Monetary Policy And The Fed Test Bank Answers Chapter.11 - Macroeconomics v3.0 Complete Test Bank by LibRittenberg. DOCX document preview.
Chapter 11: Monetary Policy and the Fed
Multiple Choice
1. Toward the end of 2008, the U.S. economy was characterized by all of the following except
A) credit tightening by banks.
B) rising inflation.
C) falling real GDP.
D) an unprecedented federal funds rate below 1%.
Difficulty: Easy
2. In December 2008, the Federal Reserve announced that it would take extraordinary measures to address the financial crisis in the economy. These measures include all of the following except
A) buying mortgage-backed securities.
B) buying long-term Treasury bills.
C) creating other new credit facilities to make credit more easily available to households and small businesses.
D) lowering the reserve requirement to encourage banks to create loans.
Difficulty: Easy
3. According to the text, in many respects, the single most powerful economic policymaker in the United States is
A) Congress.
B) the Federal Reserve.
C) the President.
D) the Supreme Court.
Difficulty: Easy
4. The first official statement of goals for macroeconomic performance in the United States came with the passage of the
A) Federal Reserve Act of 1913.
B) Employment Act of 1946.
C) Great Depression Act of 1933.
D) Full Employment and Balanced Growth Act of 1978.
Difficulty: Easy
5. The congressional act that established the U.S. central banking system in 1913 was the
A) Federal Reserve Act.
B) Gramm-Rudman Act.
C) Employment Act.
D) Humphrey-Hawkins Act.
Difficulty: Easy
6. The congressional act passed in 1946 that contained the first official statement of goals for economic performance in the United States was the
A) Federal Reserve Act.
B) Gramm-Rudman Act.
C) Employment Act.
D) Humphrey-Hawkins Act.
Difficulty: Medium
7. The congressional act passed in 1978 that established specific numerical goals for the unemployment rate and the inflation rate to be achieved by 1983 was the
A) Federal Reserve Act.
B) Gramm-Rudman Act.
C) Employment Act.
D) Humphrey-Hawkins Act.
Difficulty: Medium
8. Which of the following are monetary policy goals?
I. maintain high interest rates
II. keep unemployment rates low
III. reduce the size of the banking sector
IV. prevent high rates of inflation
A) I, II, III, and IV
B) I, II, and III
C) II, III, and IV
D) II and IV
Difficulty: Medium
9. Historical actions indicate that the Fed’s primary goal of monetary policy over the past 30 years has been to
A) maintain high interest rates.
B) keep employment rates low.
C) limit the availability of consumer credit.
D) prevent high rates of inflation.
Difficulty: Medium
10. The major tools of monetary policy available to the Federal Reserve System are
A) reserve requirements, margin regulations, and moral suasion.
B) reserve requirements, open-market operations, and the discount rate.
C) open-market operations, margin regulations, and moral suasion.
D) the discount rate, margin regulations, and moral suasion.
Difficulty: Medium
11. The monetary policy tool that involves the buying and selling of government bonds is
A) moral suasion.
B) reserve requirements.
C) the discount rate.
D) open-market operations.
Difficulty: Medium
12. Which of the following is a tool used by the Fed in the conduct of monetary policy?
A) changes in the prime rate
B) issuing new government bonds and retiring old ones
C) buying and selling corporate bonds
D) buying and selling federal government bonds
Difficulty: Medium
13. If the Fed buys government bonds through open-market operations, it will
A) increase the demand for bonds in the bond market.
B) decrease the demand for bonds in the bond market.
C) increase the supply of bonds in the bond market.
D) decrease the supply of bonds in the bond market.
Difficulty: Medium
14. If the Fed purchases federal government bonds on the open market, bank reserves will
A) decrease leading to a decrease in the money supply.
B) increase leading to a decrease in the money supply.
C) increase leading to an increase in the money supply.
D) decrease leading to an increase in the money supply.
Difficulty: Medium
15. Suppose the economy experiences a recessionary gap. Expansionary monetary policy will
A) increase real GDP and increase the price level.
B) increase real GDP and decrease the price level.
C) decrease real GDP and increase the price level.
D) decrease real GDP and decrease the price level.
Difficulty: Medium
16. Suppose the economy experiences a recessionary gap. Expansionary monetary policy will
A) increase interest rates and increase the bond prices.
B) increase interest rates and decrease the bond prices
C) decrease interest rates and increase the bond prices
D) decrease interest rates and decrease the bond prices
Difficulty: Medium
17. Suppose the economy experiences a recessionary gap. Expansionary monetary policy will
A) increase interest rates and increase exchange rates.
B) increase interest rates and decrease exchange rates.
C) decrease interest rates and increase exchange rates.
D) decrease interest rates and decrease exchange rates.
Difficulty: Medium
18. Suppose the economy experiences a recessionary gap. Expansionary monetary policy will
A) increase investment and increase interest rates.
B) increase investment and decrease interest rates.
C) decrease investment and increase interest rates.
D) decrease investment and decrease interest rates.
Difficulty: Medium
Use the following to answer questions 19-24.
Exhibit: The Bond Market
19. (Exhibit: The Bond Market) If the Fed wants to achieve the results shown in Panel (a), it should
A) raise the discount rate.
B) increase reserve requirements.
C) sell government bonds in the open market.
D) buy government bonds in the open market.
Difficulty: Medium
20. (Exhibit: The Bond Market) Suppose the Fed takes action that shifts the demand curve from D to D′, as illustrated in Panel (a). What happens to the interest rate?
A) It will increase.
B) It will decrease.
C) It remains unchanged.
D) Short-term interest rates will decrease but long-term interest rates will increase.
Difficulty: Medium
21. (Exhibit: The Bond Market) Suppose the Fed takes action that shifts the demand curve from D to D′, as illustrated in Panel (a). As a result, the interest rate
A) increases and investment increases.
B) increases and investment decreases.
C) decreases and investment increases.
D) decreases and investment decreases.
Difficulty: Medium
22. (Exhibit: The Bond Market) If the Fed wants to achieve the results shown in Panel (b), it should
A) lower the discount rate.
B) decrease margin requirements.
C) decrease reserve requirements.
D) sell government bonds in the open market.
Difficulty: Medium
23. (Exhibit: The Bond Market) Suppose the Fed takes action that shifts the demand curve from S to S′, as illustrated in Panel (b). What happens to the interest rate?
A) It increases.
B) It decreases.
C) It remains unchanged.
D) Short-term interest rates will increase but long-term interest rates will decrease.
