Economics of Money: Chapter 25

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Transmission Mechanisms of Monetary Policy
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1

Economic theory suggests that ________ interest rates are ________ important than ________ interest rates in explaining investment behavior.

  1. A) nominal; more; real
  2. B) real; less; nominal
  3. C) real; more; nominal
  4. D) market; more; real

Answer: C

2

According to the traditional interest-rate channel, expansionary monetary policy lowers the real interest rate, thereby raising expenditure on

  1. A) business fixed investment.
  2. B) government expenditure.
  3. C) consumer nondurables.
  4. D) net exports.

Answer: A

3

The monetary transmission mechanism that links monetary policy to GDP through real interest rates and investment spending is called the

  1. A) traditional interest-rate channel.
  2. B) Tobins' q theory.
  3. C) wealth effects.
  4. D) cash flow channel.

Answer: A

4

If the aggregate price level adjusts slowly over time, then an expansionary monetary policy lowers

  1. A) only the short-term nominal interest rate.
  2. B) only the short-term real interest rate.
  3. C) both the short-term nominal and real interest rates.
  4. D) the short-term nominal, the short-term real, and the long-term real interest rates.

Answer: D

5

If monetary policy can influence ________ prices and conditions in ________ markets, then it can affect spending through channels other than the traditional interest-rate channel.

  1. A) asset; labor
  2. B) asset; credit
  3. C) commodity; labor
  4. D) commodity; credit

Answer: B

6

An expansionary monetary policy lowers the real interest rate, causing the domestic currency to ________, thereby ________ net exports.

  1. A) appreciate; raising
  2. B) appreciate; lowering
  3. C) depreciate; raising
  4. D) depreciate; lowering

Answer: C

7

An expansionary monetary policy increases net exports by ________ interest rates and ________ the value of the dollar.

  1. A) lowering nominal; decreasing
  2. B) lowering real; decreasing
  3. C) raising nominal; increasing
  4. D) raising real; increasing

Answer: B

8

A contractionary monetary policy raises the real interest rate, causing the domestic currency to ________, thereby ________ net exports.

  1. A) appreciate; raising
  2. B) appreciate; lowering
  3. C) depreciate; raising
  4. D) depreciate; lowering

Answer: B

9

A contractionary monetary policy decreases net exports by ________ interest rates and ________ the value of the dollar.

  1. A) lowering real; decreasing
  2. B) lowering real; increasing
  3. C) raising nominal; increasing
  4. D) raising real; increasing

Answer: D

10

Tobin's q is defined as the market value of firms ________ the replacement cost of capital.

  1. A) times
  2. B) minus
  3. C) plus
  4. D) divided by

Answer: D

11

Tobin's q theory suggests that monetary policy may affect investment spending through its impact on

  1. A) stock prices.
  2. B) interest rates.
  3. C) bond prices.
  4. D) cash flow.

Answer: A

12

In the late 1990s, the stock market bubble ________ the value of Tobin's q, and caused ________ in business equipment.

  1. A) increased; underinvestment
  2. B) increased; overinvestment
  3. C) decreased; underinvestment
  4. D) decreased; overinvestment

Answer: B

13

During the Great Depression, Tobin's q

  1. A) rose dramatically, as did real interest rates.
  2. B) fell to unprecedentedly low levels.
  3. C) stayed fairly constant, in contrast to most other economic measures.
  4. D) rose only slightly, in spite of Hoover's attempts to prop it up.

Answer: B

14

According to Tobin's q theory, ________ policy can affect ________ spending through its effect on the prices of common stock.

  1. A) fiscal; consumption
  2. B) fiscal; investment
  3. C) monetary; consumption
  4. D) monetary; investment

Answer: D

15

According to Tobin's q theory, when q is ________, firms will not purchase new investment goods because the market value of firms is ________ relative to the cost of capital.

  1. A) low; low
  2. B) low; high
  3. C) high; low
  4. D) high; high

Answer: A

16

According to Tobin's q theory, if q is ________, new plant and equipment capital is ________ relative to the market value of business firms, so companies can buy a lot of new investment goods with only a ________ issue of stock.

  1. A) high; dear; large
  2. B) high; cheap; large
  3. C) high; cheap; small
  4. D) low; cheap; large
  5. E) low; cheap; small

Answer: C

17

According to Tobin's q theory, when equity prices are low the market price of existing capital is ________ relative to new capital, so expenditure on fixed investment is ________.

  1. A) cheap; low
  2. B) dear; low
  3. C) cheap; high
  4. D) dear; high

Answer: A

18

According to Tobin's q theory, when equity prices are high the market price of existing capital is ________ relative to new capital, so expenditure on fixed investment is ________.

  1. A) cheap; low
  2. B) dear; low
  3. C) cheap; high
  4. D) dear; high

Answer: D

19

Franco Modigliani has found that an expansionary monetary policy can cause stock market prices to ________ and consumption to ________.

