CH-22-23 Aggregate Demand and Supply Analysis – The Economics of Money, Banking and Financial Markets : Exam Guide

This Document Contains Chapters 22 to 23 Chapter 22 Aggregate Demand and Supply Analysis 22.1 Aggregate Demand 1) The aggregate demand curve is the total quantity of an economy's A) intermediate goods demanded at all price levels. B) intermediate goods demanded at a particular price level. C) final goods and services demanded at a particular price level. D) final goods and services demanded at different price levels. Answer: D 2) The total quantity of an economy's final goods and services demanded at different price levels is A) the aggregate supply curve. B) the aggregate demand curve. C) the Phillips curve. D) the aggregate expenditure function. Answer: B 3) The aggregate demand curve slopes downward because a decrease in the price level means ________ in the real money supply and therefore a ________ level of real spending. A) an increase; higher B) an increase; lower C) a decrease; lower D) a decrease; higher Answer: A 4) The quantity theory of money is derived from A) the concept of velocity. B) the Keynesian monetary transmission mechanism. C) the equation of exchange. D) the money supply. Answer: C 5) As approached through the quantity theory of money, aggregate demand is derived from A) the equation of exchange. B) its three component parts: consumer expenditure, investment spending, and government spending. C) its four component parts: consumer expenditure, investment spending, government spending, and net exports. D) the spending multiplier. Answer: A 6) According to the quantity theory of money, an increase in the money supply ________ aggregate ________, everything else held constant. A) increases; demand B) decreases; demand C) decreases; supply D) increases; supply Answer: A 7) According to the quantity theory of money, a decrease in the money supply, ________ aggregate ________, everything else held constant. A) increases; demand B) decreases; demand C) decreases; supply D) increases; supply Answer: B 8) One way to derive aggregate demand is by looking at its four component parts, which are: A) consumer expenditures, planned investment spending, government spending, and net exports. B) consumer expenditures, actual investment spending, government spending, and net exports. C) consumer expenditures, planned investment spending, government spending, and gross exports. D) consumer expenditures, planned investment spending, government spending, and taxes. Answer: A 9) By analyzing aggregate demand through its component parts, we can conclude that, everything else held constant, a decline in the price level causes A) a decline in the real money supply, an increase in interest rates, a decline in investment spending, and a decline in aggregate output demand. B) a decline in the real money supply, a decline in interest rates, an increase in investment spending, and an increase in aggregate output demand. C) an increase in the real money supply, a decline in interest rates, an increase in investment spending, and an increase in aggregate output demand. D) an increase in the real money supply, an increase in interest rates, a decline in investment spending, and a decline in aggregate output demand. Answer: C 10) By looking at aggregate demand via its component parts, we can conclude that the aggregate demand curve is downward sloping because A) a lower price level, holding the nominal quantity of money constant, leads to a larger quantity of money in real terms, causes the interest rate to fall, and stimulates planned investment spending. B) a lower price level, holding the nominal quantity of money constant, leads to a larger quantity of money in nominal terms, causes the interest rate to rise, and stimulates planned investment spending. C) a higher price level, holding the nominal quantity of money constant, leads to a larger quantity of money in real terms, causes the interest rate to fall, and stimulates planned investment spending. D) a higher price level, holding the nominal quantity of money constant, leads to a smaller quantity of money in real terms, causes the interest rate to fall, and stimulates planned investment spending. Answer: A 11) By looking at aggregate demand through its component parts, we can conclude that a ________ price level ________ the real quantity of money, ________ higher spending. A) lower; expands; encouraging B) higher; contracts; encouraging C) lower; contracts; discouraging D) higher; expands; encouraging Answer: A 12) By analyzing aggregate demand via its component parts, we can conclude that changes in the money supply A) have no effect on aggregate demand. B) affect aggregate demand in the opposite direction of the change in government spending. C) affect aggregate demand in the same direction as the change in government spending. D) affect the quantity of aggregate output demand. Answer: C 13) Everything else held constant, an increase in government spending ________ aggregate ________. A) increases; demand B) decreases; demand C) decreases; supply D) increases; supply Answer: A 14) Everything else held constant, a decrease in government spending ________ aggregate ________. A) increases; demand B) decreases; demand C) decreases; supply D) increases; supply Answer: B 15) Everything else held constant, a decrease in net taxes ________ aggregate ________. A) increases; demand B) decreases; demand C) decreases; supply D) increases; supply Answer: A 16) Everything else held constant, an increase in net taxes ________ aggregate ________. A) increases; demand B) decreases; demand C) decreases; supply D) increases; supply Answer: B 17) Everything else held constant, a balanced budget increase in government spending (that is, an increase in government spending that is matched by an identical increase in net taxes) will A) increase aggregate demand, but not by as much as if just government spending increases. B) increase aggregate demand by more than if just government spending increases. C) not affect aggregate