16 Monetary and Fiscal Policy (95) PDF

Question #1 of 95 Question ID: 1204729 The amount of money a commercial bank has available to lend is known as: A) fractional reserves. B) excess reserves. C) required reserves. Explanation Excess reserves are the amount of money a commerci...

Question #1 of 95 Question ID: 1204729 The amount of money a commercial bank has available to lend is known as: A) fractional reserves. B) excess reserves. C) required reserves. Explanation Excess reserves are the amount of money a commercial bank has available with which to make new loans, after depositing its required reserves with the central bank. (Study Session 5, Module 16.1, LOS 16.c) Related Material Question #2 of 95 Question ID: 1204769 If the U.S. Federal Reserve decides to decrease the money supply, which of the following is most likely to occur in the short run? A) An increase in the real rate of interest. B) A decrease in the unemployment rate. C) An increase in the velocity of money similar to decrease in the money supply. Explanation If the U.S. Federal Reserve decreases the money supply, an increase in nominal and real interest rates will occur. Higher real rates will cause businesses to invest less, which will cause the unemployment rate to increase. Furthermore, households will decrease purchases of durable goods, automobiles, and other items that are typically financed at short-term rates. This will decrease aggregate demand. The decrease in aggregate demand and expenditures will cause incomes to go down, which further decreases consumption and investment. Moreover, this decrease in aggregate demand will decrease real GDP and the price level in the short run and the long run. (Study Session 5, Module 16.2, LOS 16.i) Related Material Question #3 of 95 Question ID: 1204794 Quest o 3 o 95 Question ID: 1204794 Assuming the federal government maintains a balanced budget, the most likely effects of a tax increase on government expenditures and real GDP are: Government Real GDP Expenditures A) Increase Increase B) Increase Decrease C) Decrease Decrease Explanation The amount of the spending program exactly offsets the amount of the tax increase, leaving the budget unaffected (balanced budget). The multiplier effect is stronger for government spending versus the tax increase. Therefore, the balanced budget multiplier will be positive. All of the government spending enters the economy as increased expenditure, whereas only a portion of the tax increase results in lessened expenditure (determined by the marginal propensity to consume), because part of the tax increase will come from the savings of the taxpayer (determined by the marginal propensity to save). (Study Session 5, Module 16.3, LOS 16.p) Related Material Question #4 of 95 Question ID: 1204753 A country is experiencing a core inflation rate of 7% during a recessionary period of real GDP growth. If the central bank has a single mandate to achieve price stability and uses inflation targeting with an acceptable range of zero to 4%, its monetary policy response is most likely to decrease: A) the foreign exchange value of the country’s currency. B) short-term interest rates. C) GDP growth in the short run. Explanation If the central bank has a price stability mandate, it will most likely respond to the above- target inflation rate by decreasing the money supply, even though GDP growth is in a recessionary phase. Decreasing the money supply will result in higher short-term interest rates and appreciation of the currency, but will likely cause GDP growth to decrease further in the short run. (Study Session 5, Module 16.1, LOS 16.f) Related Material Question #5 of 95 Question ID: 1204763 When the Federal Reserve sells government securities on the open market, bank reserves are: decreased, which reduces the amount of money banks are able to lend, causing A) an increase in the federal funds rate. increased, which increases the amount of money banks are able to lend, B) causing a decrease in the federal funds rate. decreased, which reduces the amount of money banks are able to lend, causing C) a decrease in the federal funds rate. Explanation When the Federal Reserve wants to increase the federal funds rate through open market operations, it sells government securities. Open-market sales reduce bank reserves and cause the federal funds rate to increase. (Study Session 5, Module 16.2, LOS 16.h) Related Material Question #6 of 95 Question ID: 1204764 If the Federal Reserve wishes to lower market interest rates without changing the discount rate, it can: A) raise the yield on Treasury securities. B) increase bank reserve requirements. C) buy Treasury securities. Explanation Buying Treasury securities pumps money into the economy, lowering interest rates. Higher reserve requirements will restrict the money supply, causing rates to rise. The Federal Reserve has no direct control over the yield on existing Treasury securities. (Study Session 5, Module 16.2, LOS 16.h) Related Material Question #7 of 95 Question ID: 1204762 Assume the U.S. economy is undergoing a recession. In its efforts to stimulate the economy by trying to influence short-term interest rates the Fed is most likely to take which two actions? A) Sell Treasury securities and increase bank reserve requirements. B) Sell Treasury securities and decrease bank reserve requirements. C) Buy Treasury securities and decrease bank reserve requirements. Explanation If the economy is in a recession, the Fed is likely to attempt to decrease short-term interest rates. Thus, the Fed will buy Treasury securities and decrease bank reserve requirements. (Study Session 5, Module 16.2, LOS 16.h) Related Material Question #8 of 95 Question ID: 1204807 An example of a contractionary fiscal policy change is a(n): A) increase in a scal de cit. B) decrease in a scal surplus. C) increase in a scal surplus. Explanation An increase in a fiscal surplus or a decrease in a fiscal deficit is contractionary. An increase in a fiscal deficit or a decrease in a fiscal surplus is expansionary. (Study Session 5, Module 16.3, LOS 16.s) Related Material Question #9 of 95 Question ID: 1204804 Which of the following statements about achieving proper timing in fiscal policy is least accurate? There is usually a time lag between when a change in policy is needed and when A) the need is recognized by policy makers. B) Policy errors are inevitable due to unpredictable events. Improvements in quantitative methods have made the occurrence of recessions C) or expansions quite predictable. Explanation One problem in achieving proper timing in fiscal policy is the inability to accurately predict a recession or expansion. (Study Session 5, Module 16.3, LOS 16.r) Related Material Question #10 of 95 Question ID: 1204787 Which of the following conditions is difficult for monetary policy to address because a central bank cannot reduce its nominal policy rate much below zero? A) Stag ation. B) De ation. C) In ation. Explanation Deflation is difficult for central banks to address when policy rates cannot be lowered any further. Inflation can be addressed by contractionary monetary policy. Stagflation is difficult to address because monetary policy cannot pursue higher growth and lower inflation at the same time. (Study Session 5, Module 16.2, LOS 16.n) Related Material Question #11 of 95 Question ID: 1204812 The government is reducing its spending to balance the budget, while the central bank is lowering its official policy rate. What will most likely be the combined effect on the