CH 14

ch14
Student: ___________________________________________________________________________
1. In the AS/AD model, an increase in the money supply causes an increase in the interest rate and an increase
in investment spending.
True False
2. A contractionary monetary policy decreases the money supply and the interest rate, which decreases
investment and output.
True False
3. The Fed's duties include acting as a lender of last resort and supervising or regulating a variety of financial
institutions.
True False
4. The three tools of monetary policy are open market operations, setting prices, and setting the velocity of
money.
True False
5. An increase in the federal funds rate is a signal that the Fed wants a tighter monetary policy.
True False
6. The Federal funds rate is the rate banks charge one another for overnight loans.
True False
7. A decrease in the Federal funds rate is an indication that monetary policy is expansionary.
True False
8. The Taylor Rule relates changes in the money supply to changes in interest rates.
True False
9. The art of monetary policy is acting in accordance with the Taylor Rule.
True False
10. According to the Taylor Rule, if current inflation is 2.5 percent, the target inflation rate is 2 percent, and
output is 1 percent above potential, the Fed will target the Federal funds rate at 5.25 percent.
True False
11. The Fed targets the interest rate by adjusting the money demand so that its targeted interest rate will
equalize the supply and demand for money.
True False
12. The difference between a standard and an inverted yield curve is that when the yield curve is inverted, the
longer term bond pays a lower interest rate than a short-term bond.
True False
13. The Federal Reserve has control over the long term interest rate.
True False
14. It would be practical for the Fed to buy bonds even when the Fed funds rate is zero.
True False
15. Who determines U.S. monetary policy?
A. Congress.
B. The President.
C. The Internal Revenue Service.
D. The Federal Reserve.
16. Monetary policy is one of the two main macroeconomic tools governments use to control the aggregate
economy, the other being:
A. fiscal policy.
B. foreign policy.
C. trade policy.
D. immigration policy.
17. Which of the following is not directly affected by monetary policy?
A. The money supply.

B. The banking system.
C. The availability of credit.
D. The budget deficit.
18. Monetary policy directly affects:
A. social spending.
B. tax rates.
C. the availability of credit.
D. the antitrust laws.
19. Expansionary monetary policy is always expected to increase:
A. nominal income but never real income.

B. real income but never nominal income.
C. nominal income.
D. real income.
20. A monetary policy that reduces both real and nominal income:
A. must be expansionary.
B. must be contractionary.
C. cannot be expansionary or contractionary.
D. could be expansionary or contractionary.
21. Monetary policy affects:
A. only inflation.
B. only output.
C. both inflation and output.
D. neither inflation nor output.
22. Assuming an economy is initially at potential output, an expansionary monetary policy will:
A. not affect output in the long run.

B. not affect output in either the short run or the long run.
C. affect output, but only in the long run.
D. affect output in both the short run and the long run.
23. If the SAS curve is upward sloping but not vertical, monetary policy that affects nominal income but not
real income must result in the shift of:
A. both the AD and SAS curves.

B. only the AD curve.
C. only the SAS curve.
D. neither the SAS curve nor the AD curve.
24. An expansionary monetary policy that affects the price level but not real output must result in the shift of:

25. In the AS/AD model, an expansionary monetary policy has the greatest effect on the price level when it:
A. increases both nominal and real income.

B. increases real income but not nominal income.
C. increases nominal income but not real income.
D. doesn't increase real or nominal income.
26. If prices are inflexible, monetary policy:
A. affects both inflation and output.

B. affects output but not inflation.
C. affects inflation but not output.
D. doesn't affect output or inflation.
27. If nominal income increases by 3 percent and real income increases by 4 percent, the price level must:
A. increase by 7 percent.
B. increase by 1 percent.
C. decrease by 1 percent.
D. decrease by 7 percent.
28. If nominal income increases by 4 percent and the price level increases by 3 percent, real income must:
29. If real income increases by 4 percent and the price level increases by 3 percent, nominal income must:
30. Refer to the graph above. Monetary policy that shifts the AD curve from AD0 to AD2 is
A. expansionary.
B. contractionary.
C. neither expansionary nor contractionary since it does not affect output.
D. neither expansionary nor contractionary since it does not affect inflation.
31. Refer to the graph above. Monetary policy that shifts the AD curve from AD0 to AD1 and moves the
economy from A to B:
A. increases nominal output but not real output in the short run.
B. increases both real and nominal output in the short run.
C. increases real output but not nominal output in the short run.
D. doesn't increase real or nominal output in the short run.
32. Refer to the graph above. Suppose the economy is initially at O but then the Fed adopts an expansionary
monetary policy. The immediate effect of this policy will be to move the economy to:
A. A.
B. B.
C. C.
D. D.
33. Refer to the graph above. Suppose the economy is initially at O but then the Fed adopts a contractionary
monetary policy. The long term effect of this policy will be to move the economy to:
A. A.
B. B.
C. C.
D. D.
monetary policy. This policy will cause the economy to move to:
A. A in the short run and the long run.

