Money Growth, Money Demand, And Modern + Exam Prep Ch.20

Student name:__________

1) Why does the Fed have to be concerned with money growth even though its main focus seems to be on interest rates?

2) If velocity of money is constant, real growth in the output of the economy is +2.5%, and inflation is 2.0%, what is the growth rate of money?

3) The equation of exchange which is MV = PY is an identity, which means it is true by definition. If you think carefully, what variable in the equation by the way it is defined really makes the equation of exchange an identity?

4) If the Fed wanted to target price stability, meaning zero inflation, why should it set a target rate of inflation of around one percent?

5) The CPI is a commonly used and closely watched measure of inflation. However, it has limitations. What are they?

6) If the price of money is determined by supply and demand, what impact should a decrease in the supply of money (given steady money demand) have on the price of money and the rate of inflation?

7) Assuming a constant nominal GDP, would the velocity of M1 equal the velocity of M2? Explain.

8) Irving Fisher derived the quantity theory of money from the equation of exchange. What two assumptions did he make to derive the theory and what is the basic assertion of the theory?

9) Professor Milton Friedman stated that "inflation is a monetary phenomenon." What did he mean by this statement and what is the basis for this assertion?

10) The empirical evidence on the velocity of money, specifically M2, shows it to be relatively stable over the long run. Does this imply that monetary policymakers really should focus on the growth rate of money for economic stability?

11) Is keeping money growth low when the central bank can accurately forecast real growth a guarantee that short-run inflation will not occur? Explain.

12) If the Fed wanted to keep inflation in check given the growth rate of the economy, how should they have responded to the financial innovations of the mid to late 1970s and early 1980s in terms of money growth?

13) How does money velocity contribute to the observation that in countries with high rates of inflation, the inflation rate exceeds the rate of money growth?

14) Economists are fond of calculating measures of elasticity. If we calculate the income elasticity of money as the %Δ M/%Δ PY, where M is the quantity of money held and PY is nominal income, would you suspect the coefficient to be positive, negative or zero? Will the absolute value be greater or less than 1? Be sure to explain your choices.

15) Why do people hold money? Explain the reasons.

16) In what ways have financial innovations affected the demand for money?

17) What would the portfolio demand for money look like if it were graphed on a set of axes? What would each axis represent?

18) How might fear created by an event such as the global pandemic of COVID-19 affect consumers’ demand for money?

19) Identify determinants of money demand that might be affected during an event such as the global pandemic of COVID-19. Explain.

20) If we consider the relationship between the opportunity cost of holding money and velocity that existed in the 1980s, if the Fed followed the same policymaking in the 1990s and 2000s, would they have achieved the desired results? Explain.

21) What factors can cause the portfolio demand for money to increase?

22) Is variability in velocity more of a problem in high or low inflation countries? Explain.

23) Why did a decline in mortgage rates in the 1990s cause the velocity of M2 to fluctuate?

24) On what aspect of policymaking, according to Robert Lucas, have policymakers been shortsighted in the past?

25) If monetary policymakers cannot accurately forecast shifts in money demand, what short-term policy instrument are they really only left with and why?

26) Given that the velocity of money can be unstable in the short run, is this reason enough to dismiss money growth as a policy target? Explain.

27) If the correlation between the rate of inflation and the rate of money growth were closer to −1 rather than +1 would the Fed care more or less about the growth rate of money? Explain your answer.

28) Is it a necessary condition that velocity is constant, and that real output growth is assumed to be zero to have Milton Friedman's assertion that inflation is a monetary phenomenon be true?

29) If we consider the quantity theory of money and Professor Irving Fisher, who did a lot of his work in the early 20th century, why might Professor Fisher feel less confident about predicting constant velocity of money today than when he did his work?

30) The equation for money demand that is derived from the equation of exchange is



We see that the equation does not explicitly address the interest rate. In fact, Professor Fisher assumed that velocity is constant which means 1/ V is also a constant. Why do you think Professor Fisher left the interest rate out of the equation? Do you think he would if he were alive today? Explain.

31) History shows that

A) money growth rates equal inflation rates.
B) money growth and inflation are not related.
C) countries with low rates of money growth have high rates of inflation.
D) countries with high rates of money growth have high rates of inflation.