economy? A) The public sector as a percentage of GDP will increase. B) The private sector as a percentage of GDP will increase. The public and private sectors as a percentage of GDP will neither decrease nor C) increase. Explanation The private sector will expand as a percentage of GDP because (1) the public sector will decrease as a percentage of GDP due to government spending cuts and (2) lower interest rates should cause the private sector to expand. (Study Session 5, Module 16.3, LOS 16.t) Related Material Question #12 of 95 Question ID: 1204771 Contractionary monetary policy is least likely to decrease consumption spending by decreasing: A) expectations for economic growth. B) securities prices. C) the foreign exchange value of the currency. Explanation Contractionary monetary policy is likely to increase the value of the domestic currency in the foreign exchange market, which decreases foreign demand for the country's exports. Contractionary monetary policy should cause both securities prices and expectations for economic growth to decrease, each of which is likely to cause consumers to decrease spending. (Study Session 5, Module 16.2, LOS 16.i) Related Material Question #13 of 95 Question ID: 1204723 When the central bank reduces the quantity of money and credit in an economy, its monetary policy is best described as: A) expansionary. B) contractionary. C) accommodative. Explanation When the central bank is reducing the quantity of money and credit in an economy, the monetary policy is said to be contractionary, restrictive, or tight. (Study Session 5, Module 16.1, LOS 16.a) Related Material Question #14 of 95 Question ID: 1204747 According to the Fisher effect, which of the following interest rates includes a premium for the expected rate of inflation? Yields on long-term corporate debt, but not yields on short-term government A) debt. Both yields on short-term government debt and yields on long-term corporate B) debt. Neither yields on short-term government debt nor yields on long-term C) corporate debt. Explanation The Fisher effect holds that all nominal interest rates include a premium for expected inflation. (Study Session 5, Module 16.1, LOS 16.e) Related Material Question #15 of 95 Question ID: 1204750 The Fisher effect describes the relationship between: A) money supply growth and actual in ation. B) nominal and real interest rates. C) expected and unexpected in ation. Explanation The Fisher effect states that a nominal interest rate is equal to a real interest rate plus the expected rate of inflation. (Study Session 5, Module 16.1, LOS 16.e) Related Material Question #16 of 95 Question ID: 1204719 Policies used with the goal of maintaining stable prices and producing economic growth include: A) monetary policy only. B) scal policy only. C) both scal policy and monetary policy. Explanation Both fiscal and monetary policies are used to maintain stable prices and produce economic growth. Fiscal policy does so by mechanisms that involve spending and taxation, and monetary policy uses central bank tools to modify the availability of money and credit. (Study Session 5, Module 16.1, LOS 16.a) Related Material Question #17 of 95 Question ID: 1204746 The three reasons for holding money are most accurately described as: A) narrow money demand, precautionary demand, and speculative demand. B) transaction demand, precautionary demand, and speculative demand. C) broad money demand, narrow money demand, and transaction demand. Explanation The three reasons for holding money are: transaction demand, for buying goods and services; precautionary demand, to meet unforeseen future needs; and speculative demand, to take advantage of investment opportunities. Narrow money and broad money refer to measures of money in circulation. (Study Session 5, Module 16.1, LOS 16.d) Related Material Question #18 of 95 Question ID: 1204773 What are the three essential qualities an effective central bank should possess? A) Transparency, comprehensiveness, and consistency. B) Independence, credibility, and transparency. C) Understandability, relevance, and reliability. Explanation A central bank that is independent from political interference, possesses credibility, and exhibits transparency is more likely to achieve its monetary policy objectives than a central bank that lacks these qualities. The characteristics listed in the other answer choices relate to financial statements and financial reporting standards. (Study Session 5, Module 16.2, LOS 16.j) Related Material Question #19 of 95 Question ID: 1204781 Which of the following is currently the most-used target for central banks? A) Money supply targeting. B) In ation targeting. C) Interest rate targeting. Explanation Inflation targeting is the most-used tool of central banks for making monetary policy decisions. (Study Session 5, Module 16.2, LOS 16.l) Related Material Question #20 of 95 Question ID: 1204776 Silvano Jimenez, an analyst at Banco del Rey, is reviewing recent actions taken by the U.S. Federal Reserve (the Fed) in setting monetary policy. Recently, the Fed decided to increase the money supply, which has resulted in a decrease in real interest rates. At a staff meeting, Jimenez brings this matter to the attention of his colleagues and makes the following statements: Statement 1: Although the money supply increase has led to a decrease in real interest rates, we should begin to see U.S. investors decrease their investments abroad and the U.S. dollar will appreciate in the foreign exchange market. Statement 2: The Fed's increase in the money supply will increase the amount of imports into the U.S. Are Statement 1 and Statement 2 as made by Jimenez CORRECT? Statement 1 Statement 2 A) Incorrect Correct B) Incorrect Incorrect C) Correct Incorrect Explanation If the Fed increases the money supply and real interest rates decline, U.S. investors will seek higher real rates of return abroad and the U.S. dollar will depreciate as the dollar will be exchanged for foreign currencies in order to buy the foreign investments. Likewise, the decrease in real interest rates will reduce the inflow of funds from abroad as foreign investors seek higher rates of return outside the U.S. With a dollar that has depreciated, U.S. exports should increase, as U.S. products will become cheaper for foreign buyers. As such, both statements are incorrect. (Study Session 5, Module 16.2, LOS 16.k) Related Material Question #21 of 95 Question ID: 1204749 The Fisher effect describes a nominal interest rate as the: A) expected in ation rate plus the real interest rate. B) expected in ation rate less the real interest rate. C) actual in ation rate less the real interest rate. Explanation The Fisher effect states that a nominal interest rate is equal to the real interest rate plus the expected inflation rate. (Study Session 5, Module 16.1, LOS 16.e) Related Material Question #22 of 95 Question ID: 1204777 Which of the following is the most likely result of a central bank's shift to an expansionary monetary policy? A) Domestic currency appreciates. B) Interest rates increase. C) Exports increase. Explanation Expansionary monetary policy decreases interest rates. This should cause the domestic currency to depreciate, which should increase foreign demand for the country's exports. (Study Session 5, Module 16.2, LOS 16.k) Related Material Question #23 of 95 Question ID: 1204721 Attempting to influence economic growth and inflation by changing tax rates and government spending is best described as: A) government