demand. D) decrease aggregate demand. Answer: A 18) Everything else held constant, an increase in net exports ________ aggregate ________. A) increases; demand B) decreases; demand C) decreases; supply D) increases; supply Answer: A 19) Everything else held constant, a decrease in net exports ________ aggregate ________. A) increases; demand B) decreases; demand C) decreases; supply D) increases; supply Answer: B 20) Everything else held constant, an increase in planned investment expenditure ________ aggregate ________. A) increases; demand B) decreases; demand C) decreases; supply D) increases; supply Answer: A 21) Everything else held constant, a decrease in planned investment expenditure ________ aggregate ________. A) increases; demand B) decreases; demand C) decreases; supply D) increases; supply Answer: B 22) Everything else held constant, aggregate demand increases when A) taxes are cut. B) government spending is reduced. C) animal spirits decrease. D) the money supply is reduced. Answer: A 23) Everything else held constant, aggregate demand increases when A) net exports decrease. B) taxes increase. C) planned investment spending increases. D) the money supply decreases. Answer: C 24) Everything else held constant, which of the following does not cause aggregate demand to increase? A) An increase in net exports B) An increase in government spending C) An increase in taxes D) An increase in consumer optimism Answer: C 25) Explain through the component parts of aggregate demand why the aggregate demand curve slopes down with respect to the price level. Be sure to discuss two channels through which changes in prices affect demand. Answer: A fall in the price level increases the real value of a fixed nominal money supply. This increase in the real money supply lowers interest rates. Lower rates increase investment, thereby increasing aggregate demand. Lower interest rates also cause depreciation of the domestic currency, increasing net exports and aggregate demand. 22.2 Aggregate Supply 1) The aggregate supply curve is the total quantity of A) raw materials offered for sale at different prices. B) final goods and services offered for sale at the current price level. C) final goods and services offered for sale at different price levels. D) intermediate and final goods and service offered for sale at different price levels. Answer: C 2) The aggregate supply curve shows the relationship between A) the level of inputs and aggregate output. B) the price level and the level of inputs. C) the wage rate and the level of employment. D) the price level and the level of aggregate output supplied. Answer: D 3) The long-run rate of unemployment to which an economy always gravitates is the A) normal rate of unemployment. B) natural rate of unemployment. C) neutral rate of unemployment. D) inflationary rate of unemployment. Answer: B 4) The long-run aggregate supply curve is A) a vertical line through the non-inflationary rate of output. B) a vertical line through the current level of output. C) a vertical line through the natural rate level of output. D) a horizontal line through the current level of output. Answer: C 5) The long-run aggregate supply curve is a vertical line passing through A) the natural rate of output. B) the natural-rate price level. C) the actual rate of unemployment. D) the expected rate of inflation. Answer: A 6) The short-run aggregate supply curve is upward sloping because in the short run, costs of many factors that go into producing goods and services are ________, meaning that the price for a unit of output will ________ relative to input prices and the profit per unit will rise. A) fixed; rise B) fixed; fall C) flexible; rise D) flexible; fall Answer: A 7) The positively sloped short-run aggregate supply curve reflects the assumption that factor prices are A) more flexible than output prices. B) less flexible than output prices. C) fixed in the long run. D) perfectly flexible in both the short run and the long run. Answer: B 8) Everything else held constant, an increase in the cost of production ________ aggregate ________. A) increases; demand B) decreases; demand C) increases; supply D) decreases; supply Answer: D 9) Everything else held constant, a decrease in the cost of production ________ aggregate ________. A) increases; demand B) decreases; demand C) increases; supply D) decreases; supply Answer: C 10) Everything else held constant, when output is ________ the natural rate level, wages will begin to ________, increasing short-run aggregate supply. A) above; fall B) above; rise C) below; fall D) below; rise Answer: C 11) Everything else held constant, when output is ________ the natural rate level, wages will begin to ________, decreasing short-run aggregate supply. A) above; fall B) above; rise C) below; fall D) below; rise Answer: B 12) Everything else held constant, when actual output exceeds the natural rate of output ________ aggregate supply ________. A) short-run; decreases B) short-run; increases C) long-run; increases D) long-run; decreases Answer: A 13) If workers demand and receive higher real wages (a successful wage push), the cost of production ________ and the short-run aggregate supply curve shifts ________. A) rises; leftward B) rises; rightward C) falls; leftward D) falls; rightward Answer: A 14) Everything else held constant, if workers expect an increase in the price level, ________ aggregate supply ________. A) long-run; increases B) long-run; decreases C) short-run; decreases D) short-run; increases Answer: C 15) Everything else held constant, a change in workers' expectations about the aggregate price level will cause ________ to change. A) aggregate demand B) short-run aggregate supply C) the production function D) long-run aggregate supply Answer: B 16) A decrease in the availability of raw materials that increases the price level is called a ________ shock A) negative demand B) positive demand C) negative supply D) positive supply Answer: C 17) A negative supply shock causes ________ to ________. A) aggregate demand; increase