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File: Chapter 30 Financial Crises, Panics, and Unconventional Monetary Policy
True/False
[Question]
1. One of the roles of the Fed is to be the lender of last resort.
2. During the 2008/09 recession, the Fed bailed out 25 percent of banks to keep them solvent.
3. Extrapolative expectations work when prices are rising, but not when prices decline.
4. The bursting of the stock market bubble was one of the contributing factors to the 2008 crisis.
5. Leveraging can encourage herding behavior.
6. According to the efficient market hypothesis, rational people will not recognize that asset
prices are rising too quickly.
7. The following is an example of the moral-hazard problem: Homebuyers do not properly
evaluate the risks involved in buying a home because they are assuming government will bail
them out of a bad mortgage as it has done before.
8. Government regulations that deal with financial crises tend to become less effective over
time.
9. The Fed followed a pre-commitment policy when it promised to keep short-term interest rates
low for a period of time after the 2008/09 U.S. recession.
10. Having a pre-commitment strategy gives the Fed the ability to alter the Fed funds rate when
needed.
11. Negative interest rates require that there be inflation.
12. Structural stagnationists argue that unconventional monetary policy tools were necessary to
restore order in the banking system.
13. According to structural stagnationists there is an argument to be made that the Fed should
return to standard monetary policy.
14. Why are financial-sector crises scarier than collapses in other sectors of the economy?
A. The financial sector is the biggest sector.
B. Financial-sector crises happen more often than collapses in other sectors.
C. Most people work in the financial sector.
D. If the financial sector fails, it can bring the whole economy down with it.
15. Which of the following described the attitude of most economists toward the U.S.-based
automobile sector during the 2008 recession?
A. It needed to receive subsidies from the government in order to produce hybrid cars.
B. It should be taken over by the Federal Government.
C. If their industry failed, it would not take the rest of the economy down with it.
D. It needed to be bailed out, just like the financial sector was bailed out.
16. What would likely have the most severe immediate effect on an economy?
A. A significant drop in exports.
B. The Fed’s infusing reserves into the economy.
C. An aggregate demand shock.
D. A failure of the financial sector.
17. A financial bailout might make better sense on economic grounds than a bailout of the
automotive industry because:
A. automobile companies are less deserving than financial companies.
B. the automobile industry is smaller than the financial industry.
C. the finance industry is necessary for other industries to function.
D. the automobile industry brings problems on itself.
18. What role do almost all economists agree the central bank has in a financial crisis?
A. Contractionary fiscal policy to reduce leverage.
B. Lender of last resort.
C. Expansionary fiscal policy to reduce herding.
D. No role.
19. An important role of central banks during a financial crisis is:
A. passing new bank regulations.
B. the lender of last resort.
C. closing banks.
D. eliminating bank reserves.
20. When a central bank is acting as a lender of last resort it is:
A. buying long-term Treasury bonds and selling short-term Treasury notes.
B. buying Treasury bills directly from the public.
C. providing banks with Treasury bills for free.
D. providing banks with liquidity to meet their obligations.
21. Liquidity is:
A. having assets that can be readily converted into cash.
B. having liabilities that can be readily converted into cash.
C. sufficient assets to cover long-run liabilities.
D. sufficient liabilities to cover long-run assets.
22. A bank that is liquid:
A. has assets that can be readily converted into cash and money.
B. has sufficient assets to cover its long-term liabilities.
C. can sell short-term bonds to buy long-term bonds.
D. is diversified in its holdings of financial assets.
23. If a financial asset is liquid, it is:
A. considered to be a safe asset with no chance of being deleveraged.
B. an online asset and has no physical piece of paper associated with it.
C. a highly desirable asset.
D. an asset that can easily be converted into cash.
24. Solvency is having:
A. assets that can be readily converted into cash.
B. liabilities that can be readily converted into cash.
C. sufficient assets to cover long-run liabilities.
D. sufficient liabilities to cover long-run assets.
25. When the Fed loaned to banks using banks’ long-run assets such as mortgages as collateral,
it was:
A. loosening its regulations of bank.
B. providing banks with liquidity.
C. giving banks assets.
D. conducting standard monetary policy.
26. When there is unsustainable rapidly rising prices of some type of financial asset, such as
stocks, we refer to this as a(n):
