bank should increase the growth rate of the money supply to maintain the same level of economic activity, as money velocity is a component of the equation of exchange (MV=PY).

Question 6

In the AD-AS diagram, a "tight" monetary policy shifts the:
A) AD curve to the left.
B) AD curve to the right.
C) LRAS curve to the left.
D) LRAS curve to the right.

Accepted Answer

A tight monetary policy involves the central bank reducing the money supply and increasing interest rates to control inflation. This makes borrowing more expensive and reduces consumer and investment spending, causing a decrease in aggregate demand and shifting the AD curve to the left.

Question 7

Disinflation is:
A) a decrease in prices; that is, a negative inflation rate.
B) a reduction in the rate of inflation.
C) an increase in prices.
D) an increase in the rate of inflation.

Accepted Answer

Disinflation is a process where the rate of inflation decreases, but prices still continue to rise. It is not a decrease in prices (A) or an increase in the rate of inflation (D), and it is not necessarily an increase in prices (C).

Question 8

In the face of a negative shock to consumer confidence, politicians are on the fence about whether to implement policies based on the advice of economists or to make decisions on the basis of Tarot card readings. What would happen during the period in which they are making up their minds about which strategy to pursue?
A) $\vec { v }$
Would rise
B) $\vec { v }$
Would fall
C) $\bar { Y } _ { R }$
Would rise
D) $\bar { P }$
Would rise

Accepted Answer

During the period of indecision, consumer confidence remains low, leading to reduced spending and investment, which would cause the velocity of money ($\vec { v }$) to fall.

Question 9

When the Fed supplies "too much" monetary stimulus in the face of a negative aggregate demand shock:
A) inflation, real growth, and nominal wage growth all decrease.
B) inflation increases, but real growth and nominal wage growth decrease.
C) inflation and nominal wage growth decrease, but real growth increases.
D) inflation, real growth, and nominal wage growth all increase.

Accepted Answer

The answer of When the Fed supplies "too much" monetary...

Question 10

Deflation is:
A) a decrease in prices; that is, a negative inflation rate.
B) a reduction in the rate of inflation.
C) an increase in prices.
D) an increase in the rate of inflation.

Accepted Answer

Deflation is the opposite of inflation and refers to a decrease in prices. This can occur for a variety of reasons, such as decreased demand for goods and services or an increase in the supply of goods without a corresponding increase in demand.

Question 11

Which shock can the Fed deal with most effectively?
A) a major oil shock
B) a shock to the LRAS curve
C) a shock that shifts the SRAS curve
D) a shock to AD

Accepted Answer

The Fed can most effectively deal with a shock to AD through monetary policy, such as adjusting interest rates and the money supply. In contrast, a major oil shock or a shock to the LRAS curve are more difficult for the Fed to address through traditional monetary policy tools, and a shock that shifts the SRAS curve may require a combination of monetary policy and supply-side policies, which may be more politically contentious.

Question 12

If the Fed overreacts to a negative spending shock by increasing money growth too much:
A) both real GDP growth and inflation will decrease more than the Fed prefers.
B) both real GDP growth and inflation will increase more than the Fed prefers.
C) real GDP growth will increase more and inflation will increase less than the Fed prefers.
D) real GDP growth will increase less and inflation will increase more than the Fed prefers.

Accepted Answer

If the Fed overreacts to a negative spending shock by increasing money growth too much, it will lead to both real GDP growth and inflation increasing more than the Fed prefers. This is because excessive money supply can stimulate economic activity (thus increasing real GDP growth) but also lead to higher inflation rates.

Question 13

The economy's AD curve is:
A) upward sloping.
B) downward sloping.
C) vertical.
D) horizontal.

Accepted Answer

The AD (aggregate demand) curve is downward sloping because as the price level rises, the real value of money decreases and therefore people demand less quantity of goods and services. Conversely, as the price level falls, the real value of money increases and people will be able to purchase more goods and services, leading to an increase in the quantity demanded.

Question 14

What is a reason it might be hard for the Fed to restore aggregate demand in the face of a negative demand shock?
A) The Fed might run out of money.
B) Banks usually don't do what the Fed demands of them.
C) The Fed must operate in real time, when a lot of the data about the state of the economy are unknown.
D) The economy responds to the Fed's actions with no lag.

Accepted Answer

The Fed faces difficulties in restoring aggregate demand in the face of a negative demand shock since it must operate in real-time when there is a lack of complete information about the state of the economy. This makes it hard for the Fed to determine the appropriate policy response, which could limit the effectiveness of its efforts to restore aggregate demand.

