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Chapter 20
Money Growth, Money Demand and Modern Monetary Policy
Multiple-Choice Questions
1. History shows that:
a. countries with low rates of money growth have high rates of inflation.
b. money growth and inflation are not related.
c. countries with high rates of money growth have high rates of inflation.
d. money growth rates equal inflation rates.
2. Economic researchers have found:
a. no examples of countries with high rates of money growth and low inflation rates.
b. many examples of countries with low rates of money growth and high inflation rates.
c. many examples of countries with high rates of money growth and low inflation rates.
d. no relationship between rates of money growth and inflation rates.
3. When the currency loses value, causing people to spend it more quickly, this:
a. has the same effect on inflation as an increase in money growth.
b. has the same effect on inflation as a decrease in money growth.
c. causes higher inflation but not as much as an increase in money growth would.
d. causes even higher inflation than an increase in money growth would.
4. Over the long run if central banks want to avoid high rates of inflation, they need to be
concerned with the:
a. unemployment rate.
b. money growth rate.
c. real economic growth rate.
d. productivity of labor.
5. Which of the following statements is most correct?
a. The current rate of inflation is the result of money growth.
b. Money growth is the result of inflation.
c. There is no clear link between high, sustained inflation and the monetary aggregates.
d. It is impossible to have high, sustained inflation without monetary accommodation.
6. Consider the following ratio: the average annual inflation rate/the average annual money
growth rate. A country with a ratio less than one would have:
a. an average inflation rate greater than the average rate of money growth.
b. an average inflation rate less than the average rate of money growth.
c. to have a high unemployment rate.
d. an economy suffering from a recession.
7. Consider the following ratio: the average annual inflation rate/the average annual money
growth rate. If a country's rate of money growth consistently exceeds the rate of inflation the
ratio would be:
a. less than one.
b. greater than one.
c. that is infinite.
d. exactly one.
8. If money were valued in terms of how many minutes a person needs to work to buy a dollar,
an increase in the number of minutes of work needed would be:
a. a decline in the price of money.
b. an increase in the price of money.
c. no change in the real price of money, just the nominal price increases.
d. no change in the real or nominal price of money.
9. Inflation can be thought of as:
a. an increase in the price of money.
b. a decrease in the price of money.
c. no change in the price of money, just in the supply of money.
d. no change in the price of money, just in the demand for money.
10. If we look at the value of money in terms of how many units of a good it takes to buy one
dollar, then inflation means:
a. it would take more goods to buy the same dollar.
b. it would take fewer goods to buy the same dollar.
c. the same number of goods would buy fewer dollars.
d. it would take fewer dollars to buy the same goods.
11. The velocity of money increases if:
a. each unit of money is used more frequently.
b. each unit of money is used less frequently.
c
. more purchases are made.
d. none of the above answers is correct; the velocity of money is constant.
12. The velocity of money equals:
a. nominal GDP times the price level.
b. nominal GDP times the money supply.
c. nominal GDP divided by the price level.
d. nominal GDP divided by the money supply.
13. If M = the money supply; Y = real output, P = the price level, and V = velocity, which of the
following equals the velocity of money?
a. (Y × M)/P
b. (P × M)/Y
c. (P × Y)/M
d. (P × Y) + M
14. If the equation of exchange is MV = PY the Y represents:
a. nominal GDP.
b. real GDP.
c. potential output.
d. economic growth.
15. If M2 is four times larger than M1, the velocity of M1 should be:
a. one-fourth of the velocity of M2.
b. equal to the velocity of M2.
c. equal to four.
d. four times larger than the velocity of M2.
16. According to the equation of exchange, if real output and the money supply stay the same
and the price level increases:
6
a. the velocity of money has to increase.
b. the velocity of money has to decrease.
c. the real GDP had to rise.
d. nominal GDP remains constant.
17. Which of the following expresses the equation of exchange?
a. MY = PV
b. MV = Y
c. MV = PY
d. MP = VY
18. Using the equation of exchange, if inflation is 1.5%, real output grows by 3.0%, and the
growth rate of money is 5.0%, the change in the velocity of money is:
a. Zero; velocity is constant.
b. -0.5%.
c. +4.5%.
d. +0.5%.
19. Using the equation of exchange, if real GDP increases by 3.0%, the velocity of money grows
by 1.0% and the growth rate of money is 3.0%; what is the rate of inflation?
a. +1.0%
b. It is constant or a 0% change
c. It is the same as the growth rate of money, or 3.0%
d. -1.0%
20. Using the equation of exchange, if inflation is 1%, the velocity of money grows by 1.0% and
the growth rate of money is 3.0%; what is real growth?
a. +3.0%
b. 1%
c. 4.0%
d. -1.0%
21. If on average, a dollar is spent 4 times each year to purchase real output, the velocity of
money is:
a. one-fourth.
b. four.
c. the money supply divided by 4.
d. nominal GDP divided by four.
