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1 1 of 20 12/1/ :31 PM Currency held by the public, balances in transactions accounts, plus balances in most savings accounts and money market mutual funds are the Money demand. Federal funds. Money supply (M1). Money supply (M2). The M2 money supply is a broader measure than the M1 money supply, adding funds in savings accounts and money market accounts. Difficulty: 1 Easy The choice about how and where to hold idle funds is the Precautionary decision. Transactions decision. Speculative decision. Portfolio decision. A portfolio decision reflects how an individual wants to allocate wealth into different assets. Difficulty: 1 Easy

2 2 of 20 12/1/ :31 PM Money held for making everyday market purchases represents the Crisis demand for money. Speculative demand for money. Transactions demand for money. Precautionary demand for money. Since currency is accepted nearly everywhere, many individuals choose to hold it to purchase everyday goods and services. Difficulty: 1 Easy During periods of hyperinflation, money does not hold its value long enough to make everyday market purchases; therefore, people hold as little as possible for as short a time as possible. This description implies that the Transactions demand for money has decreased. Precautionary demand for money has increased. Speculative demand for money has decreased. Portfolio demand for money has decreased. Holding money for everyday purchases refers to the transactions demand for money, which will be lower when money rapidly loses its value during periods of hyperinflation. The speculative demand for money is related to money functioning as a Store of value. Standard of value. Medium of exchange. Unit of account. Wealth can be held to use in the future in the form of many different assets, including money itself.

3 3 of 20 12/1/ :31 PM The normal market demand curve for money is A horizontal curve at very high interest rates, where the quantity demanded changes but the interest rate is constant. An upward-sloping demand curve, where more money is held when interest rates are higher. A vertical demand curve, where the same amount of money is held regardless of the interest rate. A downward-sloping demand curve, where more money is held at lower interest rates. Due to the normal inverse relationship between the interest rate and the amount of money individuals desire to hold, the money demand curve is downward-sloping at very low interest rates, where it may become horizontal due to the liquidity trap. The money supply curve as determined by current Federal Reserve policy is Vertical since it's not determined by the interest rate. Horizontal since it's not determined by the interest rate. Upward-sloping to the right. Downward-sloping to the right. The money supply is set by the Fed and is a fixed amount at any given point in time, resulting in a vertical line. The Fed can change the equilibrium rate of interest by changing Government spending. Taxes. Reserve requirements or the discount rate, or through open market operations. Tariffs. The use of monetary policy through any of the Fed's main tools will lead to a new equilibrium interest rate.

4 4 of 20 12/1/ :31 PM Ceteris paribus, if the Fed sells bonds through open market operations, the money Supply curve should shift rightward. Supply curve should shift leftward. Demand curve should shift rightward. Demand curve should shift leftward. An open market sale decreases the money supply and shifts the curve to the left, resulting in a higher equilibrium interest rate. The most visible market signal of the Fed's activity is the Equilibrium interest rate. Federal funds rate. Discount rate. Prime lending rate. The federal funds rate is affected greatly through the Fed's open market operations. An increase in the money supply will Reduce interest rates and increase aggregate demand. Reduce interest rates and decrease aggregate demand. Raise interest rates and increase aggregate demand. Raise interest rates and decrease aggregate demand. A lower interest rate will spur additional spending by businesses through investment, as well as increased consumption of interest-sensitive durable consumer goods. Learning Objective: The constraints on monetary policy impact.

5 5 of 20 12/1/ :31 PM Which of the following is likely to cause monetary restraint to be effective? High expectations overwhelm high interest rates. Businesses have the ability to borrow funds from foreign banks. People behave rationally and borrow less when interest rates rise. None of the choices are correct. The fact that individuals are rational helps monetary policy to be more effective in achieving policy goals. Learning Objective: How monetary policy affects macro outcomes. The success of Fed intervention depends on how well Congress performs when manipulating the money supply. Individuals respond to the Fed's direct requests of the public. The Treasury follows the Fed's directions for releasing money. Changes in long-term interest rates closely follow changes in short-term interest rates. Monetary policy will be less effective if the long-term rates diverge too far from short-term rates. Learning Objective: How monetary policy affects macro outcomes. In which of the following situations is expansionary monetary policy most effective? The Fed prints more currency. The Fed raises the discount rate and the reserve requirement. The Fed sells more securities. Banks are willing to lend excess reserves. When the banking system lends out excess reserves, it complements Fed action that will result in successful monetary policy. Learning Objective: How monetary policy affects macro outcomes.