B. B in the short run and the long run.
C. A in the short run and C in the long run.
D. B in the short run and D in the long run.
35. In the AS/AD model, a contractionary monetary policy:
A. reduces investment but increases aggregate demand.

B. increases both investment and aggregate demand.
C. reduces both investment and aggregate demand.
D. increases investment but reduces aggregate demand.
36. If a contractionary monetary policy reduces nominal income but not real income, it must be true that prices:
A. are perfectly flexible.

B. are at least partially flexible.
C. are completely inflexible.
D. have not fully adjusted to the change in aggregate demand.
A. affects both nominal and real income.

B. affects real income but not nominal income.
C. affects nominal income but not real income.
D. doesn't affect real or nominal income.
38. Central banks are responsible for:
A. both monetary policy and fiscal policy.

B. monetary policy but not fiscal policy.
C. fiscal policy but not monetary policy.
D. neither monetary policy nor fiscal policy.
39. An effect of an expansionary monetary policy is to:
A. reduce investment spending.

B. shift the aggregate demand curve to the left.
C. raise interest rates.
D. lower interest rates.
40. The effect of an expansionary monetary policy results in a shift of the aggregate demand to the right. The
effect of the monetary policy on the aggregate demand is:
A. direct from the money supply to the aggregate demand.

B. indirect through the short-term and long-term interest rates.
C. direct from the money supply to the aggregate supply.
D. indirect through the government expenditures.
41. Refer to the graph above. When the Fed conducts an expansionary monetary policy, it:
A. shifts the money supply from M0 to M1.

B. shifts the money supply from M0 to M2.
C. neither the money supply nor money demand shifts.
D. shifts money demand from D0 to D1.
42. Refer to the graph above. An economy is initially at M0 and the Fed conducts an expansionary monetary
policy. This is represented by a movement from:
A. A to C.
B. A to B.
C. C to D.
D. D to A.
43. Refer to the graph above. An example of the Fed conducting a contractionary monetary policy is shown by
a change in interest rates from:
A. i0 to i1.
B. i0 to i2.
C. i2 to i1.
D. i2 to i0.
44. The central bank in the U.S. does all the following except:
A. act as a financial adviser to the government.

B. loan money to corporations.
C. loan money to banks.
D. issue coin and currency.
45. Congress has the power to do all of the following to the Fed except:
A. reduce the Fed's budget.

B. confirm the president's nominee to the Chair of the Federal Reserve.
C. confirm the president's nominee to the Board of Governors.
D. audit Federal Reserve District banks.
46. Unlike the practice in many other countries, in the United States:
A. only monetary policy is used to influence the economy, and fiscal policy is not allowed.
B. only fiscal policy is used to influence the economy, and monetary policy is not allowed.
C. the agency responsible for monetary policy is not directly controlled by the government.
D. the agency responsible for fiscal policy is not directly controlled by the government.
47. When Ben Bernanke steps down as chairman of the Federal Reserve's Board of Governors, his successor
will be:
A. elected by the public.

B. selected by commercial banks.
C. appointed by the President.
D. appointed by the Board of Governors.
48. In the fall of 2008 the Federal Reserve lowered its target for the Federal funds rate to close to 0 percent.
What is the name of the group within the Federal Reserve that made this decision?
A. Federal Advisory Committee.

B. Federal Deposit Insurance Corporation.
C. Federal Funds Operating Group.
D. Federal Open Market Committee
49. Which is not a function of the Fed?
A. Conducting monetary policy.

B. Serving as a lender of last resort.
C. Providing financial services such as check clearing to commercial banks.
D. Financing U.S. budget deficits.
50. How many regional banks are in the Federal Reserve System?
A. 6.
B. 8.
C. 12.
D. 15.
51. When there are no vacancies, how many people serve on the Board of Governors of the Federal Reserve
System?
A. 5.
B. 7.
C. 11.
D. 12.
52. The body that oversees the 12 regional Federal Banks is the:
A. Federal Open Market Committee.

B. Board of Governors.
C. U.S. Congress.
D. Federal Advisory Council.
53. The group that is comprised of 5 Presidents of Fed regional banks and 7 Fed governors that gathers around
a table to discuss whether to increase interest rates is the:

B. Federal Depository Insurance Corporation.
C. Federal Advisory Council.
D. National Federal Reserve Bank.
54. The explicit functions given to the Fed by the Congress include all of the following except:
A. regulating financial institutions.