22. If we look at the equation for money demand from Irving Fisher, which of the following
statements is true?
a. Velocity does not play any role in the equation
b. Money demand is not a factor of nominal income
c. The price level does not impact money demand
d. There isn't an explicit role for the interest rate in the equation
23. Based on the analysis of the equation of exchange, Irving Fisher, derived the quantity theory
of money which states that:
a. velocity changes always offset changes in the supply of money.
b. changes in the aggregate price level are caused solely by changes in velocity.
c. changes in the aggregate price level are caused solely by changes in the quantity of money.
d. none of the answers given is correct.
24. Key assumptions behind the quantity theory of money include:
a. the money supply is fixed.
b. the velocity of money is constant.
c. the percentage change in the price level equals the percentage change in real GDP.
d. the change in nominal GDP is zero.
25. Milton Friedman's assertion that "inflation is a monetary phenomenon" is based on:
a. the quantity theory of money.
b. the assumption of constant nominal GDP growth.
c. the assumption that the price level grows at the same rate as real GDP.
d. the assumption that the central bank increases the money supply by a constant rate every year.
26. If we let Md reflect money demand, then we can write the equation for money demand as:
a. Md =VY.
b. Md = PY.
c. Md = (1/V) PY.
d. Md = V(Y/P).
27. Equilibrium in the money market would be expressed by which of the following?
a. Ms = (1/V)Y
b. Ms =Md
c. Ms = (1/V)P
d. Md = (1/V)P
28. The quantity theory of money can explain which of the following?
a. If the %ΔY > 0 and the %ΔV = 0; the %ΔP < %ΔM
b. If the %ΔV = 0 and the %ΔM = 0; the %ΔP must be = 0
c. If %ΔY and the %ΔV = 0; the %ΔP > %ΔM
d. If the %ΔP > 0; the %ΔM must also be > 0
29. The quantity theory of money along with the assumption of a constant velocity can explain
which of the following?
a. At a given level of money growth, the higher the level of real growth the higher the level of
inflation will be.
b. At a given level of money growth, the higher the level of real growth the lower the level of
inflation will be.
c. If real growth is higher than money growth, the price level must be rising.
d. If real growth equals money growth, the price level is falling.
30. A rate of inflation that exceeds the growth rate of money for a country could be explained
by:
a. a growing real economy.
b. a constant velocity of money.
c. an increasing velocity of money.
d. a decreasing velocity of money.
31. Nobel-laureate economist Milton Friedman suggested that policymakers strive to ensure that
the monetary aggregates:
a. grow at a rate equal to the rate of inflation.
b. grow at a rate equal to the rate of real growth plus the desired level of inflation.
c. grow at a rate equal to the rate of real growth less the desired level of inflation.
d. remain constant in terms of dollar amounts.
32. Control of money growth to stabilize inflation only works if velocity were constant. In
practice, changes in velocity:
a. can safely be ignored in countries with relatively low inflation rates.
b. are important when inflation is low.
c. must be taken into account no matter what the inflation rate.
d. can always safely be ignored.
33. The empirical data reveals the velocity of M2 to be:
a. relatively stable in the long run.
b. highly volatile in the long run.
c. stable only when measured annually.
d. higher than the velocity of M1.
34. Which of the following statements is most correct?
a. The velocity of M2 is relatively stable across all time periods.
b. The velocity of M2 is less stable than the velocity of M1.
c. The velocity of M2 is more volatile in the short run than the long run.
d. Fisher's assumption about money velocity being stable in the long run was incorrect.
35. If money growth and real output growth are both zero, the change in the price level will:
a. also be zero.
b. equal the percentage change in velocity.
c. be indeterminate.
d. be the inverse of the percentage change in velocity.
36. During economic slowdowns (recessions) the velocity of money tends to:
a. remain relatively stable.
b. increase slightly.
c. increase dramatically.
d. decrease.
37. When nominal interest rates are high, the velocity of money should:
a. be low.
b. also be high.
c. not change; the velocity of money does not vary with the interest rate.
d. decrease by the same percent that the nominal interest rate has increased.
38. In the late 1970s and early 1980s, the velocity of money increased significantly. The main
reason(s) for the increase was:
a. as presidential election years near the velocity of money increases.
b. the introduction of stock and bond mutual funds with draft writing privileges and low
nominal interest rates.
c. high nominal interest rates.
d. the introduction of stock and bond mutual funds with draft writing privileges along with high
nominal interest rates.
39. If the nominal interest rate increases:
a. the cost of holding money decreases.
b. the cost of holding money increases.
c. the velocity of money should decrease.
d. the cost of holding money increases and the velocity of money should decrease.
