Monetary Policy & Bankers Chapter 23 Test Bank Answers

Student name:__________

1) Identify at least three effects that can impact the economy when the central bank changes its balance sheet.

2) Explain how an easing of monetary policy works through the exchange rate and what potential impact on the economy this would have.

3) Discuss why the interest-rate transmission mechanism of monetary policy isn't as strong as most people may think it might be.

4) Lower interest rates can lead to higher home prices, and this can lead to increased household spending since homeowners can spend this additional equity. If you were a lender, is there any danger in making loans to homeowners for this new equity or are these truly risk-free loans since they are secured by the equity in the house?

5) Will an open market sale by the Federal Reserve increase banks' willingness to make loans? Explain.

6) Inflation can reduce the true cost of debt, and policymakers lower interest rates to encourage borrowing. Is it a good idea then to always take advantage of lower interest rates to borrow and rely on inflation to reduce the cost of debt and to increase your ability to repay the loan?

7) How did financial regulation affect bank lending in the 1980s?

8) The name “balance-sheet channel of monetary policy” implies that monetary policy has to impact categories on a firm's balance sheet. Explain how the balance sheet of a firm will be impacted by an increase in interest rates.

9) Why might the supply of loans increase as interest rates fall?

10) How does adverse selection factor into explaining the reduced supply of loans when interest rates increase?

11) Explain why a lowering of interest rates should raise stock prices.

12) What role, if any, did the accounting scandals involving some U.S. companies in 2001 and 2002 play in the supply of loans?

13) Explain how the asset-price channel of monetary policy works in real estate markets.

14) Explain why a corporation may find it advantageous to undertake greater investment when the value of its stock shares increase.

15) During the 2007–2009 financial crisis, what prevented policy easing from being transmitted as usual to the real economy?

16) Why can't the nominal interest rate be negative?

17) Why is deflation, combined with a recessionary gap and a nominal interest rate that cannot be reduced, a monetary policymaker's nightmare?

18) Why did the FOMC cut the target federal funds rate so aggressively between September 2007 and December 2008 in a series of 10 cuts?

19) What are the unconventional policy options that central bankers can use if the traditional target interest rate hits the lower bound?

20) What are the pros and cons of a policy of "leaning against bubbles?"

21) When faced with inflation above desirable levels, is there anything that policymakers can do about concern that a deep recession will lower inflationary expectations sharply and thereby raise real interest rates in a destabilizing manner?

22) Why are policymakers reluctant to make unconventional tools part of their regular arsenal of policy tools?

23) The chapter seems to imply that the direct influence of short-term interest rate changes by central bankers is not that powerful in terms of their direct impact on spending. Why then do so many people pay attention to monetary policy?

24) Why is it more correct to say that there may be correlation between high interest rates and the growth rate of output but there is no clear causation?

25) Explain why high levels of household debt and securitization of many mortgages made things worse than they would have been during the financial crisis of 2007–2009. Describe the new “mortgages” some economists have proposed to keep this from happening again.

26) If greater stock prices can lead to greater investment spending, should central bankers ever worry about stock prices becoming too high?

27) What are the arguments for and against monetary policymakers intervening to address equity and property price bubbles?

28) Discuss the impact of the evolving financial system on the bank-lending channel of monetary policy transmission? Evaluate what that is likely to mean for future changes in the target federal funds rate.

29) Describe how, as of early 2020, the financial crisis that ended in 2009 has had a greater impact on the shape of the financial system than any event since the Great Depression.

30) During the financial crisis of 2007–2009, which one of the following countries experienced a decline in real GDP roughly twice that of the United States?

A) Canada
B) the United Kingdom
C) Japan
D) Turkey

31) All of the following could represent the transmission of monetary policy, except which one?