6 6 of 20 12/1/ :31 PM When the money market is in equilibrium in the liquidity trap, An increase in the money supply does not affect interest rates. The demand for money is perfectly insensitive to interest rates. Investment spending falls to zero. There is no speculative demand for money. Because individuals may choose to hold lots of money and no bonds when rates are very low, additional increases in the money supply will not likely have any effect on interest rates. Learning Objective: How monetary policy affects macro outcomes. U.S. multinational nonbank corporations can borrow money from all of the following except Domestic banks. Foreign bond markets. Foreign subsidiaries. Federal Reserve district banks. The Federal Reserve district banks make loans only to banks through the discount window, not to multinational corporations. Learning Objective: How monetary policy affects macro outcomes. Keynes believed that monetary stimulus would be ineffective during a recession because of all of the following except The liquidity trap. Low expectations. The reluctance of banks to lend. The willingness of consumers to increase consumption when interest rates fall. During a recession, consumers are less likely to borrow and spend even when interest rates are low. Instead they are more likely to save more. Learning Objective: How monetary policy affects macro outcomes.

7 7 of 20 12/1/ :31 PM When the Fed sells securities through open market operations, the equation of exchange (under monetarist assumptions about V being stable) requires that either aggregate spending Increases or prices decrease, or both. Or prices decrease, or both. Decreases or prices increase, or both. Or prices increase, or both. According to the monetarists, the velocity of money is constant; a reduction in the money supply must reduce either total spending or prices. Learning Objective: The constraints on monetary policy impact. The long-term rate of unemployment, determined by structural forces in labor and product markets, defines the Frictional rate of unemployment. Seasonal rate of unemployment. Natural rate of unemployment. Cyclical rate of unemployment. The natural rate of unemployment corresponds to the position of the long-run aggregate supply curve and is based on production capacity, labor market efficiency, and other "structural" forces. Difficulty: 1 Easy Learning Objective: The constraints on monetary policy impact. According to monetarists, the aggregate supply curve is Upward-sloping to the right. Vertical at the natural rate of unemployment. Flat until full employment is reached. Flat. This implies that a change in the money supply will shift the AD curve, but it will merely intersect the vertical AS curve at a different price level. Learning Objective: The constraints on monetary policy impact.

8 8 of 20 12/1/ :31 PM If a lender desires to earn a real return of 3 percent on a loan and the anticipated rate of inflation is 2 percent, the lender should charge a Real interest rate of 5 percent. Nominal interest rate of 5 percent. Real interest rate of 6 percent. Nominal interest rate of 3 percent. The real interest rate is equal to the nominal interest rate minus the rate of inflation. Learning Objective: The constraints on monetary policy impact. If the nominal interest rate is a constant 15 percent and anticipated inflation falls from 10 percent to 7 percent, the real interest rate would change from 15 to 10 percent. 5 to 8 percent. 7 to 9 percent. 8 to 5 percent. Because the inflation rate fell by 3 percent while the nominal interest rate remained constant, the real rate of interest will rise by 3 percent from 5 to 8 percent. Learning Objective: The constraints on monetary policy impact. Effective expansionary monetary policy, according to Keynesian theorists, will do all of the following except Increase bank lending capacity. Lower real output. Encourage people to borrow and spend money. Reduce interest rates. Expansionary policy, when successful, drives down interest rates, increases the money supply through the money multiplier, and increases spending on interest-sensitive goods. Learning Objective: The differences between Keynesian and monetarist monetary theories.

9 9 of 20 12/1/ :31 PM According to extreme monetarists, monetary policy affects The velocity of money and level of employment. Real output, investment, and the money supply. Aggregate demand, prices, and nominal interest rates only. Aggregate demand, real output, and real interest rates, with possible effects on prices and nominal interest rates. Monetary policy affects aggregate demand, prices, and nominal interest rates because V and Q are stable. Learning Objective: The differences between Keynesian and monetarist monetary theories.

