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Macroeconomics (Acemoglu/Laibson/List)
Chapter 11 The Monetary System
11.1 Money
1) When an asset is traded for goods and services it is serving the function of a ________.
A) store of value
B) unit of account
C) loanable fund
D) medium of exchange
Answer: D
Difficulty: Easy
AACSB: Analytical Thinking
Topic: The Functions of Money
2) When an asset enables people to transfer purchasing power into the future it serves the
function of a ________.
A) store of value
B) unit of account
C) medium of exchange
D) means of deferred payment
Answer: A
Difficulty: Easy
AACSB: Analytical Thinking
Topic: The Functions of Money
3) When an asset is used as a universal yardstick that is used for expressing the worth of different
goods and services, it is serving the function of a ________.
A) store of value
B) unit of account
C) medium of exchange
D) loanable fund
Answer: B
Difficulty: Easy
AACSB: Analytical Thinking
Topic: The Functions of Money
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4) Which of the following statements is true?
A) One of the limitations of using money is that it does not allow for the transfer of purchasing
power into the future.
B) The necessary condition required for money to function as a medium of exchange is that it
also needs to be a store of value.
C) Hours of labor that go into producing a product is a better unit of account than paper money.
D) When money is used as a yardstick to describe the price of various goods and services, it is
serving as a store of value.
Answer: B
Difficulty: Medium
AACSB: Analytical Thinking
Topic: The Functions of Money
5) Anne works as a babysitter. She uses her wage as a babysitter to buy a pair of roller skates. In
this case, money served the function of ________.
A) a medium of exchange
B) a store of value
C) a unit of account
D) a means of deferred payment
Answer: A
Difficulty: Easy
AACSB: Application of Knowledge
Topic: The Functions of Money
6) Ryan saved $50,000 last year in his bank account so that he could buy a car this year. In this
case, money served the function of a ________.
A) medium of exchange
B) store of value
C) unit of account
D) means of deferred payment
Answer: B
Difficulty: Easy
AACSB: Application of Knowledge
Topic: The Functions of Money
7) Which of the following statements is true of money?
A) Paper money was invented around 1,000 A.D. in China.
B) Fiat money was used in the barter system of exchange.
C) Paper money was the first form of money to be invented.
D) One of the limitations of paper money is that it does not function as a store of value.
Answer: A
Difficulty: Easy
AACSB: Analytical Thinking
Topic: Types of Money
2
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8) ________ money refers to something that is used as money but that is otherwise worthless and
typically has the backing of the government or a central bank.
A) Commodity
B) Fiat
C) Representative
D) Federal
Answer: B
Difficulty: Easy
AACSB: Analytical Thinking
Topic: Types of Money
9) The paper currency that is currently being used in the U.S. is an example of ________ money.
A) hard
B) fiat
C) commodity
D) price-indexed
Answer: B
Difficulty: Easy
AACSB: Analytical Thinking
Topic: Types of Money
10) In theory, any object ________ could play the role of fiat money.
A) that has an unlimited demand
B) for which demand is limited
C) in unlimited supply
D) in limited supply
Answer: D
Difficulty: Medium
AACSB: Analytical Thinking
Topic: Types of Money
11) Which of the following is true of fiat money?
A) Fiat money is not backed by a physical commodity.
B) Fiat money is illegal and difficult to counterfeit.
C) The technology required to produce fiat money is not widely available.
D) The raw materials required for the production of fiat money are available only in a few
countries.
Answer: A
Difficulty: Easy
AACSB: Analytical Thinking
Topic: Types of Money
3
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12) The paper currency used by the U.S. at the beginning of the Civil War was referred to as a
demand note because:
A) it was used to create the demand for various goods and services.
B) demand for the currency was kept constant over the entire period of Civil War.
C) the currency could be exchanged for gold on demand.
D) it was limited in supply, and there was always an excess demand for the currency in the
country.
Answer: C
Difficulty: Easy
AACSB: Analytical Thinking
Topic: Choice and Consequence: Non-Convertible Currencies in U.S. History
13) The "gold-standard" is a system in which:
A) paper currency is backed by gold.
B) people use gold as a medium of exchange.
C) gold mining firms own the right to print currency.
D) gold is imported into the U.S. in exchange of paper currency.
Answer: A
Difficulty: Easy
AACSB: Analytical Thinking
Topic: Choice and Consequence: Non-Convertible Currencies in U.S. History
14) M2 adds together:
A) currency in circulation, savings accounts, and held with foreigners.
B) currency in circulation, checking accounts, savings accounts, travelers' checks, and money
market accounts.
C) currency in circulation, checking accounts, savings accounts, travelers' checks, and currency
held with foreigners.
D) currency in circulation and currency held with foreigners.
Answer: B
Difficulty: Medium
AACSB: Analytical Thinking
Topic: The Money Supply
15) In the United States, money supply is most commonly referred to as ________.
A) M1
B) M2
C) M3
D) M4
Answer: B
Difficulty: Easy
AACSB: Analytical Thinking
Topic: The Money Supply
4
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16) Which of the following statements is true?
A) Currency in circulation in any economy is likely to be equal to the total money supply in the
economy.
B) Currency in circulation in any economy is likely to be less than the total money supply in the
economy.
C) In the United States, currency in circulation accounts for more than 50% of the total money
supply.
D) In the United States, currency in circulation accounts for less than 1% of the money supply.
Answer: B
Difficulty: Easy
AACSB: Analytical Thinking
Topic: The Money Supply
17) Sheena gets her paycheck on the first day of every month and spends it over the month to
purchase various goods and services. What are the functions that money is performing in this
case?
Answer: Since Sheena is using money as means to purchase goods and services, it is acting as a
medium of exchange. Moreover, she receives her salary on the first of every month and spends it
over the month. This implies, money is also acting as a store of value.
Difficulty: Medium
AACSB: Application of Knowledge
Topic: The Functions of Money
18) What is the main difference between the type of money that was used before the invention of
the printing press and today?
Answer: In the days before the invention of the printing press, most societies used something
that is valuable itself as money, for example, gold, silver, chickens, and even goats. Today, in
most of the world, money is fiat money. Fiat money refers to something that is used as money
but is otherwise worthless and is typically backed by the government or the central bank of a
country.
Difficulty: Medium
AACSB: Analytical Thinking
Topic: Types of Money
19) Is there any risk involved in using fiat money? How can it be minimized?
Answer: One of the problems of using fiat money is that since it is actually worthless, it is easy
to counterfeit. Hence, the risk of counterfeiting fiat money and using it to purchase goods and
services is comparatively higher. This problem is partially resolved by having the supply of
money controlled by the government. The government can create fiat money that is difficult and
illegal to counterfeit.
Difficulty: Medium
AACSB: Analytical Thinking
Topic: Types of Money
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20) If the money supply in an economy is $100,000, currency in circulation is $50,000, amount
in savings accounts is $18,000, travelers' checks is $12,000, and the amount in money market
accounts is $9,000, then what is the amount held in checking accounts in the economy?
Answer: The total money supply in an economy is the sum of currency in circulation, amount in
savings accounts, amount in checking accounts, travelers' checks, and the amount in money
market accounts. Hence, the amount in checking accounts is $100,000 - $50,000 - $18,000 $12,000 - $9,000 = $11,000.
Difficulty: Medium
AACSB: Application of Knowledge
Topic: The Money Supply
11.2 Money, Prices, and GDP
1) Which of the following statements correctly highlights a difference between real GDP and
nominal GDP?
A) Real GDP includes the value of goods and services produced by foreign firms, while nominal
GDP does not.
B) Real GDP includes the value of goods and services produced by domestic firms in foreign
countries, while nominal GDP does not.
C) Real GDP strips out the effect of changing prices on the value of goods and services
produced, while nominal GDP does not.