policy. B) monetary policy. C) scal policy. Explanation Fiscal policy refers to actions by a government to influence economic activity through changes in taxes and government spending. (Study Session 5, Module 16.1, LOS 16.a) Related Material Question #24 of 95 Question ID: 1204811 Which one of the following Federal Reserve monetary policies, when pursued in line with the U.S. government's fiscal policies, would help increase aggregate demand during a period of high unemployment? A) An increase in the reserve requirements for nancial institutions. B) A decrease in the discount rate. C) The sale of bonds by the Fed. Explanation A decrease in the Fed's lending rate is a monetary tool that the Fed can use to increase the money supply, thereby increasing aggregate demand during recessionary times when there is high unemployment. An increase in the reserve requirements and the sale of bonds by the Fed would all be restrictive monetary policies that would reduce the amount of money in the economy and reduce aggregate demand. (Study Session 5, Module 16.3, LOS 16.t) Related Material Question #25 of 95 Question ID: 1204788 Discretionary fiscal policy refers to: A) active decisions regarding spending and taxing to a ect economic growth. B) built-in devices that counteract the business cycle phase. C) increasing aggregate demand through lower interest rates. Explanation Discretionary fiscal policy, in contrast to automatic stabilizers, refers to active decisions by the government to affect economic growth through changes in government spending and taxation. Increasing aggregate demand through lower interest rates describes expansionary monetary policy. (Study Session 5, Module 16.3, LOS 16.o) Related Material Question #26 of 95 Question ID: 1204735 Assume the Federal Reserve purchases $1 billion of securities in the open market. What is the maximum increase in the money supply that can result from this action, if the required reserve ratio is 15%? A) $1.00 billion. B) $6.67 billion. C) $850 million. Explanation The money multiplier is 1 / 0.15 = 6.67, so the open market purchase can increase the money supply by a maximum of $6.67 billion. (Study Session 5, Module 16.1, LOS 16.c) Related Material Question #27 of 95 Question ID: 1204758 Compared to the costs of inflation that is unexpected, costs of inflation that iscorrectly anticipated are most likely to be: A) less severe. B) equally severe. C) more severe. Explanation Costs of inflation are less severe when inflation is correctly anticipated than when inflation is unexpected. Unexpected inflation results in wealth being transferred from lenders to borrowers. In addition, producers might misallocate resources if they cannot determine whether an increase in the price of their output reflects inflation or a genuine increase in demand. (Study Session 5, Module 16.1, LOS 16.g) Related Material Question #28 of 95 Question ID: 1204792 When an economy dips into a recession, automatic stabilizers will tend to alter government spending and taxation so as to: A) reduce interest rates, thus stimulating aggregate demand. B) reduce the budget de cit (or increase the surplus). C) enlarge the budget de cit (or reduce the surplus). Explanation During a recession unemployment is high, so the government will pay out more in unemployment compensation at the exact time that tax receipts from corporations and individuals are low. This will increase the size of the deficit and also maintain aggregate demand during recessionary periods. (Study Session 5, Module 16.3, LOS 16.o) Related Material Question #29 of 95 Question ID: 1204809 The government budget deficit of Country M is increasing. At the same time, the government budget surplus of Country N is decreasing. Are the fiscal policies of these countries expansionary or contractionary? A) One is expansionary and one is contractionary. B) Both are contractionary. C) Both are expansionary. Explanation Expansionary fiscal policy increases a budget deficit or decreases a budget surplus. Contractionary fiscal policy decreases a budget deficit or increases a budget surplus. (Study Session 5, Module 16.3, LOS 16.s) Related Material Question #30 of 95 Question ID: 1204761 Which of the following statements regarding U.S. Federal Reserve open market operations is least accurate? A) When the Fed sells Treasury securities, excess reserves decrease. If the Fed wants to stimulate the economy, it will sell Treasury securities to B) banks.  When the Fed buys Treasury securities, short-term interest rates will generally C) decrease. Explanation If the Fed intends to stimulate the economy, they will buy, not sell, Treasury securities. Buying Treasury securities injects reserves into the banking system. (Study Session 5, Module 16.2, LOS 16.h) Related Material Question #31 of 95 Question ID: 1204756 Which of the following is least likely a function or objective of a central bank? A) Issuing currency. B) Keeping in ation within an acceptable range. C) Lending money to government agencies. Explanation Lending money to government agencies is not typically a function of a central bank. Central bank functions include controlling the country's money supply to keep inflation within acceptable levels and promoting a sustainable rate of economic growth, as well as issuing currency and regulating banks. (Study Session 5, Module 16.1, LOS 16.f) Related Material Question #32 of 95 Question ID: 1204737 If households are holding larger real money balances than they desire, which of the following is least likely? The central bank must issue securities to absorb the excess money supply and A) establish equilibrium. B) The opportunity cost of holding money balances will decrease. The interest rate is higher than its equilibrium rate in the market for real money C) balances. Explanation If households' real money balances are larger than they desire, the interest rate (opportunity cost of holding money balances) is higher than its equilibrium rate. Households will use their undesired cash to buy securities, bidding up securities prices and reducing the interest rate until the equilibrium rate is achieved. This market process does not require any action by the central bank. (Study Session 5, Module 16.1, LOS 16.d) Related Material Question #33 of 95 Question ID: 1204775 If a country's economy is growing at an unsustainably rapid rate and the central bank decreases its target overnight interest rate, the country's: A) expected rate of in ation is likely to decline. B) in ation rate is likely to increase. C) long-term rate of economic growth will increase. Explanation The central bank should increase target interest rates when the economy is growing at an unsustainable (above-full-employment) level. Decreasing the target overnight rate is likely to further increase aggregate demand and cause inflation to accelerate, which will be detrimental to the long-term growth rate of the economy. (Study Session 5, Module 16.2, LOS 16.k) Related Material Question #34 of 95 Question ID: 1204774 Central banks that are able to define how inflation is computed and determine its desired level are best described as having: A) operational independence. B) transparency. C) target independence. Explanation Target independence means the central bank defines how inflation is computed, sets the target inflation level, and determines the horizon over which the target is to be achieved. Central banks that have operational independence are allowed to determine the policy rate. Transparency refers to the degree to which