32) In 1998 (and until 2003), the ECB explicitly assigned money a prominent role in its stability-oriented strategy by

A) stating their inflation goal as a number.
B) tying interest rate and exchange rate policy together explicitly.
C) establishing a ceiling value for the broadest monetary aggregate.
D) announcing a quantitative reference value for the growth rate of a broad monetary aggregate.

33) As of 2020, officials at which central bank(s) use monetary targets as part of monetary policy?

A) Fed
B) ECB
C) both the Fed and ECB
D) neither the Fed nor the ECB

34) Economic researchers have found

A) no examples of countries with high rates of money growth and low inflation rates.
B) many examples of countries with low rates of money growth and high inflation rates.
C) many examples of countries with high rates of money growth and low inflation rates.
D) no relationship between rates of money growth and inflation rates.

35) In studying the average annual inflation and money growth in 160 countries over the three decades that began in 1980, it is startling to see that researchers found many countries that had experienced rates of inflation that averaged

A) 0 percent a year.
B) 20 percent a year.
C) more than 200 percent a year.
D) more than 1,000 percent a year.

36) When the currency loses value, causing people to spend it more quickly, this

A) has the same effect on inflation as an increase in money growth.
B) has the same effect on inflation as a decrease in money growth.
C) causes higher inflation but not as much as an increase in money growth would.
D) causes even higher inflation than an increase in money growth would.

37) Over the long run if central banks want to avoid high rates of inflation, they need to be concerned with the

A) unemployment rate.
B) money growth rate.
C) real economic growth rate.
D) productivity of labor.

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

A) Money growth is the result of inflation.
B) The current rate of inflation is the result of money growth.
C) There is no clear link between high, sustained inflation and the monetary aggregates.
D) It is impossible to have high, sustained inflation without monetary accommodation.

39) Consider the following ratio: the average annual inflation rate/the average annual money growth rate. If a country's rate of money growth consistently exceeds the rate of inflation the ratio would be

A) less than one.
B) greater than one.
C) infinity.
D) exactly one.

40) Researchers discovered that countries with the same annual average growth rate for money of 10 percent have average annual rates of inflation that

A) are also 10 percent.
B) vary between 1 and 8 percent.
C) vary between 8 and 10 percent.
D) are about the same but higher than 10 percent.

41) If money were valued in terms of how many minutes a person needs to work to buy a dollar, an increase in the number of minutes of work needed would be

A) a decline in the price of money.
B) an increase in the price of money.
C) no change in the real price of money, just an increase in the nominal price.
D) no change in the real or nominal price of money.

42) Inflation can be thought of as

A) a decrease in the price of money.
B) an increase in the price of money.
C) no change in the price of money, just a change in the supply of money.
D) no change in the price of money, just a change in the demand for money.

43) If we look at the value of money in terms of how many units of a good it takes to buy one dollar, then inflation means

A) it would take more goods to buy the same dollar.
B) it would take fewer goods to buy the same dollar.
C) the same number of goods would buy fewer dollars.
D) it would take fewer dollars to buy the same goods.

44) The velocity of money

A) is always constant.
B) increases if more purchases are made.
C) increases if each unit of money is used less frequently.
D) increases if each unit of money is used more frequently.

45) The velocity of money equals nominal GDP

A) times the price level.
B) times the money supply.
C) divided by the price level.
D) divided by the money supply.

46) If M = the money supply, Y = real output, P = the price level, and V = velocity, which one of the following equals the velocity of money?

A) (Y ×M)/P
B) (P ×M)/Y
C) (P ×Y)/M
D) (P ×Y) +M

47) If the equation of exchange is MV = PY, the Y represents

A) nominal GDP.
B) real GDP.
C) potential output.
D) economic growth.

48) If M2 is four times larger than M1, the velocity of M1 should be

A) one-fourth of the velocity of M2.
B) equal to the velocity of M2.
C) equal to four.
D) four times larger than the velocity of M2.

49) Using the equation of exchange, if real output and the money supply stay the same and the price level increases

A) real GDP increases.
B) velocity of money increases.
C) nominal GDP remains constant.
D) the direction of the change in velocity is unknown.

50) Which one of the following expresses the equation of exchange?