A. liquidity trap.
B. asset price bubble.
C. bad-precedent problem.
D. moral-hazard problem.
27. Asset price bubbles are not sustainable because:
A. people realize that leverage really doesn’t work mathematically.
B. invariably the government steps in to burst the asset price bubble.
C. investors eventually run out of assets with which to purchase the good.
D. they do not reflect an increase in the real productive value of the asset.
28. The 2008 financial crisis was caused largely by:
A. a run on banks and other financial institutions.
B. a bursting of the automobile market bubble.
C. a bursting of the housing market bubble.
D. by the inability of the government to issue Treasury bonds.
29. Which type of expectations can lead to an asset price bubble?
A. Extrapolative
B. Efficient
C. Eeal
D. Inverted
30. Extrapolative expectations are expectations that:
A. are consistent with trending expectations.
B. a trend will reverse.
C. are consistent with economists’ expectations.
D. a trend will continue.
31. Potential homebuyers expected house prices to continue to rise, which causes others to
believe that they will rise even faster. This is an example of:
A. imperfect expectations.
B. heightened expectations.
C. extrapolative expectations.
D. irrational expectations.
32. In which two markets did an asset bubble form that led to a financial crisis in 2008?
A. Housing and mortgage-backed securities.
B. Housing and automobiles.
C. Mortgage-backed securities and tulips.
D. South Sea Company and tulips.
33. Mortgage –backed securities are financial instruments:
A. that are highly risky.
B. that are extremely safe.
C. whose value depends on the value of mortgages.
D. that are highly leveraged but which offer high returns.
34. A company borrows money to supplement its current funds and uses it to buy more financial
assets. This is what referred to as:
A. diversification.
B. leverage.
C. quantitative easing.
D. herding.
35. Leverage is best defined as:
A. the practice of buying an asset with borrowed money.
B. using friends inside the banking industry to secure loans.
C. the ability of people without income to secure mortgages.
D. low interest rates at the beginning of the term of a loan that later rise.
36. Suppose the people in my town hear a rumor that their local bank is in trouble and all rush to
withdraw money from the bank. This is referred to as:
A. leverage.
B. a moral hazard problem.
C. a bad precedent problem.
D. a bank run.
37. I buy 100 shares of stock at $2 a share, with $100 of my own money. I borrow another $100
at 10 percent interest. The share price stays constant at $2. My rate of return is approximately:
A. 2 percent.
B. 0 percent.
C. -5 percent.
D. -10 percent.
38. I invest $100 in stock, and borrow 90 percent of the $100 at 10 percent. The stock price rises
by 20 percent. The rate of return on my investment is:
A. 10 percent.
B. 90 percent.
C. 110 percent.
D. 100 percent.
39. If housing prices are rising by 20 percent per year, you can borrow money at 5 percent per
year, and you are sure housing prices will continue to rise in the future, you would be wise to:
A. not buy a house because it will leave you in debt.
B. buy as many houses as you can.
C. buy a house if you need a house.
D. sell your house to get out of debt.
40. Why could leverage lead to an asset price bubble?
A. It allows investors to take advantage of disinflation.
B. It takes advantage of insiders who help outsiders.
C. It increases the ability of people to purchase financial instruments.
D. It takes advantage of extrapolative expectations.
41. The two main causes of an asset price bubble are:
A. herding and leverage.
B. herding and budget deficits.
C. budget surpluses and leverage.
D. herding and budget surpluses.
42. Suppose you work in investments for a financial institution, and other banks are making a
fortune with Irish goldmines. The fact that you are more likely to move to invest in Irish
goldmines just because you see other banks doing so is called:
A. the law of diminishing control.
B. leverage.
C. herding.
D. diversification.
43. Which of the following was not a direct contributor to the booming housing market in the
2000s?
A. People were expecting housing prices to keep on rising.
B. People could get mortgages with little or no money down.
C. Lending standards became loose.
D. Contractionary policy was passed in 2001.
44. Which of the following was not a contributing factor to the housing market boom of the
2000s?
A. Low interest rates
B. Mortgages with no or little money down
C. The merging of large banks giving them more assets
D. Scant concern given to people’s ability to meet the mortgage payment
45. The efficient market hypothesis suggests that:
A. Congress is unable to pass effective laws.
B. the Fed will be unable to pop an asset price bubble.
C. asset price bubbles are a normal part of an economy.
D. asset price bubbles won’t occur.
46. The efficient market hypothesis suggests that:
A. while individuals can be irrational, collectively they will not.
B. because individuals are rational, collectively they are also rational.
C. irrationality must a part of every economic model.
D. asset price bubbles are efficient.
47. Initially, policy makers were not concerned about the financial crisis because:
A. conventional economic theory was telling them they did not have to worry about such an
event occurring.
B. no other comparable crisis had happened before in history.
C. fiscal policy would kick in to stabilize the economy.
D. banks and other financial institutions had convinced policy makers that they would take care
of any type of crisis.
48. Structural stagnationists believe:
A. the efficient market hypothesis is operational at all times.
B. people can be irrational at times.
C. people are generally irrational.
D. the efficient market hypothesis is never operational.
49. Structural stagnationists believe expansionary monetary policy in the early 2000s:
A. was channeled into asset prices.
B. created far too much inflation.
C. required contractionary fiscal policy.
D. was entirely ineffective in affecting the economy.
50. Deposit insurance is:
A. private insurance by depositors to guarantee against a bank run that would affect deposits.
B. government insurance that promised to reimburse individuals for loss in the value of deposits.
C. a regulation that limits how much an individual can deposit at a single bank to avoid bank
runs.
D. a Federal Reserve Bank regulation that covered deposits by individuals against losses.
51. The FDIC is an example of:
A. the Glass-Steagall Act
B. a Federal Reserve Bank tool.
C. risk premium.
D. deposit insurance.
52. Moral hazard is a problem that arises when:
A. people are required to bear the negative consequences of their actions.
B. people don’t have to bear the negative consequences of their actions.
C. people benefit from the negative actions of others.
D. government discourages companies from taking risks.