  1. A) increase; increase
  2. B) increase; decrease
  3. C) decrease; decrease
  4. D) decrease; increase

Answer: A

20

Since Regulation Q has been abolished, there have been doubts raised about the size of the effect of the ________ channel.

  1. A) balance sheet
  2. B) bank lending
  3. C) cash flow
  4. D) unanticipated price level

Answer: B

21

A rise in stock prices ________ the net worth of firms and so leads to ________ investment spending because of the reduction in moral hazard.

  1. A) raises; higher
  2. B) raises; lower
  3. C) reduces; higher
  4. D) reduces; lower

Answer: A

22

Because of the presence of asymmetric information problems in credit markets, an expansionary monetary policy causes a ________ in net worth, which ________ the adverse selection problem, thereby ________ increased lending to finance investment spending.

  1. A) decline; increases; encouraging
  2. B) rise; increases; discouraging
  3. C) rise; reduces; encouraging
  4. D) decline; reduces; discouraging

Answer: C

23

Due to asymmetric information in credit markets, monetary policy may affect economic activity through the balance sheet channel, where an increase in the money supply

  1. A) raises stock prices, lowering the cost of new capital relative to firms' market value, thus increasing investment spending.
  2. B) raises firms' net worth, decreasing adverse selection and moral hazard problems, thus increasing banks' willingness to lend to finance investment spending.
  3. C) raises the level of bank reserves, deposits, and bank loans, thereby raising spending by those individuals who do not have access to credit markets.
  4. D) lowers the value of the dollar, increasing net exports and aggregate demand.

Answer: B

24

An expansionary monetary policy raises firms' cash flows by ________ interest rates.

  1. A) lowering real
  2. B) lowering nominal
  3. C) raising real
  4. D) raising nominal

Answer: B

25

If a contractionary monetary policy lowers the price level by more than expected, it raises the real value of consumer debt. This reduces consumer expenditure through

  1. A) the bank lending channel.
  2. B) Tobin's q.
  3. C) the traditional interest-rate channel.
  4. D) the household liquidity effect.

Answer: D

26

An expansionary monetary policy may cause asset prices to rise, thereby reducing the likelihood of financial distress and causing consumer durable and housing expenditures to rise. This monetary transmission mechanism is referred to as

  1. A) the household liquidity effect.
  2. B) the wealth effect.
  3. C) Tobin's q theory.
  4. D) the cash flow effect.

Answer: A

27

According to the household liquidity effect, an expansionary monetary policy causes a ________ in the value of households' financial assets, causing consumer durable expenditure to ________.

  1. A) decline; rise
  2. B) rise; rise
  3. C) rise; fall
  4. D) decline; fall

Answer: B

28

According to the household liquidity effect, higher stock prices lead to increased consumption expenditures because consumers

  1. A) feel more secure about their financial position.
  2. B) want to sell stocks and spend the proceeds before stock prices fall.
  3. C) believe that their wages will increase due to increased profitability of firms.
  4. D) can now afford more expensive imports.

Answer: A

29

The subprime financial crisis caused a recession because of the ________ in adverse selection and moral hazard problems and the ________ in housing prices.

  1. A) increase; increase
  2. B) increase; decrease
  3. C) decrease; increase
  4. D) decrease; decrease

Answer: B

30

Explain the traditional interest-rate channel for expansionary monetary policy. Explain how a tight monetary policy affects the economy through this channel.

Answer: In the traditional channel, a monetary expansion reduces real interest rates, lowering the cost of capital and increasing investment spending. The increase in investment increases aggregate demand. A monetary contraction has the opposite effect, raising real interest rates, lowering investment and aggregate spending.

31

Explain how expansionary and contractionary monetary policies affect aggregate demand through the exchange rate channel.

Answer: An expansionary monetary policy reduces real interest rates, causing depreciation of the domestic currency. This depreciation increases net exports and aggregate spending. A monetary contraction increases real interest rates, causing appreciation of the domestic currency, reducing net exports and aggregate spending.

32

Discuss three channels by which monetary policy affects stock prices and aggregate spending.

Answer: The answer should include three of the following:

In Tobin's q theory, a monetary expansion increases stock prices, increasing the value of the firm relative to the cost of new capital. This stimulates investment in new capital goods, which in turn increases aggregate spending.

A monetary expansion increases stock prices, increasing wealth and stimulating consumption and aggregate spending.

Expansionary monetary policy increases equity prices. This improves firms' balance sheets, reducing adverse selection and moral hazard and increasing lending for investment, which increases aggregate spending.

In the household liquidity effect, the increase in equity prices due to a monetary expansion improves consumer balance sheets, reducing the probability of financial distress, and increasing consumer spending on durable goods and housing.