central banks report to the public on the state of the economic environment and is one of the three essential qualities of an effective central bank. (Study Session 5, Module 16.2, LOS 16.j) Related Material Question #35 of 95 Question ID: 1204727 When comparing a barter economy with an economy that uses money as a medium of exchange we would expect increased efficiencies due to a reduction in which of the following? A) Transaction costs. B) Nominal interest rates. C) The need to specialize. Explanation Money functions as a medium of exchange because it is accepted as payment for goods and services. Compare this to a barter economy, where if I have goat and want an ox, I have to find someone willing to trade. Finding someone takes time and time is costly. With money, I can sell the goat and buy the ox. Thus, transaction costs are reduced. Having money as a medium of exchange would not reduce the inflation rate, interest rates, or the need to specialize in the production of those goods in which we have a comparative advantage (low opportunity cost producer). (Study Session 5, Module 16.1, LOS 16.b) Related Material Question #36 of 95 Question ID: 1204743 If the money interest rate is measured on the y-axis and the quantity of money is measured on the x-axis, the money supply curve is: A) downward sloping to the lower right. B) vertical. C) upward sloping to the upper right. Explanation The money supply schedule is vertical because it is not affected by changes in the interest rate but is determined by the monetary authorities such as the Federal Reserve System (Fed) in the United States. (Study Session 5, Module 16.1, LOS 16.d) Related Material Question #37 of 95 Question ID: 1204730 On January 5, the U.S. Federal Reserve (the Fed) bought $10,000,000 of U.S. Treasury securities in the open market. At the time, the reserve requirement was 25%, and all banks had zero excess reserves. What is the potential impact of the Fed's purchase on the U.S. money supply? A) $10,000,000 increase. B) $40,000,000 increase. C) $25,000,000 decrease. Explanation Buying securities by the Fed increases the money supply because they are injecting money into the banking system. The money supply can potentially increase by 1 / 0.25 × $10,000,000 = $40,000,000. (Study Session 5, Module 16.1, LOS 16.c) Related Material Question #38 of 95 Question ID: 1204795 Robert Necco and Nelson Packard are economists at Economic Research Associates. ERA asks Necco and Packard for their opinions about the effects of fiscal policy on real GDP for an economy currently experiencing a recession. Necco states that real GDP is likely to increase if both government spending and taxes are increased by the same amount. Packard states that if both government spending and taxes are increased by the same amount, there is no expected net effect on real GDP. Are the statements made by Necco and Packard CORRECT? Necco Packard A) Correct Incorrect B) Incorrect Incorrect C) Incorrect Correct Explanation Necco is correct because the multiplier effect is stronger for government expenditures versus government taxes. All of the increase in government spending enters the economy as increased expenditure, whereas only a portion of the tax increase results in lessened expenditure (determined by the marginal propensity to consume), because part of the tax increase will come from the savings of the taxpayer (determined by the marginal propensity to save). Packard is incorrect; the effect on real GDP of an increase in government spending combined with equal increase in taxes will be positive because the multiplier effect is stronger for government spending versus the tax increase. (Study Session 5, Module 16.3, LOS 16.p) Related Material Question #39 of 95 Question ID: 1204733 Banks choose to hold a higher percentage of deposits as reserves because they believe general business conditions in the economy are subject to greater uncertainty. If all else is held constant, what is the most likely impact of this action? The money supply will increase during a period of in ation, but will decrease if A) the economy goes into a recession. B) There will be no e ect on the money supply. C) The money supply will decrease. Explanation If banks choose to hold excess reserves, they will decrease their lending. Less bank lending will cause the money supply to decrease. (Study Session 5, Module 16.1, LOS 16.c) Related Material Question #40 of 95 Question ID: 1204767 If a central bank's targeted inflation rate is above the current rate, the central bank is most likely to: A) increase the overnight lending rate. B) increase the reserve requirement. C) buy government securities. Explanation Buying government securities is an expansionary policy that would increase the money supply and allow the inflation rate to increase to the targeted range. Increasing reserve requirements and overnight lending rates are contractionary and would have the opposite effects. (Study Session 5, Module 16.2, LOS 16.h) Related Material Question #41 of 95 Question ID: 1204800 Arguments against being concerned about the size of a fiscal deficit include: A) the crowding-out e ect. B) higher future taxes. C) Ricardian equivalence. Explanation Ricardian equivalence suggests that it does not matter whether a government finances its spending with debt or a tax increase because the effect on the total level of demand in the economy is the same. Arguments for being concerned about the size of the fiscal deficit include the crowding-out effect of government borrowing taking the place of private sector borrowing and the negative effects on work incentives and entrepreneurship from higher future taxes. (Study Session 5, Module 16.3, LOS 16.q) Related Material Question #42 of 95 Question ID: 1204755 Central banks are most likely to pursue a target inflation rate: A) above 3%. B) equal to 0%. C) between 0 and 3%. Explanation Central banks typically define price stability as a stable inflation rate of about 2% to 3%. A target of zero is not typically used because it would risk deflation. (Study Session 5, Module 16.1, LOS 16.f) Related Material Question #43 of 95 Question ID: 1204741 Which of the following statements regarding money demand and supply is least accurate? A) As the Fed reduces the money supply, short-term interest rates decrease. B) The supply curve for money is vertical. The supply of money is determined by the monetary authority and is not C) a ected by changes in interest rates. Explanation As the Fed reduces the money supply, short-term interest rates increase. The other statements concerning the demand and supply for money are true. (Study Session 5, Module 16.1, LOS 16.d) Related Material Question #44 of 95 Question ID: 1204782 An analyst has determined the projected trend rate of real GDP growth is 2.5% and the central bank's inflation target is 2.5%. If the central bank policy rate is 5.0%, monetary policy is most likely: A) contractionary. B) expansionary. C) neutral. Explanation The neutral rate of interest is real trend rate of economic growth plus the inflation target. In this example, the neutral rate = 2.5% + 2.5% = 5.0%. Because the policy rate is the same as the neutral rate of interest, monetary policy is neither contractionary nor expansionary. (Study Session 5, Module 16.2, LOS 16.m) Related Material Question #45 of 95 Question ID: 1204752 If a bank needs to borrow funds from the Federal Reserve to fund a temporary shortage in reserves, it would borrow funds at the: A) prime rate. B) discount rate. C) federal funds