A) MY = PV
B) MV = Y
C) MV = PY
D) MP = VY

51) Using the equation of exchange, if inflation is 1.5 percent, real output grows by 3.0 percent, and the growth rate of money is 5.0 percent, the change in the velocity of money is

A) zero; velocity is constant.
B) −0.5 percent.
C) +4.5 percent.
D) +0.5 percent.

52) Using the equation of exchange, if real GDP increases by 3.0 percent, the velocity of money grows by 1.0 percent and the growth rate of money is 3.0 percent; what is the rate of inflation?

A) +1.0 percent
B) −1.0 percent
C) It is constant or a 0 percent change.
D) It is the same as the growth rate of money, or 3.0 percent.

53) Using the equation of exchange, if inflation is 1 percent, the velocity of money grows by 1.0 percent and the growth rate of money is 3.0 percent; what is real growth?

A) +3.0 percent
B) 1 percent
C) 4.0 percent
D) −1.0 percent

54) If, on average, a dollar is spent four times each year to purchase real output, the velocity of money is

A) one-fourth.
B) four.
C) the money supply divided by four.
D) nominal GDP divided by four.

55) If we look at the equation for money demand that summarizes Irving Fisher’s quantity theory of money, which one of the following statements is true?

A) Velocity does not play any role in the equation.
B) Money demand is not a factor of nominal income.
C) The price level does not impact money demand.
D) There isn't an explicit role for the interest rate in the equation.

56) Based on the analysis of the equation of exchange, Irving Fisher derived the quantity theory of money which states that changes in the aggregate price level

A) are the result of unstable velocity.
B) are caused solely by changes in velocity.
C) are caused solely by changes in the quantity of money.
D) always offset changes in the product of (velocity x real GDP).

57) Key assumptions behind the quantity theory of money include that the

A) money supply is fixed.
B) velocity of money is constant.
C) percentage change in the price level equals the percentage change in real GDP.
D) change in nominal GDP is zero.

58) Milton Friedman's assertion that "inflation is a monetary phenomenon" is based on the

A) quantity theory of money.
B) assumption of constant nominal GDP growth.
C) assumption that the price level grows at the same rate as real GDP.
D) assumption that the central bank increases the money supply by a constant rate every year.

59) If we let M_d reflect money demand, in equilibrium in the money market, we can write the equation for money demand as

A) M_d =VY.
B) M_d =PY.
C) M_d = (1/V)PY.
D) M_d =V(Y/P).

60) Equilibrium in the money market would be expressed by which one of the following?

A) Ms = (1/V)Y
B) Ms =M_d
C) M_s = (1/V)P
D) M_d = (1/V)P

61) The quantity theory of money can explain which one of the following?

A) If the %ΔY > 0 and the %ΔV = 0, then %ΔP < %ΔM.
B) If the %ΔV = 0 and the %ΔM = 0, then %ΔP must be = 0.
C) If %ΔY = 0 and %ΔV = 0, then %ΔP > %ΔM.
D) If the %ΔP > 0, then %ΔM must also be > 0.

62) The quantity theory of money along with the assumption of constant velocity can explain which one of the following?

A) If real growth equals money growth, the price level is falling.
B) If real growth is higher than money growth, the price level must be rising.
C) Higher levels of real growth are accompanied by higher levels of inflation.
D) At a given level of money growth, the higher the level of real growth the lower the level of inflation will be.

63) A rate of inflation that exceeds the growth rate of money for a country could be explained by

A) a growing real economy.
B) a constant velocity of money.
C) an increasing velocity of money.
D) a decreasing velocity of money.

64) Nobel-laureate economist Milton Friedman suggested that policymakers strive to ensure that the monetary aggregates grow at a rate

A) equal to the rate of inflation.
B) equal to the rate of real growth plus the desired level of inflation.
C) equal to the rate of real growth less the desired level of inflation.
D) that is constant in terms of dollar amounts.

65) Control of money growth to stabilize inflation only works if velocity is constant. In practice, changes in velocity

A) can safely be ignored in countries with relatively low inflation rates.
B) are important when inflation is low.
C) must be taken into account no matter what the inflation rate.
D) can always safely be ignored.