33

Analysis of the transmission mechanisms of monetary policy provides four basic lessons for a central bank's conduct of monetary policy. These lessons include the following.

  1. A) Rising interest rates indicate a tightening of monetary policy, whereas falling interest rates indicate an easing of monetary policy.
  2. B) Monetary policy can be highly effective in reviving a weak economy even if short-term interest rates are already near zero.
  3. C) Avoiding fluctuations in the level of unemployment is an important objective of monetary policy, thus providing a rationale for interest-rate stability as the primary long-run goal for monetary policy.
  4. D) Other asset prices beside those on short-term debt instruments do not contain important information about the stance of monetary policy because they are not important elements in various monetary policy transmission mechanisms.

Answer: B

34

Analysis of the transmission mechanisms of monetary policy provides four basic lessons for a central bank's conduct of monetary policy. Which of the following is NOT one of these lessons?

  1. A) Rising interest rates indicate a tightening of monetary policy, whereas falling interest rates indicate an easing of monetary policy.
  2. B) Monetary policy can be highly effective in reviving a weak economy even if short-term interest rates are already near zero.
  3. C) Avoiding unanticipated fluctuations in the price level is an important objective of monetary policy, thus providing a rationale for price stability as the primary long-run goal for monetary policy.
  4. D) Other asset prices beside those on short-term debt instruments do not contain important information about the stance of monetary policy because they are important elements in various monetary policy transmission mechanisms.

Answer: A

35

From 1990s until 2012, the Japanese economy has experienced

  1. A) easy monetary policy as indicated by falling nominal interest rates.
  2. B) easy monetary policy as indicated by short-term interest rates near zero.
  3. C) tight monetary policy as indicated by falling asset prices.
  4. D) tight monetary policy as indicated by short-term interest rates near zero.

Answer: C

36

From the earlier 1990s until 2012, the Japanese monetary was ________ and stock and real estate prices were ________.

  1. A) tight; rising.
  2. B) easy; rising.
  3. C) tight; falling.
  4. D) easy; falling.

Answer: C

37

________ examines whether one variable has an effect on another by simply looking directly at the relationship between the two variables.

  1. A) Reduced-form evidence
  2. B) Organizational-model evidence
  3. C) Direct-model evidence
  4. D) Structural-model evidence

Answer: A

38

________ examines whether one variable affects another by using data to build a model that explains the channels through which this variable affects the other.

  1. A) Indirect-model evidence
  2. B) Organizational-model evidence
  3. C) Reduced-form evidence
  4. D) Structural-model evidence

Answer: D

39

On the evening news you hear of a scientific study that directly links premature births to cigarette smoking. This is an example of

  1. A) direct-model evidence.
  2. B) informed voter-model evidence.
  3. C) structural-model evidence.
  4. D) reduced-form evidence.

Answer: D

40

The monetarist-Keynesian debate on the importance of monetary policy is unresolved because monetarists and Keynesians focus on two different types of evidence that generate conflicting conclusions. Monetarists tend to focus on

  1. A) structural-model evidence, while Keynesians focus on reduced-form evidence.
  2. B) reduced-form evidence, while Keynesians focus on structural-model evidence.
  3. C) reduced-form evidence, while Keynesians focus on direct-model evidence.
  4. D) structural-model evidence, while Keynesians focus on direct-model evidence.

Answer: B

41

The channels through which monetary policy affects economic activity are called the ________ of monetary policy.

  1. A) transmission mechanisms
  2. B) flow mechanisms
  3. C) distribution mechanisms
  4. D) allocational mechanisms

Answer: A

42

A model that is composed of many equations that show the channels through which monetary and fiscal policy affect aggregate output and spending is called a

  1. A) reduced-form model.
  2. B) median-voter model.
  3. C) informed median-voter model.
  4. D) structural model.

Answer: D

43

Monetarists directly study the link between money and economic activity using

  1. A) structural models.
  2. B) reduced-form models.
  3. C) scientific models.
  4. D) experimental models.

Answer: B

44

Which of the following is NOT an advantage of a correctly specified structural model?

  1. A) Structural models may help us to more accurately predict the effect that monetary policy has on economic activity.
  2. B) A structural model provides more pieces of evidence about monetary policy's effect on economic activity.
  3. C) Structural models may allow economists to more accurately predict the impact institutional changes have on the link between monetary policy and income.
  4. D) A structural model imposes no restrictions on the way monetary policy affects the economy.

Answer: D

45

Predicting the impact of institutional change on the effectiveness of monetary policy is best done with a

  1. A) structural model.
  2. B) reduced-form model.
  3. C) black-box model.
  4. D) scientific model.

Answer: A

46

Monetarists contend that the channels of monetary influence in Keynesian structural models are too ________ defined, ________ the importance of monetary policy.

