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The Influence of Monetary and Fiscal Policy on Aggregate Demand 8423
69. According to a 2009 article in The Economist, the multiplier effect and crowding-out effect would
exactly offset each other when the economy is
a. operating at full capacity.
b. in recession.
c. experiencing zero inflation.
d. experiencing high rates of inflation.
Multiple Choice – Section 04: Conclusion
1. In the short run,
a. the price level alone adjusts to balance the supply and demand for money.
b. output responds to changes in the aggregate demand for goods and services.
c. changes in the money supply cause a proportional change in the price level.
d. increases in the money supply shift the aggregate supply curve causing output to rise.
8424 The Influence of Monetary and Fiscal Policy on Aggregate Demand
2. In the long run, the level of output
a. depends on the money supply.
b. depends on the price level.
c. is determined by supply-side factors.
d. All of the above are correct.
3. In the long run, changes in the money supply affect
a. prices.
b. output.
c. unemployment rates.
d. All of the above.
The Influence of Monetary and Fiscal Policy on Aggregate Demand 8425
4. When Congress reduces spending in order to balance the government’s budget, it needs to consider
a. both the short-run effects on aggregate demand and aggregate supply, and the long-run effects
on saving and growth.
b. only the short-run effects on aggregate demand and aggregate supply.
c. only the long-run effects on saving and growth.
d. only the long-run effects on aggregate demand and aggregate supply.
True/False and Short Answer
1. Both monetary policy and fiscal policy affect aggregate demand.
a. True
b. False
8426 The Influence of Monetary and Fiscal Policy on Aggregate Demand
2. Monetary policy and fiscal policy are the only factors that influence aggregate demand.
a. True
b. False
3. Sometimes, changes in monetary policy and/or fiscal policy are intended to offset changes to
aggregate demand over which policymakers have little or no control.
a. True
b. False
4. For the U.S. economy, the most important reason for the downward slope of the aggregate-
demand curve is the interest-rate effect.
a. True
b. False
The Influence of Monetary and Fiscal Policy on Aggregate Demand 8427
5. According to the theory of liquidity preference, the interest rate adjusts to balance the supply of,
and demand for, loanable funds.
a. True
b. False
6. The theory of liquidity preference was developed by Irving Fisher.
a. True
b. False
7. An increase in the money supply decreases the equilibrium interest rate and shifts the aggregate-
demand curve to the right.
a. True
b. False
8428 The Influence of Monetary and Fiscal Policy on Aggregate Demand
8. Other things the same, an increase in the price level causes the real value of the dollar to fall in the
market for foreign-currency exchange.
a. True
b. False
9. Changes in monetary policy aimed at reducing aggregate demand involve decreasing the money
supply or increasing the interest rate.
a. True
b. False
10. For the most part, fiscal policy affects the economy in the short run while monetary policy
primarily matters in the long run.
a. True
b. False
The Influence of Monetary and Fiscal Policy on Aggregate Demand 8429
11. For a country such as the U.S., the wealth effect exerts a very important influence on the slope of
the aggregate- demand curve, since U.S. wealth is large relative to wealth in most other countries.
a. True
b. False
12. If the inflation rate is zero, then the nominal and real interest rate are the same.
a. True
b. False
13. In liquidity preference theory, an increase in the interest rate, other things the same, decreases the
quantity of money demanded, but does not shift the money demand curve.
a. True
b. False
8430 The Influence of Monetary and Fiscal Policy on Aggregate Demand
14. An increase in the price level shifts the money demand curve to the left, causing interest rates to
increase.
a. True
b. False
15. An increase in the money supply shifts the aggregate-supply curve to the right.
a. True
b. False
16. When the Fed increases the money supply, the interest rate decreases. This decrease in the
interest rate increases consumption and investment demand, so the aggregate-demand curve shifts
to the right.
a. True
b. False
The Influence of Monetary and Fiscal Policy on Aggregate Demand 8431
17. Stock prices often rise when the Fed raises interest rates.
a. True
b. False
18. When the Fed announces a target for the federal funds rate, it essentially accommodates the day-
to-day fluctuations in money demand by adjusting the money supply accordingly.
a. True
b. False
19. An increase in the money supply decreases the interest rate in the short run.
a. True
b. False
8432 The Influence of Monetary and Fiscal Policy on Aggregate Demand
20. Other things equal, the higher the price level, the higher is the real wealth of households.
a. True
b. False
21. The theory of liquidity preference is largely at odds with the basic ideas of supply and demand.
a. True
b. False
22. The Fed can influence the money supply by changing the interest rate it pays banks on the
reserves they are holding.