B) aggregate demand; decrease C) short-run aggregate supply; decrease D) short-run aggregate supply; increase Answer: C 18) A positive supply shock causes ________ to ________. A) aggregate demand; increase B) aggregate demand; decrease C) short-run aggregate supply; decrease D) short-run aggregate supply; increase Answer: D 19) Which of the following increases aggregate supply in the short-run, everything else held constant? A) An increase in the price of crude oil. B) A successful wage push by workers. C) Expectations of a higher aggregate price level. D) A technological improvement that increases worker productivity. Answer: D 22.3 Equilibrium in Aggregate Supply and Demand Analysis 1) The fact that an economy always returns to the natural rate level of output is known as A) the excess demand hypothesis. B) the price-adjustment mechanism. C) the self-correcting mechanism. D) the natural rate of unemployment. Answer: C 2) Assuming the economy is starting at the natural rate of output and everything else held constant, the effect of ________ in aggregate ________ is a rise in both the price level and output in the short-run, but in the long-run the only effect is a rise in the price level. A) a decrease; supply B) a decrease; demand C) an increase; supply D) an increase; demand Answer: D 3) The aggregate demand-aggregate supply framework indicates that the long-run effect of a ________ in the money supply is an increase in ________, everything else held constant. A) fall; aggregate output B) fall; the price level C) rise; aggregate output D) rise; the price level Answer: D 4) Suppose the economy is producing at the natural rate of output. Assuming a fixed natural rate of output and everything else held constant, the development of a new, more productive technology will cause ________ in the unemployment rate in the short run and ________ in the aggregate price level in the short run. A) an increase; an increase B) a decrease; a decrease C) a decrease; an increase D) no change; no change Answer: B 5) Suppose the economy is producing at the natural rate of output. Assuming a fixed natural rate of output and everything else held constant, the development of a new, more productive technology will cause ________ in the unemployment rate in the long run and ________ in the aggregate price level in the short run. A) an increase; an increase B) a decrease; a decrease C) no change; a decrease D) no change; no change Answer: C 6) Suppose the economy is producing at the natural rate of output. Assuming a fixed natural rate of output and everything else held constant, the development of a new, more productive technology will cause ________ in the unemployment rate and ________ in the aggregate price level in the long run. A) an increase; an increase B) a decrease; a decrease C) a decrease; an increase D) no change; no change Answer: D 7) Suppose the economy is producing at the natural rate of output. An increase in consumer and business confidence will cause ________ in real GDP in the short run and ________ in the aggregate price level in the short run, everything else held constant. A) an increase; an increase B) a decrease; a decrease C) no change; an increase D) no change; a decrease Answer: A 8) Suppose the economy is producing at the natural rate of output. An increase in consumer and business confidence will cause ________ in real GDP in the long run and ________ in the aggregate price level in the long run, everything else held constant. A) an increase; an increase B) a decrease; a decrease C) no change; an increase D) no change; a decrease Answer: C 9) Suppose the economy is producing at the natural rate of output. A decrease in consumer and business confidence will cause ________ in real GDP in the short run and ________ in the aggregate price level in the short run, everything else held constant. A) an increase; an increase B) a decrease; a decrease C) no change; an increase D) no change; a decrease Answer: B 10) Suppose the economy is producing at the natural rate of output. A decrease in consumer and business confidence will cause ________ in real GDP in the long run and ________ in the aggregate price level in the long run, everything else held constant. A) an increase; an increase B) a decrease; a decrease C) no change; an increase D) no change; a decrease Answer: D 11) Suppose the economy is producing at the natural rate of output. An open market purchase of bonds by the Fed will cause ________ in real GDP the the short run and ________ in the aggregate price level in the short run, everything else held constant. A) an increase; an increase B) a decrease; a decrease C) no change; an increase D) no change; a decrease Answer: A 12) Suppose the economy is producing at the natural rate of output. An open market purchase of bonds by the Fed will cause ________ in real GDP in the long run and ________ in the aggregate price level in the long run, everything else held constant. A) an increase; an increase B) a decrease; a decrease C) no change; an increase D) no change; a decrease Answer: C 13) Suppose the economy is producing at the natural rate of output. An open market sale of bonds by the Fed will cause ________ in real GDP in the short run and ________ in the aggregate price level in the short run, everything else held constant. A) an increase; an increase B) a decrease; a decrease C) no change; an increase D) no change; a decrease Answer: B 14) Suppose the economy is producing at the natural rate of output. An open market sale of bonds by the Fed will cause ________ in real GDP in the long run and ________ in the aggregate price level in the long run, everything else held constant. A) an increase; an increase B) a decrease; a decrease C) no change; an increase D) no change; a decrease Answer: D 15) Suppose the U.S. economy is producing at the natural rate of output. A depreciation of the U.S. dollar will cause ________ in real GDP in the short run and ________ in the aggregate price level in the short run, everything else held constant. (Assume the depreciation