Download midterm exam 3

ECO 212
Fall 2010 Semester
Midterm 3
Exam No. ________
Name: _______________________
ID #: ________________________
Part I Use the space provided or the back of the page if necessary.
1.
Both Keynesian and classical economists agree that if wages and prices adjust
rapidly, then the use of monetary policy to try to smooth out fluctuations in output and
employment is unnecessary. Both types of economists agree that if wages and prices
cannot adjust within a reasonable period of time, then the use of monetary policy makes
sense.
Suppose the economy’s adjustment of wages and prices to shocks takes place with time
lags that are unpredictable in length – sometimes the adjustment is slow.
Suppose the response of the economy to the effects of monetary policy (like lowering
interest rates) takes place with time lags that are unpredictable in length – sometimes the
impact is after a long lag.
How would these two features affect the desirability of using monetary policy to try to
counteract a business cycle slowdown?
2.
Should a country with a history of high inflation -- as well as erratic and/or
irresponsible government – adopt a fixed exchange rate? Discuss the arguments both for
and against such a proposal.
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3.
The recent global financial crisis exposed several weaknesses in the world’s
financial system. One is that small countries (like Iceland and Ireland) can be the home of
financial institutions that are not only “too-big-to-fail”, but also “too-big-to-rescue”. In
the latter case, the cost of rescuing a large bank may be beyond the capability of the
government. Some people think such cases require the creation of an “International
Lender of Last Resort” (ILLR), that would rescue such financial institutions instead of the
government. Given what we know about the advantages and disadvantages of a single
country’s lender of last resort – what advantages and risks do you see in the proposal to
create an ILLR? Would you be in favor?
4.
The government of a country maintaining a fixed exchange rate is similar to a
bank in several ways.
A bank accepts deposits, and promises that those deposits can be turned back into cash.
Most of the deposits are turned into illiquid assets. (The bank hopes/expects that not all
depositors will withdraw funds at once.) If all the depositors rush to convert their deposits
into cash, the bank will face a liquidity crisis, in which it may be unable to fulfill its
promise without significant outside help.
A government has illiquid assets, and promises that holders of its domestic currency can
be converted into foreign exchange at a fixed rate. (The government hopes/expects that
not all holders of currency will try to convert into foreign exchange at once.) If all holders
of currency rush to convert their currency into foreign currency, the country will face a
liquidity crisis, in which it may be unable to fulfill its promise without significant outside
help.
A bank can be rescued from a panic and liquidity crisis by a lender of last resort. Could a
government be rescued from a panic by an ILLR? If so, who do you propose should
fund/manage/direct the ILLR, and what regulatory or oversight authority should it have?
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Part II: Instructions: Select the best answer for each question and record your answer
on the exam.
1.
When domestic real interest rates rise, the foreign exchange value of the domestic
currency ____; when domestic nominal interest rates rise because of a rise in the
expected rate of inflation, the foreign exchange value of the domestic currency _____.
a.
b.
c.
d.
e.
appreciates
depreciates
depreciates
appreciates
none of the above.
appreciates
depreciates
appreciates
depreciates
2.
An increase in the expected future exchange rate (# units of foreign currency per
one unit of domestic currency) will:
a.
cause the demand for domestic assets and domestic currency to rise, and cause the
domestic currency to appreciate.
b.
cause the demand for domestic assets and domestic currency to rise, and cause the
domestic currency to depreciate.
c.
cause the demand for domestic assets and domestic currency to fall, and cause the
domestic currency to depreciate.
d.
cause the supply of domestic assets and domestic currency to rise, and cause the
domestic currency to depreciate.
e.
cause the supply of domestic assets and domestic currency to fall, and cause the
domestic currency to depreciate.
3.
The term capital mobility refers to:
a.
the absence of traffic congestion in a country’s major city.
b.
the concentration of employment opportunities that occurs in a country’s largest
city.
c.
the absence of barriers to buying or selling foreign assets, or to foreigners buying
or selling domestic assets.
d.
the ability of firms to move their manufacturing operations to countries (like
China) that have lower wages.
e.
the ability of firms to replace high-wage domestic workers with low-wage foreign
workers.
4.
When a central bank purchases its own currency in foreign exchange markets in
order to raise the foreign exchange value of the currency, this transaction is called _____.
This transaction also has the effect of _____ the domestic money supply.
a.
b.
c.
intervention
intervention
sterilization
raising
lowering
raising
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d.
e.
open market operations
open market operations
raising
lowering
5.
When a central bank carries out a sterilized intervention in foreign exchange
markets, it wishes to change (the) _____ but does not want to change (the) _____.
a.
b.
c.
d.
e.
domestic interest rates
foreign exchange rate
foreign exchange rate
domestic money supply
domestic money supply
foreign exchange rate
holdings of international reserve assets
domestic money supply
foreign exchange rate
domestic interest rates
The following information relates to the next 2 questions:
Iceland had the following transactions with the outside world in 2010:
Exports of fish:
Imports of oil:
Repayment of old foreign debt:
Remittances received from abroad:
New borrowing from foreign lenders:
Interest payments made on foreign debt:
$200
$250
$300
$100
$350
$20
6.