a. True
b. False
The Influence of Monetary and Fiscal Policy on Aggregate Demand 8433
23. An essential piece of the liquidity preference theory is the demand for money.
a. True
b. False
24. The interest-rate effect is partially explained by the fact that a higher price level reduces money
demand.
a. True
b. False
25. If the marginal propensity to consume is 4/5, then a decrease in government spending of $1 billion
decreases the demand for goods and services by $5 billion.
a. True
b. False
8434 The Influence of Monetary and Fiscal Policy on Aggregate Demand
26. If the marginal propensity to consume is 6/7, then the multiplier is 7.
a. True
b. False
27. Both the multiplier effect and the investment accelerator tend to make the aggregate-demand
curve shift further than it does due to an initial increase in government expenditures.
a. True
b. False
28. The multiplier is computed as MPC / (1 - MPC).
a. True
b. False
The Influence of Monetary and Fiscal Policy on Aggregate Demand 8435
29. Permanent tax cuts have a larger impact on consumption spending than temporary ones.
a. True
b. False
30. Some economists, called supply-siders, argue that changes in the money supply exert a strong
influence on aggregate supply.
a. True
b. False
31. If the MPC is 4/5, the multiplier is 5/4.
a. True
b. False
8436 The Influence of Monetary and Fiscal Policy on Aggregate Demand
32. Other things the same, an increase in taxes shifts aggregate demand to the left. In the short run
this makes output fall which makes the interest rate rise.
a. True
b. False
33. Government expenditures on capital goods such as roads could increase aggregate supply. Such
effects on aggregate supply are likely to matter more in the short run than in the long run.
a. True
b. False
34. If the spending multiplier is 8, then the marginal propensity to consume must be 7/8.
a. True
b. False
The Influence of Monetary and Fiscal Policy on Aggregate Demand 8437
35. In principle, the government could increase the money supply or increase government
expenditures to try to offset the effects of a wave of pessimism about the future of the economy.
a. True
b. False
36. The main criticism of those who doubt the ability of the government to respond in a useful way to
the business cycle is that the theory by which money and government expenditures change output
is flawed.
a. True
b. False
37. A significant lag for monetary policy is the time it takes to for a change in the money supply to
change the economy. A significant lag for fiscal policy is the time it takes to pass legislation
authorizing it.
a. True
b. False
8438 The Influence of Monetary and Fiscal Policy on Aggregate Demand
38. Unemployment insurance and welfare programs work as automatic stabilizers.
a. True
b. False
39. Depending on the size of the multiplier and crowding-out effects, the rightward shift in aggregate
demand from a tax cut could be larger or smaller than the tax cut.
a. True
b. False
40. During recessions, unemployment insurance payments tend to rise.
a. True
b. False
The Influence of Monetary and Fiscal Policy on Aggregate Demand 8439
41. During recessions, the government tends to run a budget deficit.
a. True
b. False
42. An implication of the Employment Act of 1946 is that the government should respond to changes
in the private economy to stabilize aggregate demand.
a. True
b. False
43. During a recession unemployment benefits rise. This rise in benefits makes aggregate demand
higher than otherwise.
a. True
b. False
8440 The Influence of Monetary and Fiscal Policy on Aggregate Demand
44. A severe problem that many economists have with the active use of monetary policy and fiscal
policy to stabilize the economy is that, while those policies obviously work well in practice, they
are not well understood on a theoretical level.
a. True
b. False
45. One of President Obama’s first policy initiatives was a stimulus bill that included large increases in
government spending.
a. True
b. False
46. What is the difference between monetary policy and fiscal policy?
The Influence of Monetary and Fiscal Policy on Aggregate Demand 8441
47. There are three factors that help explain the slope of the aggregate demand curve. Which two are
less important? Why are they less important?
48. Explain why the interest rate is the opportunity cost of holding currency. What is the benefit of
holding currency?
8442 The Influence of Monetary and Fiscal Policy on Aggregate Demand
49. Describe the process in the money market by which the interest rate reaches its equilibrium value
if it starts above equilibrium.
50. Use the money market to explain the interest-rate effect and its relation to the slope of the
aggregate demand curve.