causes no effects in the supply side of the economy.) A) an increase; an increase B) a decrease; a decrease C) no change; an increase D) no change; a decrease Answer: A 16) Suppose the U.S. economy is producing at the natural rate of output. A depreciation of the U.S. dollar will cause ________ in real GDP in the short run and ________ in the aggregate price level in the long run, everything else held constant. (Assume the depreciation causes no effects in the supply side of the economy.) A) an increase; an increase B) a decrease; a decrease C) no change; an increase D) no change; a decrease Answer: C 17) Suppose the U.S. economy is producing at the natural rate of output. An appreciation of the U.S. dollar will cause ________ in real GDP in the short run and ________ in the aggregate price level in the short run, everything else held constant. (Assume the appreciation causes no effects in the supply side of the economy.) A) an increase; an increase B) a decrease; a decrease C) no change; an increase D) no change; a decrease Answer: B 18) Suppose the U.S. economy is producing at the natural rate of output. An appreciation of the U.S. dollar will cause ________ in real GDP in the short run and ________ in the aggregate price level in the long run, everything else held constant. (Assume the appreciation causes no effects in the supply side of the economy.) A) an increase; an increase B) a decrease; a decrease C) no change; an increase D) no change; a decrease Answer: D 19) Suppose the economy is producing below the natural rate of output and the government is suffering from large budget deficits. To deal with the deficit problem, suppose the government takes a policy action to reduce the size of the deficits. This policy action will cause ________ in the unemployment rate in the short run and ________ in the aggregate price level in the short run, everything else held constant. A) an increase; an increase B) a decrease; a decrease C) a decrease; an increase D) an increase; a decrease Answer: D 20) Suppose the economy is producing at the natural rate of output and the government passes legislation that severely restricts a company's ability to reduce production costs via outsourcing. Everything else held constant, this policy action will cause ________ in the unemployment rate in the short run and ________ in the aggregate price level in the short run. A) an increase; an increase B) a decrease; a decrease C) a decrease; an increase D) no change; no change Answer: A 21) Suppose the U.S. economy is operating at potential output. A negative supply shock that is accommodated by an open market purchase by the Federal Reserve will cause ________ in real GDP in the long run and ________ in the aggregate price level in the long run, everything else held constant. A) no change; an increase B) no change; a decrease C) an increase; an increase D) a decrease; a decrease Answer: A 22) A theory of aggregate economic fluctuations called real business cycle theory holds that A) changes in the real money supply are the only demand shocks that affect the natural rate of output. B) aggregate demand shocks do affect the natural rate of output. C) aggregate supply shocks do affect the natural rate of output. D) changes in net exports are the only demand shocks that affect the natural rate of output. Answer: C 23) This theory views shocks to tastes (workers' willingness to work, for example) and technology (productivity) as the major driving forces behind short-run fluctuations in the business cycle because these shocks lead to substantial short-run fluctuations in the natural rate of output. A) The natural rate hypothesis B) Hysteresis C) Real business cycle theory D) The Phillips curve model Answer: C 24) Because shifts in aggregate demand are not viewed as being particularly important to aggregate output fluctuations, they do not see much need for activist policy to eliminate high unemployment. "They" refers to proponents of A) the natural rate hypothesis. B) monetarism. C) the Phillips curve model. D) real business cycle theory. Answer: D 25) A group of economists believe that the natural rate of output is affected by aggregate ________ shocks. They contend that the natural rate level of unemployment and output are subject to ________, a departure from full employment levels as a result of past high unemployment. A) supply; hysterisis B) supply; systerisis C) demand; hysterisis D) demand; systerisis Answer: C 26) A reduction of aggregate demand may raise the natural rate of unemployment above the full employment level, meaning that the self-correcting mechanism will only be able to return the economy to the natural rate level of output and unemployment—not to the full employment levels. Such a view is consistent with A) monetarism. B) hysterisis. C) Keynesianism. D) real business cycle theory. Answer: B 27) According to aggregate demand and supply analysis, America's involvement in the Vietnam War had the effect of A) increasing aggregate output, lowering unemployment, and raising the price level. B) decreasing aggregate output, lowering unemployment, and lowering the price level. C) increasing aggregate output, raising unemployment, and raising the price level. D) decreasing aggregate output, raising unemployment, and lowering the price level. Answer: A 28) According to aggregate demand and supply analysis, the negative supply shocks of 1973-1975 and 1978-1980 had the effect of A) increasing aggregate output, lowering unemployment, and raising the price level. B) decreasing aggregate output, raising unemployment, and raising the price level. C) increasing aggregate output, raising unemployment, and raising the price level. D) decreasing aggregate output, raising unemployment, and lowering the price level. Answer: B 29) According to aggregate demand and supply analysis, the favorable supply shock of 1995-1999 had the effect of A) increasing aggregate output, lowering unemployment, and raising inflation. B) decreasing aggregate output, raising unemployment, and raising inflation. C) increasing