40. In May of 2003, the European Central Bank (ECB) decided to:
a. focus almost exclusively on money growth as their target.
b. downgrade the role of money growth in their policymaking strategy.
c. limit the role of interest rate targeting to be second in importance to money growth targeting.
d. switch from an inflation target to a money growth target.
41. Which of the following would reflect the transactions demand for money?
a. Keeping funds in your checking account to pay your rent
b. Keeping funds in your savings account because the interest rate looks relatively attractive
c. Selling common stocks you own and increasing the money in your savings account because
you think stock prices will fall soon
d. Buying a U.S. Treasury security using funds from your checking account
42. If real GDP stays the same but the price level increases:
a. nominal money demand should remain the same.
b. nominal money demand should decrease.
c. nominal money demand should increase.
d. real money demand should decrease.
43. The higher the nominal interest rate:
a. the less money individuals will hold for any given level of transactions and the higher the
velocity of money.
b. the more money individuals will hold for any given level of transactions and the higher the
velocity of money.
c. the more money individuals will hold for any given level of transactions and the lower the
velocity of money.
d. the less money individuals will hold for any given level of transactions and the lower the
velocity of money.
44. The opportunity cost of holding money is:
a. the nominal interest rate.
b. the real interest rate.
c. the nominal interest rate less the cost of converting a bond to cash.
d. the rate of inflation.
45. All other factors equal, if the costs of converting bonds and other financial securities to
a means of payment increase:
a. the transactions demand for money should increase.
b. the transactions demand for money should decrease.
c. it shouldn't impact the transactions demand for money.
d. nominal interest rates should decrease.
46. All other factors equal, as nominal interest rates decrease, checking account
balances should:
a. increase.
b. decrease.
c. remain constant.
d. be converted to cash.
47. If you were going to write a function for money demand, you would say that the demand
for money holdings:
a. varies directly with both the nominal interest rate and nominal income.
b. varies inversely with both the nominal interest rate and nominal income.
c. varies inversely with nominal income and directly with the nominal interest rate.
d. varies inversely with the nominal interest rate and directly with nominal income.
48. Which of the following statements best completes the sentence, "All other factors constant,
as the nominal interest rate increases, the opportunity cost of money..."?
a. decreases, the velocity of money decreases, and the quantity of money people want to hold
decreases.
b. increases, the velocity of money decreases, and the quantity of money people want to hold
decreases.
c. decreases, the velocity of money increases, and the quantity of money people want to hold
decreases.
d. increases, the velocity of money increases, and the quantity of money people want to hold
decreases.
49. In high inflation countries, inflation rates can exceed the rate of growth of money because:
a. high inflation increases the velocity of money.
b. high rates of inflation increase the opportunity cost of holding money.
c. money loses value quickly with inflation.
d. all of the answers given are correct.
50. Which of the following would be classified as precautionary demand for money?
a. You keep a $1,000 in a money market account because the return is better than a savings
account at your bank
b. You apply for and receive a credit card with a $1,000 limit
c. You put $1,000 in a savings account at your bank for emergencies
d. You put $1,000 in your checking account each month to cover your regular expenses
51. Money held for precautionary reasons is included in the demand for money:
a. as a third, separate category called the precautionary demand for money.
b. as part of transactions demand.
c. as part of portfolio demand.
d. partly as transactions demand and partly as portfolio demand.
52. The portfolio demand for money reflects:
a. the money we hold for our everyday transactions.
b. the portion of wealth people desire to hold in the form of money.
c. the money we hold to purchase stocks and bonds and other financial securities.
d. the money we hold for our everyday transactions and the money we hold to purchase
stocks and bonds and other financial securities.
53. People have a portfolio demand for money in part because:
a. money is part of a well-diversified financial portfolio.
b. the return on money is often higher than other financial assets.
c. money is needed to pay brokerage commissions.
d. there is no cost to holding money which gives it a relatively high return.
54. As a person's wealth increases we would expect the demand for money to:
a. decrease.
b. increase dollar for dollar with wealth.
c. increase but at a rate less than dollar for dollar.
d. not change; money demand does not vary with wealth, only with income.
55. A decline in the yields earned by bonds should:
a. not impact the demand for money since money doesn't earn any interest.
b. also decrease the demand for money.
c. increase the demand for money.
d. increase the velocity of money.
56. If an investor thinks interest rates are likely to rise, she would:
a. sell her bonds and hold more money.
b. buy more bonds now and hold less money.
c. not alter her bond portfolio until interest rates actually rise.
d. not change her money holdings at all.
57. Crises that occasionally hit financial markets will increase the demand for money since:
a. the return on money increases.
b. the return on financial assets increases.
c. there is no risk with holding money.
d. the risk of holding money relative to other financial assets decreases.
58. The demand for money varies:
a. directly with the liquidity of other financial
a
ss
et
s.
b. inversely with the liquidity of other financial assets.
c. not all with the liquidity of other assets since money is liquid.
d. inversely with wealth.