D) Real GDP does not take into account the value of goods produced and also services provided,
while nominal GDP takes these into account.
Answer: C
Difficulty: Easy
AACSB: Analytical Thinking
Topic: Nominal GDP, Real GDP, and Inflation
2) Consider an economy that only produces wooden chairs. In 2012, the economy produced 100
wooden chairs priced at $10 each. The nominal GDP of the economy for the year 2012 will be:
A) $10.
B) $100.
C) $1,000.
D) $10,000.
Answer: C
Difficulty: Easy
AACSB: Application of Knowledge
Topic: Nominal GDP, Real GDP, and Inflation
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Consider an economy that produces only cell phones. In the year 2012, the economy
manufactures 275 cell phones, and each cell phone sells at $200. In the year 2013, the economy
manufactures 280 cell phones but the price of each cell phone falls to $180.
3) Refer to the scenario above. What is the nominal GDP of the economy in 2012?
A) $47,000
B) $49,500
C) $55,000
D) $56,000
Answer: C
Difficulty: Easy
AACSB: Application of Knowledge
Topic: Nominal GDP, Real GDP, and Inflation
4) Refer to the scenario above. What is the nominal GDP of the economy in 2013?
A) $47,000
B) $50,000
C) $50,400
D) $55,000
Answer: C
Difficulty: Easy
AACSB: Application of Knowledge
Topic: Nominal GDP, Real GDP, and Inflation
5) Refer to the scenario above. Using 2012 as the base year, what is the real GDP of the
economy in 2013?
A) $47,000
B) $49,500
C) $55,000
D) $56,000
Answer: D
Difficulty: Medium
AACSB: Application of Knowledge
Topic: Nominal GDP, Real GDP, and Inflation
6) Refer to the scenario above. Using 2012 as the base year, what is the real GDP of the
economy in 2012?
A) $45,000
B) $55,000
C) $57,500
D) $75,000
Answer: B
Difficulty: Medium
AACSB: Application of Knowledge
Topic: Nominal GDP, Real GDP, and Inflation
7
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7) Refer to the scenario above. Using 2013 as the base year, what is the real GDP of the
economy in 2012?
A) $40,500
B) $49,500
C) $50,000
D) $52,500
Answer: B
Difficulty: Medium
AACSB: Application of Knowledge
Topic: Nominal GDP, Real GDP, and Inflation
8) A researcher finds that for an economy, the nominal GDP in the year 2012 equals the nominal
GDP in the year 2013. He also finds that the output of the economy has been the same over the
two years. A situation like this is possible only if:
A) the annual inflation rate in the economy is negative.
B) the annual inflation rate in the economy is zero percent.
C) the annual interest rate in the economy is negative.
D) the annual interest rate in the economy is zero percent.
Answer: B
Difficulty: Medium
AACSB: Analytical Thinking
Topic: Nominal GDP, Real GDP, and Inflation
9) Which of the following equations is correct?
A) Growth Rate of Nominal GDP = Inflation - Growth Rate of real GDP
B) Growth Rate of Nominal GDP = Inflation + Growth Rate of real GDP
C) Growth Rate of Nominal GDP = Inflation/Growth Rate of Interest Rates
D) Growth Rate of Nominal GDP = Growth Rate of Interest Rates/Inflation
Answer: B
Difficulty: Easy
AACSB: Analytical Thinking
Topic: Nominal GDP, Real GDP, and Inflation
10) If the growth rates of nominal GDP and real GDP in an economy are 6% and 2%
respectively, the inflation rate in the economy must be:
A) 2%.
B) 3%.
C) 4%.
D) 8%.
Answer: C
Difficulty: Easy
AACSB: Application of Knowledge
Topic: Nominal GDP, Real GDP, and Inflation
8
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11) If the growth rate of nominal GDP and the rate of inflation in an economy are 4% and 1%
respectively, the growth rate of real GDP in the economy must be:
A) 1%.
B) 3%.
C) 4%.
D) 5%.
Answer: B
Difficulty: Easy
AACSB: Application of Knowledge
Topic: Nominal GDP, Real GDP, and Inflation
12) If the growth rate of real GDP and the rate of inflation in an economy are 2% and 1%
respectively, the growth rate of nominal GDP in the economy must be:
A) 1%.
B) 2%.
C) 3%.
D) 5%.
Answer: C
Difficulty: Easy
AACSB: Application of Knowledge
Topic: Nominal GDP, Real GDP, and Inflation
13) Consider an economy over the years 2008 and 2009. The output in the economy has
remained constant over the two years but the prices of all goods and services have halved. In
such a situation,
A) the nominal GDP of the economy increases over the two years.
B) the nominal GDP of the economy remains the same over the two years.
C) the real GDP of the economy increases over the two years.
D) the real GDP of the economy stays the same over the two years.
Answer: D
Difficulty: Medium
AACSB: Analytical Thinking
Topic: Nominal GDP, Real GDP, and Inflation
14) The quantity theory of money assumes a constant ratio of ________.
A) real GDP to nominal GDP
B) money supply to nominal GDP
C) money supply to real GDP
D) money demand to money supply
Answer: B
Difficulty: Easy
AACSB: Analytical Thinking
Topic: The Quantity Theory of Money
9
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15) The quantity theory of money:
A) assumes that the ratio of money supply to nominal GDP increases over time.
B) assumes that the ratio of money supply to nominal GDP decreases over time.
C) is an exact representation of how the economy behaves in the long-run.
D) is a representation of how a change in money supply affects the price level in an economy.
Answer: D
Difficulty: Easy
AACSB: Analytical Thinking
Topic: The Quantity Theory of Money
16) The ratio of nominal GDP to money supply is referred to as:
A) price index.
B) Fischer's ratio.
C) velocity.
D) inflation ratio.
Answer: C
Difficulty: Easy
AACSB: Analytical Thinking
Topic: The Quantity Theory of Money
17) Velocity of money is the ratio of ________.
A) nominal GDP to money demand
B) real GDP to money demand
C) money supply to money demand
D) nominal GDP to money supply
Answer: D
Difficulty: Easy
AACSB: Analytical Thinking
Topic: The Quantity Theory of Money
18) If two variables have the same rate of growth over the long run, their ratio will:
A) increase over the long run.
B) decrease over the long run.
C) remain constant over the long run.
D) initially decrease and then increase.
Answer: C
Difficulty: Medium
AACSB: Analytical Thinking
Topic: The Quantity Theory of Money
10
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19) The quantity theory of money implies that:
A) growth rate of money demand = growth rate of money supply.
B) growth rate of money supply = growth rate of nominal GDP.
C) growth rate of money supply = growth rate of real GDP.
D) growth rate of currency in circulation = growth rate of the price level
Answer: B
Difficulty: Easy
AACSB: Analytical Thinking
Topic: The Quantity Theory of Money
20) According to the quantity theory of money, if the growth rate of money supply is 6% and the
growth rate of real GDP is 9%, then the growth rate of nominal GDP in the economy will be:
A) 3%.
B) 6%.
C) 9%.
D) 15%.
Answer: B
Difficulty: Medium
AACSB: Application of Knowledge
Topic: The Quantity Theory of Money
21) If the quantity theory of money holds, then in an economy,
A) inflation = growth rate of money supply + growth rate of real GDP.
B) inflation = growth rate of money supply - growth rate of real GDP.
C) inflation = growth rate of money supply + growth rate of nominal GDP.
D) inflation = growth rate of money supply - growth rate of nominal GDP.
Answer: B
Difficulty: Medium
AACSB: Analytical Thinking
Topic: The Quantity Theory of Money
22) Consider an economy where the growth rate of real GDP is 6% and the annual rate of
inflation is 2%. If the quantity theory of money holds, the growth rate of money supply in the
economy will be:
A) 2%.