aggregate output, lowering unemployment, and lowering inflation. D) decreasing aggregate output, raising unemployment, and lowering inflation. Answer: C 30) According to aggregate demand and supply analysis, the negative demand shock of 2000-2004 had the effect of A) increasing aggregate output, lowering unemployment, and raising inflation. B) decreasing aggregate output, raising unemployment, and raising inflation. C) increasing aggregate output, lowering unemployment, and lowering inflation. D) decreasing aggregate output, raising unemployment, and lowering inflation. Answer: D 31) According to aggregate demand and supply analysis, the rising oil prices coupled with the subprime financial crisis in 2007-2008 caused the unemployment rate to ________ and the level of real aggregate output to ________. A) increase; increase B) increase; decrease C) decrease; increase D) decrease; decrease Answer: B 32) Using the aggregate demand-aggregate supply model, explain and demonstrate graphically the short-run and long-run effects of an increase in the money supply. Answer: See figure below. An increase in the money supply increases aggregate demand, from AD to AD'. The economy moves from point 1 to point 2. In the short run both the price level and real output increase. In the long run, wages adjust, decreasing short-run aggregate supply, to AS', raising prices further and reducing real output until the economy returns to the natural level of output. The long-run result is to only increase the price level. The path is from 1 to 2 to 3. 33) Explain and demonstrate graphically the effects of a negative supply shock in both the short-run and long-run. Answer: See figure below. The supply shock decreases short-run aggregate supply from AS1 to AS2, reducing real output and raising the price level, or from points 1 to 2 in the graph. In the long run, the supply curve eventually adjusts back to the original position as wages fall. The economy adjusts from 2 back to 1. 22.4 APPENDIX: Aggregate Supply and the Phillips Curve 1) The Phillips curve indicates that when the labor market is ________, production costs will ________ and aggregate supply increases. A) easy; rise B) easy; fall C) tight; fall D) tight; rise Answer: B 2) The Phillips curve indicates that when the labor market is ________, production costs will ________ and aggregate supply decreases. A) easy; rise B) easy; fall C) tight; fall D) tight; rise Answer: D 3) The expectations-augmented Phillips curve implies that as expected inflation increases, nominal wages ________ to prevent real wages from ________. A) fall; rising B) fall; falling C) rise; falling D) rise; rising Answer: C 4) The Lucas supply function indicates that deviations of unemployment from the natural rate level respond to A) any increase in aggregate demand. B) unanticipated inflation. C) a supply shock. D) expected changes in inflation. Answer: B Chapter 23 Transmission Mechanisms of Monetary Policy: The Evidence 23.1 Framework for Evaluating Empirical Evidence 1) Evidence that examines whether one variable has an effect on another by simply looking directly at the relationship between the two variables is A) reduced-form evidence. B) organizational-model evidence. C) direct-model evidence. D) structural-model evidence. Answer: A 2) Evidence that is based on a variable having its effect on another variable through channels rather than a direct effect is known as A) indirect-model evidence. B) organizational-model evidence. C) reduced-form evidence. D) structural-model evidence. Answer: D 3) On the evening news you hear of a scientific study that directly links premature births to cigarette smoking. This is an example of A) direct-model evidence. B) informed voter-model evidence. C) structural-model evidence. D) reduced-form evidence. Answer: D 4) 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 A) structural-model evidence, while Keynesians focus on reduced-form evidence. B) reduced-form evidence, while Keynesians focus on structural-model evidence. C) reduced-form evidence, while Keynesians focus on direct-model evidence. D) structural-model evidence, while Keynesians focus on direct-model evidence. Answer: B 5) The channels through which monetary policy affects economic activity are called the ________ of monetary policy. A) transmission mechanisms B) flow mechanisms C) distribution mechanisms D) allocational mechanisms Answer: A 6) 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 A) reduced-form model. B) median-voter model. C) informed median-voter model. D) structural model. Answer: D 7) Monetarists directly study the link between money and economic activity using A) structural models. B) reduced-form models. C) scientific models. D) experimental models. Answer: B 8) The monetarist reduced-form evidence does not specify the working of the economy and thus is considered to be a A) scientific model. B) open model. C) black box. D) black hole. Answer: C 9) Which of the following is not an advantage of a correctly specified structural model? A) Structural models may help us to more accurately predict the effect that monetary policy has on economic activity. B) A structural model provides more pieces of evidence about monetary policy's effect on economic activity. C) Structural models may allow economists to more accurately predict the impact institutional changes have on the link between monetary policy and income. D) A structural model imposes no restrictions on the way monetary policy affects the economy. Answer: D 10) Predicting the impact of institutional change on the effectiveness of monetary policy is best done with a A) structural model. B) reduced-form model. C) black-box model. D) scientific model. Answer: A 11) The monetarists complained that early Keynesian structural models tended to ignore the impact of monetary policy changes on A) interest rates. B) investment spending. C) consumption spending. D) capital goods spending. Answer: C 12) Monetarists contend that the channels of monetary influence in Keynesian structural models are