A) households altering their spending on durable goods
B) income tax rates changing
C) firms altering their growth plans
D) net exports changing

32) The monetary policy transmission mechanism refers to the concept that monetary policy

A) always seems to work the way central bankers think it will.
B) works quickly.
C) only works through changes consumption and investment.
D) affects the economy in potentially many ways.

33) Traditional channels of the monetary policy transmission mechanism include

A) income tax rates.
B) interest rates.
C) fiscal policy transmission.
D) regulatory channels.

34) An easing of monetary policy should

A) increase spending by households and businesses and increase net exports.
B) raise net exports but lower spending by households and businesses.
C) decrease spending by households and businesses as well as net exports.
D) increase investment and household spending but lower net exports.

35) An easing of monetary policy means

A) decreasing the target interest rate.
B) decreasing the central bank’s balance sheet.
C) increasing reserve requirements.
D) increasing the federal funds rate.

36) Decreases in the real interest rate will result in a(n)

A) increase in net exports because it will lead to a depreciation of the dollar.
B) decrease in net exports because it will lead to a depreciation of the dollar.
C) increase in net exports because it will lead to an appreciation of the dollar.
D) decrease in net exports because it will lead to an appreciation of the dollar.

37) Which one of the following traditional channels of monetary policy transmission can be described as powerful?

A) the interest-rate channel
B) the exchange-rate channel
C) both the interest-rate channel and the exchange-rate channel
D) neither the interest-rate channel nor the exchange-rate channel

38) The interest-rate channel of monetary policy transmission appears to be

A) weak because the investment component of total spending isn't very sensitive to interest rates.
B) weak because the investment component of total spending is very sensitive to interest rates.
C) strong because the investment component of total spending isn't very sensitive to interest rates.
D) strong because the investment component of total spending is very sensitive to interest rates.

39) Changing short-term interest rates have a(n)

A) strong and immediate impact on household purchase decisions.
B) no impact on household purchasing decisions.
C) somewhat modest impact on household purchasing decisions.
D) a modest impact on current decisions and no impact on future purchasing decisions.

40) With respect to consumer behavior, the interest-rate channel of monetary policy transmission appears to be

A) weak because people's decisions to purchase cars or houses depend more on short-term rates rather than long-term rates.
B) weak because people's decisions to purchase cars or houses depend more on long-term rates rather than short-term rates.
C) strong because people's decisions to purchase cars or houses depend on the short-term rates that policymakers can change.
D) strong because it affects both spending and saving decisions.

41) The impact of monetary policy on the exchange rate and net exports is best described as

A) the strongest of all the parts of the transmission mechanism.
B) powerful, but lagging.
C) difficult to forecast.
D) nonexistent.

42) The direct impact of short-term interest rate changes by central banks on spending is

A) definitely the strongest of all transmission mechanisms.
B) not that powerful.
C) only effective for consumption but not investment.
D) only effective for net exports but not for investment and consumption.

43) Evidence suggests that

A) high real interest rates cause recessions.
B) central bankers raise real interest rates to cause recessions.
C) high real interest rates have no effect on levels of growth.
D) high real interest rates are followed by lower levels of growth.

44) The Federal Reserve's surveys of bank loan officers contain questions about all of the following except which one?

A) interest rates being charged
B) supply of and demand for loans
C) quantity and quality of loans
D) tax rates being charged

45) The Federal Reserve's surveys of bank loan officers contain questions about

A) the interest rates being charged.
B) the supply of and demand for loans.
C) the quantity and quality of loans.
D) All of the answers given are correct.

46) The Federal Reserve conducts an opinion survey on bank-lending practices because

A) if banks stop making loans and businesses can’t borrow to finance investment projects, economic growth could slow.
B) an increase in the quantity of loans granted is a signal of tighter credit standards.
C) climbing interest-rate spreads indicate that banks are engaging in riskier behavior.
D) an increase in the quantity of new loans is a leading indicator of slower economic growth.

47) Banks provide all of the following essential services for a modern economy except which one?