66) Empirical data reveal the velocity of M2 to be

A) relatively stable in the long run.
B) highly volatile in the long run.
C) stable only when measured annually.
D) higher than the velocity of M1.

67) The velocity of M2 is

A) relatively stable across all time periods.
B) less stable than the velocity of M1.
C) more volatile in the short run than the long run.
D) unstable in the long run.

68) If money growth and real output growth are both zero, the change in the price level will

A) also be zero.
B) equal the percentage change in velocity.
C) be indeterminate.
D) be the inverse of the percentage change in velocity.

69) During economic slowdowns (recessions), the velocity of money tends to

A) remain relatively stable.
B) increase slightly.
C) increase dramatically.
D) decrease.

70) When nominal interest rates are high, the velocity of money should

A) be low.
B) also be high.
C) not change; the velocity of money does not vary with the interest rate.
D) decrease by the same percentage that the nominal interest rate has increased.

71) In the late 1970s and early 1980s, the velocity of money increased significantly. The main reason(s) for the increase was

A) controversial presidential elections along with high nominal interest rates.
B) controversial presidential elections along with low nominal interest rates.
C) the introduction of stock and bond mutual funds with draft writing privileges along with high nominal interest rates.
D) the introduction of stock and bond mutual funds with draft writing privileges along with low nominal interest rates.

72) If the nominal interest rate increases, then the

A) cost of holding money decreases.
B) cost of holding money increases.
C) velocity of money should decrease.
D) cost of holding money increases and the velocity of money should decrease.

73) In May of 2003, the European Central Bank (ECB) decided to

A) focus almost exclusively on money growth as their target.
B) downgrade the role of money growth in their policymaking strategy.
C) limit the role of interest rate targeting to be second in importance to money growth targeting.
D) switch from an inflation target to a money growth target.

74) The European Central Bank (ECB) originally assigned a prominent role to money in its monetary policy strategy because

A) velocity was easy to predict in the newly created euro area.
B) they modeled the strategy after successful policies of the German Bundesbank.
C) researchers had proven that money growth is tightly linked to inflation in the short run.
D) they had accurate data available about real growth and velocity growth for the euro area.

75) Which one of the following would reflect the transactions demand for money?

A) keeping funds in your checking account to pay your rent
B) keeping funds in your savings account because the interest rate looks relatively attractive
C) selling common stocks you own and increasing the money in your savings account because you think stock prices will fall soon
D) buying a U.S. Treasury security using funds from your checking account

76) If real GDP stays the same but the price level increases, then nominal money demand should

A) increase.
B) decrease.
C) remain the same.
D) lead to a decrease in real money demand.

77) The higher the nominal interest rate

A) the less money individuals will hold for any given level of transactions and the higher the velocity of money.
B) the more money individuals will hold for any given level of transactions and the higher the velocity of money.
C) the more money individuals will hold for any given level of transactions and the lower the velocity of money.
D) the less money individuals will hold for any given level of transactions and the lower the velocity of money.

78) The opportunity cost of holding money is the

A) nominal interest rate.
B) real interest rate.
C) nominal interest rate less the cost of converting a bond to cash.
D) rate of inflation.

79) All other factors equal, if the costs of converting bonds and other financial securities to a means of payment increase, then

A) the transactions demand for money should increase.
B) the transactions demand for money should decrease.
C) it shouldn't impact the transactions demand for money.
D) nominal interest rates should decrease.

80) All other factors equal, as nominal interest rates decrease, checking account balances should

A) increase.
B) decrease.
C) remain constant.
D) be converted to cash.

81) If you were going to write a function for money demand, you would say that the demand for money holdings varies

A) directly with both the nominal interest rate and nominal income.
B) inversely with both the nominal interest rate and nominal income.
C) inversely with nominal income and directly with the nominal interest rate.
D) inversely with the nominal interest rate and directly with nominal income.

82) All other factors constant, as the nominal interest rate increases, the opportunity cost of money

A) decreases, the velocity of money decreases, and the quantity of money people want to hold decreases.
B) increases, the velocity of money decreases, and the quantity of money people want to hold decreases.
C) decreases, the velocity of money increases, and the quantity of money people want to hold decreases.
D) increases, the velocity of money increases, and the quantity of money people want to hold decreases.