too ________ defined, ________ the importance of monetary policy. A) broadly; exaggerating B) broadly; understating C) narrowly; understating D) narrowly; exaggerating Answer: C 13) Monetarists claim that ________ models ignore important transmission mechanisms and therefore ________ the importance of the effects of monetary policy on the economy. A) structural; overstate B) reduced-form; overstate C) reduced-form; understate D) structural; understate Answer: D 14) Monetarists assert that monetary policy may affect aggregate demand through A) only an interest rate channel. B) only an exchange rate channel. C) only two channels: interest rates and exchange rates. D) many channels. Answer: D 15) If the particular channels through which changes in the money supply affect aggregate income are diverse and continually changing, the best evidence of monetary policy's effect is likely to come from A) reduced-form models. B) structural models. C) median-voter models. D) indirect models. Answer: A 16) Monetarists' preference for reduced-form models is based on their belief that A) reverse causation is a problem. B) structural models may understate money's effect on economic activity. C) money supply changes are always endogenous. D) monetary policy affects only investment spending. Answer: B 17) When Keynesians argue that "correlation does not necessarily imply causation," they are probably criticizing A) structural-model evidence. B) reduced-form evidence. C) indirect-model evidence. D) black-box evidence. Answer: B 18) Reverse causation between money and aggregate output is likely to be a problem when a central bank targets A) a monetary aggregate. B) an interest rate. C) the exchange rate. D) the inflation rate. Answer: B 19) With regard to aggregate demand, early Keynesians tended to believe that A) monetary policy mattered most. B) monetary policy was all that mattered. C) monetary policy mattered. D) monetary policy did not matter. Answer: D 20) The ________ held the view that monetary policy does not matter at all for movements in aggregate output. A) new Keynesian economists B) early Keynesians C) early monetarists D) early classical economists Answer: B 21) Early Keynesians felt that ________ policy was ________, so they stressed the importance of ________ policy. A) fiscal; ineffective; monetary B) monetary; ineffective; fiscal C) monetary; potent; monetary D) fiscal; too potent; monetary Answer: B 22) Early Keynesians believed that ________ interest rates during the Great Depression indicated that monetary policy had been ________. A) high; contractionary B) high; expansionary C) low; contractionary D) low; expansionary Answer: D 23) Early Keynesians viewed monetary policy as influencing aggregate demand solely through its impact on ________ interest rates, which, in turn, affect ________ spending. A) nominal; consumer B) nominal; investment C) real; consumer D) real; investment Answer: B 24) Early Keynesians believed that ________ interest rates during the Great Depression indicated that monetary policy was ________. A) high; easy B) high; tight C) low; easy D) low; tight Answer: C 25) Early Keynesians believed that low ________ during the Great Depression indicated that ________ policy was easy. A) money growth; fiscal B) money growth; monetary C) interest rates; fiscal D) interest rates; monetary Answer: D 26) 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 ________. A) nominal interest rates; investment spending B) real interest rates; investment spending C) money supply; aggregate output D) investment spending; aggregate output Answer: A 27) In response to the early Keynesians, monetarists contended that A) monetary policy during the Great Depression was not easy. B) bank failures during the Great Depression were not the cause of the decline in the money supply. C) evidence from the Great Depression demonstrated the ineffectiveness of monetary policy. D) there is a weak link between interest rates and investment spending. Answer: A 28) Milton Friedman and Anna Schwartz showed that monetary policy during the Great Depression had A) been quite inflationary. B) never been more contractionary. C) been more expansionary than in the 1920s. D) been essentially neutral. Answer: B 29) By the standard of low-grade bonds, interest rates were ________ and monetary policy was ________ during the Great Depression. A) low; tight B) low; easy C) high; tight D) high; easy Answer: C 30) During the Great Depression, real interest rates A) rose to unprecedentedly high levels. B) rose only slightly above the long-run trend. C) fell to unprecedentedly low levels. D) fell only slightly below the long-run trend. Answer: A 31) Movements of ________ interest rates indicate that, contrary to the early Keynesians' beliefs, monetary policy was ________ during the Great Depression. A) nominal; tight B) nominal; easy C) real; tight D) real; easy Answer: C 32) Movements of real interest rates indicate that, contrary to the early Keynesians' beliefs, ________ policy was ________ during the Great Depression. A) fiscal; tight B) fiscal; easy C) monetary; tight D) monetary; easy Answer: C 33) Periods of price deflation, such as the Great Depression, are characterized by A) low nominal rates but high real rates of interest. B) low nominal and real interest rates. C) real rates of interest lower than the nominal rate of interest. D) high nominal and real rates of interest. Answer: A 34) Monetarists contend that A) monetary policy affects aggregate demand solely through investment. B) monetary policy may affect aggregate demand through many channels. C) a weak link between nominal interest rates and investment spending implies monetary policy ineffectiveness. D) monetary policy affects aggregate demand solely through consumption. Answer: B 35) In the early 1960s, monetarists used reduced-form timing, statistical, and historical evidence to show that A) fiscal policy had a strong impact on economic activity. B) monetary policy had a strong impact on economic activity. C) monetary policy had a weak