B) 4%.
C) 6%.
D) 8%.
Answer: D
Difficulty: Medium
AACSB: Application of Knowledge
Topic: The Quantity Theory of Money
11
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23) Consider an economy where the growth rate of real GDP is 6% and the growth rate of money
supply is 8%. If the quantity theory of money holds, the inflation rate in the economy will be:
A) 2%.
B) 6%.
C) 8%.
D) 14%.
Answer: A
Difficulty: Medium
AACSB: Application of Knowledge
Topic: The Quantity Theory of Money
24) Consider an economy where the growth rate of money supply is 2% and the inflation rate is
2%. If the quantity theory of money holds, the growth rate of real GDP in the economy will be:
A) 0%.
B) 1%.
C) 2%.
D) 4%.
Answer: A
Difficulty: Medium
AACSB: Application of Knowledge
Topic: The Quantity Theory of Money
25) The quantity theory of money implies that:
A) inflation is equal to the gap between the growth rate of money supply and the current nominal
interest rates.
B) inflation is equal to the gap between the growth rate of money supply and the current real
interest rates.
C) inflation is equal to the gap between the growth rate of money supply and the growth rate of
nominal GDP.
D) inflation is equal to the gap between the growth rate of money supply and the growth rate of
real GDP.
Answer: D
Difficulty: Medium
AACSB: Analytical Thinking
Topic: The Quantity Theory of Money
12
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26) According to the quantity theory of money:
A) when the gap between the growth rate of money supply and the growth rate of real GDP
widens, inflation increases.
B) when the gap between the growth rate of money supply and the growth rate of real GDP
widens, inflation decreases.
C) when the gap between the growth rate of money supply and the growth rate of real GDP
widens, real interest rates increase.
D) when the gap between the growth rate of money supply and the growth rate of real GDP
widens, nominal interest rates decrease.
Answer: A
Difficulty: Medium
AACSB: Analytical Thinking
Topic: The Quantity Theory of Money
27) Consider two economies: A and B. If the gap between the growth rate of money supply and
growth rate of real GDP is larger in country A than in country B, then according to the quantity
theory of money:
A) the inflation rate will be higher in country A.
B) the inflation rate will be lower in country A.
C) real interest rates will be higher in country A.
D) nominal interest rates will be lower in country A.
Answer: A
Difficulty: Medium
AACSB: Application of Knowledge
Topic: The Quantity Theory of Money
28) Which of the following statements is true of the quantity theory of money?
A) The theory is applicable only in the short run.
B) Predictions of the theory can be verified with data.
C) The theory states that inflation will always be positive.
D) The theory explains the relationship between growth in real GDP and changes in nominal
interest rates.
Answer: B
Difficulty: Medium
AACSB: Analytical Thinking
Topic: The Quantity Theory of Money
13
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29) Why is real GDP a more accurate measure of the level of production in an economy than
nominal GDP? Explain with an example.
Answer: Consider an economy that produces only apples. If the price of apples in 2001 is $1 and
the economy produces 10 apples, the nominal GDP of the economy is $10. Now, suppose in
2002, the price of apples doubles without any change in production. In this case, the nominal
GDP of the economy in 2002 is $20. However, real GDP in both years is $10 if year 2001 is
taken as the base year. So, according to real GDP, output has not changed between the two years.
Hence, the real GDP, which accounts for inflation, is a more accurate measure of the level of
production than nominal GDP.
Difficulty: Medium
AACSB: Analytical Thinking
Topic: Nominal GDP, Real GDP, and Inflation
30) What does the quantity theory of money imply? If the growth rate of money supply and
growth rate of real GDP in an economy are 8% and 6%, respectively, then what is the inflation
rate in the economy?
Answer: The quantity theory of money implies that inflation is equal to the gap between the
growth rate of money supply and real GDP.
In this case, inflation rate = growth rate of money supply - growth rate of real GDP
= 8% - 6% = 2%.
Difficulty: Medium
AACSB: Application of Knowledge
Topic: The Quantity Theory of Money
31) Suppose an economy's money supply is fixed at $4,000 and its nominal GDP is $800,000.
Calculate the velocity of money.
Answer: According to the quantity theory of money, the velocity of money is obtained by
dividing nominal GDP by money supply. In this case, the velocity of money is
$800,000/$4,000 = 50.
Difficulty: Hard
AACSB: Application of Knowledge
Topic: The Quantity Theory of Money
14
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32) i) The growth rate of Eduland's money supply in a particular year was 8.5%. What was the
growth rate of real GDP if the inflation rate in the same year was 4%?
ii) What is likely to happen if the growth rate of money supply doubles in the following year,
while the growth rate of real output remains unchanged?
Answer:
i) According to the quantity theory of money, the ratio of money supply to nominal GDP is
constant. Therefore, the rate of growth of money supply must equal the rate of growth of nominal
GDP. However, growth rate of nominal GDP is the sum of growth rate of real GDP and the
inflation rate. Thus,
Rate of Growth in Money Supply = Rate of Growth in Real GDP + Inflation Rate. Thus, the
growth rate of real GDP in this case is 8.5% - 4% = 4.5%.
ii) If the growth rate of money supply doubles in the following year and the growth rate of real
output remains unchanged, the inflation rate will also double.
Difficulty: Hard
AACSB: Application of Knowledge
Topic: The Quantity Theory of Money
11.3 Inflation
1) The rate at which a price index decreases is referred to as the:
A) deflation rate.
B) depreciation rate.
C) cross inflation rate.
D) reverse inflation rate.
Answer: A
Difficulty: Easy
AACSB: Analytical Thinking
Topic: Inflation
2) Data confirms that the quantity theory of money:
A) holds in the long run.
B) holds only in the short run.
C) holds both in the long run and the short run.
D) does not hold either in the short run or in the long run.
Answer: A
Difficulty: Easy
AACSB: Analytical Thinking
Topic: What Causes Inflation?
15
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3) Assume that the inflation rate in an economy is measured on the vertical axis and the
annualized growth rate of money supply minus the annualized growth rate of real GDP is
measured on the horizontal axis on a graph. If a curve is plotted to establish the relationship
between both variables, the curve is likely to be:
A) vertical.
B) horizontal.
C) upward sloping.
D) downward sloping.
Answer: C
Difficulty: Medium
AACSB: Analytical Thinking
Topic: What Causes Inflation?
4) Which of the following is likely to happen if the annualized growth rate of money supply
increases while real GDP remains unchanged?
A) The inflation rate will rise.
B) The inflation rate will fall.
C) The nominal GDP will fall.
D) The unemployment rate will rise.
Answer: A
Difficulty: Medium
AACSB: Analytical Thinking
Topic: What Causes Inflation?
5) Which of the following statements best defines hyperinflation?
A) It is a situation when the annual rate of inflation in an economy is between 0% to 10%.
B) It is a situation when the annual rate of inflation in an economy is between 10% to 20%.
C) It is a situation when the annual rate of inflation in an economy is between 20% to 50%.
D) It is a situation when the annual rate of inflation in an economy exceeds 50%.
Answer: D
Difficulty: Easy
AACSB: Analytical Thinking
Topic: What Causes Inflation?
6) Hyperinflationary episodes are always related to extremely rapid growth of:
A) real GDP.
B) interest rates.
C) money supply.
D) money demand.
Answer: C
Difficulty: Easy
AACSB: Analytical Thinking
Topic: What Causes Inflation?
16
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7) One of the main reasons behind hyperinflation episodes is:
A) high tax rates.
B) large government budget deficits.
C) a decrease in real GDP.
D) a decrease in the demand for consumer goods.