rate. Explanation Banks are able to borrow from the Fed at the discount rate. The federal funds rate is the interest rate banks charge other banks to borrow reserves from other banks. The prime rate is the rate that commercial banks charge their best customers. (Study Session 5, Module 16.1, LOS 16.f) Related Material Question #46 of 95 Question ID: 1204806 The country of Zurkistan is experiencing both high interest rates and high inflation. The government passes laws that reduce government spending and increase taxes. It takes many months before interest rates fall and inflation is reduced. This is an example of: A) action lag and automatic stabilizers. B) recognition lag in discretionary scal policy. C) impact lag in discretionary scal policy. Explanation This is an example of discretionary fiscal policy involving impact lag because it takes time for the impact of the change in taxing and spending to be felt throughout the economy. (Study Session 5, Module 16.3, LOS 16.r) Related Material Question #47 of 95 Question ID: 1204736 According to the quantity theory of money, if nominal GDP is $7 trillion, the price index is 150, and the money supply is $1 trillion, then the velocity of the money supply is closest to: A) 10.5. B) 4.7. C) 7.0. Explanation The equation of exchange is MV = PY. Nominal GDP = PY, so that MV = nominal GDP. Therefore, ($1.0 trillion)(V) = $7.0 trillion. V = $7.0 trillion / $1.0 trillion. V = 7.0. (Study Session 5, Module 16.1, LOS 16.c) Related Material Question #48 of 95 Question ID: 1204789 Unemployment compensation is an example of: A) a discretionary scal policy stabilizer. B) an automatic scal policy stabilizer. C) an automatic monetary policy stabilizer. Explanation Unemployment compensation automatically rises and falls with the business cycle, therefore it is an example of an automatic fiscal policy stabilizer. (Study Session 5, Module 16.3, LOS 16.o) Related Material Question #49 of 95 Question ID: 1204760 If a monetary policy is focused on combating inflation, which open market actions by the Federal Reserve will most effectively accomplish this? A) Purchase Treasury securities, causing aggregate demand to decrease. B) Sell Treasury securities, causing aggregate demand to increase. C) Sell Treasury securities, causing aggregate demand to decrease. Explanation If the Federal Reserve wants to slow inflation, it needs to decrease aggregate demand (i.e., business investment, consumer purchases of durable goods, and exports). To accomplish this, the Federal Reserve could engage in open market sales of Treasury securities. (Study Session 5, Module 16.2, LOS 16.h) Related Material Question #50 of 95 Question ID: 1204796 Assuming the economy currently is experiencing high inflation, an example of appropriate discretionary fiscal policy is: A) reduce the money supply. B) increase the federal funds target rate. C) reduce government expenditures on major government construction projects. Explanation Discretionary fiscal policy refers to the federal government's decisions regarding government spending and taxing. A reduction in government spending on major government construction projects is likely to lead to a reduction in aggregate demand and less pressure on prices, reducing inflation. (Study Session 5, Module 16.3, LOS 16.p) Related Material Question #51 of 95 Question ID: 1204805 Which of the following statements best explains the importance of the timing of changes in discretionary fiscal policy? Changes in discretionary fiscal policy must be timed properly if they are going to: A) exert a stabilizing in uence on an economy. B) enable the government to control the money supply. C) help the government achieve a balanced budget. Explanation Proper timing of discretional policy is needed to reduce economic instability. If timed incorrectly, the fiscal policy change could increase rather than reduce economic instability. (Study Session 5, Module 16.3, LOS 16.r) Related Material Question #52 of 95 Question ID: 1204780 A central bank follows an inflation targeting monetary policy. If the permissible band is plus- or-minus 2% around the target inflation rate, the central bank is most likely to choose a target inflation rate of: A) 1%. B) 3%. C) 0%. Explanation Because they consider deflation to be disruptive to an economy, central banks typically choose inflation targets and bands that do not include a negative rate of inflation. (Study Session 5, Module 16.2, LOS 16.l) Related Material Question #53 of 95 Question ID: 1204731 When additional or excess reserves are injected into the U.S. banking system, the money supply can potentially increase by an amount equal to the additional excess reserves multiplied by which of the following? A) Reciprocal of one minus the required reserve ratio. B) Required reserve ratio. C) Reciprocal of the required reserve ratio. Explanation The potential deposit expansion multiplier = 1 / (required reserve ratio) The potential increase in the money supply = potential deposit expansion multiplier × increase in excess reserves (Study Session 5, Module 16.1, LOS 16.c) Related Material Question #54 of 95 Question ID: 1204766 Central banks pursuing expansionary policies may: A) increase the policy rate and make open market purchases of securities. B) decrease the policy rate and make open market purchases of securities. C) decrease the policy rate and make open market sales of securities. Explanation Decreasing the policy rate, decreasing reserve requirements, and purchasing securities in the open market are expansionary monetary policy actions. (Study Session 5, Module 16.2, LOS 16.h) Related Material Question #55 of 95 Question ID: 1204725 Money serves as a unit of account because: money received for work or goods can be saved to purchase goods or services A) in the future. B) prices of goods and services are expressed in units of money. C) money is accepted as the form of payment for goods. Explanation Money has three primary functions: it serves as a unit of account because prices of goods and services are expressed in units of money; it provides a store of value because money received for work or goods can be saved to purchase goods or services at another time; and it serves as a medium of exchange because money is accepted as a form a payment. (Study Session 5, Module 16.1, LOS 16.b) Related Material Question #56 of 95 Question ID: 1204779 If a central bank implements an exchange rate targeting policy successfully, the country's inflation rate is most likely to be: A) greater than that of the target currency. B) less than that of the target currency. C) the same as that of the target currency. Explanation Successful exchange rate targeting should result in the same inflation rate in the targeting country as in the country of the target currency. (Study Session 5, Module 16.2, LOS 16.l) Related Material Question #57 of 95 Question ID: 1204720 Monetary policy refers to actions that influence economic activity by increasing or decreasing: A) tax rates on income and consumption. B) the supply of money and credit. C) government purchases of goods and services. Explanation Monetary policy attempts to influence economic growth and inflation by increasing or decreasing the money supply and the availability of credit in the economy. Taxes and government spending are tools of fiscal policy. (Study Session 5, Module 16.1, LOS 16.a) Related Material Question #58 of 95 Question ID: 1204801 The time it takes for a fiscal policy action to affect the economy is best described as: A) impact