impact on economic activity. D) neither monetary nor fiscal policy had a strong impact on economic activity. Answer: B 36) 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. A) money supply; interest rates B) money supply; output C) budget deficit; interest rates D) budget deficit; output Answer: B 37) Friedman and Schwartz found that the rate of money growth fell prior to business cycle downturns in A) about three out of every four instances. B) four out of every five instances. C) about two out of every three instances. D) every instance studied. Answer: D 38) 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, A) the growth rate of the money supply decreased before output decreased. B) interest rates decreased before output decreased. C) the growth rate of federal government spending decreased before output decreased. D) the growth rate of state and local government spending decreased before output decreased. Answer: A 39) Timing evidence is valid only if it is known that the first event is A) endogenous. B) exogenous. C) a leading indicator of the second event. D) a lagging indicator of the second event. Answer: B 40) Because ________ evidence is of a ________ nature, there is always the possibility of reverse causation, in which output growth causes money growth. A) historical; structural B) statistical; structural C) timing; structural D) timing; reduced-form Answer: D 41) If the movements of the level of the money supply and real output are perfectly coordinated the growth rate of money A) will lead the level of real output. B) will move in synchronization with the level of real output. C) will lag the level of real output. D) can either lead or lag the level of real output. Answer: A 42) The monetarist statistical evidence examines the correlations between both ________ and ________ with ________. A) money; aggregate spending; the unemployment rate B) money; autonomous expenditures; the unemployment rate C) money; consumption spending; aggregate spending D) money; autonomous expenditures; aggregate spending Answer: D 43) A criticism of the monetarist autonomous spending variable is that A) some types of autonomous spending do not affect aggregate demand. B) some types of autonomous spending affect aggregate demand before the spending occurs. Some types of autonomous spending affect aggregate demand when they occur. C) some types of autonomous spending affect aggregate demand only long after they occur. D) Keynesians do not think that autonomous spending affects aggregate demand. Answer: B 44) One of the best examples of an episode in which a change in monetary policy appears to have been an exogenous event is the ________ in reserve requirements in ________. A) increase; 1936-1937 B) decrease; 1936-1937 C) decrease; 1818-1819 D) increase; 1818-1819 Answer: A 45) The monetarist position on the importance of monetary policy is probably best supported by ________ evidence. A) timing B) statistical C) historical D) structural Answer: C 46) The monetarist ________ evidence in which declines in money growth are followed by recessions provides the strongest support for their position that monetary policy matters. A) statistical B) historical C) timing D) structural Answer: B 47) As a result of recent empirical research, there has been a convergence of Keynesian and monetarist opinion to the view that A) money is all that matters. B) money does matter. C) money does not matter. D) fiscal policy is all that matters. Answer: B 48) Real business cycle theorists are critical of monetarist reduced-form evidence because they believe A) money is the most important cause of changes in aggregate demand. B) there is reverse causation from the business cycle to money. C) there is reverse causation from money to the business cycle. D) business cycles do not exist. Answer: B 49) Real business cycle theory states that the most important cause of business cycles is A) shocks to the money supply. B) interest rate shocks. C) Federal Reserve policy decisions. D) shocks to tastes and technology. Answer: D 23.2 Transmission Mechanism of Monetary Policy 1) Economic theory suggests that ________ interest rates are ________ important than ________ interest rates in explaining investment behavior. A) nominal; more; real B) real; less; nominal C) real; more; nominal 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 A) business fixed investment. B) government expenditure. C) consumer nondurables. 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 A) traditional interest-rate channel. B) Tobins' q theory. C) wealth effects. D) cash flow channel. Answer: A 4) If the aggregate price level adjusts slowly over time, then an expansionary monetary policy lowers A) only the short-term nominal interest rate. B) only the short-term real interest rate. C) both the short-term nominal and real interest rates. 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. A) asset; labor B) asset; credit C) commodity; labor D) commodity; credit Answer: B 6) An expansionary monetary policy lowers the real interest rate, causing the domestic currency to ________, thereby ________ net exports. A) appreciate; raising B) appreciate; lowering C) depreciate; raising D) depreciate; lowering Answer: C 7) An expansionary monetary policy increases net exports by ________ interest rates and ________ the value of the dollar. A) lowering nominal; decreasing B) lowering real; decreasing C) raising nominal; increasing D) raising real; increasing Answer: B 8) A contractionary monetary policy raises the real interest rate, causing the domestic currency to ________, thereby ________ net exports. A) appreciate; raising B) appreciate; lowering C) depreciate; raising D) depreciate; lowering Answer: B 9) A contractionary monetary policy decreases net exports by ________ interest rates and ________ the value of the dollar. A) lowering real; decreasing B) lowering real; increasing C) raising nominal; increasing D) raising real; increasing Answer: D 10) Tobin's q is defined as the market value of firms ________ the replacement cost of capital. A) times B) minus C) plus D) divided by Answer: D 11) Tobin's q theory suggests that monetary policy may affect investment spending through its impact on A) stock prices. B) interest rates. C) bond prices. 