B. serving as a lender of last resort to financial institutions.
C. providing banking services to the U.S. government.
D. holding the nominal interest rate no more than 2 percent above the real interest rate.
55. Most decisions about monetary policy are made by:
A. the Chairman of the Fed only.

B. the President.
C. the President and Congress.
D. the Federal Open Market Committee.
56. All of the following are components of the Federal Reserve System except the:
A. twelve regional Federal Reserve banks.

B. Federal Open Market Committee.
C. Federal Deposit Insurance Corporation.
D. Board of Governors.
57. Which of the following is not something the Fed can change directly?
A. The reserve requirement.

B. The discount rate.
C. Open market operations.
D. The prime rate.
58. Which is NOT something the Fed can do to conduct monetary policy?
A. Change the exchange rate.

B. Change the reserve requirement.
C. Change the discount rate.
D. Execute open market operations.
59. The monetary base includes:
A. currency and coin in circulation plus checkable deposits.

B. currency and coin in circulation only.
C. vault cash plus checkable deposits.
D. currency and cash plus commercial bank deposits at the Fed.
60. The monetary base is comprised of:
A. currency held by the public.

B. vault cash.
C. commercial bank deposits at the Fed.
D. all of the options listed here.
61. The reserve requirement is the:
A. maximum ratio of reserves to deposits that a bank can have.

B. minimum ratio of reserves to deposits that a bank can have.
C. maximum level of reserves a bank can have.
D. minimum level of reserves a bank can have.
62. By law, a commercial bank is allowed to lend out all its:
A. deposits.
B. excess reserves.
C. required reserves.
D. demand (checkable) deposits.
63. The Federal Open Market Committee:
A. makes decisions that influence the amount of excess reserves available to banks.
B. reports directly to Congress.
C. makes decisions that influence the nation's fiscal policy.
D. determines who may buy and sell government bonds.
64. One of the duties of the Fed is to:
A. change the demand for money.

B. define the market interest rate.
C. offer financial advising to the government.
D. offer financial advising to the public.
65. Fed watchers are:
A. financial advisers for the government, telling them when raising taxes will raise revenue and when it
won't.
B. part of the Fed governor system and are given voting power on the FOMC.
C. individuals or organizations whose sole occupation is to follow the Fed's FOMC.
D. individuals or organizations whose sole occupation is to predict the future of the interest rates.
66. The reserve requirement for large banks on customer deposits in checking accounts is around:
A. 2 percent.
B. 5 percent.
C. 10 percent.
D. 15 percent.
67. Although rarely used, which of the following is an instrument the Fed has to conduct monetary policy?
A. The corporate income tax.

B. The tax on unearned income.
C. The discount rate.
D. The interest rate on Treasury bonds.
68. To decrease the nation's money supply, the Fed can:
A. increase reserve requirements.

B. decrease reserve requirements.
C. decrease the discount rate.
D. buy government securities in the open market.
69. When the Fed increases the reserve requirement, it:
A. expands the money supply because banks have more to lend.

B. expands the money supply because banks have less to lend.
C. contracts the money supply because banks have more to lend.
D. contracts the money supply because banks have less to lend.
70. If the Federal Reserve reduced its reserve requirement from 6.5 percent to 5 percent. This policy would
most likely:
A. increase both the money multiplier and the money supply.

B. increase the money multiplier but decrease the money supply.
C. decrease the money multiplier but increase the money supply.
D. decrease both the money multiplier and the money supply.
71. When the Fed decreases the reserve requirement, the money supply:
A. expands and the money multiplier contracts.

B. expands and so does the money multiplier.
C. contracts and so does the money multiplier.
D. contracts and the money multiplier expands.
72. If the Fed increases the required reserves, financial institutions will likely lend out:
A. more than before, increasing the money supply.

B. less than before, decreasing the money supply.
C. more than before, decreasing the money supply.
D. less than before, increasing the money supply.
73. If the Fed decreases the reserve requirement, it:
A. decreases the amount of excess reserves and this eventually increases the money supply.
B. decreases the amount of excess reserves and this eventually decreases the money supply.
C. increases the amount of excess reserves and this eventually increases the money supply.
D. increases the amount of excess reserves and this eventually decreases the money supply.
74. Suppose the reserve requirement is 20% and there are no cash holdings or excess reserves. A $1 billion
purchase of government securities by the Fed will:
A. increase the potential amount of checkable deposits in the banking system by $5 billion.
B. increase the potential amount of checkable deposits in the banking system by $1 billion.
C. reduce the potential amount of checkable deposits in the banking system by $1 billion.
D. reduce the potential amount of checkable deposits in the banking system by $5 billion.
75. Suppose the reserve requirement is 20 percent and there are no cash holdings or excess reserves. A $1
billion sale of government securities by the Fed will:
A. increase checkable deposits in the banking system by $5 billion.