Difficulty: Medium
24. (Exhibit: The Bond Market) Suppose the Fed takes action that shifts the demand curve from S to S′, as illustrated in Panel (b). As a result, the interest rate
A) increases and investment increases.
B) increases and investment decreases.
C) decreases and investment increases.
D) decreases and investment decreases.
Difficulty: Medium
25. If the Fed sells government bonds, bank reserves will
A) decrease leading to a decrease in the money supply.
B) increase leading to a decrease in the money supply.
C) increase leading to an increase in the money supply.
D) decrease leading to an increase in the money supply.
Difficulty: Medium
26. When the Fed sells bonds in the open market, we can expect
A) bond prices and interest rates to fall.
B) bond prices to rise and interest rates to fall.
C) bond prices to fall and interest rates to rise.
D) bond prices and interest rates to rise.
Difficulty: Medium
27. When the Fed buys bonds in the open market, we can expect
A) bond prices and interest rates to fall.
B) bond prices to rise and interest rates to fall.
C) bond prices to fall and interest rates to rise.
D) bond prices and interest rates to rise.
Difficulty: Medium
28. When the Fed sells bonds in the open market, we can expect the
A) exchange rate to rise and interest rates to fall.
B) exchange rate and interest rates to rise.
C) exchange rate to fall and interest rates to rise.
D) exchange rate and interest rates to fall.
Difficulty: Medium
29. When the Fed buys bonds in the open market, we can expect the
A) exchange rate to rise and interest rates to fall.
B) exchange rate and interest rates to rise.
C) exchange rate to fall and interest rates to rise.
D) exchange rate and interest rates to fall.
Difficulty: Medium
30. When the Fed sells bonds in the open market, we can expect
A) investment and net exports to rise.
B) investment to rise and net exports to fall.
C) investment to fall and net exports to rise.
D) investment and net exports to fall.
Difficulty: Medium
31. When the Fed buys bonds in the open market, we can expect
A) investment and net exports to rise.
B) investment will rise and net exports to fall.
C) investment will fall and net exports to rise.
D) investment and net exports fall.
Difficulty: Medium
32. When the Fed sells bonds in the open market, in the product market (the aggregate demand- aggregate supply model),
A) real GDP will fall and the price level will rise.
B) real GDP and the price level will rise.
C) real GDP and the price level will fall.
D) real GDP will rise and the price level will fall.
Difficulty: Medium
33. When the Fed buys bonds in the open market, in the product market (the aggregate demand- aggregate supply model),
A) real GDP will fall and the price level will rise.
B) real GDP and the price level will rise.
C) real GDP and the price level will fall.
D) real GDP will rise and the price level will fall.
Difficulty: Medium
Use the following to answer questions 34-36.
Exhibit: Monetary Policy 1
34. (Exhibit: Monetary Policy 1) By shifting the demand curve from D1 to D2, the Fed is exercising
A) contractionary monetary policy to lower interest rates.
B) expansionary monetary policy to lower interest rates.
C) contractionary monetary policy to increase interest rates.
D) expansionary monetary policy to increase interest rates.
Difficulty: Medium
35. (Exhibit: Monetary Policy 1) To shift the demand curve from D1 to D2, the Fed will be
A) buying bonds in the open market which decrease the money supply.
B) selling bonds in the open market which decrease the money supply.
C) buying bonds in the open market which increases the money supply.
D) selling bonds in the open market which increases the money supply.
Difficulty: Medium
36. (Exhibit: Monetary Policy 1) By shifting the demand curve from D1 to D2, the Fed is attempting to
A) contract the economy by increasing interest rates.
B) expand the economy by increasing interest rates.
C) contract the economy by decreasing interest rates.
D) expand the economy by decreasing interest rates.
Difficulty: Medium
Use the following to answer questions 37-39.
Exhibit: Monetary Policy 2
37. (Exhibit: Monetary Policy 2) By shifting the supply curve from S1 to S2, the Fed is exercising
A) expansionary monetary policy in order to lower interest rates.
B) expansionary monetary policy in order to increase interest rates.
C) contractionary monetary policy in order to increase interest rates.
D) contractionary monetary policy in order to lower interest rates.
Difficulty: Medium
38. (Exhibit: Monetary Policy 2) By shifting the supply curve from S1 to S2, the Fed will be
A) buying bonds in the open market which decreases the money supply.
B) selling bonds in the open market which decreases the money supply.
C) buying bonds in the open market which increases the money supply.
D) selling bonds in the open market which increases the money supply.
Difficulty: Medium
39. (Exhibit: Monetary Policy 2) By shifting the supply curve from S1 to S2, the Fed is attempting to
A) expand the economy by increasing interest rates.
B) contract the economy by increasing interest rates.
C) contract the economy by decreasing interest rates.
D) expand the economy by decreasing interest rates.
Difficulty: Medium
Use the following to answer questions 40-45.
Exhibit: Effects of Monetary Policy
40. (Exhibit: Effects of Monetary Policy) Suppose the economy is initially at Y1 in Panel (a). It is experiencing
A) an inflationary gap.
B) a recessionary gap.
C) an actual unemployment rate that is less than the natural unemployment rate.
D) a situation that warrants a decrease in the money supply.
Difficulty: Medium
41. (Exhibit: Effects of Monetary Policy) Which of the following actions by the Fed could have caused the movement from AD1 to AD2 in Panel (a)?
A) selling government bonds in the open market
B) buying government bonds in the open market
C) increasing the discount rate
D) increasing the federal funds rate
Difficulty: Medium
42. (Exhibit: Effects of Monetary Policy) If a nonintervention policy were adopted in Panel (a),
A) the aggregate demand curve would have eventually shifted as shown.
B) the short-run aggregate supply curve would have eventually shifted to the left and restored full employment.
C) the short-run aggregate supply curve would have eventually shifted to the right and restored full employment.
D) both the aggregate demand curve and the short-run aggregate supply curve would have eventually shifted to the left.
Difficulty: Medium
43. (Exhibit: Effects of Monetary Policy) If the Fed acts to close the output gap in Panel (a), it would
A) sell government bonds which will lead to the shift in demand for bonds in Panel (b). This action will raise the price of bonds and lower the interest rate.
B) buy government bonds which will lead to the shift in demand for bonds in Panel (b). This action will raise the price of bonds and increase the interest rate.
C) buy government bonds which will lead to the shift in demand for bonds in Panel (b). This action will raise the price of bonds and lower the interest rate.
D) sell government bonds which will lead to the shift in demand for bonds in Panel (b). This action will raise the price of bonds and increase the interest rate.