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. A) increased; underinvestment B) increased; overinvestment C) decreased; underinvestment D) decreased; overinvestment Answer: B 13) During the Great Depression, Tobin's q A) rose dramatically, as did real interest rates. B) fell to unprecedentedly low levels. C) stayed fairly constant, in contrast to most other economic measures. 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. A) fiscal; consumption B) fiscal; investment C) monetary; consumption 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. A) low; low B) low; high C) high; low 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. A) high; dear; large B) high; cheap; large C) high; cheap; small D) low; cheap; large 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 ________. A) cheap; low B) dear ; low C) cheap; high 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 ________. A) cheap; low B) dear ; low C) cheap; high D) dear; high Answer: D 19) Franco Modigliani has found that an expansionary monetary policy can cause stock market prices to ________ and consumption to ________. A) increase; increase B) increase; decrease C) decrease; decrease 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. A) balance sheet B) bank lending C) cash flow 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. A) raises; higher B) raises; lower C) reduces; higher 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. A) decline; increases; encouraging B) rise; increases; discouraging C) rise; reduces; encouraging 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 A) raises stock prices, lowering the cost of new capital relative to firms' market value, thus increasing investment spending. B) raises firms' net worth, decreasing adverse selection and moral hazard problems, thus increasing banks' willingness to lend to finance investment spending. 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. 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. A) lowering real B) lowering nominal C) raising real 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 A) the bank lending channel. B) Tobin's q. C) the traditional interest-rate channel. 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 A) the household liquidity effect. B) the wealth effect. C) Tobin's q theory. 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 ________. A) decline; rise B) rise; rise C) rise; fall D) decline; fall Answer: B 28) According to the household liquidity effect, higher stock prices lead to increased consumption expenditures because consumers A) feel more secure about their financial position. B) want to sell stocks and spend the proceeds before stock prices fall. C) believe that their wages will increase due to increased profitability of firms. D) can now afford more expensive imports. Answer: A 29) Corporate scandals involving Enron and Arthur Andersen reduced investment and aggregate spending because these scandals A) forced the Fed to raise interest rates. B) caused appreciation of the dollar. C) worsened adverse selection and moral hazard. D) caused bank failures. Answer: C 30) In a period of deflation, when there is a declining price level, ________ nominal interest rates do not necessarily indicate that the cost of borrowing is ________ or that monetary policy is easy. A) low; low B) low; high C) high; low D) high; high Answer: A 31) In a period of deflation, when there is a declining price level, low nominal interest rates do not necessarily indicate that the cost of borrowing is ________ or that monetary policy is ________. A) low; tight B) low; easy C) high; tight D) high; easy Answer: B 32) The subprime financial crisis caused a recession because of the ________ in adverse selection and moral hazard problems and the ________ in housing prices. A) increase; increase B) increase; decrease C) decrease; increase D) decrease; decrease Answer: B 33) 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. 34) 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. 35) 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. 23.3 Lessons for Monetary Policy 1) Analysis of the transmission mechanisms of monetary policy provides four basic lessons for a central bank's conduct of monetary policy. These lessons include: A) Rising interest rates indicate a tightening of monetary policy, whereas falling interest rates indicate an easing of monetary policy. B) Monetary policy can be highly effective in reviving a weak economy even if short-term interest rates are already near zero. 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. 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 2) 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? A) Rising interest rates indicate a tightening of monetary policy, whereas falling interest rates indicate an easing of monetary policy. B) Monetary policy can be highly effective in reviving a weak economy even if short-term interest rates are already near zero. 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. 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 3) In the late 1990s and early 2000s, the Japanese economy has experienced A) easy monetary policy as indicated by falling nominal interest rates. B) easy monetary policy as indicated by short-term interest rates near zero. C) tight monetary policy as indicated by falling asset prices. D) tight monetary policy as indicated by short-term interest rates near zero. Answer: C 4) Recent Japanese experience has been characterized by tight monetary policy, as indicated by A) falling interest rates. B) short-term interest rates near zero. C) falling asset prices. D) low real interest rates. Answer: C Test Bank for The Economics of Money, Banking and Financial Markets Frederic S. Mishkin 9780321599797, 9780134734200, 9780133836790, 9780134734606, 9780134733821