lag. B) scal lag. C) economic lag. Explanation The time it takes for a fiscal policy action, once implemented, to have its effect on the economy is referred to as impact lag. (Study Session 5, Module 16.3, LOS 16.r) Related Material Question #59 of 95 Question ID: 1204739 The supply of money is primarily determined by: A) interest rates. B) the monetary authorities. C) in ation. Explanation The monetary authorities determine the quantity of money available to the economy. Inflation and interest rates affect the demand for money balances. (Study Session 5, Module 16.1, LOS 16.d) Related Material Question #60 of 95 Question ID: 1204745 Which of the following is determined by the equilibrium between the demand for money and the supply of money? A) In ation rate. B) Money supply. C) Interest rate. Explanation Interest rates are determined by the equilibrium between money supply and money demand. (Study Session 5, Module 16.1, LOS 16.d) Related Material Question #61 of 95 Question ID: 1204797 An argument against being concerned with the size of a fiscal deficit is that a deficit can: aid in increasing GDP and employment if the economy is operating at less than A) potential GDP. B) cause government borrowing to crowd out private borrowing. C) lead to higher future taxes that will increase government revenues. Explanation One potential argument against being concerned about the size of fiscal deficits is that a deficit can help increase GDP and employment if output is below potential GDP and the spending does not divert capital from productive uses. Higher deficits that lead to crowding out or higher future taxes that result in lower long-term economic growth are arguments for concern about the size of fiscal deficits. (Study Session 5, Module 16.3, LOS 16.q) Related Material Question #62 of 95 Question ID: 1204810 Which of the following fiscal and monetary policy scenarios is most likely to increase the size of the public sector relative to the private sector? A) Contractionary scal and monetary policy. B) Expansionary scal policy and contractionary monetary policy. C) Expansionary monetary policy and contractionary scal policy. Explanation Expansionary fiscal policy tends to expand the public sector. Contractionary monetary policy tends to contract the private sector. (Study Session 5, Module 16.3, LOS 16.t) Related Material Question #63 of 95 Question ID: 1204732 If a bank receives a deposit of $1 million in cash which has been held outside the banking system and the reserve requirement is 10%, the maximum increase in the money supply that could result is: A) $10,000,000. B) $100,000. C) $900,000. Explanation The maximum increase in the money supply from a fractional reserve banking system is the money multiplier (1 / reserve requirement) times the amount of a new deposit of cash. 1/0.10 × $1 million = $10 million. (Study Session 5, Module 16.1, LOS 16.c) Related Material Question #64 of 95 Question ID: 1204808 A government that is implementing a contractionary fiscal policy is most likely to: A) decrease income tax rates. B) increase spending on public works. C) decrease transfer payments to households. Explanation Decreasing spending or increasing taxes are contractionary fiscal policy actions. Increasing spending or decreasing taxes are expansionary. (Study Session 5, Module 16.3, LOS 16.s) Related Material Question #65 of 95 Question ID: 1204772 A central bank has operational independence if it can independently determine: A) how in ation is calculated. B) the policy rate. C) the horizon over which to achieve its in ation target. Explanation A central bank is said to have operational independence if it has the authority to determine the policy rate independently. Determining how inflation is calculated and the time horizon for achieving its target rate of inflation refer to a central bank that has target independence. (Study Session 5, Module 16.2, LOS 16.j) Related Material Question #66 of 95 Question ID: 1204724 Promoting economic growth and price stability are the goals of: A) monetary policy, but not scal policy. B) scal policy, but not monetary policy. C) both scal and monetary policy. Explanation Both monetary and fiscal policies are used by policymakers with the goals of maintaining stable prices and producing positive economic growth. (Study Session 5, Module 16.1, LOS 16.a) Related Material Question #67 of 95 Question ID: 1204798 Arguments for being concerned about the size of a fiscal deficit least likely include: A) a reduction in long-term economic growth. B) Ricardian equivalence. C) the crowding-out e ect. Explanation If Ricardian equivalence holds, private savings will increase in anticipation of the future taxes required by a fiscal deficit. The crowding-out effect of government borrowing on private investment and the reduction in long-term economic growth due to higher future taxes argue in favor of being concerned about the size of a fiscal deficit. (Study Session 5, Module 16.3, LOS 16.q) Related Material Question #68 of 95 Question ID: 1204770 The open market sale of Treasury securities by the Federal Reserve is least likely to result in: A) increased longer-term interest rates. B) increased exports of U.S. goods. C) a decreased rate of in ation. Explanation When the Fed sells Treasuries, it causes both short- and long-term interest rates to increase. This rate increase causes the dollar to appreciate, which reduces foreign demand for domestic goods, causing exports to decline. The interest rate increase also puts downward pressure on price levels, which causes inflation to slow. (Study Session 5, Module 16.2, LOS 16.i) Related Material Question #69 of 95 Question ID: 1204726 Money functions as a store of value because: A) prices of goods and services are expressed in units of money. money received for work or goods can be saved to purchase goods or services B) in the future. C) money is accepted as the form of payment for goods. Explanation Money has three primary functions: it provides a store of value because money received for work or goods can be saved for future consumption; it serves as a unit of account because prices of all goods and services are expressed in units of money; and it serves as a medium of exchange because money is accepted as a form a payment. (Study Session 5, Module 16.1, LOS 16.b) Related Material Question #70 of 95 Question ID: 1204734 Which of the following relationships in regard to the quantity theory of money is least accurate? A) Money × Velocity = Money Supply × Velocity. B) Nominal GDP = Price × Money Supply. C) Nominal GDP = Money Supply × Velocity = Price × Real Output. Explanation The quantity theory of money holds that: Money Supply × Velocity = Nominal GDP = Price × Real Output. (Study Session 5, Module 16.1, LOS 16.c) Related Material Question #71 of 95 Question ID: 1204722 A distinction between fiscal policy and monetary policy is that fiscal policy: concerns taxes and government spending, while monetary policy concerns the A) money supply. is aimed at promoting economic growth, while monetary policy is aimed at B) promoting price stability. C) is typically expansionary, while monetary policy is typically contractionary. Explanation The distinction between fiscal and monetary policy is that a country's government determines fiscal policy through taxes and spending, but its central bank determines monetary policy by controlling the money supply. Both fiscal and monetary policy can be used to promote economic growth and price stability. Either fiscal policy