10 10 of 20 12/1/ :31 PM Which diagram in Figure 15.1 best represents the Keynesian view of investment demand when monetary policy is effective? a. b. c. d. Effective monetary policy gives businesses a greater incentive to invest when interest rates fall, resulting in a downward-sloping investment spending curve. Learning Objective: The

11 11 of 20 12/1/ :31 PM differences between Keynesian and monetarist monetary theories. In Figure 15.2, if the money supply decreased from $200 billion to $100 billion, which of the following would be likely to occur? Aggregate supply would increase. The demand for money would increase. Aggregate demand would decrease. The quantity of money demanded would increase. A lower money supply increases interest rates, reducing investment spending, and shifts the AD curve to the left.

12 12 of 20 12/1/ :31 PM In Figure 15.3, the Fed can change the equilibrium interest rate from 2 percent to 6 percent by Buying bonds in the open Decreasing the reserve requirement. Raising the discount rate. Increasing the amount of coins in circulation. Many interest rates move in step with changes to the discount rate; by raising the discount rate, these rates should rise as well. The money market demonstrates this when a decrease in the money supply due to an increase in the discount rate leads to a higher equilibrium interest rate.

13 13 of 20 12/1/ :31 PM In Figure 15.3, the Fed can use all of the following to decrease the equilibrium interest rate from 6 percent to 2 percent except Decreasing the reserve requirement. Selling bonds. Buying bonds. Decreasing the discount rate. A decrease in the interest rate would increase investment, causing the AD curve to increase rather than decrease.

14 14 of 20 12/1/ :31 PM In Figure 15.3, the Fed can decrease the equilibrium interest rate from 6 percent to 2 percent by Decreasing the reserve requirement. Decreasing the money supply. Selling bonds. Increasing the discount rate. A lower reserve requirement allows bank to lend out more reserves, thereby increasing the money supply and lowering the interest rate.

15 15 of 20 12/1/ :31 PM In Figure 15.4, an increase in the money supply from $65 billion to $100 billion will cause the equilibrium rate of interest to Decrease from 7 percent to 5 percent. Increase from 5 percent to 7 percent. Decrease from 7 percent to 3 percent. Increase from 3 percent to 5 percent. Increasing the money supply causes the interest rate to fall when money demand is constant.

16 16 of 20 12/1/ :31 PM The liquidity trap illustrated in Figure 15.5 is the result of a Low opportunity cost of money. Low demand for cash at low interest rates. Fed ceiling on interest rates. Currency that is not serving its function as a store of value. With such a low opportunity cost of holding money, individuals will hang onto large amounts of funds. Learning Objective: How monetary policy affects macro outcomes.

17 17 of 20 12/1/ :31 PM Refer to Figure Which of the following Fed actions is most likely to decrease the aggregate demand curve from AD 2 to AD 1? Buying bonds in the open Raising the federal funds rate. Lowering the discount rate. Decreasing the reserve requirement. Raising the federal funds rate will lower the money supply, raising interest rates, reducing investment, and causing AD to shift to the left.

18 18 of 20 12/1/ :31 PM Refer to Figure All of the following Fed actions are likely to increase the aggregate demand curve from AD to AD 1 2 except Buying bonds in the open Lowering the reserve requirement. Lowering the federal funds rate. Raising the discount rate. Any Fed tool used to increase the money supply will increase AD, but raising the discount rate will do the opposite.

19 19 of 20 12/1/ :31 PM Refer to Figure Suppose the money supply decreases. This will cause interest rates to and cause a shift from point. increase; A to point B decrease; B to point C increase; A to point D decrease; C to point D Decreasing the money supply raises interest rates, decreases investment, and shifts AD to the left, leading to a new macro equilibrium.

20 20 of 20 12/1/ :31 PM The liquidity trap refers to the portion of the money demand curve that is Upward-sloping. Downward-sloping. Horizontal. Vertical. A liquidity trap occurs along the horizontal portion of the money demand curve; increases in money supply do not cause interest rates to fall any further. Learning Objective: How monetary policy affects macro outcomes.