Survey of Economics, 6e (O’Sullivan/Sheffrin/Perez)
Chapter 17 Monetary Policy and Inflation
17.1 The Money Market
1) In the short run when prices don’t have enough time to change, the Federal Reserve
A) can influence the level of interest rates in the economy.
B) cannot influence the level of interest rates in the economy.
C) can influence the level of interest rates in the economy but generally will not because it would
be destabilizing.
D) can only affect the amount of money in the economy.
2) Generally, when the Federal Reserve lowers interest rates, investment spending ________ and
GDP ________.
A) increases; decreases
B) increases; increases
C) decreases; decreases
D) decreases; increases
3) When the Federal Reserve increases interest rates, investment spending ________ and GDP
________.
A) increases; decreases
B) increases; increases
C) decreases; decreases
D) decreases; increases
4) The nominal interest rate is determined in the
A) stock market.
B) money market.
C) exchange market.
D) bond market.
5) The transaction demand for money comes mostly from the fact that
A) money is a store of value.
B) money is a medium of exchange.
C) money is a unit of account.
D) money has low opportunity cost.
6) The opportunity cost of holding money is
A) heavy and awkward.
B) the probability of theft or loss.
C) the ease of conducting everyday business.
D) the return that could have been earned from holding wealth in other assets.
7) Suppose that the interest rate available to you on a long-term bond is 4%. If you hold $1,000
of your wealth in currency instead of in the form of a bond, the annual opportunity cost is
A) $0.04.
B) $4.
C) $40.
D) $400.
8) At higher interest rates the
A) money supply is higher.
B) money supply is indeterminate.
C) quantity of money demanded is higher.
D) quantity of money demanded is lower.
9) At lower interest rates the
A) money supply is indeterminate.
B) money supply is lower.
C) quantity of money demanded is higher.
D) quantity of money demanded is lower.
10) An increase in the price level in the economy leads to
A) a leftward shift in the demand for money curve.
B) a rightward shift in the demand for money curve.
C) a leftward movement along the demand for money curve.
D) a rightward movement along the demand for money curve.
11) A decrease in the price level in the economy leads to
A) a leftward shift in the demand for money curve.
B) a rightward shift in the demand for money curve.
C) a leftward movement along the demand for money curve.
D) a rightward movement along the demand for money curve.
12) An increase in the level of real GDP in the economy leads to
A) a leftward shift in the demand for money curve.
B) a rightward shift in the demand for money curve.
C) a leftward movement along the demand for money curve.
D) a rightward movement along the demand for money curve.
13) A decrease in the level of real GDP in the economy leads to
A) a leftward shift in the demand for money curve.
B) a rightward shift in the demand for money curve.
C) a leftward movement along the demand for money curve.
D) a rightward movement along the demand for money curve.
14) Which of the following factors does NOT shift the demand curve for money?
A) changes in the interest rate
B) changes in the price level in the economy
C) changes in real income
D) changes in real GDP
15) The demand for money that arises so that individuals or firms can make purchases on quick
notice is called the
A) real demand for money.
B) transaction demand for money.
C) liquidity demand for money.
D) speculative demand for money.
16) The demand for money that arises because holding money over short periods is less risky
than holding stocks or bonds is called the
A) transactions demand for money.
B) liquidity demand for money.
C) opportunity cost demand for money.
D) speculative demand for money.
17) If your wealth is held as currency or in checking accounts, or other assets that you can
convert to money on short notice, your assets are considered to be
A) abundant.
B) fast moving.
C) interest bearing.
D) liquid.
18) What is the motivation for individuals to hold money?
A) to reduce risk
B) to have liquidity
C) to facilitate transactions
D) all of the above
Recall the Application about the Fed’s expanded involvement in the economy following the
financial crisis in 2008 to answer the following question(s).
19) Recall the Application. Prior to the financial crisis in 2008, the Fed’s traditional method of
conducting monetary policy to expand the money supply was
A) purchasing Treasury securities.
B) purchasing mortgage-backed securities.
C) lowering reserve requirements.
D) raising the discount rate.
20) Recall the Application. During 2008, the value of the Fed’s total assets
A) fell by over $2 trillion.
B) remained virtually unchanged.
