Download ECN202 Practice Questions: Domestic Money

ECN202
Practice Questions: Domestic Money
Interest rate Wages
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
7.7
8.3
8.6
8.3
6.8
5.3
4.4
6.3
6.3
6.0
316.8
326.3
338.1
349.3
358.1
367.8
378.4
390.7
399.5
412.7
CPI
113.6
118.3
124.0
130.7
136.2
140.3
144.5
148.2
152.4
156.9
Inflation
rate
3.6
4.1
5.4
4.2
3.0
3.0
2.6
2.8
3.0
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
Interest rate
Wages
CPI
Inflation rate
6.1
5.1
5.5
6.2
4.1
3.1
2.1
2.8
3.9
4.6
431.3
448.0
462.5
480.4
493.2
506.1
517.3
528.6
543.9
566.6
160.5
163.0
166.6
172.2
177.1
179.9
184.0
188.9
195.3
199.3
2.3
1.6
2.2
3.4
2.8
1.6
2.3
2.7
3.4
2.1
1. What was the real interest rate in 2001?
a. 6.9
b. 4.1
c. 2.8
d. 1.3
The real interest rate is based on the formula r = n - i = 4.1 - 2.8 = 1.3
2. What graph best demonstrates the relationship between interest rate (Y) and the inflation rate (X) in the US
economy.
a. a
b. b
c. c
d. d
e.e
The two graphs tend to mirror each other so you would expect a positive relationship.
3. Which one of the following statements is not true when we look at the economic history of the capital market in the
last 20 years in the 20th century?
a. nominal interest rates tended to peak in the early 1980s
b. short-term interest rates tend to be more volatile than long-term interest rates
c. interest rates on the federal debt tend to be higher than rates on corporate rates
d. short-term interest rates tend to be lower than long-term interest rates
e. the spread between Aaa and Baa corporate bonds widened in the Great Recession
The only wrong statement here is the assertion that interest rates on the federal debt tend to be higher than rates on
corporate rates
4. In 1998 there was a financial crisis in Argentina that was reflected in the international bond market. What we saw
was the interest rates on Argentina's bonds increased relative to the bonds of the US that were seen as a safe
investment. The widening gap between the interest rates on Argentina's and the US's bonds would be an example of the
____ effect.
a. inflation risk
b. maturity risk
c. default risk
d. deflation risk
Because we are talking about the likelihood of a country being unable to repay its debt, this is the default risk.
5. In the graph we have time-series graphs of two interest
rates. Based on the theory of interest rates, which of the
following is the best description of the two lines?
a. if the dashed line is the rate on municipal bonds the
solid could be the rate on corporate bonds
b. if the dashed line is the rate on short-term
government bonds the solid could be the rate on
long-term government rates
c. if the solid line is the rate on municipal bonds the
dashed could be the rate on long-term government
bonds
d. if the solid line is the rate on Baa bonds the dashed
could be the rate on Aaa bonds
It you go back to the differences between interest rates you will find that the dashed line is the higher rate – and that is
true only for answer c - the solid line is the rate on municipal bonds the dashed could be the rate on long-term
government bonds
Dd2@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@
6. Given the mechanics of monetary policy, which of the following policies do you think the Fed would undertake to
increase the money supply?
a. OMO sales of securities
b. increase in the discount rate
c. reduction in excise taxes
d. decrease in required reserve rate
The Fed’s three tools for increasing the money supply are lowering the required reserve rate, lowering the discount
rate, or purchasing government securities (OMO).
7. The 1970s was a decade where the Fed experimented with monetary policy as a tool to manage the macroeconomy.
Which of the following policies do you think the Fed should have undertaken in the late 1990s if it were worried about
rising inflation rates?
a. decrease the discount rate
b. OMO sales of securities
c. reduce excise taxes
d. decrease the required reserve rate
The Fed would want to slow down the overheated economy and the three tools for decreasing the money supply are
raising the required reserve rate, raising the discount rate, or selling government securities (OMO).
8. This is a graphical representation of the money market
as Keynes saw it. Based on this Keynesian view, if you
knew the economy was moving out of a recession then
how would you show this in the graph?
a.
b.
c.
d.
shift the D curve in
shift the D curve out
shift the S curve in
shift the S curve out
An increase in income increases money demand – and this shifts the money demand curve out.
9. Above is a graphical representation of the money market as Keynes saw it. Based on this Keynesian view, if the FED
purchased government securities, then how would you show this in the graph?
a.
b.
c.
shift the D curve in
shift the D curve out
shift the S curve in
d.
shift the S curve out
The Fed’s purchase of securities increases money supply – and this shifts the money supply curve out.
10. In 1995 the money supply decreased. Which of the following would be a potential explanation, according to
Keynesians, for decreases in the money supply such as we saw in 1995?
a. the Fed tries to free up banking reserves by lowering the required reserve rate
b. the Fed lowers the target for the federal funds rate
c. the Fed's open market sales of securities
d. households reallocate their portfolios to include less cash and currency
To decrease the money supply the Fed needs to conduct open market sales of securities
11. Based on the Keynesian view of the money market, if you knew the economy was contracting and the Fed was
conducting open market purchases of securities, then which of the following would be true?
a. interest rates will rise, but we cannot predict what will happen to the money supply
b. interest rates will fall, but we cannot predict what will happen to the money supply
c. money supply will rise, but we cannot predict what will happen to interest rates
d. money supply will fall, but we cannot predict what will happen to interest rates
OM purchases means increase Ms and contracting economy means declining demand - so we know the interest rate
will fall
12. In the late 1970s there was a BIG ideological shift that took place at the Fed when Fed Chair Paul Volcker
announced a policy shift that moved the Fed policy toward monetarism. Which of the following best reflects the shift in
attitudes at the Fed? The Fed _______
a. should refocus its efforts on maintaining the level of unemployment at its full employment rate
b. should refocus its attention on the money supply and stop trying to stabilize interest rates
c. should focus its attention on the budget deficit that were rising under Reagan
d. should stop focusing its attention on stabilizing the money supply
It was very clear - start looking at money supply
13. We know that both fiscal and monetary policies can be used to manage the macro economy and that there are times
when one might be more effective than the other. What if you knew that American consumers have become more
highly leveraged - they owe far more than consumers did twenty years so debt payments represent a far bigger share of
their income. If the higher debt for American's means that American's spending is more sensitive to movements in
interest rates, then
a. fiscal policy has become more effective
b. monetary and fiscal policy are both more effective today
c. monetary and fiscal policy are both less effective today
d. monetary policy is more effective today
If AD is more sensitive to interest rates then this helps monetary policy since this is how monetary policy works.