A) direct resources from savers to investors
B) monitor loan recipients’ use of borrowed funds
C) improve social welfare through taxes and transfers
D) solve problems caused by information asymmetries

48) The bank-lending channel of monetary policy focuses on

A) the interest rate banks charge their largest customer.
B) the willingness and ability of banks to lend.
C) how central bank policy influences the solvency of banks.
D) the deposit insurance premiums banks will end up paying.

49) An open market purchase of securities by the central bank from banks usually will

A) increase the banks' revenue even if the bank does nothing with the reserves.
B) induce the banks to make more loans since their revenue will decrease if they do nothing.
C) decrease the amount of deposits in the banking system.
D) decrease the banks' willingness and ability to make loans.

50) An open market sale of securities by the central bank to banks usually will

A) diminish the inclination of banks to make loans.
B) induce the banks to make more loans since their revenue will decrease if they do nothing.
C) increase the amount of deposits in the banking system.
D) increase the banks' willingness and ability to make loans.

51) The additional capital requirements put in place following the banking crisis of the 1980s led to a

A) quick rebound in the willingness and ability of banks to make loans.
B) further slowdown in bank lending.
C) period of rapid economic growth in the early 1990s.
D) prolonged economic slowdown lasting much of the 1990s.

52) The balance-sheet channel of monetary policy works because it can

A) increase a borrower's asset value but not the burden of their liabilities.
B) change the value of a borrower's assets and liabilities, but not a borrower's net worth.
C) increase a borrower's assets and reduce the cost of their liabilities.
D) change a borrower's net worth without affecting the value of their assets and liabilities.

53) For a firm, a decrease in the interest rate resulting from monetary policy can decrease

A) the value of its assets.
B) the cost of its liabilities.
C) its net worth.
D) the firm’s value.

54) Firm A has assets that are mainly in financial securities and liabilities that carry variable interest rates. Firm B has the same assets as Firm A and the same amount of liabilities, but its liabilities are all at fixed interest rates. If the central bank lowers interest rates, everything else constant, then

A) Firm B's net worth will increase more than Firm A's.
B) Firm A's net worth will increase more than Firm B's.
C) Neither firm's net worth will change.
D) The net worth of both firms will increase and by the same amount.

55) If a borrower's net worth increases, the

A) likelihood of moral hazard also increases.
B) borrower is likely to want to take less risk.
C) moral hazard risk for the potential lenders decreases.
D) supply of loans decreases.

56) Increases in a borrower's net worth reduce the

A) information symmetries.
B) profit potential for banks.
C) ease of obtaining financing.
D) information costs of lending.

57) What is the driving force in the bank-lending and balance sheet channels of monetary policy transmission?

A) profit
B) information
C) homogeneity
D) competition

58) A change in each of the following can contribute to the change in the supply of loans resulting from an interest rate change, except which one?

A) borrowers' net worth
B) demand for loans
C) potential of moral hazard
D) percentage of loan payment to income

59) A fall in interest rates tends to push stock prices

A) and real estate prices up.
B) and real estate prices down.
C) up and real estate prices down.
D) down and real estate prices up.

60) Bankers might be less willing to make loans even as interest rates rise when

A) the net worth of borrowers also increases.
B) the demand for loans falls.
C) there are accounting scandals.
D) there is stability in financial markets.

61) The importance of the bank-lending channel of monetary policy transmission increases

A) with the growth of loan brokers and asset-backed securities.
B) when banks contribute less to an economy’s growth over time.
C) when banks are a more important source of funds for firms and individuals.
D) because technology has solved the problems of information and moral hazard.

62) The relationship between interest rates and stock prices is referred to as the

A) interest-rate mechanism of monetary policy.
B) investment-spending mechanism of monetary policy.
C) wealth-creating mechanism of monetary policy.
D) asset-price channel of monetary policy.