Difficulty: Medium
44. (Exhibit: Effects of Monetary Policy) The shift in the demand for bonds from D1 to D2, in Panel (b) will result in a
A) lower interest rate and no change in investment.
B) higher interest rate and lower investment.
C) lower interest rate and higher investment.
D) higher interest rate and higher investment.
Difficulty: Medium
45. (Exhibit: Effects of Monetary Policy) In Panel (b), assume that the price of bonds rises from P1 to P2. Now, in Panel (c), the higher price of bonds will
A) reduce the demand for and increase the supply of dollars and cause the exchange rate to increase.
B) reduce the demand for and increase the supply of dollars and cause the exchange rate to rise.
C) increase the demand for and reduce the supply of dollars and cause the exchange rate to increase.
D) reduce the demand for and increase the supply of dollars and cause the exchange rate to fall.
Difficulty: Medium
46. Holding all else constant, higher interest rates in the United States would
A) decrease the demand for U.S. dollars in the foreign exchange market. In turn, this will lead to a decrease in the exchange rate, and subsequently, U.S. net exports would rise.
B) increase the demand for U.S. dollars in the foreign exchange market. In turn, this will lead to an increase in the exchange rate, and subsequently, U.S. net exports would fall.
C) increase the demand for U.S. dollars in the foreign exchange market. In turn, this will lead to a decrease in the exchange rate, and subsequently, U.S. net exports would rise.
D) decrease the demand for U.S. dollars in the foreign exchange market. In turn, this will lead to an increase in the exchange rate, and subsequently, U.S. net exports would fall.
Difficulty: Medium
47. Which of the following result from a change in the money supply brought about by an open market purchase?
A) lower interest rate, higher exchange rate, decreased demand for investment and net exports
B) higher interest rate, higher exchange rate, increased demand for investment and decreased demand for net exports
C) lower interest rate, lower exchange rate, increased demand for investment and net exports
D) higher interest rate, lower exchange rate, decreased demand for investment and increased demand for net exports
Difficulty: Hard
48. Which of the following result from a change in the money supply brought about by an open market sale?
A) lower interest rate, higher exchange rate, decreased demand for investment and net exports
B) higher interest rate, higher exchange rate, decreased demand for investment and decreased demand for net exports
C) lower interest rate, lower exchange rate, increased demand for investment and net exports
D) higher interest rate, lower exchange rate, decreased demand for investment and increased demand for net exports
Difficulty: Hard
49. If inflation is a threat, then the Fed will be expected to engage in
A) expansionary monetary policy.
B) contractionary monetary policy.
C) policies to increase the money supply.
D) policies to lower the rate of interest.
Difficulty: Medium
50. If inflation is a threat, then the Fed will conduct monetary policy aimed at
A) increasing the interest rate which then will shift aggregate demand to the right.
B) decreasing the interest rate which then will shift aggregate demand to the right.
C) decreasing the interest rate which then will shift aggregate demand to the left.
D) increasing the interest rate which then will shift aggregate demand to theleft.
Difficulty: Medium
51. Contractionary monetary policy by the Fed could include
A) lowering the discount rate.
B) decreasing government transfer payments.
C) decreasing reserve requirements.
D) selling government securities in the open market.
Difficulty: Medium
52. If the economy experiences an inflationary gap, a contractionary monetary policy will
A) increase real GDP and increase the price level.
B) increase real GDP and decrease the price level.
C) decrease real GDP and increase the price level.
D) decrease real GDP and decrease the price level.
Difficulty: Medium
53. If the economy experiences an inflationary gap, a contractionary monetary policy will
A) increase interest rates and increase the bond prices.
B) increase interest rates and decrease the bond prices.
C) decrease interest rates and increase the bond prices.
D) decrease interest rates and decrease the bond prices.
Difficulty: Medium
54. If the economy experiences an inflationary gap, a contractionary monetary policy will
A) increase interest rates and increase exchange rates.
B) increase interest rates and decrease exchange rates.
C) decrease interest rates and increase exchange rates.
D) decrease interest rates and decrease exchange rates.
Difficulty: Medium
55. If the economy experiences an inflationary gap, a contractionary monetary policy will
A) increase investment and increase interest rates.
B) increase investment and decrease interest rates.
C) decrease investment and increase interest rates.
D) decrease investment and decrease interest rates.
Difficulty: Medium
Use the following to answer questions 56-66.
Exhibit: Monetary Policy and Long-Run Aggregate Demand and Aggregate Supply
56. (Exhibit: Monetary Policy and Long-Run Aggregate Demand and Aggregate Supply) If the economy is at point a,
A) employment is greater than the natural level of employment.
B) it is at the natural level of employment.
C) it is in a recessionary gap.
D) the unemployment rate is negative.
Difficulty: Medium
57. (Exhibit: Monetary Policy and Long-Run Aggregate Demand and Aggregate Supply) If the economy is at point c,
A) it is in a recessionary gap.
B) it is at natural level of employment.
C) the level of employment is greater than the natural level of employment.
D) the unemployment rate is negative.
Difficulty: Medium
58. (Exhibit: Monetary Policy and Long-Run Aggregate Demand and Aggregate Supply) If the economy is at point c, the Federal Reserve can close the output gap by buying bonds. In the bond market,
A) the supply curve shifts right, leading to a decrease in bond prices and an increase in interest rates.
B) the demand curve shifts right, leading to an increase in bond prices and a decrease in interest rates.
C) the supply curve shifts left, leading to an increase in bond prices and an increase in interest rates.
D) the demand curve shifts left, leading to a decrease in bond prices and an increase in interest rates.
Difficulty: Medium
59. (Exhibit: Monetary Policy and Long-Run Aggregate Demand and Aggregate Supply) If the economy is at point c, the Federal Reserve can close the output gap
A) by pursuing an expansionary monetary policy to raise the interest rate and increase short-run aggregate supply.
B) by pursuing a contractionary monetary policy to drive down the interest rate and increase aggregate demand.
C) by pursuing an expansionary monetary policy to drive down the interest rate and increase aggregate demand.
D) by pursuing a contractionary monetary policy to raise the interest rate and short-run aggregate supply.
Difficulty: Medium
60. (Exhibit: Monetary Policy and Long-Run Aggregate Demand and Aggregate Supply) If the economy is at point c, an open market purchase would cause
A) a shift of the short-run aggregate supply curve from AS1 to AS2.
B) a shift of the short-run aggregate supply curve from AS2 to AS1.
C) a shift of the aggregate demand curve from AD1 to AD2.
