5) Intermediate targets are
A) identical to instruments.
B) macroeconomic variables that the Fed can influence that are related to the Fed’s goals.
C) also known as the Fed’s tools.
D) macroeconomic variables that never get revised.
6) Which of the following might the Fed rely on as an intermediate target?
A) The monetary base
B) The discount rate
C) M2
D) The exchange rate of the dollar
7) Which of the following variables is likely to serve as an intermediate target for monetary
policy?
A) Money supply
B) Inflation rate
C) Open-market operations
D) Unemployment rate
8) In the Keynesian model, suppose the Fed sets a target for the money supply. If the IS curve
shifts to the left, and the Fed wants to keep output unchanged, what should the Fed do?
A) Reduce taxes.
B) Reduce the money supply.
C) Increase taxes.
D) Increase the money supply.
9) In the Keynesian model, suppose the Fed sets a target for the real interest rate. If the IS curve
shifts to the left, and the Fed wants to keep output unchanged
A) taxes will increase.
B) the money supply will decline.
C) the real interest rate will decrease.
D) taxes will decrease.
10) In the Keynesian model, suppose the Fed wants to keep output unchanged. If the IS curve
shifts to the left, and the Fed acts to keep output unchanged, then
A) taxes will increase.
B) the money supply will decline.
C) the real interest rate will decrease.
D) taxes will decrease.
11) In the Keynesian model, suppose the Fed sets a target for the real interest rate. If the IS curve
shifts down and to the left, and the Fed wants to keep output unchanged in the short run and the
price level unchanged in the long run, it will
A) shift the LR curve up.
B) not shift the LR curve.
C) shift the LR curve down.
D) shift the IS curve up and to the right.
12) In the Keynesian model, suppose the Fed sets a target for the real interest rate. If the IS curve
shifts up and to the right, and the Fed wants to keep output unchanged in the short run and the
price level unchanged in the long run, it will
A) shift the LR curve up.
B) not shift the LR curve.
C) shift the LR curve down.
D) shift the IS curve up and to the right.
13) In the Keynesian model, suppose the Fed sets a target for the real interest rate. If the IS curve
shifts down and to the left, and the Fed wants to keep output unchanged in the short run and the
price level unchanged in the long run, what should the Fed do? Use the LR curve to formulate
your answer.
14) Describe how the real interest rate changes in a Keynesian model if a shock shifts the IS
curve down and to the right and the Fed changes its policy to keep output unchanged.
15) In the Keynesian model, suppose the Fed sets a target for the real interest rate. If the IS curve
shifts up and to the right, and the Fed wants to keep output unchanged in the short run and the
price level unchanged in the long run, what should the Fed do? Use the LR curve to formulate
your answer.
16) Suppose the Fed cares only about keeping the economy close to full-employment output. The
Fed can target the real money supply (thus keeping the LM curve fixed) or it can target the real
interest rate, changing the money supply and shifting the LM curve however is necessary to
prevent a change in the real interest rate.
(a) Which is the best policy if the main shocks to the economy are shocks to the IS curve?
Explain why. Illustrate with a diagram.
(b) Which is the best policy if the main shocks to the economy are shocks to real money
demand? Explain why. Illustrate with a diagram.
17) Use the LR curve to show what happens to output, the real interest rate, and the price level in
the short run and in the long run if the government provides a tax credit to people who buy a new
home, which leads to an increase in new housing investment.
14.4 Making Monetary Policy in Practice
1) In response to an unanticipated tightening of monetary policy, the Fed funds rate ________ at
first, then ________ after 6 to 12 months.
A) rises; returns most of the way to its original value
B) falls; returns most of the way to its original value
C) remains roughly unchanged; rises significantly
D) remains roughly unchanged; falls significantly
2) In response to an unanticipated easing of monetary policy, the Fed funds rate ________ at
first, then ________ after 6 to 12 months.
A) rises; returns most of the way to its original value
B) falls; returns most of the way to its original value
C) remains roughly unchanged; rises significantly
D) remains roughly unchanged; falls significantly
3) In response to an unanticipated easing of monetary policy, output ________ at first, then
________ after about four months.
A) rises; returns most of the way to its original value
B) falls; returns most of the way to its original value
C) remains roughly unchanged; rises significantly
D) remains roughly unchanged; falls significantly
4) In response to an unanticipated tightening of monetary policy, output ________ at first, then
________ after about four months.
A) rises; returns most of the way to its original value
B) falls; returns most of the way to its original value
C) remains roughly unchanged; rises significantly
D) remains roughly unchanged; falls significantly
5) In response to an unanticipated tightening of monetary policy, the price level ________ at
first, then ________ after a year.
A) rises; returns most of the way to its original value
B) falls; returns most of the way to its original value
C) remains roughly unchanged; begins to rise
D) remains roughly unchanged; begins to fall
6) In response to an unanticipated easing of monetary policy, the price level ________ at first,
then ________ after a year.
A) rises; returns most of the way to its original value
B) falls; returns most of the way to its original value
C) remains roughly unchanged; begins to rise
D) remains roughly unchanged; begins to fall
7) Policymakers may be uncertain about the state of the economy because
A) initial releases of data may be less accurate than later data releases.