83) In high inflation countries, inflation rates can exceed the rate of growth of money because

A) high inflation decreases the velocity of money.
B) high rates of inflation increase the opportunity cost of holding money.
C) money gains value quickly with inflation.
D) some countries with high inflation do not have monetary accommodation.

84) Which one of the following would be classified as precautionary demand for money?

A) You keep $1,000 in a money market account because the return is better than a savings account at your bank.
B) You apply for and receive a credit card with a $1,000 limit.
C) You put $1,000 in a savings account at your bank for emergencies.
D) You put $1,000 in your checking account each month to cover your regular expenses.

85) Money held for precautionary reasons is included in the demand for money

A) as part of transactions demand.
B) as part of portfolio demand.
C) partly as transactions demand and partly as portfolio demand.
D) as a third, separate category called the precautionary demand for money.

86) The portfolio demand for money reflects the

A) money we hold for our everyday transactions.
B) portion of wealth people desire to hold in the form of money.
C) money we hold to purchase stocks and bonds and other financial securities.
D) money we hold for our everyday transactions and the money we hold to purchase stocks and bonds and other financial securities.

87) People have a portfolio demand for money in part because

A) money is part of a well-diversified financial portfolio.
B) the return on money is often higher than other financial assets.
C) money is needed to pay brokerage commissions.
D) there is no cost to holding money which gives it a relatively high return.

88) As a person's wealth increases, we would expect the demand for money to

A) decrease.
B) increase dollar for dollar with wealth.
C) increase but at a rate less than dollar for dollar.
D) not change; money demand does not vary with wealth, only with income.

89) A decline in the yields earned by bonds should

A) not impact the demand for money since money doesn't earn any interest.
B) decrease the demand for money.
C) increase the demand for money.
D) increase the velocity of money.

90) If an investor thinks interest rates are likely to rise, ceteris paribus, she would

A) sell her bonds and hold more money.
B) buy more bonds now and hold less money.
C) not alter her bond portfolio until interest rates actually rise.
D) not change her money holdings at all.

91) Crises that occasionally hit financial markets will increase the demand for money since

A) the return on money increases.
B) the return on financial assets increases.
C) there is no risk with holding money.
D) the risk of holding money relative to other financial assets decreases.

92) The demand for money varies

A) inversely with wealth.
B) directly with the liquidity of other financial assets.
C) inversely with the liquidity of other financial assets.
D) not all with the liquidity of other assets since money is liquid.

93) You graduate from law school and can now begin charging clients fees for your time. What impact will this have on your demand for money?

A) Your increased income will likely cause your preference for liquidity to decrease.
B) Your opportunity cost of making trips to the bank will decrease.
C) Your increased income will likely cause your demand for money to increase.
D) Your demand for money will not be affected.

94) The only solution available to a country experiencing extremely high rates of inflation is to

A) raise interest rates.
B) peg your currency to another country's currency.
C) reduce money growth.
D) revert to a gold standard.

95) Stable velocity as a contributing factor to successfully using money growth as a stabilizing monetary policy tool, is more important in an environment where

A) inflation is extremely high (e.g., over 100 percent).
B) inflation is low (e.g., less than 10 percent).
C) inflation occurs, regardless of whether the levels of inflation are high or low.
D) there is deflation.

96) For the Fed to use money growth as a direct monetary policy target, which of the following needs to exist?

A) a highly variable deposit expansion multiplier
B) a stable link between the monetary base and the quantity of money
C) a predictable link between the quantity of money and the deposit expansion multiplier
D) a stable link between the monetary base and the quantity of money and a predictable relationship between the quantity of money and the rate of inflation

97) To use money growth as a short-term monetary policy instrument, a central bank must believe that

A) there is a stable link between the monetary base and the rate of inflation.
B) only money matters.
C) there is an unpredictable relationship between money aggregates and inflation.
D) the deposit expansion multiplier is volatile and unpredictable.

98) Empirical research has shown that

A) in the 1990s and 2000s, velocity was more sensitive to an increase in the opportunity cost of holding money than in the 1980s.
B) in the 1990s and 2000s, velocity was less sensitive to an increase in the opportunity cost of holding money than in the 1980s.
C) during the 1980s and 1990s, the velocity of money was not sensitive to changes in the opportunity cost of holding money.
D) during the 1980s and 1990s, the velocity of money actually decreased as the opportunity cost of holding money increased.