Answer: B
Difficulty: Easy
AACSB: Analytical Thinking
Topic: What Causes Inflation?
8) Printing money to meet government budget deficits:
A) helps combat inflation.
B) increases the demand for money.
C) increases real income.
D) acts as a tax on the citizens in an economy.
Answer: D
Difficulty: Easy
AACSB: Analytical Thinking
Topic: What Causes Inflation?
9) The great German hyperinflation during 1922-1923 can be attributed to the:
A) absence of financial intermediaries in Germany.
B) German government printing money to pay bills.
C) emergence of large number of monopolies in Germany.
D) economic policy that restricted the import of goods into Germany.
Answer: B
Difficulty: Easy
AACSB: Analytical Thinking
Topic: What Causes Inflation?
10) The cost of inflation will be minimized if:
A) the growth rate of inflation exceeds the rate of growth of wages.
B) the growth rate of inflation equals the rate of growth of wages.
C) money supply is increased during times of high inflation.
D) taxes are increased during the periods of high inflation.
Answer: B
Difficulty: Easy
AACSB: Analytical Thinking
Topic: The Consequences of Inflation
17
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11) Business's cost of changing prices is referred to as:
A) shoeleather costs.
B) menu costs.
C) intangible costs.
D) inflation tax.
Answer: B
Difficulty: Easy
AACSB: Analytical Thinking
Topic: The Social Costs of Inflation
12) A worker has negotiated a nominal wage contract with his employer for a period of 3 years.
Which of the following will happen if the rate of inflation rises beyond the worker's expectation
during this period?
A) The worker will be better off.
B) The worker will be worse off.
C) The worker's real wage will increase.
D) The company's shareholders will be worse off.
Answer: B
Difficulty: Easy
AACSB: Application of Knowledge
Topic: The Consequences of Inflation
13) A retired worker receives a pension that is not indexed to inflation. Which of the following
will happen if the rate of inflation rises?
A) The retiree will be better off.
B) The retiree's purchasing power will fall.
C) The retiree's purchasing power will increase.
D) The shareholders of the firm in which he worked will lose.
Answer: B
Difficulty: Medium
AACSB: Application of Knowledge
Topic: The Consequences of Inflation
14) Suppose you have borrowed money from a bank to buy a house. Which of the following will
happen if the inflation rate unexpectedly rises?
A) You will be better off.
B) You will be worse off.
C) The bank's shareholders will be better off.
D) The real cost of your mortgage will rise.
Answer: A
Difficulty: Medium
AACSB: Application of Knowledge
Topic: The Consequences of Inflation
18
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15) When prices rise:
A) money demand tends to fall.
B) money supply tends to rise.
C) menu costs tend to fall.
D) consumers' purchasing power falls.
Answer: D
Difficulty: Medium
AACSB: Analytical Thinking
Topic: The Social Costs of Inflation
16) Economists often refer to the government revenue obtained from money creation as:
A) liquid revenue.
B) an inflation tax.
C) windfall revenue.
D) a supplementary tax.
Answer: B
Difficulty: Easy
AACSB: Analytical Thinking
Topic: The Social Benefits of Inflation
17) Government revenue from printing money is referred to as:
A) seigniorage.
B) menu costs.
C) shoeleather costs.
D) excise tax
Answer: A
Difficulty: Easy
AACSB: Analytical Thinking
Topic: The Social Benefits of Inflation
18) One advantage of using an inflation tax over other methods of tax collection is that:
A) the revenue from inflation tax is extremely high.
B) the collection of inflation tax is more organized.
C) people who evade other taxes also feel the burden of an inflation tax.
D) inflation tax only affects individuals with a high income.
Answer: C
Difficulty: Hard
AACSB: Analytical Thinking
Topic: The Social Benefits of Inflation
19
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19) A government that generates revenue mostly through an inflation tax faces the risk of:
A) hyperinflation.
B) mass tax evasion.
C) rapidly falling prices.
D) a sudden fall in revenue.
Answer: A
Difficulty: Easy
AACSB: Analytical Thinking
Topic: The Social Benefits of Inflation
20) Assuming all else equal, inflation can:
A) reduce the real interest rate, and increase the real wage rate.
B) increase the real interest rate, and reduce the real wage rate.
C) reduce both the real interest rate and the real wage rate.
D) increase both the real interest rate and the real wage rate.
Answer: C
Difficulty: Easy
AACSB: Analytical Thinking
Topic: The Social Benefits of Inflation
21) If real wages fall:
A) consumer demand is likely to increase.
B) employers are likely to hire more workers.
C) the level of economic production will always decrease.
D) the level of economic production will always increase.
Answer: B
Difficulty: Medium
AACSB: Analytical Thinking
Topic: The Social Benefits of Inflation
22) Which of the following statements correctly identifies a reason why inflation can be used as
a countercyclical policy tool?
A) Inflation reduces money costs and hence stimulates an economy during slowdowns.
B) Inflation increases consumer demand which is necessary for combating slowdowns.
C) Inflation sometimes increases the demand for workers that increases output and helps combat
slowdowns.
D) Inflation increases consumer confidence, which is an absolute necessity to counter act
business cycles.
Answer: C
Difficulty: Hard
AACSB: Analytical Thinking
Topic: The Social Benefits of Inflation
20
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23) How does inflation act as a tax?
Answer: Rapidly printing money leads to an increase in the growth rate of money supply that
exceeds growth rate of real GDP. This results in inflation in the economy. A higher inflation rate
further reduces the buying power of currency. Hence, printing currency reduces the buying
power of currency by reducing its value among consumers and producers, but increases the
revenue of the government in the form of newly printed notes.
Difficulty: Medium
AACSB: Analytical Thinking
Topic: What Causes Inflation?
24) State two social benefits of inflation.
Answer: The social benefits of inflation are as follows:
a) Inflation caused by money creation acts as an implicit tax. It increases the government's
revenue by transferring purchasing power from consumers and producers in an economy to the
government.
b) Inflation can temporarily reduce the real interest rate and the real wage rate. This increases an
employer's willingness to hire more and produce more.
Difficulty: Medium
AACSB: Analytical Thinking
Topic: The Social Benefits of Inflation
25) The prices of several essential goods in Agraria almost doubled over the last decade. In order
to satisfy the voters, the government of Agraria introduced price controls. What is likely to
happen after the introduction of these price controls?
Answer: Inflation generates voter anger, and politicians sometimes respond by advancing
economically destructive schemes, especially price controls. In most of these cases, the policy
cure is worse than the disease. Price controls cause problems like long lines and supply
disruptions. In addition, price controls are partially undone when some of those consumers who
are lucky enough to obtain the good at the official capped price, resell it at a higher price in the
underground economy. Hence, price controls create an inefficient incentive for consumers who
don't want to consume the good to buy it anyway, just so they can resell it to someone else at a
higher price. This is what is most likely to happen in Agraria.
Difficulty: Medium
AACSB: Application of Knowledge
Topic: The Social Costs of Inflation
21
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11.4 The Federal Reserve
1) The U.S. central bank is the government institution that:
A) controls the money supply and invests in foreign assets.
B) monitors financial institutions, controls the money supply, and invests in foreign assets.
C) monitors financial institutions, controls the money supply, and sets certain key interest rates.
D) monitors financial institutions, controls the money supply, sets certain key interest rates, and
decides on political targets.
Answer: C
Difficulty: Easy
AACSB: Analytical Thinking
Topic: The Central Bank and the Objectives of Monetary Policy
2) In the United States, the central bank is called the:
A) Bank of America.
B) Federal Reserve Bank.
C) Reserve Bank of America.
D) National Bank of America.
Answer: B
Difficulty: Easy
AACSB: Analytical Thinking
Topic: The Central Bank and the Objectives of Monetary Policy
3) The two key objectives of the Fed are:
A) low and predictable levels of inflation, and interest rates above 10%.