B) they don’t know the predominant source of shocks to the economy.
C) they don’t know how shocks affect people’s expectations.
D) they are not aware of modern macroeconomic modeling techniques.
8) Policymakers may be uncertain about the structure of the economy because
A) initial releases of data may be less accurate than later data releases.
B) they don’t know the predominant source of shocks to the economy.
C) they don’t know how shocks affect people’s expectations.
D) they are not aware of modern macroeconomic modeling techniques.
9) If the public is not sure about the central bank’s motives, then
A) initial releases of data may be less accurate than later data releases.
B) the predominant source of shocks to the economy must be shocks to the LM curve.
C) central bankers should try to stabilize the inflation rate.
D) modern macroeconomic modeling techniques will fail.
10) Zero lower bound refers to the fact that
A) the government budget deficit must be zero in the long run.
B) the lowest possible level of the current account deficit is zero in the long run.
C) the inflation rate can never decline below zero.
D) nominal interest rates cannot fall below zero.
11) A liquidity trap occurs when
A) any additions to the monetary base are held as cash by people or reserves at banks.
B) the Fed increases the money supply, causing the expected inflation rate to rise more than the
real interest rate declines, so that the nominal interest rate increases.
C) there are runs on banks that are solvent but illiquid.
D) the demand for loans increases in a country on the gold standard, so that the monetary supply
is not able to increase and interest rates rise dramatically.
12) When the Fed signals how long it expects interest rates to remain at a low level, it is said to
be engaging in
A) credit easing.
B) forward guidance.
C) quantitative easing.
D) a maturity extension program.
13) The Fed’s first forward guidance in 2009 was framed in terms of keeping interest rates low
A) for an extended period.
B) at least until a particular date in the future.
C) based on outcomes for the unemployment rate and inflation rate.
D) until the next Presidential election.
14) The Fed’s forward guidance in 2011 and early 2012 was framed in terms of keeping interest
rates low
A) for an extended period.
B) at least until a particular date in the future.
C) based on outcomes for the unemployment rate and inflation rate.
D) until the next Presidential election.
15) The Fed’s forward guidance in late 2012 through mid-2015 was framed in terms of keeping
interest rates low
A) for an extended period.
B) at least until a particular date in the future.
C) based on outcomes for the unemployment rate and inflation rate.
D) until the next Presidential election.
16) When the Fed alters the types of assets it owns, it is engaging in
A) international balance management.
B) forward guidance.
C) quantitative easing.
D) changing the discount rate.
17) When the Fed sells short-term bonds and buys long-term bonds, it is engaging in
A) changing the discount rate.
B) forward guidance.
C) backward guidance.
D) a maturity extension program.
18) When the Fed increases the quantity of assets it owns, it is said to be engaging in
A) credit easing.
B) forward guidance.
C) quantitative easing.
D) a maturity extension program.
19) From 2007 to 2012, the amount of assets owned by the Fed approximately
A) doubled.
B) tripled.
C) quadrupled.
D) quintupled.
20) From 2007 to 2015, the amount of assets owned by the Fed approximately
A) doubled.
B) tripled.
C) quadrupled.
D) quintupled.
21) From 2008 to 2014, the Fed engage in ________ rounds of quantitative easing.
A) 1.
B) 2.
C) 3.
D) 4.
22) In late 2007 and early 2008, concerns about financial institutions led the Fed to
A) create special lending facilities.
B) raise the target for the fed funds rate.
C) increase reserve requirements.
D) pay interest on bank reserves.
23) In the financial crisis in 2008, the Federal government created the ________, to purchase
financial assets that were thought to be temporarily undervalued, preventing further financial
panic.
A) Federal Home Loan Board.
B) Troubled Asset Relief Program.
C) Federal Deposit Insurance Corporation.
D) Bank Insurance Fund.
24) Describe, in general terms, the lags in the effects of monetary policy on interest rates, output,
and prices. Be sure to note how long it takes each variable to respond to policy changes.
14.5 The Conduct of Monetary Policy: Rules Versus Discretion
1) Which of the following statements would Milton Friedman disagree with?
A) Monetary policy has few short-run effects on the real economy.
B) In the long run, changes in the money supply primarily affect the price level.
C) In practice, there is little scope for using monetary policy actively to smooth out business
cycles.
D) The Federal Reserve cannot be relied on to effectively smooth out business cycles.
2) Which of the following statements would Milton Friedman agree with concerning the conduct
of monetary policy?
A) Information lags are short, enabling the central bank to respond quickly to changes in the
economy.
B) There is little uncertainty over the effect of a change in the money supply on the economy.
C) There are long and variable lags between monetary policy actions and their economic results.
D) Wage and price adjustments are relatively slow, so changing the money supply will have a
minimal impact on the real economy.
3) Milton Friedman would eliminate the destabilizing effect of the Federal Reserve’s monetary
policy by
A) eliminating the Federal Reserve.
B) removing the Federal Reserve’s political independence.
C) requiring that the Federal Reserve choose a monetary aggregate and increase it at a fixed
percentage rate each year.
D) eliminating the Federal Reserve’s right to carry out open-market operations.
4) Monetarists suggest doing which of the following?
A) Maintain a steady growth rate of the money supply.
B) Use fiscal policy to combat unemployment in the short run.
C) Use monetary policy to combat unemployment in the long run.
D) Use fiscal policy to combat inflation in the long run.
5) Most Keynesians suggest that the Fed
A) use discretion in setting monetary policy.
B) use fiscal policy to combat unemployment in the short run.
C) follow a rule, such as keeping the money growth rate at 3%, regardless of the state of the
economy.
D) use fiscal policy to combat inflation in the long run.
6) The basic Keynesian argument for discretionary monetary policy is that
A) monetary policy is the principal cause of business cycles.
B) monetary policy is much more effective than fiscal policy.
C) aggregate demand is unstable and monetary policy can help to stabilize it.
D) reducing unemployment is much more important than reducing inflation.
7) The Taylor rule relates
A) the nominal Fed funds rate to inflation over the past year and the deviation of output from
full-employment output.
B) the growth rate of the monetary base to the growth rate of nominal GDP and the change in
velocity over the past year.
C) the nominal Fed funds rate to the growth rate of nominal GDP and the change in velocity over
the past year.
D) the growth rate of the monetary base to inflation over the past year and the deviation of output
from full-employment output.
8) According to the Taylor rule, if inflation in the last year was 6% and output was 2% below its
full-employment level, the nominal Fed funds rate should be
A) 3%.
B) 5%.
C) 7%.
D) 9%.
9) According to the Taylor rule, if the inflation rate in the last year was 2% and output was equal
to its full-employment level, the nominal Fed funds rate should be
A) 3%.
B) 4%.
C) 5%.
D) 6%.
10) According to the Taylor rule, if output is above its full-employment level and inflation is less
than 2%
A) the Fed should raise the Fed funds rate above 4%.
B) the Fed should reduce the Fed funds rate below 4%.
C) the Fed should make the Fed funds rate exactly 4%.
D) what the Fed should do is ambiguous.
11) According to estimates of the Taylor rule, monetary policy was too easy
A) from 1960 to 1965.
B) from 1965 to 1979.
C) in the 1980s.
D) in the 1990s.
12) According to estimates of the Taylor rule, monetary policy was too tight
A) from 1960 to 1965.
B) from 1965 to 1979.
C) in the 1980s.
D) in the 1990s.
13) Based on the Taylor rule, from 1965 to 1979, monetary policy was
A) too tight.
B) too easy.
C) just about right.
D) too tight from 1965 to about 1970 and too easy from about 1970 to 1979.
14) Based on the Taylor rule, in the 1980s, monetary policy was
A) too tight.
B) too easy.
C) just about right.
D) too tight in the first half of the decade and too easy in the second half.
15) The degree to which the public believes the central bank’s announcements about future
policy is its
A) reputation.
B) transparency.
C) openness.
D) credibility.
16) The problem with the strategy of achieving credibility through reputation is that
A) reputations are rarely credible.
B) reputations lack any commitment.
C) serious costs may be incurred during the period in which reputation is established.
D) rules always have a lower cost than reputations in maintaining credibility.
17) The primary criticism by Keynesians of the credibility argument for rules is that
A) reputations are a less costly method of gaining credibility.
B) reputations are a less costly method of maintaining credibility.
C) the cost of losing flexibility over policy choices may exceed the cost of gaining credibility.
D) rules that reduce presidential and congressional influence over monetary policy could
ultimately be harmful to the economy.
18) Monetarists argued that the Fed wasn’t serious about adhering to a money-growth target
because
A) it was unable to reduce inflation at all.
B) it tried to target three different monetary aggregates simultaneously.
C) the sacrifice ratio remained too high.
D) it gave too much weight to movements in exchange rates.
19) Many countries dropped their use of money-growth targets in the 1980s because
A) they were in severe recessions.
B) political opponents claimed money-growth targeting helped the rich at the expense of the
poor.
C) money demand became unstable.
D) it was too difficult to coordinate monetary policy with fiscal policy.
20) When the central bank announces the inflation rate that it will achieve over the next one to
four years, it is following a strategy known as
A) money targeting.
B) inflation targeting.
C) a currency board.
D) real business cycle targeting.
21) There is ________ relationship between inflation and central bank independence and
________ relationship between long-run rates of unemployment and central bank independence.
A) a negative; no
B) a negative; a negative
C) a positive; no
D) a positive; a negative
22) The Fed first announced an inflation target of 2% in
A) 1979.
B) 2005.
C) 2012.
D) 2015.
23) What types of rules for monetary policy may be sensible for policymakers to consider? What
is the advantage of using rules over discretion? What problems might there be with rules?
24) Describe the strategy of inflation targeting. Why have many countries begun to use this
strategy instead of targeting money growth? What are the advantages and disadvantages of
inflation targeting?
25) Describe the Taylor rule. If the Fed were following the rule, what would the nominal Fed
funds rate be if inflation over the past year were 4% and output were 1% below its full–
employment level?