63) If central bankers raise the interest rate, the asset-price channel of monetary policy implies that

A) stock prices will decrease.
B) stock prices will remain the same but bond prices will increase.
C) bond prices will remain flat.
D) stock prices will increase and bond prices will remain flat.

64) Stock prices may rise from a reduction in interest rates because

A) the present value of future earnings will increase.
B) stockholders will expect lower future earnings.
C) financial market participants are less optimistic about future earnings.
D) the present value of future earnings will decrease.

65) Stock prices rise

A) usually 6 to 12 months after interest rates are reduced.
B) immediately after interest rates are increased.
C) in anticipation of an interest rate reduction.
D) only after people are convinced the central bank interest rate cut is permanent.

66) The relationship between real estate markets and interest rates is

A) nonexistent.
B) inverse; higher interest rates drive down real estate prices and vice versa.
C) complex; cuts in the short-term interest rate lead to increases in long-term rates and higher real estate prices.
D) direct; high interest rates lead to high real estate values as people abandon other financial assets.

67) Higher home values can increase output in the economy if homeowners

A) sell their existing home and build a new one.
B) continue to build equity in their current homes.
C) plan for retirement by holding onto homes as a long-term asset.
D) use college savings plans to finance college education instead of refinancing their mortgage.

68) Higher stock prices can lead to greater investment spending by firms because the

A) cost of external financing is lower.
B) market value of a firm is now less than the replacement cost of the firm.
C) firm gets 100 percent of the increase in the stock value.
D) cost of internal financing is lower and the firm also gets 100 percent of the increase in the stock value.

69) Each of the following is a transmission channel of monetary policy, except which one?

A) balance-sheet channel
B) tax-impact channel
C) asset-price channel
D) exchange-rate channel

70) Which one of the following statements best reflects monetary policy?

A) It is a hard and fast science.
B) Its impact is impossible to predict.
C) It is a lot like gambling because the outcomes are uncertain most of the time.
D) There is certainly some science involved, a lot of understanding that is needed, but a lot of uncertainty remains.

71) The challenges facing policymakers today include each of the following, except which one?

A) The economy's sustainable growth rate is highly stable.
B) Nominal interest rates cannot fall below the effective lower bound (somewhat below zero).
C) Stock and property values are subject to booms and busts.
D) The structure of the economy and financial system continues to evolve.

72) To compensate for the collapse of intermediation and the fragility of financial markets during the 2007–2009 financial crisis, central banks deployed all but which one of the following unconventional tools?

A) forward guidance
B) lowering interbank lending interest rate targets
C) quantitative easing
D) targeted asset purchases

73) All but which one of the following is a reason that policymakers are concerned about the strength of the rebound from the 2007–2009 financial crisis?

A) Banks would make credit expensive and difficult to obtain.
B) Investors would be cautious about buying securitized assets.
C) Households would prefer to save more and borrow less.
D) The pace of technological change would slow.

74) The information problems that intensified the financial crisis of 2007–2009 are similar to those that exist in the market for

A) oil.
B) eggs.
C) wheat.
D) used cars.

75) All but which one of the following could be adjusted as a means of deflating asset price bubbles?

A) tariffs
B) capital requirements
C) capital surcharges
D) fees for insuring the capital of banks

76) If a zero-coupon bond sells for par, the nominal interest rate on that bond is

A) 100 percent.
B) negative.
C) zero.
D) infinity.

77) Bonds must have yields above the effective lower bound because

A) people can always hold cash.
B) central banks cannot act boldly when facing deflation.
C) the U.S. Treasury guarantees all bonds to have a positive yield.
D) the banking technology does not exist to deal with negative yields.

78) The fact that investors can always hold cash creates

A) a problem for monetary policymakers when the short-term interest rates approach zero.
B) an opportunity for the U.S. Treasury to issue bonds that have negative nominal interest rates.
C) an upward bound on nominal interest rates.
D) negative nominal interest rates.