B) zero inflation, and zero unemployment.
C) low and predictable levels of inflation, and zero unemployment.
D) low and predictable levels of inflation, and maximum levels of employment.
Answer: D
Difficulty: Easy
AACSB: Analytical Thinking
Topic: The Central Bank and the Objectives of Monetary Policy
4) The policy of attempting to obtain a specific low level of inflation over the long run is referred
to as:
A) price control.
B) inflation targeting.
C) the seigniorage policy.
D) the minimal inflation policy.
Answer: B
Difficulty: Easy
AACSB: Analytical Thinking
Topic: The Central Bank and the Objectives of Monetary Policy
22
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5) The European Central Bank:
A) lays more emphasis on controlling inflation than on controlling employment.
B) lays more emphasis on controlling employment than on controlling inflation.
C) emphasizes maintaining interest rates below 5%.
D) emphasizes maintaining unemployment rates below 5%.
Answer: A
Difficulty: Medium
AACSB: Analytical Thinking
Topic: The Central Bank and the Objectives of Monetary Policy
6) Which of the following is a role played by the Fed in the U.S. economy?
A) It acts as a direct source of funds for new businesses and startups.
B) It takes political decisions during periods of recessions.
C) It acts as a lender of the last resort in case of bank runs.
D) It determines the import duty on raw materials being imported into the country.
Answer: C
Difficulty: Easy
AACSB: Analytical Thinking
Topic: What Does the Central Bank Do?
7) Which of the following tools does the Fed use to pursue its objectives?
A) It influences short-run and long-run interest rates.
B) It determines the efficient level of government spending.
C) It influences market prices through price ceilings and price floors.
D) It provides loans to new firms and businesses at extremely low rates of interest.
Answer: A
Difficulty: Easy
AACSB: Analytical Thinking
Topic: What Does the Central Bank Do?
8) Which of the following is likely to happen when the Fed raises the federal funds rate?
A) The long-run interest rate will fall.
B) The volume of economic activity will increase.
C) The labor demand curve shifts to the right.
D) The labor demand curve shifts to the left.
Answer: D
Difficulty: Medium
AACSB: Analytical Thinking
Topic: What Does the Central Bank Do?
23
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9) Which of the following is likely to happen when the interest rate falls?
A) Equilibrium wage rate will fall.
B) The labor demand curve will shift to the right.
C) The volume of economic activity will reduce.
D) The labor demand curve will shift to the left.
Answer: B
Difficulty: Medium
AACSB: Analytical Thinking
Topic: What Does the Central Bank Do?
10) Which of the following statements is NOT a function of the Fed?
A) It oversees interbank payment systems.
B) It monitors the stockholders' equity of commercial banks.
C) It regulates the various stock markets in the economy.
D) It ensures that commercial banks report their assets and liabilities with accuracy.
Answer: C
Difficulty: Easy
AACSB: Analytical Thinking
Topic: Bank Reserves
11) In the United States, if a customer at HDFC bank writes a check and the recipient of the
check deposits the check in Citibank, then the check is cleared by:
A) HDFC bank.
B) the Fed.
C) Citibank.
D) either HDFC bank or Citibank.
Answer: B
Difficulty: Easy
AACSB: Application of Knowledge
Topic: Bank Reserves
12) Which of the following holds the reserves of private banks in the United States?
A) The Fed
B) The Pentagon
C) The Treasury Department
D) Various venture capitalists
Answer: A
Difficulty: Easy
AACSB: Analytical Thinking
Topic: Bank Reserves
24
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13) ________ refers to funds available for immediate payment.
A) Velocity
B) Liquidity
C) Term deposits
D) Mutual funds
Answer: B
Difficulty: Easy
AACSB: Analytical Thinking
Topic: Bank Reserves
14) A bank is said to have enough liquidity if:
A) it holds deposits amounting to at least $100,000.
B) it operates for seven days a week for more than 12 hours a day.
C) the value of its assets exceeds the value of its liabilities by at least $50,000.
D) it has enough funds to conduct its day-to-day businesses and meet the regulatory
requirements.
Answer: D
Difficulty: Medium
AACSB: Analytical Thinking
Topic: Bank Reserves
15) The federal funds market refers to the market where:
A) banks obtain loans of reserves from each other.
B) the federal government borrows overnight funds from the Fed.
C) the Fed obtains loans of reserves from central banks of other nations.
D) there are no predetermined rates of interest on loans and the highest bidding borrower gets the
loan.
Answer: A
Difficulty: Easy
AACSB: Analytical Thinking
Topic: Bank Reserves
16) Which of the following statements is true of the federal funds market?
A) No banks are refused loans in the federal funds market.
B) In the federal funds market, banks with a shortage of reserves borrow funds, while banks with
an excess of reserves lends them out.
C) The interbank lending system works more efficiently in periods of financial panic than in
periods of financial stability.
D) Although the federal funds market aims to provide liquidity to needy banks, it is not very
popular as overnight loans are logistically inefficient for large banks.
Answer: B
Difficulty: Medium
AACSB: Analytical Thinking
Topic: Bank Reserves
25
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17) A commercial bank's last resort for borrowing reserves is from the:
A) federal funds market.
B) discount window.
C) central government.
D) foreign banks.
Answer: B
Difficulty: Easy
AACSB: Analytical Thinking
Topic: Choice and Consequence: Obtaining Reserves Outside the Federal Funds Market
18) Which of the following statements is true?
A) The discount window in the United States is operated by Citibank.
B) The discount window is accessible only to well-performing banks.
C) The discount window is operated only in periods of economic expansion.
D) When banks borrow from the discount window, it is an admission of trouble.
Answer: D
Difficulty: Easy
AACSB: Analytical Thinking
Topic: Choice and Consequence: Obtaining Reserves Outside the Federal Funds Market
19) The ________ is the interest rate that banks charge each other for overnight loans.
A) spot interest rate
B) federal funds rate
C) discount window interest rate
D) subsidized banking interest rate
Answer: B
Difficulty: Easy
AACSB: Analytical Thinking
Topic: Bank Reserves
20) The funds being lent in the federal funds market are:
A) bank deposits of domestic households.
B) reserves at the Fed.
C) investments of foreign firms.
D) tax revenue earned by the federal government.
Answer: B
Difficulty: Easy
AACSB: Analytical Thinking
Topic: Bank Reserves
26
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21) The demand curve for reserves is:
A) vertical.
B) horizontal.
C) upward sloping.
D) downward sloping.
Answer: D
Difficulty: Easy
AACSB: Analytical Thinking
Topic: The Demand Side of the Federal Funds Market
22) If a bank has $6 billion in reserves and loans $2 billion to another bank, then the total
quantity of reserves demanded is:
A) $2 billion.
B) $4 billion.
C) $6 billion.
D) $8 billion.
Answer: C
Difficulty: Medium
AACSB: Application of Knowledge
Topic: The Demand Side of the Federal Funds Market
23) Which of the following is true of the quantity demanded of reserves?
A) The quantity demanded of reserves is constant over time for almost every bank.
B) The quantity demanded of reserves increases as the federal funds rate falls.
C) The quantity demanded of reserves increases as the inflation rate increases.
D) The quantity demanded of reserves increases at a constant rate over time.
Answer: B
Difficulty: Easy
AACSB: Analytical Thinking
Topic: The Demand Side of the Federal Funds Market
24) Which of the following changes will cause a downward movement along the demand curve
for reserves?
A) An increase in deposits held by banks
B) A decrease in deposits held by banks
C) An increase in the federal funds rate
D) A decrease in the federal funds rate
Answer: D
Difficulty: Easy
AACSB: Analytical Thinking
Topic: The Demand Side of the Federal Funds Market
27
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25) Which of the following is likely to happen to the demand curve for reserves if the federal
funds rate increases?
