Question 1

Conventional monetary policy was limited during the 2008-2009 U.S. financial crisis because the central bank could not:

Accepted Answer

During the 2008-2009 financial crisis, the Federal Reserve faced the zero lower bound problem, meaning it could not reduce the target interest rate below zero to stimulate the economy further.

Question 2

A credit crunch reduces aggregate demand by:

Accepted Answer

A credit crunch reduces the availability of credit, making it more difficult and expensive for consumers and businesses to borrow money. This leads to a reduction in consumption and investment spending, which in turn lowers aggregate demand. The other options may have effects on the economy, but they are not directly related to the reduction in aggregate demand caused by a credit crunch.

Question 3

Ideally, the purpose of providing funds to insolvent banks beyond required insurance payouts is to:

Accepted Answer

The purpose of providing funds to insolvent banks beyond required insurance payouts is to prevent the failure of one bank from multiplying and causing a domino effect throughout the financial system. This is known as systemic risk, and is a major concern for regulators and policymakers. By providing funds to insolvent banks, the hope is that they can recover and continue operating, thus preventing further disruptions to the financial system. Choices A, B, and C are not accurate depictions of the purpose of providing funds to insolvent banks.

Question 4

To the extent that risky mortgage-backed securities that were sold to buyers who were not fully aware of the risks contributed to the U.S. financial crisis of 2008-2009, blame for this action lies with:

Accepted Answer

Investment banks packaged and sold risky mortgage-backed securities to buyers who were not fully aware of the risks. This contributed to the U.S. financial crisis of 2008-2009.

Question 5

Since the financial crisis and recession of 2008-2009, regulators in Canada require financial institutions to periodically undergo a stress test. Stress tests are:

Accepted Answer

Stress tests are designed to assess how financial institutions can handle adverse economic scenarios, such as a significant drop in housing prices, to ensure their stability and resilience.

Question 6

Conventional monetary and fiscal policies during a financial crisis are aimed at _____, while acting as a lender of last resort or injecting government funds into the financial system during a financial crisis is aimed at _____.

Accepted Answer

Conventional monetary and fiscal policies aim to expand aggregate demand to stimulate the economy, while actions like acting as a lender of last resort or injecting funds are aimed at restoring confidence in the financial system during a crisis.

Question 7

When the central bank acts as a lender of last resort, it:

Accepted Answer

When the central bank acts as a lender of last resort, it provides loans to financial institutions that are facing liquidity issues. To mitigate the risk of default on these loans, the central bank requires the borrower to put up collateral, such as securities or other assets, as a form of security. However, the central bank does not take ownership of the borrower or have voting rights on their board of directors. Confiscation of assets is not a common practice for a lender of last resort.

Question 8

The effect of the financial crisis of 2008-2009 on the real economy in the United States was a(n) _____ in aggregate demand, a(n) _____ in output, and a(n) _____ in the unemployment rate.

Accepted Answer

The financial crisis of 2008-2009 led to a decrease in aggregate demand due to decreased spending and investment. This decrease in demand led to a decrease in output, as businesses cut back on production and hiring. This, in turn, led to an increase in the unemployment rate as businesses laid off workers to cut costs. Therefore, the correct answer is D.

Question 9

Conventional fiscal policy was limited during the 2008-2009 financial crisis because of:

Accepted Answer

Conventional fiscal policy involves changes in government spending and taxation to stabilize the economy during a recession. However, during the 2008-2009 financial crisis, concerns about increasing the government's budget deficit and debt limited the use of this policy tool. Many policymakers were hesitant to increase government spending or cut taxes because of fears that it would exacerbate the already high levels of public debt.

Question 10

The 2008-2009 recession in Canada was much smaller than in the U.S. for all of these reasons, except:

Accepted Answer

Canadian banks did engage in mortgage lending, but they were more conservative in their practices compared to U.S. banks.

Question 11

In the United States during the 2008-2009 period, the conventional monetary policy response was to _____ the target federal funds rate, while the conventional fiscal policy response was to _____ taxes and to _____ government spending.

Accepted Answer

During the 2008-2009 financial crisis, the Federal Reserve decreased the target federal funds rate to stimulate the economy. Concurrently, the fiscal policy response involved decreasing taxes and increasing government spending to boost economic activity.

Question 12

Conventional monetary and fiscal policies used in a recession are aimed at:

Accepted Answer

Conventional monetary and fiscal policies during a recession are designed to increase aggregate demand. This is achieved through lowering interest rates, increasing government spending, and cutting taxes to stimulate economic activity.

Question 13

If banks fear failure and become more conservative in making loans, then the sharp decline in bank lending is called a credit:

Accepted Answer

A credit crunch refers to a sudden reduction in the availability of credit or loans due to a decrease in lending by banks or other financial institutions. This can occur when banks become more conservative in their lending practices, often due to fear of failure or economic uncertainty. A credit crunch can have negative impacts on the economy, as businesses and individuals may be unable to secure the funding they need to grow or finance their operations.

Question 14

The principal purpose of a central bank acting as a lender of last resort is to:

Accepted Answer

The principal purpose of a central bank acting as a lender of last resort is to maintain the liquidity of the financial system, ensuring that financial institutions have access to emergency funds to prevent a liquidity crisis that could lead to a systemic collapse.

Question 15

A bank with assets worth less than liabilities is said to be _____, while a bank without adequate funds immediately available to make promised payments is said to be _____.

Accepted Answer

A bank with assets worth less than liabilities is insolvent, meaning it cannot meet its financial obligations. A bank without adequate funds immediately available to make promised payments is illiquid, meaning it lacks sufficient cash reserves to cover its short-term obligations.

Question 16

To the extent that low interest rates contributed to the U.S. financial crisis of 2008-2009, the blame for this policy lies with:

Accepted Answer

The Federal Reserve is responsible for setting interest rates, and its policy of maintaining low interest rates contributed to the housing bubble and subsequent financial crisis.

Question 17

During the 2008-2009 U.S. financial crisis, the Federal Reserve served as a lender of last resort by providing liquidity to:

Accepted Answer

The Federal Reserve acted as a lender of last resort by providing liquidity to both banks and shadow banks that had reliable collateral, helping to stabilize the financial system during the crisis.

Question 18

To the extent that the undervaluation of the riskiness of mortgage-backed securities contributed to the U.S. financial crisis of 2008-2009, blame for this mistake lies with:

Accepted Answer

Rating agencies were responsible for assessing the risk of mortgage-backed securities and often gave them high ratings, which contributed to their undervaluation and the subsequent financial crisis.

Question 19

To the extent that mortgage defaults contributed to the U.S. financial crisis of 2008-2009, blame for these actions lies with:

Accepted Answer

The financial crisis was a result of multiple factors, including homebuyers taking on excessive debt, mortgage brokers pushing risky loans, and government policies promoting homeownership.

Question 20

An illiquid bank can become insolvent when it:

Accepted Answer

When an illiquid bank sells assets at fire-sale prices to meet its liquidity demands, it may not fetch the fair value of its assets, leading to losses. This can reduce the bank's net worth and ultimately may lead to insolvency. Refusing to make promised payments or extending due dates of liabilities are not typical strategies banks use to address liquidity issues. Selling additional stock may help raise additional funds, but it may not be a sustainable or desirable long-term solution.

Quiz 18: The Financial System: Opportunities and Dangers