or monetary policy can be expansionary or contractionary. (Study Session 5, Module 16.1, LOS 16.a) Related Material Question #72 of 95 Question ID: 1204778 Xanadu attempts to decrease its inflation rate by implementing contractionary monetary policy. Which of the following is most likely to be the long-run effect on Xanadu's trade balance as a result of the monetary policy change? A) Improve. B) Worsen. C) Remain the same. Explanation Contractionary monetary policy likely will cause higher domestic interest rates and attract foreign capital. As foreign capital flows in, the currency will appreciate relative to other currencies. The higher cost of its currency will result in higher cost exports that become less attractive to other countries. Xanadu's trade balance will most likely worsen. (Study Session 5, Module 16.2, LOS 16.k) Related Material Question #73 of 95 Question ID: 1204784 An economy's long-term trend rate of real GDP growth is 3% and the central bank's target inflation rate is 2%. If the policy rate is 6%, monetary policy is: A) neutral. B) expansionary. C) contractionary. Explanation Monetary policy is contractionary when the policy rate is greater than the neutral rate, which is the sum of the real trend rate of economic growth and the target rate of inflation. Here, the neutral rate is 3% + 2% = 5% and the policy rate of 6% is greater than the neutral rate. Monetary policy is expansionary when the policy rate is less than the neutral interest rate. (Study Session 5, Module 16.2, LOS 16.m) Related Material Question #74 of 95 Question ID: 1204791 The term "automatic stabilizers" refers to: changes in taxes and expenditure programs legislators automatically enact in A) response to changes the level of economic activity in order to smooth economic cycles. increases in transfer payments and decreases in tax revenues that result from B) an economic contraction without new legislation. government expenditures and tax receipts that are required to balance over the C) course of the business cycle, although they may be out of balance in any single year. Explanation Automatic stabilizers refers the increase (decrease) in transfer payments such as unemployment compensation and the decrease (increase) in tax revenue that result from a decrease (increase) in the level of economic activity. These effects tend to move the fiscal budget toward a deficit when economic activity decreases and toward surplus when economic activity increases, and tend to dampen economic cycles. (Study Session 5, Module 16.3, LOS 16.o) Related Material Question #75 of 95 Question ID: 1204759 An individual has just purchased a home by taking on a 30-year fixed rate mortgage. She would benefit most from this transaction if future inflation rates are: A) exactly as anticipated. B) lower than anticipated. C) higher than anticipated. Explanation Inflation that is higher than anticipated will result in a transfer of wealth from lenders to borrowers. (Study Session 5, Module 16.1, LOS 16.g) Related Material Question #76 of 95 Question ID: 1204740 Which of the following statements about the demand for and supply of money is least accurate? As in ation rises, the demand for money by households and businesses also A) rises. B) As the interest rate rises, the supply of money also rises. C) As gross domestic product rises, the demand for money balances also rises. Explanation The supply of money is determined by the monetary authorities and is not affected by changes in interest rates. Thus, the supply of money curve is vertical. (Study Session 5, Module 16.1, LOS 16.d) Related Material Question #77 of 95 Question ID: 1204751 The primary objective of a central bank is to: A) achieve full employment. B) control in ation. C) stabilize exchange rates. Explanation Although some central banks have other stated goals including stabilizing exchange rates and achieving full employment, the primary objective for a central bank is to control inflation and promote price stability. (Study Session 5, Module 16.1, LOS 16.f) Related Material Question #78 of 95 Question ID: 1204748 The Fisher effect holds that a nominal rate of interest equals a real rate: A) minus expected in ation. B) plus expected in ation. C) plus actual in ation. Explanation The Fisher effect states that a nominal rate of interest equals a real rate plus expected inflation. (Study Session 5, Module 16.1, LOS 16.e) Related Material Question #79 of 95 Question ID: 1204718 Policies that can be used as tools for redistribution of wealth and income include: A) scal policy only. B) monetary policy only. C) both scal policy and monetary policy. Explanation Fiscal policy can be used as a tool for redistribution of income and wealth, through a variety of taxation and spending policies. (Study Session 5, Module 16.1, LOS 16.a) Related Material Question #80 of 95 Question ID: 1204728 Which of the following is the most accurate definition of the velocity of money? The velocity of money is the: A) GDP of a country divided by its money supply. B) money supply of a country divided by its price level. C) GDP of a country divided by its price level. Explanation Velocity is the average number of times per year each dollar is used to buy goods and services (velocity = nominal GDP / money). Therefore, the money supply multiplied by velocity must equal nominal GDP. The equation of exchange must hold with velocity defined in this way. Letting money supply = M, velocity = V, price = P, and real output = Y, the equation of exchange may be symbolically expressed as: MV = PY. (Study Session 5, Module 16.1, LOS 16.c) Related Material Question #81 of 95 Question ID: 1204768 A central bank that wants to increase short-term interest rates is most likely to: A) issue long-term bonds. B) decrease bank reserve requirements. C) sell government securities. Explanation Open market operations to sell securities will decrease the outstanding supply of cash balances and increase short-term interest rates. The central bank does not issue long- term bonds but may buy and sell bonds issued by the government. Decreasing reserve requirements or purchasing government securities would tend to decrease short-term interest rates. (Study Session 5, Module 16.2, LOS 16.h) Related Material Question #82 of 95 Question ID: 1204803 The time it takes for policy makers to determine that the economy requires a fiscal policy action is best described as: A) recognition lag. B) action lag. C) impact lag. Explanation Recognition lag refers to the time it takes for fiscal policy makers to determine the need for a policy action. (Study Session 5, Module 16.3, LOS 16.r) Related Material Question #83 of 95 Question ID: 1204738 Which of the following statements about the relationship between interest rates and the demand for and supply of money is most accurate? Interest rates affect: A) the demand for money only. B) the supply of money only. C) both the demand for and supply of money. Explanation Interest rates only affect the demand for money. With higher interest rates, the opportunity cost of holding money increases, and people hold less money and more interest-earning assets. Monetary authorities determine the supply of money. Therefore, the supply of money is independent of the interest rate. (Study Session 5, Module 16.1, LOS 16.d) Related Material Question #84 of 95 Question ID: 1204799 The crowding-out model implies that a: budget de cit will stimulate aggregate demand and trigger a multiplier e ect A) which will lead to in ation. budget de cit will increase