A) The demand curve for reserves will shift to the right.
B) The demand curve for reserves will shift to the left.
C) There will be a downward movement along the demand curve for reserves.
D) There will be an upward movement along the demand curve for reserves.
Answer: D
Difficulty: Easy
AACSB: Analytical Thinking
Topic: The Demand Side of the Federal Funds Market
26) Assuming all else equal, what is likely to happen to the demand curve for reserves in an
economy if it goes through a period of rapid expansion?
A) The demand curve for reserves will shift to the right.
B) The demand curve for reserves will shift to the left.
C) There will be a downward movement along the demand curve for reserves.
D) There will be a n upward movement along the demand curve for reserves.
Answer: A
Difficulty: Medium
AACSB: Analytical Thinking
Topic: The Demand Side of the Federal Funds Market
27) Assuming all else equal, the demand curve for reserves in an economy shifts to the left.
Which of the following could be a likely reason for this shift?
A) Rapid expansion of the economy
B) Rapid contraction of the economy
C) An increase in the federal funds rate
D) A decrease in the federal funds rate
Answer: B
Difficulty: Medium
AACSB: Analytical Thinking
Topic: The Demand Side of the Federal Funds Market
28) Assuming all else equal, if there is a contraction in the quantity of bank account balances, it
will cause:
A) a downward movement along the demand curve for reserves.
B) an upward movement along the demand curve for reserves.
C) a leftward shift in the demand curve for reserves.
D) a rightward shift in the demand curve for reserves.
Answer: C
Difficulty: Medium
AACSB: Analytical Thinking
Topic: The Demand Side of the Federal Funds Market
28
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29) Assuming all else equal, if a bank expects a bank run in the future:
A) there will be a downward movement along its demand curve for reserves.
B) there will be an upward movement along its demand curve for reserves.
C) its demand curve for reserves will shift to the right.
D) its demand curve for reserves will shift to the left.
Answer: C
Difficulty: Medium
AACSB: Analytical Thinking
Topic: The Demand Side of the Federal Funds Market
30) Which of the following will NOT cause a shift in the demand curve for reserves?
A) Business cycles
B) Liquidity shocks
C) Changes in deposit base
D) A change in the federal funds rate
Answer: D
Difficulty: Easy
AACSB: Analytical Thinking
Topic: The Demand Side of the Federal Funds Market
31) The supply curve of reserves is:
A) downward sloping.
B) upward sloping.
C) vertical.
D) horizontal.
Answer: C
Difficulty: Easy
AACSB: Analytical Thinking
Topic: The Supply Side of the Federal Funds Market and Equilibrium in the Federal Funds
Market
32) The slope of the supply curve of reserves can be attributed to the fact that:
A) the Fed fixes the supply of reserves.
B) quantity supplied of reserves increases with the federal funds rate.
C) quantity supplied of reserves decreases with the federal funds rate.
D) the supply of reserves is arbitrarily set by the World Bank.
Answer: A
Difficulty: Medium
AACSB: Analytical Thinking
Topic: The Supply Side of the Federal Funds Market and Equilibrium in the Federal Funds
Market
29
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33) Everything else remaining unchanged, if the demand curve for reserves shifts to the right and
borrowed reserves is zero:
A) there will be an increase in both the federal funds rate and the quantity of reserves.
B) there will be a decrease in both the federal funds rate and the quantity of reserves.
C) there will be a decrease in the federal funds rate but no change in the quantity of reserves.
D) there will be an increase in the federal funds rate but no change in the quantity of reserves.
Answer: D
Difficulty: Medium
AACSB: Analytical Thinking
Topic: The Supply Side of the Federal Funds Market and Equilibrium in the Federal Funds
Market
34) Everything else remaining unchanged, if the demand curve for reserves shifts to the left and
borrowed reserves is zero:
A) there will be an increase in both the federal funds rate and the quantity of reserves.
B) there will be a decrease in both the federal funds rate and the quantity of reserves.
C) there will be a decrease in the federal funds rate but no change in the quantity of reserves.
D) there will be an increase in the federal funds rate but no change in the quantity of reserves.
Answer: C
Difficulty: Medium
AACSB: Analytical Thinking
Topic: The Supply Side of the Federal Funds Market and Equilibrium in the Federal Funds
Market
35) At the federal funds market equilibrium,
A) both the federal funds rate and the total quantity of reserves tend to fall automatically.
B) both the federal funds rate and the total quantity of reserves tend to rise automatically.
C) the equilibrium quantity of reserves demanded is equal to the equilibrium quantity of reserves
supplied by the Fed.
D) the equilibrium quantity of reserves demanded exceeds the equilibrium quantity of reserves
supplied by the Fed.
Answer: C
Difficulty: Easy
AACSB: Analytical Thinking
Topic: The Supply Side of the Federal Funds Market and Equilibrium in the Federal Funds
Market
36) Which of the following financial organizations have the ability to influence the supply of
reserves in the United States?
A) The Fed
B) Only private commercial banks
C) Only public sector banks
D) The World Bank
Answer: A
Difficulty: Easy
AACSB: Analytical Thinking
Topic: The Fed's Influence on the Money Supply and the Inflation Rate
30
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37) When the Fed buys or sells government bonds to private banks in exchange for reserves, it is
referred to as:
A) moral suasion.
B) reserve targeting.
C) the Fed's dual mandate.
D) open market operations.
Answer: D
Difficulty: Medium
AACSB: Analytical Thinking
Topic: The Supply Side of the Federal Funds Market and Equilibrium in the Federal Funds
Market
38) If the Fed sells government bonds in the open market, it will cause:
A) a shift of the supply curve for reserves to the left.
B) a shift of the supply curve for reserves to the right.
C) an upward movement along the supply curve for reserves.
D) a downward movement along the supply curve for reserves.
Answer: A
Difficulty: Medium
AACSB: Analytical Thinking
Topic: The Supply Side of the Federal Funds Market and Equilibrium in the Federal Funds
Market
39) If the Fed buys government bonds from the open market, it will cause:
A) a shift of the supply curve for reserves to the left.
B) a shift of the supply curve for reserves to the right.
C) an upward movement along the supply curve for reserves.
D) a downward movement along the supply curve for reserves.
Answer: B
Difficulty: Medium
AACSB: Analytical Thinking
Topic: The Supply Side of the Federal Funds Market and Equilibrium in the Federal Funds
Market
31
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40) Everything else remaining unchanged, what will happen if the Fed sells government bonds in
the open market and borrowed reserves is zero?
A) It will cause the equilibrium federal funds rate to rise, but no change in the equilibrium
quantity of reserves.
B) It will cause the equilibrium federal funds rate to fall, but no change in the equilibrium
quantity of reserves.
C) It will cause the equilibrium federal funds rate to rise and the equilibrium quantity of reserves
to fall.
D) It will cause both the equilibrium federal funds rate and equilibrium quantity of reserves to
fall.
Answer: C
Difficulty: Medium
AACSB: Analytical Thinking
Topic: The Supply Side of the Federal Funds Market and Equilibrium in the Federal Funds
Market
41) Everything else remaining unchanged, what will happen if the Fed buys government bonds
in the open market and borrowed reserves is zero?
A) It will cause both the equilibrium federal funds rate and equilibrium quantity of reserves to
fall.
B) It will cause the equilibrium federal funds rate to fall and the equilibrium quantity of reserves
to increase.
C) It will cause the equilibrium federal funds rate to rise, but no change in the equilibrium
quantity of reserves.
D) It will cause the equilibrium federal funds rate to fall, but no change in the equilibrium
quantity of reserves.