C) became negative.
D) more than doubled.
21) Recall the Application. Prior to the financial crisis, the Fed primarily held ________ as
assets.
A) mortgage-backed securities
B) cash
C) corporate stocks and bonds
D) Treasury securities
22) Recall the application. In 2010 the Fed
A) ended its support of the mortgage market.
B) converted all its assets to cash.
C) held over $1 trillion in mortgage-backed securities.
D) stopped trading in Treasury securities.
23) The Fed has immense power and there are no limits to the extent to which it can effectively
control the economy.
24) We use interest rates to measure the opportunity cost of holding money.
25) The quantity of money demanded will increase as interest rates increase.
26) Both increases in the price level and increases in real GDP will decrease the demand for
money.
27) If your assets are highly liquid, this means you can make transactions on short notice.
28) What three factors affect the demand for money?
29) Explain the three different types of money demand.
17.2 How the Federal Reserve Can Change the Money Supply
1) The one organization that has the power to change the total amount of reserves in the banking
system is the
A) Congress.
B) Executive Branch of the Federal Government.
C) U.S. Treasury.
D) Federal Reserve System.
2) Increased investment spending in the economy would be a possible result of
A) an increase in interest rates.
B) an open market purchase of bonds by the Fed.
C) an open market sale of bonds by the Fed.
D) a decrease in the money supply.
3) Decreased investment spending in the economy would be a possible result of
A) a decrease in interest rates.
B) an open market purchase of bonds by the Fed.
C) an open market sale of bonds by the Fed.
D) an increase in the money supply.
4) From time to time, the Federal Reserve buys back government bonds from the private sector
through a process called
A) bond recall procedures.
B) open market purchases.
C) backflip bond investments.
D) voluntary redemption procedures.
5) From time to time, the Federal Reserve sells various quantities of government bonds to the
private sector through a process called
A) bond recall procedures.
B) backflip bond investments.
C) open market sales.
D) voluntary redemption procedures.
6) Selling government bonds through open market operations allows the Federal Reserve to
A) decrease money in the Treasury.
B) decrease the money supply in the private sector.
C) receive discounts on future sales.
D) receive a high rate of interest on the bonds.
7) How can the Federal Reserve actually increase the money supply?
A) by delaying transfer of money among banks
B) by raising the discount rate
C) by doubling the reserve requirement
D) by purchasing more government bonds in the open market
8) What would be a way for the Federal Reserve to stimulate a sluggish economy?
A) print more money
B) buy government bonds on the open market
C) sell more government bonds
D) encourage the stock market
9) What would be a way for the Federal Reserve to slow down the economy when it is growing
too quickly or is inflationary?
A) print more money
B) buy back government bonds on the open market
C) sell more government bonds
D) encourage the stock market
10) An open market purchase by the Fed
A) increases the total amount of reserves in the banking system.
B) decreases the total amount of reserves in the banking system.
C) does not change the total amount of reserves in the banking system.
D) causes the reserve requirement to fall.
11) The most commonly used tool in monetary policy is
A) changes in required reserve ratios.
B) changes in the discount rate.
C) open market operations.
D) express lending transactions.
12) To increase the money supply using the reserve requirements, what would the Fed typically
do?
A) increase the reserve requirement for banks
B) reduce the reserve requirement for banks
C) make each bank set its own reserve levels
D) let each bank get more currency from the Treasury
13) To decrease the money supply using the reserve requirements, what would the Fed typically
do?
A) raise the reserve requirement for banks
B) reduce the reserve requirement for banks
C) make each bank voluntarily set its own reserve levels
D) let each bank get less currency from the Treasury
14) If the Federal Reserve wanted to change the money supply in the economy, it would be least
likely to
A) buy bonds on the open market.
B) sell bonds on the open market.
C) change the level of reserves required to be held by banks.
D) change the federal funds rate.
15) By raising the discount rate, the Federal Reserve ________ banks from borrowing more
reserves.
A) encourages
B) discourages
C) prohibits
D) short-changes
16) A change in the reserve requirement is used infrequently by the Fed because it
A) is disruptive to the banking system.
B) does not influence the money supply.
C) does not affect bank reserves.