B. increase checkable deposits in the banking system by $1 billion.
C. reduce checkable deposits in the banking system by $1 billion.
D. reduce checkable deposits in the banking system by $5 billion.
76. If the reserve requirement is 0.1 and the ratio of money people hold as cash relative to deposits is 0.2, the
money multiplier will be:
A. 2.
B. 3.
C. 4.
D. 5.
77. If the cash-to-deposit ratio is 0.1 and the money multiplier is 2.5, the reserve requirement is:
A. 0.14.
B. 0.24.
C. 0.34.
D. 0.44.
78. Assuming that r = .05 and c = .25, the money multiplier is:
A. 4.07.
B. 4.17.
C. 4.27.
D. 4.37.
79. Assuming that r = .05 and c = .25, if reserves fall by 100, the money supply will decline by:
A. 400.
B. 407.
C. 417.
D. 427.
80. Assuming that r = .05 and c = .2, how much would reserves need to be increased to increase the money
supply by 500?
A. 25.17.
B. 100.17.
C. 104.17.
D. 204.17.
81. Which of the following is an example of a direct expansionary monetary policy action?
A. Raising the discount rate.

B. Lowering the prime rate.
C. Selling bonds.
D. Reducing the reserve requirement.
82. The discount rate is the interest rate:
A. commercial banks charge their largest customers.

B. the Fed charges on loans to individuals.
C. the Fed charges on loans to commercial banks.
D. the interest rate commercial banks charge one another for overnight loans.
83. To increase the nation's money supply, the Fed can:
A. increase the required reserve ratio.

B. decrease the discount rate.
C. increase the discount rate.
D. sell bonds.
84. When the Fed reduces the discount rate, this sends a signal to banks that the Fed wants:
A. the money supply to expand.

B. the money supply to contract.
C. the Federal funds rate to increase.
D. to reduce the reserve requirement.
85. When the Fed lowered the discount rate in late 2008 the action was ultimately designed to:
A. increase the money supply.

B. increase the prime rate.
C. decrease the monetary base.
D. increase the reserve requirement.
86. Suppose the approximate money multiplier in the U.S. is 3. Suppose further that if the Fed changes the
discount rate by 1 percentage point, banks change their reserves by 400. To reduce the money supply by
4200 the Fed should:
A. reduce the discount rate by 10.5 percentage points.

B. raise the discount rate by 10.5 percentage points.
C. reduce the discount rate by 3.5 percentage points.
D. raise the discount rate by 3.5 percentage points.
87. Suppose the money multiplier in the U.S. is 3. Suppose further that if the Fed changes the discount rate
by 1 percentage point, banks change their reserves by 300. To increase the money supply by 2700 the Fed
should:
A. reduce the discount rate by 3 percentage points.

B. reduce the discount rate by 10 percentage points.
C. raise the discount rate by 3 percentage points.
D. raise the discount rate by 10 percentage points.
88. The primary tool of monetary policy is:
A. the discount rate.

B. the reserve requirement.
C. the prime rate.
D. open market operations.
89. Open market operations are related to:
A. actions taken by the Fed to close or merge weakened banks.

B. changes in the reserve requirement.
C. changes in the discount rate.
D. the Fed's buying and selling of government securities.
90. Which of the following Fed actions increases the money supply?
A. Decreasing the amount of loans made to commercial banks.

B. Buying government securities in the open market.
C. Selling government securities in the open market.
D. Increasing reserve requirements.
91. Suppose the money multiplier in the U.S. is 2.5. If the Fed wants to reduce the money supply by 1000 it
should:
A. buy government securities worth 250.

B. buy government securities worth 400.
C. sell government securities worth 250.
D. sell government securities worth 400.
92. Suppose the money multiplier in the U.S. is 2.5. If the Fed wants to reduce the money supply by 1,500 it
should:
A. raise the required reserve ratio to 0.2.

B. raise the discount rate by 2 percentage points.
C. buy government securities worth 600.
93. Suppose the money multiplier in the U.S. is 4. If the Fed wants to expand the money supply by 600 it
should:

A. decrease the reserve requirement.

D. buy bonds.
95. Federal Reserve sales of government securities:
A. increase bank reserves and increase the money supply.