D) a shift of the aggregate demand curve from AD2 to AD1.
Difficulty: Medium
61. (Exhibit: Monetary Policy and Long-Run Aggregate Demand and Aggregate Supply) Short-run but not long-run equilibrium positions occur at points
A) a and b.
B) b and c.
C) c and d.
D) a and c.
Difficulty: Medium
62. (Exhibit: Monetary Policy and Long-Run Aggregate Demand and Aggregate Supply) Long-run equilibrium positions occur at points
A) a and d.
B) a and b.
C) c and d.
D) b and d.
Difficulty: Medium
63. (Exhibit: Monetary Policy and Long-Run Aggregate Demand and Aggregate Supply) If the economy is at point b,
A) the unemployment rate is negative.
B) the unemployment rate is zero.
C) the level of employment is greater than the natural level of employment.
D) it is at the natural level of employment.
Difficulty: Medium
64. (Exhibit: Monetary Policy and Long-Run Aggregate Demand and Aggregate Supply) If the economy is at point b, the Federal Reserve can close the output gap by selling bonds. In the bond market,
A) the supply curve shifts right, leading to a decrease in bond prices and an increase in interest rates.
B) the demand curve shifts right, leading to an increase in bond prices and a decrease in interest rates.
C) the supply curve shifts left, leading to an increase in bond prices and an increase in interest rates.
D) the demand curve shifts left, leading to a decrease in bond prices and an increase in interest rates.
Difficulty: Medium
65. (Exhibit: Monetary Policy and Long-Run Aggregate Demand and Aggregate Supply) If the economy is at point b, the Federal Reserve can close the output gap
A) by pursuing an expansionary monetary policy to raise the interest rate and decrease short-run aggregate supply.
B) by pursuing a contractionary monetary policy to drive down the interest rate and decrease aggregate demand.
C) by pursuing an expansionary monetary policy to drive down the interest rate and decrease short-run aggregate supply.
D) by pursuing a contractionary monetary policy to raise the interest rate and reduce aggregate demand.
Difficulty: Medium
66. (Exhibit: Monetary Policy and Long-Run Aggregate Demand and Aggregate Supply) Assume that the economy is at point b. A decrease in the money supply would cause
A) a shift of the aggregate demand curve from AD1 to AD2.
B) a shift of the aggregate demand curve from AD2 to AD1.
C) a shift of the short-run aggregate supply curve from AS1 to AS2.
D) a shift of the short-run aggregate supply curve from AS2 to AS1.
Difficulty: Medium
67. On October 12, 1987, the Dow Jones Industrial Average plunged 508 points, wiping out more than $500 billion in a few hours. How did the Fed respond to this drastic fall in the stock market index?
A) The Fed responded precisely as it did when faced with a similar situation in 1929, that is, it deemed that no action was necessary.
B) To encourage the business community to invest in the stock market, the Fed announced that it will sell federal securities to raise the interest rate.
C) In an attempt to ward off a recession, the Fed announced that it will provide adequate liquidity, by buying federal securities.
D) The Fed provided long-term loans to those corporations that experienced significant decreases in their stock value.
Difficulty: Medium
68. Following the U.S. financial crisis in 2008, some observers assert that the policies of Fed Chairman Greenspan contributed to the crisis. Which of the following is a criticism of Greenspan’s policies?
I. The very low interest rates used to fight the 2001 recession were maintained for too long, leading to the real estate bubble.
II. The Fed provided real estate developers with liquidity to encourage property development and offered tax breaks to first-time home buyers, which in turn fueled the real estate bubble.
III. The Fed did not promote appropriate regulations to deal with the new financial instruments that were created in the early 2000s.
A) I and II only.
B) I and III only.
C) II and III only.
D) I, II, and III.
Difficulty: Medium
69. What are the two policy-making bodies of the Federal Reserve?
A) the Board of Governors and the U.S. Congress
B) the Board of Governors and the Federal Open Market Committee
C) the Board of Governors and the Presidents’ office
D) the Federal Open Market Committee and the U.S. Congress
Difficulty: Medium
70. Which of the following statements about the structure of the Fed is an advantage from the perspective of conducting monetary policy?
A) The two policymaking bodies of the Fed are deliberately large to allow for different viewpoints and they work very closely with other political institutions.
B) The two policymaking bodies of the Fed are deliberately large to allow for different viewpoints and they work relatively independently of other political institutions.
C) The two policymaking bodies of the Fed are small to allow deliberations in private and they work relatively independently of other political institutions.
D) The two policymaking bodies of the Fed are small to allow members to work closely with other political institutions.
Difficulty: Medium
71. Which of the following is perhaps the greatest obstacle facing the Fed in discharging monetary policy?
A) the difficulties involved in regulating the complex structure of financial institutions
B) the problem of monetary policy lags
C) the problem of identifying a monetary measure that is closely linked to real GDP
D) the problem of coordinating monetary and fiscal policy
Difficulty: Medium
72. What are the three types of monetary policy lags?
A) the recognition lag, the identification lag, and the implementation lag
B) the recognition lag, the inflation lag, and the impact lag
C) the recognition lag, the implementation lag, and the government lag
D) the recognition lag, the implementation lag, and the impact lag
Difficulty: Easy
73. The delay between the time at which an event occurs and the time at which policymakers become aware of it is called
A) the impact lag.
B) the implementation lag.
C) the government lag.
D) the recognition lag.
Difficulty: Easy
74. The lag in realizing that a macroeconomic problem exists is called
A) the recognition lag.
B) the implementation lag.
C) the impact lag.
D) the market lag.
Difficulty: Easy
75. The delay between the time at which a problem is recognized and the time at which a policy to deal with it is enacted is called
A) the impact lag.
B) the implementation lag.
C) the government lag.
D) the recognition lag.
Difficulty: Medium
76. The time between recognizing the existence of a problem and adopting a course of action to deal with the problem is called the
A) impact lag.
B) recognition lag.
C) implementation lag.
D) theory lag.
Difficulty: Easy
77. The delay between the time a policy is enacted and the time the policy has its effect on the economy is called
A) the impact lag.
B) the implementation lag.
C) the government lag.
D) the recognition lag.
Difficulty: Easy
78. The lag between the time at which a policy is put in place and the time that policy affects the economy is called
A) the recognition lag.
B) the impact lag.
C) the implementation lag.
D) the theoretical lag.
Difficulty: Easy
79. The shortest of the three lags for monetary policy is
A) the impact lag.
B) the implementation lag.
C) the government lag.
D) the recognition lag.