79) One of the limiting factors for using monetary policy is that

A) the central banks are limited in their ability to print money.
B) central banks are limited in their ability to make loans.
C) there is a lower nominal-interest-rate bound of zero.
D) the real interest rate cannot fall below zero.

80) Firms have a harder time getting loans during periods of deflation because

A) deflation increases the net worth of firms.
B) deflation aggravates information problems in ways dissimilar to inflation.
C) the economy’s self-adjustment process works more quickly during deflation.
D) for a firm seeking a loan, deflation increases the real amount of their assets but doesn’t change the value of their liabilities.

81) A way for policymakers to avoid the problems that deflation can present and still meet their objective of price stability is to

A) set a target of zero inflation.
B) keep the monetary base fixed.
C) set a higher inflation target.
D) target a nominal interest rate of zero.

82) Most central bankers do not set an inflation target of zero because

A) it is almost impossible to achieve.
B) they believe it would cause price volatility.
C) the central bank could hit the lower bound.
D) it is difficult to act preemptively.

83) When central bankers are acting preemptively, they are

A) letting markets work and taking a wait and see approach.
B) aggressively trying to hit a zero-inflation target.
C) usually focused on reducing expansionary gaps.
D) taking bold steps to stabilize the economy.

84) Between September 2007 and December 2008, the FOMC reduced the target federal funds rate 5.25 percentage points toward zero. A reason for this was that the FOMC

A) was acting preemptively.
B) feared over stimulating the economy.
C) was taking a wait-and-see approach to previous cuts.
D) was feeling political pressure to act.

85) If the target federal funds rate reaches the lower bound

A) the FOMC would run out of policy options.
B) monetary policy would no longer be of use.
C) the FOMC would turn to unconventional measures, such as forward guidance.
D) the FOMC would simply reset the target.

86) If the target federal funds rate reaches the lower bound, the FOMC

A) must stop purchasing securities since they cannot lower nominal rates below the lower bound.
B) would likely shift their focus to purchasing longer-term securities.
C) would likely raise the required reserve rate.
D) would likely raise the discount rate.

87) Policymakers are often reluctant to turn to unconventional monetary policy measures because

A) they are uncertain of the quantitative impact of using them.
B) such policies are potentially too powerful.
C) such policies require Congressional approval and Congress is often slow to act.
D) such policies require coordination with the central bankers of foreign countries.

88) Think about the consequences of a shock that depresses aggregate expenditure and leads to a recessionary gap. Under normal circumstances, the central bank could use conventional monetary policy tools and

A) seek to reduce expectations of future policy rates.
B) cut the nominal interest rate enough to lower the real interest rate.
C) use its balance sheet to expand the monetary base.
D) purchase securities of different maturities to affect their market prices and rates.

89) Think about the consequences of a shock that depresses aggregate expenditure and leads to a recessionary gap. Suppose that inflation is zero, and the overnight interest rate falls to the effective lower bound. Which one of the following unconventional monetary policy tools would likely not work in this scenario?

A) Seek to reduce expectations of future policy rates.
B) Use its balance sheet to expand the monetary base.
C) Purchase securities of different maturities to affect their market prices and rates.
D) Set an inflation objective low enough to combat price instability.

90) Price bubbles, such as those that occurred in markets for equity and property in 2007–09, are identified

A) by earnings reports that are overstated.
B) while they are happening by a sharp rise in prices.
C) after the fact by a sharp rise and then a sharp decline in prices.
D) when financial asset prices reflect the book value of companies.

91) Monetary policymakers could keep equity and property price bubbles from developing by

A) raising their interest rate target when they suspect a bubble.
B) lowering their interest rate target when they suspect a bubble.
C) expanding the money supply in the economy.
D) purchasing U.S. Treasury securities to drive up their prices.

92) When equity and property prices collapse (bust), bank balance sheets are impaired because

A) banks hold a lot of corporate stocks.
B) banks own a lot of property outright.
C) the collateral that is backing many of the loans banks have made is now worth less.
D) banks hold a lot of corporate stocks and they also own a lot of property outright.