Question 15

If initially, $\bar { M }$ = 5%, $\vec { v }$
= 3%, $\bar { P }$
= 2%, and $\bar { Y } _ { R }$
= 6% and then because of economic uncertainty $\vec { v }$
Falls to 1%, what should the Fed do?
A) Quietly raise $\bar { Y } _ { R }$
To 8% to offset the decrease in $\vec { v }$
.
B) Publicly lower $\bar { M }$
To 3% so that $\bar { M }$
- $\vec { v }$
Stays constant at 2%.
C) Publicly demonstrate a commitment to keep $\bar { M }$
+ $\vec { v }$
At 8% by raising $\bar { M }$
.
D) Quietly raise $\bar { M }$
Without telling anyone, as only unexpected inflation is expansionary.

Accepted Answer

The Fed should publicly demonstrate a commitment to keep $\bar { M }$ + $\vec { v }$ at 8% by raising $\bar { M }$ to offset the fall in $\vec { v }$ to maintain economic stability and confidence.

Question 16

The economy's SRAS curve is:
A) upward sloping.
B) downward sloping.
C) vertical.
D) horizontal.

Accepted Answer

The economy's SRAS curve is upward sloping because in the short run, as the price level increases, firms are willing to produce more because they can charge higher prices and earn higher profits. This relationship is captured by the law of supply, which states that producers are willing to supply more at higher prices.

Question 17

In the absence of monetary intervention following a negative shock to aggregate demand:
A) inflation, real growth, and nominal wage growth will all decrease.
B) inflation will decrease, but real growth and nominal wage growth will increase.
C) inflation will increase, real growth will decrease, and nominal wage growth will stay the same.
D) inflation and real growth will decrease, but nominal wage growth will stay the same.

Accepted Answer

In the event of a negative shock to aggregate demand without monetary intervention, inflation, real growth, and nominal wage growth will all decrease. This is because a decrease in aggregate demand leads to lower prices (reduced inflation), reduced production (lower real growth), and lower demand for labor, which typically results in lower wages (decreased nominal wage growth).

Question 18

The economy's LRAS curve is:
A) upward sloping.
B) downward sloping.
C) vertical.
D) horizontal.

Accepted Answer

The economy's LRAS (long-run aggregate supply) curve is vertical because it represents the potential output of an economy in the long run, which is determined by factors such as the availability of resources, technology, and efficiency of production. In the long run, changes in the price level only affect nominal but not real GDP, so the LRAS curve is vertical at the potential output level.

Question 19

Which is NOT a tool that the Federal Reserve can use to influence AD?
A) open-market operations
B) lending to banks and other financial institutions
C) changes in reserve requirements and the interest rate paid on reserves
D) printing money

Accepted Answer

While the Federal Reserve can use open-market operations, lending to banks, changes in reserve requirements and interest rates paid on reserves to influence AD, printing money is not a tool that is commonly used by the Fed. In fact, increasing the money supply through printing money can lead to inflation, which the Fed typically tries to avoid.

Question 20

Disinflation is more painful when the central bank:
A) increases the rate of inflation.
B) runs out of money.
C) is credible.
D) is not credible.

Accepted Answer

Disinflation is more painful when the central bank is not credible because people and businesses are less likely to believe that the central bank will successfully reduce inflation. This disbelief can lead to less cooperation from the public in terms of adjusting wage demands and prices, making the process of reducing inflation more difficult and potentially requiring more stringent measures.

Quiz 16: Monetary Policy

Monetary policy is used to stabilize the economy by changing factors that shift the:

In the case of a negative shock to aggregate demand, the central bank should:

Which is a limitation of monetary policy in stabilizing the economy?

If the Fed adheres to a strict "money growth rule" of 3% (that is, they keep $\vec { M }$ at 3% no matter what) , what happens if velocity growth ( $\vec { v }$ ) drops?

To offset the effect of negative growth in money velocity ( $\vec { v }$ ) , the central bank should:

In the AD-AS diagram, a "tight" monetary policy shifts the:

Disinflation is:

When the Fed supplies "too much" monetary stimulus in the face of a negative aggregate demand shock:

Deflation is:

Which shock can the Fed deal with most effectively?

If the Fed overreacts to a negative spending shock by increasing money growth too much:

The economy's AD curve is:

What is a reason it might be hard for the Fed to restore aggregate demand in the face of a negative demand shock?

If initially, $\bar { M }$ = 5%, $\vec { v }$ = 3%, $\bar { P }$ = 2%, and $\bar { Y } _ { R }$ = 6% and then because of economic uncertainty $\vec { v }$ Falls to 1%, what should the Fed do?

The economy's SRAS curve is:

In the absence of monetary intervention following a negative shock to aggregate demand:

The economy's LRAS curve is:

Which is NOT a tool that the Federal Reserve can use to influence AD?

Disinflation is more painful when the central bank: