15) Which of the following best describes the relationship between the Fed funds rate and the
discount rate, beginning in 2003?
A) The Fed funds rate is usually lower than the discount rate.
B) The two rates are equal.
C) The discount rate is usually lower than the Fed funds rate.
D) There is no relationship between the two rates.
16) The new monetary policy tool that the Fed began using in 2008 is
A) changing the interest rate paid on reserves
B) imposing a surcharge on credit cards
C) putting a tax on all financial transactions
D) borrowing from China
17) 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
18) 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
19) 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.
20) 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.
21) 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.
22) 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.
23) 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.
24) 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.
25) 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.
26) 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
27) In response to an unanticipated easing of monetary policy, output ________ at first, then
________ after about 4 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
28) 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
29) Which of the following is not a major channel of monetary policy transmission?
A) Interest rate channel
B) Exchange rate channel
C) Fiscal channel
D) Credit channel
30) When the effects of monetary policy on the economy work through changes in real interest
rates, the effect is called
A) disintermediation.
B) the interest rate channel.
C) the credit channel.
D) the fiscal channel.
31) When monetary policy works through changes in the real exchange rate, the effect is called
A) disintermediation.
B) the interest rate channel.
C) the credit channel.
D) the exchange rate channel.
32) When monetary policy works by affecting the supply and demand for credit, the mechanism
is referred to as
A) the exchange rate channel.
B) the interest rate channel.
C) the credit channel.
D) the fiscal channel.
33) The credit channel of monetary policy transmission works in two ways. On the supply side
of the credit market, tight monetary policy leads to ________ lending by banks; on the demand
side of the credit market, tight monetary policy leads to ________ in the credit-worthiness of
borrowers.
A) increased; an increase
B) increased; a decrease
C) reduced; a decrease
D) reduced; an increase
34) Evidence on the existence of a credit channel for monetary policy transmission shows that on
the supply side of the credit market, the credit channel was ________ in the 1960s and 1970s,
and has ________ more recently.
A) powerful; weakened
B) powerful; become stronger
C) weak; become stronger
D) weak; disappeared completely
35) Bernanke suggested methods for monetary policy to deal with the lower bound, including all
of the following except:
A) affecting interest rate expectations.
B) altering the composition of assets held by the central bank.
C) tightening monetary policy more aggressively.
D) expanding the size of the central bank balance sheet.
36) Worries about the zero bound from 2002 to 2005 led the Fed to
A) increase reserve requirements on banks.
B) make more discount loans than usual.
C) tighten monetary policy.
D) keep the Federal funds rate below the inflation rate.
37) Describe the difference between a primary credit discount rate and the secondary credit
discount rate, including who can borrow at which rate and how such lending is managed by the
Fed.
38) Describe, in general terms, the strategy of monetary policy, explaining how monetary-policy
tools are used to achieve the goals of monetary policy. What intermediate stages are important in
going from tools to goals? What are the links between the different stages? How does the Federal
Reserve use this strategy today?
39) Suppose the Fed has just learned that some foreign economies are headed for recession,
which will reduce U.S. exports. This is an economic shock that shifts the IS curve down. What
would you do in response to the shock if you want to keep the economy at full-employment
equilibrium under each of the following cases?
(a) You use the classical (RBC) model.
(b) You use the Keynesian (efficiency wage) model.
(c) You use the extended classical model with misperceptions.
In each case, show the IS–LM–FE diagram associated with your answer.
40) 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.
41) 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.
42) 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.
14.3 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 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.
7) 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%.
8) 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%.
9) 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.
10) 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.
11) 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.
12) 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.
13) 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.
14) 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.
15) 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.
16) 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
17) 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?
18) 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?
19) 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?