Answer: B
Difficulty: Medium
AACSB: Analytical Thinking
Topic: The Supply Side of the Federal Funds Market and Equilibrium in the Federal Funds
Market
42) If there is a change in the federal funds rate from a target rate due to an increase in the
demand for reserves, the Fed can maintain the target by:
A) causing the supply curve of reserves to shift to the left.
B) causing the supply curve of reserves to shift to the right.
C) causing an upward movement along the supply of reserves curve.
D) causing a downward movement along the supply of reserves curve.
Answer: B
Difficulty: Medium
AACSB: Analytical Thinking
Topic: The Supply Side of the Federal Funds Market and Equilibrium in the Federal Funds
Market
32
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43) If there is a change in the federal funds rate from a target rate due to a decrease in the
demand for reserves, the Fed can maintain the target by:
A) causing the supply curve of reserves to shift to the left.
B) causing the supply curve of reserves to shift to the right.
C) causing an upward movement along the supply of reserves curve.
D) causing a downward movement along the supply of reserves curve.
Answer: A
Difficulty: Medium
AACSB: Analytical Thinking
Topic: The Supply Side of the Federal Funds Market and Equilibrium in the Federal Funds
Market
44) If the nominal interest rate in an economy is 8% and the real interest rate is 4%, the inflation
in the economy is:
A) 4%.
B) 8%.
C) 12%.
D) 32%.
Answer: A
Difficulty: Easy
AACSB: Application of Knowledge
Topic: The Relationship Between the Federal Funds Rate and the Long-Run Real Interest Rate
45) If the nominal interest rate in an economy is 6% and the inflation rate in the economy is
10%, then the real interest rate is:
A) -4%.
B) -6%.
C) 6%.
D) 10%.
Answer: A
Difficulty: Easy
AACSB: Application of Knowledge
Topic: The Relationship Between the Federal Funds Rate and the Long-Run Real Interest Rate
46) In an economy, investment is most likely to be dependent on:
A) the short-run real interest rate.
B) the long-run real interest rate.
C) the short-run nominal interest rate.
D) the long-run nominal interest rate.
Answer: B
Difficulty: Medium
AACSB: Analytical Thinking
Topic: The Relationship Between the Federal Funds Rate and the Long-Run Real Interest Rate
33
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47) The federal funds rate is a:
A) short-term real interest rate.
B) short-term nominal interest rate.
C) long-term real interest rate.
D) long-term nominal interest rate.
Answer: B
Difficulty: Easy
AACSB: Analytical Thinking
Topic: The Relationship Between the Federal Funds Rate and the Long-Run Real Interest Rate
48) Which of the following equations is correct?
A) Realized real interest rate = nominal interest rate - realized nominal interest rate
B) Realized real interest rate = nominal interest rate + realized inflation rate
C) Realized real interest rate = nominal interest rate - realized inflation rate
D) Realized real interest rate = realized inflation rate
Answer: C
Difficulty: Easy
AACSB: Analytical Thinking
Topic: The Relationship Between the Federal Funds Rate and the Long-Run Real Interest Rate
49) If the realized real interest rate in an economy is 6%, the nominal interest rate is 8%, and the
expected inflation rate is 8%, then the realized inflation rate in the economy is:
A) 2%.
B) 4%.
C) 6%.
D) 8%.
Answer: A
Difficulty: Medium
AACSB: Application of Knowledge
Topic: The Relationship Between the Federal Funds Rate and the Long-Run Real Interest Rate
50) If the realized real interest rate in an economy is 6%, the realized inflation rate is 8%, and the
expected inflation rate is 8%, then the nominal interest rate in the economy is:
A) 2%.
B) 8%.
C) 14%.
D) 20%.
Answer: C
Difficulty: Medium
AACSB: Application of Knowledge
Topic: The Relationship Between the Federal Funds Rate and the Long-Run Real Interest Rate
34
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51) Which of the following equations is correct?
A) Expected real interest rate = nominal interest rate + expected inflation rate
B) Expected real interest rate = nominal interest rate/expected inflation rate
C) Expected real interest rate = expected inflation rate/nominal interest rate
D) Expected real interest rate = nominal interest rate - expected inflation rate
Answer: D
Difficulty: Easy
AACSB: Analytical Thinking
Topic: The Relationship Between the Federal Funds Rate and the Long-Run Real Interest Rate
52) If the nominal interest rate in an economy is 9% and the expected inflation rate is 6%, then
the expected real interest rate in the economy is:
A) 3%.
B) 6%.
C) 9%.
D) 15%.
Answer: A
Difficulty: Medium
AACSB: Analytical Thinking
Topic: The Relationship Between the Federal Funds Rate and the Long-Run Real Interest Rate
53) If the expected real interest rate in an economy is 6% and the expected inflation rate is 4%,
then the nominal interest rate in the economy is:
A) 4%.
B) 6%.
C) 10%.
D) 14%.
Answer: C
Difficulty: Medium
AACSB: Analytical Thinking
Topic: The Relationship Between the Federal Funds Rate and the Long-Run Real Interest Rate
54) Changes in the federal funds rate:
A) have no effect on the long-run expected interest rate.
B) change the long-run expected interest rates in the same direction.
C) change the long-run expected interest rates in the opposite direction.
D) can change the long-run expected interest rate either in any direction depending on the
magnitude of the change in the federal funds rate.
Answer: B
Difficulty: Easy
AACSB: Analytical Thinking
Topic: The Federal Funds Rate and the Long-Run Expected Real Interest Rate
35
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55) The model of expectations in which the current level of inflation depends on past levels is
referred to as:
A) composite expectations.
B) adaptive expectations.
C) rational expectations.
D) realized real expectations.
Answer: B
Difficulty: Easy
AACSB: Analytical Thinking
Topic: Choice and Consequence: Two Models of Inflation Expectations
56) George believes that the inflation in this year will be around 9% because it was around 9% in
the previous year. George can be said to have:
A) marginal expectations.
B) rational expectations.
C) adaptive expectations.
D) composite expectations.
Answer: C
Difficulty: Easy
AACSB: Application of Knowledge
Topic: Choice and Consequence: Two Models of Inflation Expectations
57) The model that states that individuals develop their inflation expectations after considering
all the available information is referred to as the:
A) composite expectations model.
B) adaptive expectations model.
C) rational expectations model.
D) marginal expectations model.
Answer: C
Difficulty: Easy
AACSB: Analytical Thinking
Topic: Choice and Consequence: Two Models of Inflation Expectations
58) Before developing an expectation on inflation, Jenny reads through all available material on
consumer price indexes and producer price indexes. Later she also reads through recent
magazines and newspapers to identify factors that could affect the inflation rate in the coming
days. Jenny can be said to have:
A) adaptive expectations.
B) rational expectations.
C) marginal expectations.
D) conditional expectations.
Answer: B
Difficulty: Medium
AACSB: Application of Knowledge
Topic: Choice and Consequence: Two Models of Inflation Expectations
36
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59) If there are no changes in inflation expectations, a fall in the federal funds rate:
A) decreases the long-run nominal interest rate and increases the long-run expected interest rate.
B) increases the long-run nominal interest rate and decreases the long-run expected interest rate.
C) decreases both the long-run nominal interest rate and the long-run expected interest rate.
D) increases both the long-run nominal interest rate and the long-run expected interest rate.
Answer: C
Difficulty: Medium
AACSB: Analytical Thinking
Topic: The Federal Funds Rate and the Long-Run Expected Real Interest Rate
60) If there are no changes in inflation expectations, a sale of government bonds by the Fed in
the open market will cause ________.