99) Given that velocity was more sensitive to an increase in the opportunity cost of holding money in the 1990s and 2000s as compared to the 1980s, using the relationship from the 1980s to make monetary policy in the 1990s

A) was not possible under new leadership.
B) would not have produced the desired results.
C) could have created more price stability in the 1990s.
D) would have created a period of stable economic expansion in the 1990s.

100) Since 2015, the slope of the money demand curve has

A) gotten flatter.
B) gotten steeper.
C) not changed in slope.
D) followed the same pattern as in the 1990s.

101) To say that the relationship between the velocity of money and the opportunity cost of holding money is not stable is the same as saying

A) the supply of money is not stable.
B) the money market is always in disequilibrium.
C) money demand is stable.
D) money demand is not stable.

102) The relationship between the velocity of money and interest rates is

A) positive but not stable.
B) negative but not stable.
C) positive and stable.
D) negative and stable.

103) A major contributing factor to the instability of money demand over the past 25 years is the

A) introduction of financial instruments that pay higher returns than money but can be used as a means of payment.
B) Fed changing the way the money aggregates are defined.
C) failure of many savings and loans.
D) introduction of credit cards.

104) The Lucas critique focuses specifically on the

A) relationship between Fed policy and the money supply.
B) role that economic policymaking has on people's economic behavior.
C) inability to measure economic performance accurately.
D) moving away from fixed exchange rates to flexible exchange rates.

105) Between 1970 and 2000, the Fed

A) published their targets for money growth and often hit these targets.
B) never published targets or actual amounts for money growth.
C) published targets for money growth and rarely hit them.
D) published actual money growth but not targets.

106) Between 1970 and 2000, if the Fed had tried to hit its money growth targets, the

A) economy would have likely experienced very high inflation.
B) federal funds rate would have changed often and by large amounts.
C) interest rates would have likely been more stable.
D) economy would have likely experienced very high inflation but interest rates would have likely been more stable.

107) Statistical analysis reveals that the long-run money velocity for euro-area M3 (which is equivalent to U.S. M2)

A) is unstable in the euro area similar to the instability that exists in the United States.
B) is much more stable in the United States than in the euro area.
C) has increased in the euro area since 1980.
D) is more stable in the euro area than in the United States.

108) Which one of the following statements is true?

A) While the Fed emphasizes money growth more than the ECB, both central banks have chosen interest rates as their operating target.
B) While the Fed emphasizes money growth less than the ECB, both central banks have chosen interest rates as their operating target.
C) Because the Fed emphasizes money growth less than the ECB, the Fed uses interest rates as their operating target while the ECB looks at growth in money aggregates.
D) Both the Fed and the ECB use growth in money aggregates as their operating targets.

109) One cost that potentially could result from central banks targeting money growth is

A) high inflation.
B) a slowdown in financial innovation.
C) volatile interest rates.
D) decreased independence.

110) For a three-year period from October 1979 to October 1982, the FOMC

A) primarily targeted reserves.
B) primarily targeted the real federal funds interest rate.
C) primarily targeted M2.
D) gave up targeting reserves entirely.

111) During the period of October 1979 to October 1982, the FOMC's primary operating target resulted in

A) the most stable period for the federal funds rate in history.
B) reserves being highly volatile.
C) the federal funds rate experiencing high volatility.
D) the federal funds rate dropping to 2 percent (an all-time low to that date) and not rising above 3 percent.

112) If the nominal interest rate decreases, the

A) cost of holding money decreases.
B) cost of holding money increases.
C) velocity of money should increase.
D) cost of holding money increases, and the velocity of money should decrease.

113) All other factors equal, if the costs of converting bonds and other financial securities to a means of payment decrease,

A) the transactions demand for money should increase.
B) the transactions demand for money should decrease.
C) it shouldn't impact the transactions demand for money.
D) nominal interest rates should decrease.

114) All other factors equal, as nominal interest rates increase, checking account balances should

A) increase.
B) decrease.
C) remain constant.
D) be converted to cash.