the real interest rate and thereby retard private B) investment. budget surplus will retard aggregate demand and trigger an economic C) downturn. Explanation Increased budget deficits will increase the demand for loanable funds and lead to higher interest rates and thus lower private investment. Crowding-out implies that an increase in government spending will choke off private investment and reduce the intended impact of fiscal policy changes on aggregate demand. (Study Session 5, Module 16.3, LOS 16.q) Related Material Question #85 of 95 Question ID: 1204785 The most likely reason for deflation to persist despite expansionary monetary policy is: A) inelastic demand for money. B) bond market vigilantes. C) a liquidity trap. Explanation Deflation is often associated with liquidity trap conditions. A liquidity trap is a situation in which demand for money becomes highly elastic. Expanding the money supply has little effect on economic activity under these conditions because individuals and firms choose to hold the additional money in cash. "Bond market vigilantes" is an expression referring to the fact that expansionary monetary policy may cause long-term interest rates to increase, instead of decreasing as intended, if bond market participants expect the expansionary policy to increase future inflation rates. (Study Session 5, Module 16.2, LOS 16.n) Related Material Question #86 of 95 Question ID: 1204754 Which of the following is least likely to be a function of the central bank? A) Control money supply. B) Issue currency. C) Tax collection. Explanation The three functions of a central bank are to issue a country's currency, regulate its banking system, and to manage the money supply. Tax collection is typically conducted by a government agency created specifically to carry out that function. (Study Session 5, Module 16.1, LOS 16.f) Related Material Question #87 of 95 Question ID: 1204744 Which of the following statements about the demand and supply of money is most accurate? People who are: buying bonds to reduce their money balances will increase the demand for A) bonds with an associated increase in interest rates. holding money when interest rates are higher will try to reduce their money B) balances and, as a result, the demand for money decreases. holding money when interest rates are lower will try to increase their money C) balances and, as a result, the supply of money increases. Explanation Buying bonds would drive bond prices up and interest rates down. Selling bonds would have the opposite effect; driving bond prices down and interest rates up. When interest rates are lower, there is an excess demand for money. The supply of money is determined by the monetary authorities. (Study Session 5, Module 16.1, LOS 16.d) Related Material Question #88 of 95 Question ID: 1204786 Which of the following statements regarding the monetary policy transmission mechanism is most accurate? Central banks can control short-term interest rates directly, but long-term A) interest rates are beyond their control. Central banks can control short-term interest rates by increasing the money B) supply to increase interest rates or by decreasing the money supply to decrease interest rates.  Central banks can control long-term interest rates directly because decisions by C) consumers and businesses are based on these rates. Explanation Central banks can control short-term interest rates directly. However, the decisions of consumers and businesses are based on long-term interest rates, which are beyond the control of central banks. Increasing the money supply will decrease interest rates and decreasing the money supply will increase interest rates. (Study Session 5, Module 16.2, LOS 16.n) Related Material Question #89 of 95 Question ID: 1204802 The time it takes for policy makers to enact a fiscal policy action is best described as: A) action lag. B) legislative lag. C) implementation lag. Explanation The time it takes for fiscal policy actions to be proposed, approved, and implemented is referred to as action lag. (Study Session 5, Module 16.3, LOS 16.r) Related Material Question #90 of 95 Question ID: 1204765 Which of the following policy tools is the least likely to be available to the U.S. Federal Reserve Board? A) Setting the discount rate at which banks can borrow from the Federal Reserve. B) Requiring the banking system to tighten or loosen its credit policies. C) Buying and selling Treasury securities in the open market. Explanation The U.S. Federal Reserve can encourage or persuade banks as a whole to tighten or loosen their credit policies, but it cannot compel them to do so. (Study Session 5, Module 16.2, LOS 16.h) Related Material Question #91 of 95 Question ID: 1204742 The demand for money curve represents the relationship between the quantity of money demanded and: A) short-term interest rates. B) the quantity of money supplied. C) the price level. Explanation The demand for money curve represents the relationship between short-term interest rates and the quantity of real money that households and firms demand to hold. (Study Session 5, Module 16.1, LOS 16.d) Related Material Question #92 of 95 Question ID: 1204757 Frequent changes in advertised prices are one of the costs of: A) expected in ation only. B) both expected and unexpected in ation. C) unexpected in ation only. Explanation Inflation imposes "menu costs" on an economy as businesses must frequently change their advertised prices, regardless of whether inflation is expected or unexpected. (Study Session 5, Module 16.1, LOS 16.g) Related Material Question #93 of 95 Question ID: 1204790 Which of the following statements best explains how automatic stabilizers work? Even without a change in fiscal policy, automatic stabilizers tend to promote: a budget surplus during a recession and a budget de cit during an in ationary A) expansion. a budget de cit during a recession and a budget surplus during an in ationary B) expansion. a budget de cit during a recession but do not promote a budget surplus during C) an in ationary expansion. Explanation Automatic stabilizers such as unemployment compensation, corporate profits tax, and the progressive income tax run a deficit during a business slowdown but run a surplus during an economic expansion. Therefore, they automatically implement countercyclical fiscal policy without the delays associated with policy changes that require legislative action. (Study Session 5, Module 16.3, LOS 16.o) Related Material Question #94 of 95 Question ID: 1204783 To determine whether monetary policy is expansionary or contractionary, an analyst should compare the central bank's policy rate to the: A) neutral interest rate. B) trend rate of real growth. C) target in ation rate. Explanation The neutral interest rate is the sum of the trend rate of real economic growth and the target inflation rate. Monetary policy is expansionary if the policy rate is less than the neutral interest rate and contractionary if the policy rate is greater than the neutral interest rate. (Study Session 5, Module 16.2, LOS 16.m) Related Material Question #95 of 95 Question ID: 1204793 Fiscal policy includes a government's: A) spending and tax policies only. B) tax policies only. C) spending, tax, and monetary policies. Explanation Fiscal policy refers to a government's use of spending and taxation to meet macroeconomic goals. Monetary policy refers to central bank actions and is not considered part of fiscal policy. (Study Session 5, Module 16.3, LOS 16.o) Related Material