Difficulty: Medium
80. Which of the following explains why the monetary policy implementation lag is relatively short?
I. The FOMC meets several times a year and policymakers are easily able to confer in between meetings.
II. Open market operations, one of the Fed’s policy instruments can be put into effect
immediately.
III. The Chairman of the Fed works in close collaboration with the President.
IV. Most financial institutions are member banks and will not hesitate to put into effect any new monetary policy.
A) I
B) I and II
C) I, II, and III
D) I, II, III, and IV
Difficulty: Medium
81. The time it takes to collect and process data is the biggest source of which lag?
A) implementation lag
B) recognition lag
C) government lag
D) impact lag
Difficulty: Medium
82. The time it takes for the Fed or government policymakers to enact policies to correct unemployment or inflation problems is a source of which lag?
A) the implementation lag
B) the recognition lag
C) the government lag
D) the impact lag
Difficulty: Easy
83. Which lag stems from the fact that it takes time for people and firms to react to a policy change, to acquire or reduce loans, and to change their level of consumption?
A) the implementation lag
B) the recognition lag
C) the market lag
D) the impact lag
Difficulty: Medium
84. All of the following are sources of the impact lag except
A) it takes some time for the deposit multiplier process to work itself out.
B) firms need some time to respond to the monetary policy with respect to their investment plans.
C) it takes time for the Fed to formulate a policy that best addresses a problem in the economy.
D) a monetary change is likely to affect the exchange rate, but that translates into a change in net exports only after some delay.
Difficulty: Medium
85. The problem of lags suggests that monetary policy should
A) respond swiftly to statistical reports of economic conditions in the recent past.
B) respond to conditions expected to exist in the future.
C) stagger its implementation of policies so that there will be an ongoing effect on the economy.
D) not respond to changing economic conditions in the economy but instead rely on the economy’s self correcting mechanism.
Difficulty: Medium
86. Adjusting monetary growth based on previous changes in nominal GDP
A) is relatively easy for the Fed to undertake because the implementation lag is quitelong.
B) could be destabilizing because of the uncertainty of the length of impact lags.
C) is an effective policy because it allows the Fed to influence future macroeconomic performance.
D) raises the price level proportionately.
Difficulty: Medium
87. Possible targets for monetary policy include all of the following except
A) the government’s budget deficit or surplus.
B) money growth rate.
C) expected changes in the price level.
D) the interest rate.
Difficulty: Medium
88. Which of the following is an interest rate that the Fed has targeted in the last several years?
A) the prime rate
B) the discount rate
C) the government bond rate
D) the federal funds rate
Difficulty: Easy
89. When the Fed lowers the target rate of interest for federal funds, it
A) buys government bonds.
B) lowers the discount rate.
C) sells government bonds.
D) lowers the required reserve ratio.
Difficulty: Medium
90. When the Fed raises the target for federal funds, it
A) sells government bonds.
B) increases the discount rate.
C) buys government bonds.
D) increases the required reserve ratio.
Difficulty: Medium
91. In order to move the federal funds rate to the level it desires, the Fed must
A) first change the discount rate to the desired federal funds rate.
B) specify the interest rate on previously issued government bonds.
C) adjust the money supply to achieve the target federal funds rate.
D) limit the amount of bank lending activity.
Difficulty: Medium
92. If the Fed’s primary goal is price stability which macroeconomic variable should it target?
A) the price level itself or a particular rate of change in the price level
B) the growth rate of money supply
C) the real money supply
D) real GDP
Difficulty: Medium
93. Suppose the Fed’s primary goal is price stability and it aims to keep the inflation rate at 2%. If the inflation rate rose above 2%, what should it do?
A) pursue an expansionary monetary policy
B) pursue a contractionary monetary policy
C) reduce the required reserve ratio
D) impose a temporary ceiling on the federal funds rate
Difficulty: Medium
94. Studies in the 1980s and early 1990s showed that, in general, greater central bank independence
A) was associated with lower average inflation.
B) was associated with lower average inflation and higher average real GDP growth.
C) was associated with lower average inflation and higher unemployment.
D) was associated with higher average inflation and higher average real GDP growth.
Difficulty: Hard
95. During an economic slump, policies that lower interest rates may not actually boost investment because
A) lower interest rates tend to discourage investment, all other things unchanged.
B) investment is never affected by interest rate changes.
C) of pessimistic expectations by businesses about the future of the economy.
D) taxes may have been decreased during a recessionary period.
Difficulty: Medium
96. An effort by the Fed to reduce aggregate demand may be thwarted because
A) investment could remain the same or increase because of optimistic expectations by businesses about the future of the economy.
B) investment and interest rates are positively related.
C) investment could fall because of pessimistic expectations.
D) taxes may have been increased.
Difficulty: Medium
97. A liquidity trap is said to exist when a change in monetary policy has no effect on
A) the money supply.
B) the natural level of employment.
C) aggregate supply.
D) interest rates.
Difficulty: Medium
98. If the demand curve for money were horizontal at some interest rate, an increase in the money supply
A) would lower the interest rate.
B) would increase the rate of inflation.
C) would be highly effective in reducing inflation.
D) would not change the interest rate.
Difficulty: Medium
99. Which of the following statements is true if interest rates were zero?
A) The demand for bonds increases because bonds will be a more attractive alternative to money.
B) People will hold their wealth in the form of money rather than in bonds.
C) Bonds and money will become perfect substitutes since both are non-interest earning assets.
D) The supply of bonds will increase.
Difficulty: Medium
100. Suppose the interest rate is zero and the public expects the price level to fall by 2%. Which of the following statement is true?
A) The value of money falls by 2%.
B) Money becomes an interest earning asset; it earns a nominal interest rate of 2%.
C) Money becomes an interest earning asset; it earns a real interest rate of 2%.
D) Bonds and money will become perfect substitutes since both are non-interest earning assets.
Difficulty: Hard
101. At the end of 2008, the federal funds rate in the United States was close to zero. Which of the
following is a major concern associated with such a low rate?
A) That traditional monetary policy will have no impact on the economy.
B) Such a low rate spurs excessive consumption and investment spending which may lead to inflation.
C) Such a low rate spurs excessive consumption and investment spending which may lead to deflation.
D) Economic agents might be unwilling to borrow in anticipation of even lower interest rates.
Difficulty: Medium
102. Which of the following is a major problem with deflation?
A) Money loses value so rapidly that economic agents will be reluctant to hold money.
B) Economic agents tend to put off purchases in anticipation of lower prices for goods and services, leading to a downward spiral in economic activity.