  1. A) broadly; exaggerating
  2. B) broadly; understating
  3. C) narrowly; understating
  4. D) narrowly; exaggerating

Answer: C

47

Monetarists' preference for reduced-form models is based on their belief that

  1. A) reverse causation is a problem.
  2. B) structural models may understate money's effect on economic activity.
  3. C) money supply changes are always endogenous.
  4. D) monetary policy affects only investment spending.

Answer: B

48

When Keynesians argue that "correlation does not necessarily imply causation," they are probably criticizing

  1. A) structural-model evidence.
  2. B) reduced-form evidence.
  3. C) indirect-model evidence.
  4. D) black-box evidence.

Answer: B

49

Early Keynesians felt that ________ policy was ________, so they stressed the importance of ________ policy.

  1. A) fiscal; ineffective; monetary
  2. B) monetary; ineffective; fiscal
  3. C) monetary; potent; monetary
  4. D) fiscal; too potent; monetary

Answer: B

50

Early Keynesians concluded that changes in monetary policy had no impact on aggregate output because early empirical studies found no linkage between movements in ________ and ________.

  1. A) nominal interest rates; investment spending
  2. B) real interest rates; investment spending
  3. C) money supply; aggregate output
  4. D) investment spending; aggregate output

Answer: A

51

In response to the early Keynesians, monetarists contended that

  1. A) monetary policy during the Great Depression was not easy.
  2. B) bank failures during the Great Depression were not the cause of the decline in the money supply.
  3. C) evidence from the Great Depression demonstrated the ineffectiveness of monetary policy.
  4. D) there is a weak link between interest rates and investment spending.

Answer: A

52

By the standard of low-grade bonds, interest rates were ________ and monetary policy was ________ during the Great Depression.

  1. A) low; tight
  2. B) low; easy
  3. C) high; tight
  4. D) high; easy

Answer: C

53

During the Great Depression, real interest rates

  1. A) rose to unprecedentedly high levels.
  2. B) rose only slightly above the long-run trend.
  3. C) fell to unprecedentedly low levels.
  4. D) fell only slightly below the long-run trend.

Answer: A

54

Movements of ________ interest rates indicate that, contrary to the early Keynesians' beliefs, monetary policy was ________ during the Great Depression.

  1. A) nominal; tight
  2. B) nominal; easy
  3. C) real; tight
  4. D) real; easy

Answer: C

55

Periods of price deflation, such as the Great Depression, are characterized by

  1. A) low nominal rates but high real rates of interest.
  2. B) low nominal and real interest rates.
  3. C) real rates of interest lower than the nominal rate of interest.
  4. D) high nominal and real rates of interest.

Answer: A

56

In a study published in 1963, Milton Friedman and Anna Schwartz found that in every business cycle they studied over nearly a hundred-year period, the growth rate of the ________ decreased before ________ decreased.

  1. A) money supply; interest rates
  2. B) money supply; output
  3. C) budget deficit; interest rates
  4. D) budget deficit; output

Answer: B

57

In a study published in 1963, Milton Friedman and Anna Schwartz found that in every business cycle they studied over nearly a hundred-year period

  1. A) the growth rate of the money supply decreased before output decreased.
  2. B) interest rates decreased before output decreased.
  3. C) the growth rate of federal government spending decreased before output decreased.
  4. D) the growth rate of state and local government spending decreased before output decreased.

Answer: A

58

The monetarist statistical evidence examines the correlations between both ________ and ________ with ________.

  1. A) money; aggregate spending; the unemployment rate
  2. B) money; autonomous expenditures; the unemployment rate
  3. C) money; consumption spending; aggregate spending
  4. D) money; autonomous expenditures; aggregate spending

Answer: D

59

A criticism of the monetarist autonomous spending variable is that

  1. A) some types of autonomous spending do not affect aggregate demand.
  2. B) some types of autonomous spending affect aggregate demand before the spending occurs. Some types of autonomous spending affect aggregate demand when they occur.
  3. C) some types of autonomous spending affect aggregate demand only long after they occur.
  4. D) Keynesians do not think that autonomous spending affects aggregate demand.

Answer: B

60

As a result of recent empirical research, there has been a convergence of Keynesian and monetarist opinion to the view that

  1. A) money is all that matters.
  2. B) money does matter.
  3. C) money does not matter.
  4. D) fiscal policy is all that matters.

Answer: B

61

Real business cycle theorists are critical of monetarist reduced-form evidence because they believe

  1. A) money is the most important cause of changes in aggregate demand.
  2. B) there is reverse causation from the business cycle to money.
  3. C) there is reverse causation from money to the business cycle.
  4. D) business cycles do not exist.

Answer: B

62

Real business cycle theory states that the most important cause of business cycles is

  1. A) shocks to the money supply.
  2. B) interest rate shocks.
  3. C) Federal Reserve policy decisions.
  4. D) shocks to tastes and technology.

Answer: D


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