93) Some people who believe monetary policymakers should not address equity and property price bubbles argue their position based on

A) their belief that government should stay out of private matters.
B) their belief that staying out of the economy promotes stability.
C) the lack of experience policymakers have with financial markets.
D) the observation that price bubbles are virtually impossible to identify when they are developing.

94) Over the past 30 years, bank loans as a percentage of total credit

A) increased from less than 60 percent to over 90 percent.
B) stayed fairly constant at around 80 percent.
C) decreased from accounting for virtually all the credit to less than 60 percent.
D) dropped from 75 percent to less than 30 percent.

95) The importance of the bank lending transmission mechanism of monetary policy

A) has increased over the past 30 years.
B) decreased during the three decades leading up to the financial crisis of 2007–2009.
C) should continue to grow in importance.
D) has always been the weakest of all the mechanisms.

96) Changes such as the movement away from bank lending toward asset-backed securities leading up to the financial crisis of 2007–2009

A) increase the importance of the bank-lending channel of monetary policy.
B) eliminated the bank-lending channel as a mechanism for monetary policy.
C) do not affect the importance of the bank-lending channel.
D) require central bankers to rethink quantitative impacts of changing policy tools.

97) The movement away from bank lending toward asset-backed securities leading up to the financial crisis of 2007–2009

A) increased the importance of the bank-lending channel of monetary policy.
B) eliminated the bank-lending channel as a mechanism for monetary policy.
C) decreased the importance of the bank-lending channel.
D) led the FOMC to abandon interest-rate targets.

98) Instruments that have been securitized are created when

A) the central expands its balance sheet.
B) consumers carry debt on more than five credit cards at the same time.
C) mortgages are bundled, but no other instruments can become securitized.
D) a broker bundles together a large number of financial instruments such as home mortgages and then sells shares in the pool.

99) Which one of the following statements is most correct?

A) The use of monetary policy in the United States has not changed much since the creation of the Fed.
B) The quantitative impact on output of altering the target federal funds rate has been quite stable.
C) Monetary policymakers operate in an environment with very little uncertainty.
D) Monetary policymakers operate in an environment where change is quite common.

100) Increases in the real interest rate will result in a(n)

A) increase in net exports because it will lead to a depreciation of the dollar.
B) decrease in net exports because it will lead to a depreciation of the dollar.
C) increase in net exports because it will lead to an appreciation of the dollar.
D) decrease in net exports because it will lead to an appreciation of the dollar.

101) Stock prices may rise from a reduction in interest rates because

A) consumer and business confidence about future growth improves.
B) stockholders will expect lower future earnings.
C) financial market participants are less optimistic about future earnings.
D) the present value of future earnings will decrease.

102) Each of the following is a transmission channel of monetary policy, except which one?

A) household net worth channel
B) treasury securities channel
C) asset-price channel
D) exchange-rate channel

103) Bonds cannot have yields below the effective lower bound because

A) the U.S. Treasury guarantees all bonds to have a positive yield.
B) the banking technology does not exist to deal with negative yields.
C) people can always hold cash.
D) monetary policymakers have no restrictions.

104) In theory, lower real interest rates will tend to cause all but which one of the following to increase?

A) consumption spending
B) investment spending
C) net exports
D) government spending

105) The driving force in the balance-sheet channel of monetary policy mechanism is

A) information.
B) timing.
C) asset diversity.
D) bank net worth.

106) One impact of the 2007–2009 financial crisis was to heighten the challenges faced by monetary policymakers. All but which one of the following outcomes grew more prominent as a result of the crisis?

A) Stock and property values tend to go through boom and bust cycles.
B) The nation’s current account deficit keeps widening.
C) Policymakers options are limited since the nominal interest rate cannot fall below the effective lower bound.
D) The structures of the economy and financial system are constantly evolving.