C) Low prices for goods and services tend to result in massive shortages in most markets.
D) Money supply cannot keep pace with consumption spending.
Difficulty: Medium
103. When interest rates are near zero and traditional monetary policy is ineffective, the Fed or other central bank may resort to a strategy referred to as quantitative easing. What does this strategy involve?
A) allowing interest rates to rise slowly by providing substantial reserves for as long as is necessary to avoid inflation
B) reducing the money supply to raise the interest rates slowly without discouraging spending
C) keeping interest rates very low by providing substantial reserves for as long as is necessary to avoid deflation and encourage spending
D) increasing the money supply and interest rates at a constant rate to stimulate economic activity
Difficulty: Medium
104. What is meant by the term “credit easing”?
A) It is a strategy which involves the extension of central bank lending to influence more broadly the
proper functioning of credit markets and to improve liquidity.
B) It is a strategy which involves keeping interest rates very low by providing substantial reserves for as long as is necessary to avoid deflation and encourage spending.
C) It is a strategy which involves lowering the required reserve ratio and lowering the federal funds
rate to encourage banks to increase loan creation.
D) It is a strategy which involves allowing interest rates to rise slowly by providing substantial reserves for as long as is necessary to avoid inflation.
Difficulty: Medium
105. The rational expectations hypothesis suggests that
A) people are creatures of habit and tend not to change their economic behavior in the short run.
B) people are rational if they make forecasts about economic activity.
C) people use all available information to make forecasts about future economic activity and adjust their behavior to these forecasts.
D) people use all available information to make forecasts about future economic activity but often fail to adjust their behavior to these forecasts.
Difficulty: Easy
Use the following to answer questions 106-110.
Exhibit: Monetary Policy and Rational Expectations
106. (Exhibit: Monetary Policy and Rational Expectations) If the economy is initially operating at point a and there are no rational expectations, an expansionary monetary policy would move the short-run equilibrium from
A) a to b.
B) a to c.
C) b to a.
D) c to a.
Difficulty: Medium
107. (Exhibit: Monetary Policy and Rational Expectations) Suppose the economy is operating at point a and that individuals have rational expectations. They calculate that expansionary monetary policy
A) will raise the price level to Pd; and they adjust their expectations and wage demands shifting the short-run aggregate supply curve to AS2.
B) will raise the price level to Pc; and they adjust their expectations and wage demands shifting the short-run aggregate supply curve to AS2.
C) will raise the price level to Pb; and they adjust their expectations and wage demands shifting the short-run aggregate supply curve to AS1.
D) will keep the price level at Pa; and the short-run aggregate supply curve at AS1.
Difficulty: Hard
108. (Exhibit: Monetary Policy and Rational Expectations) Suppose the economy is operating at point a. Some people observe that an expansionary monetary policy will increase the money supply and ultimately drive the price level to the equilibrium at
A) d. They rationally adjust their behavior and the aggregate demand curve shifts to the left and d becomes the new equilibrium point.
B) b. They rationally adjust their behavior and the aggregate demand curve shifts to the left and b becomes the new equilibrium point.
C) d. They rationally adjust their behavior and the short-run aggregate supply curve shifts to the left and d becomes the new equilibrium point.
D) c. They rationally adjust their behavior and the short-run aggregate supply curve shifts to the left and d becomes the new equilibrium point.
Difficulty: Hard
109. (Exhibit: Monetary Policy and Rational Expectations) Suppose the economy is operating at point a. Some people observe that an expansionary monetary policy will increase the money supply and ultimately drive the price level to the equilibrium at
A) d. They rationally adjust their behavior, bypassing the short-run equilibrium at c.
B) d. They rationally adjust their behavior, bypassing the short-run equilibrium at b
C) b. They rationally adjust their behavior, bypassing the long-run equilibrium at d
D) a . They rationally adjust their behavior, bypassing the short-run equilibrium at b
Difficulty: Hard
110. (Exhibit: Monetary Policy and Rational Expectations) If rational expectations exist and the economy is initially operating at point d. If the Fed undertakes contractionary monetary policy the economy will
A) spend some time at c with a recessionary gap.
B) spend no time at c and move directly to b.
C) bypass c and move to a, because the short-run aggregate supply curve shifts to the left.
D) bypass c and move to a, because the short-run aggregate supply curve shifts immediately to the right and the economy moves down the long-run aggregate supply curve.
Difficulty: Hard
111. The rational expectations argument relies on
A) wages and prices being sticky so that changes in expectations about future economic activity and the price level will prevent the short-run aggregate supply curve from shifting quickly to restore long-run equilibrium.
B) the ability of monetary policy authorities to identify and respond quickly to close output gaps and restore the economy to its long-run equilibrium.
C) wages and prices being sufficiently flexible so that the change in expectations about future economic activity and the price level will allow the short-run aggregate supply curve to shift quickly to restore long-run equilibrium.
D) wages and prices being sufficiently flexible so that changes in expectations about future economic activity and the price level will allow the aggregate demand curve to shift quickly to restore long-run equilibrium.
Difficulty: Medium
112. Which of the following is an important implication of the rational expectations argument?
A) Since people form their expectations using all available information, the use of monetary policies to eliminate output gaps will lead to inflation.
B) Since any consistent set of monetary policies will be learned and anticipated by a population with rational expectations, policies designed to influence the economy to a level of production other than the potential real GDP will be ineffective.
C) Although people may revise their expectations about the price level and future economic activity, they cannot act on these changes because in reality, wages and prices are sticky. Thus, policy intervention is necessary.
D) Policymakers must constantly monitor economic activity and revise their economic policy goals to keep up with changing expectations of a population with rational expectations.
Difficulty: Medium
113. Let M = money supply; P = price level; V = velocity; Y = real GDP. The equation of exchange is given by
A) M × V = nominal GDP.
B) M × Y = P × V.
C) M × P = V × Y.
D) M × V = (1/V)P × Y.
Difficulty: Medium
114. Let M = money supply; P = price level; V = velocity; Y = real GDP. The equation of exchange is given by:
A) M × P = V × Y.
B) M × V = P × Y.
C) M × Y = P × V.
D) M × V = (1/ P) × Y.
Difficulty: Easy
115. Using the equation of exchange, if the nominal GDP is $8,000 billion and the money supply is $1,600 billion, then
A) the price level is 5.0.
B) the price level is 0.2.
C) velocity is 5.0.
D) velocity is 0.2.
Difficulty: Medium
116. The equation of exchange states that
A) saving equals investment.
B) gross domestic product equals the money supply multiplied by its velocity.