D) does not affect the money multiplier.
17) The rate of interest charged to commercial banks by the Fed for loans is called the ________
rate.
A) federal funds
B) discount
C) prime
D) commercial paper
18) The federal funds rate is the interest rate that
A) the Fed charges to banks that borrow from it.
B) banks charge the Fed for using their reserves.
C) the Fed pays on bank reserves.
D) banks charge each other for borrowed money.
19) An increase in the discount rate
A) reduces the cost of reserves borrowed from the Fed.
B) signals the Fed’s desire to increase the money supply.
C) signals the Fed’s desire to lend increased reserves to banks.
D) increases the cost of reserves borrowed from the Fed.
20) A decrease in the discount rate
A) reduces the cost of borrowing from the Fed.
B) signals the Fed’s desire to decrease the money supply.
C) signals the Fed’s desire to reduce lending to commercial banks.
D) increases the cost of reserves borrowed from the Fed.
21) An increase in the discount rate will
A) decrease the money supply.
B) not affect the money supply.
C) increase the money supply.
D) have an unclear effect on the money supply.
22) A decrease in the discount rate will
A) decrease the money supply.
B) not affect the money supply.
C) increase the money supply.
D) have an unclear effect on the money supply.
23) Which action could the Fed use to decrease the money supply?
A) an open market purchase
B) an increase in the required reserve ratio
C) a tax increase
D) a decrease in the discount rate
24) In addition to lowering the discount rate to increase the money supply, the Fed could also
A) purchase bonds on the open market and raise reserve requirements.
B) sell bonds on the open market and raise reserve requirements.
C) purchase bonds on the open market and lower reserve requirements.
D) sell bonds on the open market and lower reserve requirements.
25) In practice, the Federal Reserve keeps the discount rate close to the ________ rate in order to
avoid large swings in borrowed reserves by banks.
A) inflation
B) six-month Treasury bill
C) federal funds
D) prime
26) What impact does the Fed’s raising the interest rate have on the money supply and on the
price level?
A) An increase in interest rates raises the money supply and eventually reduces prices.
B) An increase in interest rates reduces the money demand which will slow the growth in prices.
C) An increase in interest rates lowers the money supply and raises the money demand, which
will neutralize price increases.
D) An increase in interest rates will increase investment spending and GDP, which will lower
prices.
27) What impact would the Fed’s raising the interest rate have on any inflationary pressure in the
economy?
A) An increase in interest rates decreases the money demand, which could slow increases in the
price level.
B) An increase in interest rates increases the money supply, which could cause the price level to
increase.
C) An increase in interest rates decreases the exchange rate, which causes net exports to rise,
generating inflation.
D) An increase in interest rates increases real GDP, which creates inflation in an economy.
28) The Fed can change the money supply by buying or selling long-term Treasury bonds.
Purchasing long-term securities is commonly called
A) open market operations.
B) discount operations.
C) federal funds speculation.
D) quantitative easing.
29) When the Federal Reserve buys bonds on the open market, it decreases the money supply.
30) An open market sale of bonds by the Federal Reserve will lead to an increase of reserves in
banks.
31) When the Federal Reserve decreases the money supply, it generally does so by purchasing
bonds.
32) Banks can obtain funds to make loans by borrowing reserves from other banks through the
federal funds market.
33) If the Federal Reserve raises the discount rate, banks will be inclined to borrow additional
reserves and the money supply will increase.
34) The prime rate is the interest rate at which banks can borrow from the Fed.
35) If the Federal Reserve is interested in conducting contractionary policy, what types of
policies should it consider?
36) How would the Fed’s sale of government bonds on the open market affect the money supply?
37) How would the Fed’s reduction of the reserve ratio requirement affect the money supply?
38) How would the Fed’s changing the discount rate affect the money supply?
17.3 How Interest Rates Are Determined: Combining the Demand and Supply of Money
1) The Federal Reserve influences the level of interest rates in the short run by changing the
A) demand for money through open market operations.
B) demand for money through changes in reserve requirements.
C) supply of money through open market operations.
D) supply of money through changes in stock market operations.
2) The ________ determines the supply of money.
A) Congress
B) President
C) Federal Reserve
D) banking system