A) both the federal funds rate and long-run expected real interest rate to rise
B) both the federal funds rate and long-run expected real interest rate to fall
C) the federal funds rate to rise and the long-run expected real interest rate to fall
D) the federal funds rate to fall and the long-run expected real interest rate to rise
Answer: A
Difficulty: Medium
AACSB: Analytical Thinking
Topic: The Federal Funds Rate and the Long-Run Expected Real Interest Rate
61) If there are no changes in inflation expectations, a purchase of government bonds by the Fed
in the open market will cause ________.
A) both the federal funds rate and long-run expected real interest rate to rise
B) both the federal funds rate and long-run expected real interest rate to fall
C) the federal funds rate to rise and the long-run expected real interest rate to fall
D) the federal funds rate to fall and the long-run expected real interest rate to rise
Answer: B
Difficulty: Medium
AACSB: Analytical Thinking
Topic: The Federal Funds Rate and the Long-Run Expected Real Interest Rate
62) Which of the following statements is true?
A) The Fed has the power to dictate the volume of deposits held with commercial banks.
B) The rate of inflation in the long run is equal to the rate of growth of real GDP minus the rate
of growth of money supply.
C) The Fed can influence the money supply in the economy by influencing the required amount
of reserves.
D) The Fed can reduce the growth of money supply by increasing the growth in bank reserves.
Answer: C
Difficulty: Medium
AACSB: Analytical Thinking
Topic: The Federal Funds Rate and the Long-Run Expected Real Interest Rate
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63) What is meant by the term "inflation targeting"? What is the Fed's objective regarding
inflation?
Answer: Inflation targeting refers to the policy of attempting to obtain a specific low level of
inflation over the long run. The Fed aims to keep inflation low and predictable.
Difficulty: Easy
AACSB: Analytical Thinking
Topic: The Central Bank and the Objectives of Monetary Policy
64) Why is the Fed referred to as the "lender of last resort"?
Answer: Sometimes the federal funds market can fail. For example, during a financial panic,
banks with excess reserves do not know who they can trust. They don't know which banks are
solvent and which banks are not. Accordingly the banks with excess reserves may be unwilling
to lend these reserves out. In such a crisis, the Fed can step in and provide reserves to the banks
that need them and is hence referred to as the "lender of the last resort."
Difficulty: Medium
AACSB: Analytical Thinking
Topic: Bank Reserves
65) Explain the shapes of the demand curve for reserves and the supply curve of reserves.
Answer: The demand curve for reserves shows the relationship between the quantity of reserves
demanded and the federal funds rate. It is a downward sloping curve. This is because a higher
federal funds rate increases the cost of holding reserves and reduces the quantity of reserves
demanded by optimizing banks. The supply of reserves is determined by the central bank of a
nation. Hence, it is vertical.
Difficulty: Medium
AACSB: Analytical Thinking
Topic: The Demand Side of the Federal Funds Market
66) What are open market operations? If the economy is experiencing a recession, what kind of
open market operations should the Fed undertake?
Answer: When the Fed buys or sells government bonds from/to private banks in exchange of
reserves held by those private banks at the Fed, it is referred to as an open market operation.
When an economy is going through a recession, the Fed should buy government bonds from
private banks to stimulate the economy.
Difficulty: Medium
AACSB: Analytical Thinking
Topic: The Supply Side of the Federal Funds Market and Equilibrium in the Federal Funds
Market
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67) Is there any difference between borrowing from the federal funds market and borrowing
from the discount window? Explain.
Answer: The federal funds market refers to the market where banks obtain overnight loans of
reserves from one another. On the other hand, when banks are not granted funds from the federal
funds market, they can borrow from the Fed. This is referred to as borrowing from the discount
window.
Difficulty: Medium
AACSB: Analytical Thinking
Topic: Choice and Consequence: Obtaining Reserves Outside the Federal Funds Market
68) Differentiate between the adaptive expectations and the rational expectations models of
inflation.
Answer: The adaptive expectations model of inflation states that inflationary expectations are
determined by the level of inflation in the recent past. Conversely, the rational expectations
model assumes that people have highly sophisticated beliefs about inflation that rationally
incorporate all the information available to them.
Difficulty: Medium
AACSB: Analytical Thinking
Topic: Choice and Consequence: Two Models of Inflation Expectations
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69) Suppose the U.S. economy is recovering from a long recession. How will this affect the
demand curve for reserves and the federal funds rate? Explain with a diagram.
Answer: The diagram below shows the federal funds market. D1 is the initial demand curve for
reserves and S is the supply curve of reserves. In an economy that is coming out of recession,
private banks need to obtain liquidity so they can make new loans to their customers–for
instance, a manufacturing firm that wishes to expand production by building a new factory.
Reserves provide liquidity that can be used to fund these loans. Therefore, the demand curve for
reserves is likely to shift to the right from D1 to D2 when the economy is recovering. The
equilibrium federal funds rate is the rate at which the demand for reserves equals the supply of
reserves. If the demand curve shifts to the right, the equilibrium federal funds rate will rise from
r1 to r2.
Difficulty: Medium
AACSB: Application of Knowledge
Topic: The Demand Side of the Federal Funds Market; The Supply Side of the Federal Funds
Market and Equilibrium in the Federal Funds Market
70) What can the central bank of Autarkia do to lower the rate which banks charge each other for
overnight loans? How will this affect the economy if it is facing a downturn?
Answer: The central bank of Autarkia can increase the supply of reserves. This can be done by
buying government bonds from private banks. Such a transaction is referred to as an open market
operation. If the central bank buys government bonds from private banks, the supply curve of
reserves will shift to the right. The demand for reserves will equal the supply of reserves at a
lower federal funds rate. If the federal funds rate falls, the banks will be able to make more loans.
The easy availability of loans will boost economic activity in the economy.
Difficulty: Medium
AACSB: Application of Knowledge
Topic: The Supply Side of the Federal Funds Market and Equilibrium in the Federal Funds
Market
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71) Rising inflation is the pressing concern of the government of Greatland. Suggest a suitable
monetary policy that the Central Bank should adopt to lower the rate of inflation.
Answer: In order to lower the rate of inflation using monetary policy, the central bank of
Greatland needs to raise the rate which banks charge each other for overnight loans, called the
federal funds rate. This can be done using four different tools. First, the central bank can reduce
the quantity of bank reserves by using open market operations. Second, it can increase the
reserve requirement. Third, it can increase the interest rate that it pays on reserves. Fourth, it can
increase the discount rate. All of these policies will increase the federal funds rate and have a
related effect on the interest rates that households and firms face for borrowing. Consequently, a
rise in the federal funds rate reduces the rate of loan growth to households and firms, reducing
the rate at which the money supply grows, and reducing the rate of inflation.
Difficulty: Medium
AACSB: Application of Knowledge
Topic: The Fed's Influence on the Money Supply and the Inflation Rate
72) Suppose the interest rate which banks in Techland charge each other for overnight loans is
5%, the long-run nominal interest rate is 4.5%, and the long-run expected inflation rate is 3%.
i) What is the long-run expected real interest rate?
ii) How will the long-run expected real interest rate be affected if the central bank of Techland
starts purchasing government bonds from banks?
Answer:
i) The long-run expected real interest rate can be obtained by subtracting the long-run expected
inflation rate from the long-run nominal interest rate. Therefore, long-run expected real interest
rate in this case is 4.5% - 3% = 1.5%.
ii) If the central bank of Techland starts purchasing government bonds from private banks, the
supply of reserves will increase. This will lead to a fall in the cost of borrowing funds for private
banks. As a result, they will be able to make more loans. This will lead to a decrease in the longrun nominal interest rate. If the long-run expected inflation rate remains unchanged, the long-run
expected real interest rate will fall.
Difficulty: Medium
AACSB: Application of Knowledge
Topic: The Relationship Between the Federal Funds Rate and the Long-Run Real Interest Rate
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