C) increases in money supply cause decreases in velocity.
D) increases in money supply cause increases in velocity.
Difficulty: Medium
117. What is velocity of money?
A) It is the number of times households convert bonds to money to facilitate economic transactions.
B) It is the rate at which money supply is spent to obtain the goods and services that make up GDP during a particular time period.
C) It is the rate at which money supply can grow while keeping the price level stable.
D) It is the number of times the money supply is spent to obtain the goods and services that make up GDP during a particular time period.
Difficulty: Easy
118. If you earn and spend $300 per week and maintain an average cash balance of $100 per week, your velocity of money is
A) $100.
B) $200.
C) 3.
D) 2.
Difficulty: Medium
119. If you earn and spend $2,000 per month and maintain an average cash balance of $500 per month, your velocity of money is
A) $1,250.
B) 2.
C) 4.
D) $1,500.
Difficulty: Medium
120. If nominal GDP = $900 billion and the public holds $300 billion in M2, then the velocity of the M2 money supply is
A) 1.
B) 2.
C) 3.
D) 4.
Difficulty: Medium
121. Suppose the public holds $200 billion in M2 and the velocity of the M2 money supply is 5. What is the value of nominal GDP?
A) $500.
B) $1,000.
C) $1,500.
D) That information cannot be determined.
Difficulty: Medium
122. If nominal GDP is $5,000 billion and the velocity of the M2 money supply is 5, what is the amount of the public’s holding in the form of M2?
A) $500 billion
B) $1,000 billion
C) $1,500 billion
D) $2,000 billion
Difficulty: Medium
123. The velocity of money is
A) independent of M, P, and Y.
B) independent of M and Y.
C) calculated from M, P, and Y.
D) calculated from M and Y.
Difficulty: Medium
124. In the equation of exchange, the variable whose value must be computed from the other variables is the
A) price level.
B) quantity of output.
C) quantity of money.
D) velocity of money.
Difficulty: Medium
125. Suppose money supply (M) = $3,960 billion, price level (P) = 1.1, and real GDP (Y) = $7,200 billion. Calculate the value of velocity using the equation of exchange.
A) 1.6
B) 1.8
C) 2.0
D) 2.2
Difficulty: Medium
126. Suppose money supply (M) = $500, price level (P) = 2, and real GDP (Y) = $1,000. Calculate the value of velocity using the equation of exchange.
A) 1
B) 2
C) 4
D) 5
Difficulty: Medium
127. Suppose money supply (M) = $500, real GDP (Y) = $1,000, and nominal GDP = $5,000. Calculate the value of velocity and the price level.
A) V = 2; P = 1
B) V = 4; P = 5
C) V = 10; P = 5
D) V = 10; P = 1
Difficulty: Hard
128. Suppose money supply (M) = $4,000, real GDP (Y) = $30,000, and nominal GDP = $60,000. Calculate the value of velocity and the price level.
A) V = 7.5; P = 2
B) V = 15; P = 2
C) V = 7.5; P = 0.5
D) V = 15; P = 15
Difficulty: Hard
129. Suppose velocity = 5, money supply = $200, and price = 2. What is the value of real GDP?
A) $10
B) $40
C) $400
D) $500
Difficulty: Medium
130. The equation of exchange always holds because
A) the quantity of money is determined by the amount of spending on goods and services.
B) the quantity of money dictates the size of nominal GDP, since money is a social usage.
C) the number of times money is spent to obtain goods and services measures total spending on GDP.
D) MV measures total spending on GDP and PY also measures of total spending on GDP.
Difficulty: Medium
131. Which of the following statements is true about velocity?
A) In the short run, velocity varies but in the long run, velocity is relatively constant.
B) In the short run, velocity is relatively constant but in the long run, velocity varies.
C) Velocity is relatively constant in the short run and in the long run.
D) Velocity fluctuates with fluctuations in economic activity and changes in the growth rate of money supply.
Difficulty: Medium
132. Which of the following equations correctly describes the quantity equation in terms of percentage rate of change? ∆ means “change in.”
A) % ∆M ÷ % ∆V = % ∆P × % ∆Y
B) % ∆M + % ∆V = % ∆P + % ∆Y
C) % ∆M ÷ % ∆V = % ∆Y ÷ % ∆P
D) % ∆M × % ∆V = % ∆P × % ∆Y
Difficulty: Medium
133. Assume that velocity is constant in the long run. Which of the following equations correctly describes the quantity equation in terms of percentage rate of change? ∆ means “change in.”
A) % ∆M ÷ % ∆P = % ∆Y
B) % ∆M +− % ∆P = % ∆Y
C) % ∆M − % ∆Y = % ∆P
D) % ∆M × % ∆Y = % ∆P
Difficulty: Medium
134. If the velocity of money is constant, then
A) a change in nominal GDP can be caused only by a change in the money supply.
B) a change in the money supply can be caused only by a change in the price level.
C) a change in the money supply is negatively related to a change in nominal GDP.
D) a change in the money supply would result in no change in nominal GDP.
Difficulty: Medium
135. If the velocity of money is constant, then a 2% increase in the money supply
A) must be the result of a 2% increase in the price level.
B) would change nominal GDP by a smaller percentage.
C) would change nominal GDP by an equal percentage.
D) would change nominal GDP by a larger percentage.
Difficulty: Medium
136. Which of the following predictions can be made using the growth rates associated with the quantity equation, assuming velocity is stable?
A) If the money supply grows at a faster rate than real GDP, there will be inflation.
B) If the money supply grows at a slower rate than real GDP, there will be inflation.
C) If the money supply grows at the same rate as real GDP, the price level will be fall and there will be deflation.
D) If the money supply grows at the same rate as real GDP, the price level will also increase at the same rate as real GDP.
Difficulty: Hard
137. If velocity is constant in the long run, which of the following results flow from the quantity theory of money?
A) A change in the money supply changes real GDP by an equal percentage.
B) A change in the money supply changes nominal GDP by an equal percentage.
C) A change in the money supply changes real interest rates by an equal percentage.
D) A change in the money supply changes consumer lending by an equal percentage.
Difficulty: Hard
138. If velocity is constant, which of the following results flow from the quantity equation?
A) Nominal GDP could change only if there were a change in the money supply.
B) In the short run, nominal GDP could change only if there were a change in the money supply and in the long run, nominal GDP could change only if there were a change in the money supply.
C) In the short run, nominal GDP could change only if there were a change in the money supply but in the long run, nominal GDP is affected by changes in any component of GDP.