Iceland’s current account balance in 2010 is:
a.
b.
c.
d.
e.
+ $30
-$50
+$50
+$70
-$30
7.
Iceland’s official reserve transaction balance in 2010 is:
a.
b.
c.
d.
e.
+ $30
-$50
+$80
+$70
-$80
8.
If the velocity of money is unstable, then _____ is unstable and _____ is unstable.
a.
b.
c.
d.
e.
the LM curve
the LM curve
the IS curve
the IS curve
the IS curve
the AD curve
the AS curve
the AS curve
the AD curve
the LM curve
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9.
The Quantity Equation says that the total nominal GDP of a country in a given
year is equal to:
a.
b.
c.
d.
e.
the money supply.
the velocity of money.
the money demand.
real balances.
the money supply multiplied by the velocity of money
10.
The Keynesian Theory of Money Demand states that the motives for holding
money include the:
a.
b.
c.
d.
e.
inflationary, precautionary, and investment motives.
speculative, normative, and positive motives.
transactions, savings, and investment motives.
savings, spending, and precautionary motives.
the speculative, transactions, and precautionary motives.
11.
The diagrams above show 2 different ways a person could spend $1000 per month
according to the Baumol-Tobin model. When the person switches from the method in
graph (A) to the method illustrated in graph (B), this results in:
a.
b.
c.
d.
e.
an increase in spending.
a fall in the interest rate.
an increase in the velocity of money.
an increase in money demand.
a fall in nominal GDP.
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12.
According to Milton Friedman’s Modern Quantity Theory, money demand
depends inversely on rb – rm, where rb is the expected return on bonds and rm is the
expected return on money. According to Friedman, when rb rises:
a.
b.
c.
d.
e.
money demand will rise.
spending rises.
competition among banks to attract deposits will cause rm to rise.
rm will fall.
the velocity of money will rise.
13.
Modern monetary theory has identified other ways that expansionary monetary
policy can affect nominal GDP – even if interest rates are not sensitive to changes in the
money supply. These other ways include:
(i)
(ii)
(iii)
(iv)
the bank lending channel
the balance sheet channel
the cash-flow channel
the unanticipated price level channel
a.
b.
c.
d.
e.
only (i) is true.
only (ii) is true.
only (iii) and (iv) are true.
only (i) and (iv) are true.
(i), (ii), (iii), and (iv) are all true.
14.
If investment spending by firms is unstable, then ____ will be unstable. Interest
rates will tend to _____ during recessions.
a.
b.
c.
d.
e.
the LM curve
the IS curve
the IS curve
the LM curve
the AS curve
rise
fall
rise
fall
rise
15.
If recessions are caused by sudden and unexpected changes in money demand,
then in a recession, interest rates will tend to _____, and the central bank should follow a
_____ target.
a.
b.
c.
d.
e.
rise
fall
rise
fall
rise
inflation
exchange rate
interest rate
price level
velocity
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16.
According to the Keynesian Theory of Money Demand, money demand is
sensitive to the level of interest rates because the _____ is sensitive to interest rates.
a.
b.
c.
d.
e.
transactions demand for money
speculative demand for money
precautionary demand for money
excess reserve to deposit ratio
currency to deposit ratio
17.
The Quantity Theory of Money Demand states that the velocity of money should
_________ . Actual data from the economy suggest that the velocity of money is
__________.
a.
b.
c.
d.
e.
rise during recessions;
fall during recessions;
rise during recessions;
remain fairly constant;
none of the above.
fall during recessions.
rise during recessions.
fairly constant.
rise during recessions.
18.
add:
In order to find the monetary base on the central bank's balance sheet, one would
a.
b.
c.
d.
e.
loans to commercial banks plus central bank notes.
loans to commercial banks plus deposits of government agencies.
central bank notes plus deposits of banks at the central bank.
international reserve assets plus loans to commercial banks
none of the above.
19.
“Interest Rate Targeting” is the monetary policy supported by economists who
believe that the likely cause of recessions is:
a.
b.
c.
d.
e.
disruptions to the supply of labor.
unexpected changes to the money supply.
unexpected changes in technology.
sudden changes in money demand.
sudden changes to the willingness of businesses to invest.
20.
In the Keynesian view of money demand, the _________ motive for holding
money is related to its role as a store of wealth. If money held because of this motive
increased suddenly, that would imply that _____________.
a.
b.
c.
d.
e.
speculative
precautionary
transactions
precautionary
none of the above.
the velocity of money would rise suddenly
interest rates would rise
the price level would rise
output would fall
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