D) In the short run, nominal GDP is affected by changes in any component of GDP but in the long run, nominal GDP could change only if there were a change in the money supply.
Difficulty: Hard
139. In the short-run velocity is not constant. Which of the following variables can be affected by a change in money supply?
I. real GDP
II. nominal GDP
III. the price level
A) III only
B) II and III
C) I, II, and III
D) If velocity is not constant, then none of the variables is affected.
Difficulty: Medium
140. Which of the following factors may cause velocity to fluctuate?
I. changes in interest rates
II. changes in expectations about inflation
III. changes in expectations about bond prices
IV. an increase in the number of financial products that affects the demand for money
A) I, II, III, and IV
B) I, II, and III
C) I, III, and IV
D) I and II
Difficulty: Medium
141. Using the quantity equation, the demand for money can be expressed as
A) M = (V × Y) ÷ P.
B) M = (P × Y) ÷ V.
C) M = (P × V) ÷ Y.
D) M × V = (1/ P) V × Y.
Difficulty: Medium
142. All other things unchanged, the velocity of money will
A) increase if the quantity of money demanded decreases.
B) increase if the quantity of money demanded increases.
C) decrease if the quantity of money demanded decreases.
D) fall to zero if the quantity of money demanded increases.
Difficulty: Medium
143. All other things unchanged, we expect that a reduction in interest rates will tend to
A) increase the quantity of money demanded and increase velocity.
B) increase the quantity of money demanded and reduce velocity.
C) reduce the quantity of money demanded and increase velocity.
D) reduce the quantity of money demanded and reduce velocity.
Difficulty: Medium
144. All other things unchanged, we expect that an increase in interest rates will tend to
A) increase the quantity of money demanded and increase velocity.
B) increase the quantity of money demanded and reduce velocity.
C) reduce the quantity of money demanded and increase velocity.
D) reduce the quantity of money demanded and reduce velocity.
Difficulty: Medium
145. If people wished to hold a quantity of money equal to 80% of nominal GDP, the velocity of money would be
A) 1.00.
B) 1.25.
C) 1.50.
D) 1.75.
Difficulty: Difficult
146. Suppose at present people hold a quantity of money equal to 80% of nominal GDP. What happens to velocity if people wish to increase their money holdings to 85% of nominal GDP?
A) Velocity can increase or decrease depending on people’s tastes and preferences toward money.
B) Velocity is unaffected.
C) Velocity increases.
D) Velocity decreases.
Difficulty: Difficult
147. Suppose at present people hold a quantity of money equal to 85% of nominal GDP. What happens to velocity if people wish to increase their money holdings to 80% of nominal GDP?
A) Velocity can increase or decrease depending on people’s tastes and preferences toward money.
B) Velocity is unaffected.
C) Velocity increases.
D) Velocity decreases.
Difficulty: Difficult
148. The Case in Point titled “Velocity and the Confederacy” suggests that during the Civil War, the South faced
A) hyperinflation and rising velocity.
B) hyperinflation and falling velocity.
C) deflation and rising velocity.
D) deflation and falling velocity.
Difficulty: Medium
149. In an economy experiencing hyperinflation, we expect to observe
A) an increase in the demand for money and an increase in velocity.
B) an increase in the demand for money and a reduction in velocity.
C) a decrease in the demand for money and an increase in velocity.
D) a decrease in the demand for money and a reduction in velocity.
Difficulty: Medium
150. Mary Chestnut reported in her diary that, during the Civil War, she became much less willing to hold “'Confederates,” currency issued by the Confederate State of America. Assuming that this change in preferences was widespread in the South, it suggests
A) a reduction in the demand for money and a reduction in velocity.
B) a reduction in the demand for money and an increase in velocity.
C) an increase in the demand for money and a reduction in velocity.
D) an increase in the demand for money and an increase in velocity.
Difficulty: Medium
True/False
1. The Employment Act of 1946 was an outgrowth of the Great Depression.
2. Open-market operations are such a powerful tool of monetary policy that they are seldom used.
3. When the Fed buys bonds in the open market, it pursues an expansionary monetary policy.
4. The shortest time lag for monetary policy is the implementation lag.
5. The Fed is structured as an agency of the executive branch, with the Chairman of the Fed answering directly to the President.
6. Expansionary monetary policy, by increasing the money supply, also increases interest rates and recessionary gaps.
7. Contractionary monetary policy, achieved by selling bonds in the open market, tends to discourage investment.
8. The equation of exchange can be stated as M = (V × P)/Y.
9. The equation of exchange determines the supply of money in the economy.
10. The demand for money can be stated as M = (P × Y)/V.
11. If the velocity of money is constant, then nominal GDP can change only if there is a change in the money supply.
12. When the Fed buys government bonds, bank reserves fall.
13. All other thing unchanged, when the Fed sells government bonds, it aims to shift the aggregate demand curve to the right.
14. The Fed increases the money supply by selling bonds.
15. The federal funds rate is set directly by the Fed.
16. The federal funds rate is never targeted by the Fed.
17. The Fed changes the federal funds rate using open-market operations.
18. The federal funds rate is determined by demand and supply of bank reserves.
19. Changing the required reserve ratio is an often-used monetary tool to influence the federal funds rate.
20. If inflation is a threat, the Fed is likely to engage in a contractionary monetary policy.
21. The impact lag is the time between putting a policy in place and when its effects are felt in the economy.
22. The recognition lag is the length of time it takes between recognizing a problem and adopting a policy to address that problem.
23. The Fed can raise the target for the federal funds rate by selling government bonds in the open market.
24. A liquidity trap exists when a change in the money supply immediately and drastically affects interest rates.
Short Answer
1. Suppose inflationary pressures are building up in an economy. Is this economy likely to
experience a recessionary gap or an inflationary gap? Explain how the Fed could use monetary policy to combat inflation. A complete answer must include an explanation of the policy tools that can be used and their effects on the money supply, interest rates, and aggregate demand. Use a diagram of LRAS, SRAS, and AD to illustrate your answer.
2. Explain how the Fed could use monetary policy to close a recessionary gap. A complete answer
must include an explanation of the policy tools that can be used and their effects on the money supply, interest rates, and aggregate demand. Use a diagram of LRAS, SRAS, and AD to illustrate your answer.
3. Define and explain the three lags discussed in monetary policy. For each type identify a
problem caused by the lag.
4. What is the rational expectations hypothesis? Using a diagram of the aggregate demand and
aggregate supply to illustrate your answer, explain how the hypothesis suggests that monetary policy may affect the price level but not real GDP.