B. decrease bank reserves and decrease the money supply.
C. decrease bank reserves and increase the money supply.
D. increase bank reserves and decrease the money supply.
96. Which of the following Fed policies would help the economy out of a recession?
A. Open market purchases of government securities.

B. Open market sales of government securities.
C. An increase in the discount rate.
D. An increase in reserve requirements.
97. If the Fed simultaneously raises the discount rate and the reserve requirement, the money supply will:
A. contract.
B. remain unchanged.
C. expand.
D. take on a value that cannot be determined from the information given.
98. If the Fed simultaneously lowers the reserve requirement and sells government bonds, the money supply
will:
A. contract.
C. expand.
D. move in a way that cannot be determined from the information given.
99. If the Fed simultaneously reduces the discount rate and the required reserve ratio, the money supply will:
A. contract.
C. expand.
100.Banks can borrow reserves from each other through:
A. the Fed funds market.

B. the Federal Open Market Committee.
C. open market purchases.
D. secondary reserves.
101.The Federal funds rate:
A. is always slightly higher than the discount rate.

B. can never be close to zero.
C. may sometimes have to be targeted at zero.
D. is an intermediate target.
102.When the Fed sells bonds, the:
A. Federal funds rate increases.

B. reserve requirement falls.
C. discount rate increases.
D. discount rate decreases.
103.If the level of excess reserves in the banking system drops suddenly, we might expect that the:
A. discount rate would rise.

B. Federal funds rate would rise.
C. required reserve ratio would fall.
D. prime rate would fall.
104.When the Fed targets a higher interest rate, this change in policy involves open market:
A. purchases of government securities that reduced reserves.

B. purchases of government securities that increased reserves.
C. sales of government securities that reduced reserves.
D. sales of government securities that increased reserves.
105.Who buys and sells in the Fed funds market?
A. Only commercial banks and depository institutions.

B. All large financial institutions.
C. Financial institutions and large corporations.
D. Anyone with a computer and an Internet connection can participate.
106.What tool of monetary policy will the Fed use to increase the Federal funds rate from 1% to 1.25%?
A. Open-market operations.
C. A change in reserve requirements.
D. Margin requirements.
107.The interest rate banks charge each other to borrow excess reserves is called the:
A. discount rate.
B. required reserve ratio.
C. prime rate.
D. Federal funds rate.
108.The Fed announces what it is doing with monetary policy in terms of a target for:
A. discount rate.
B. reserve requirement.
C. Federal funds rate.
D. monetary base.
109.An increase in the Federal funds rate could be caused by:
A. an open market purchase of government securities.

B. an increase in the reserve requirement.
C. a cut in the discount rate.
D. an increase in the excess reserves of the banking system.
110.A reduction in the Federal funds rate could be caused by an:
A. open market sale of government securities.

B. increase in the reserve requirement.
C. increase in the discount rate.
D. increase in the excess reserves of the banking system.
111.A reduction in the Federal funds rate could be caused by:
A. lower than expected bank deposits.

B. higher than expected bank reserves.
C. higher than expected loan demand.
D. higher than expected withdrawals.
112.An increase in the Federal funds rate could be caused by:
A. higher than expected bank deposits.

C. lower than expected loan demand.
113.If the Fed funds rate is above the Fed's target range the Fed should:
A. follow expansionary policy.

B. follow contractionary policy.
C. print money.
D. do nothing.
114.If the Fed funds rate is below the Fed's target range the Fed should:

C. print money.
D. do nothing.
115.Suppose the Fed funds rate is above the Fed's target range. The Fed will:
A. buy bonds.
B. sell bonds.
C. increase the reserve requirement.
D. increase the discount rate.
116.Suppose the Fed funds rate is below the Fed's target range. The Fed could:
A. buy bonds.
B. reduce the reserve requirement.
D. cut the discount rate.
117.If the Fed wants a tighter monetary policy, it might:
A. sell government securities to increase the Federal funds rate.

B. sell government securities to reduce the Federal funds rate.
C. buy government securities to increase the Federal funds rate.
D. buy government securities to reduce the Federal funds rate.
118.If the Fed wants an easier monetary policy, it might:

119.When the Fed took action in late 2008 to significantly decrease the Federal funds rate, these operations are
best considered as:
A. offensive actions.
B. defensive actions.
C. both offensive and defensive actions.
D. neither offensive nor defensive actions.
120.When the Fed raised interest rates between 2004 and 2007, the Federal Reserve:
A. bought U.S. government securities, thereby creating and supplying additional Federal funds.
B. sold U.S. government securities, thereby contracting funds to the Federal funds market.
C. speeded up the clearing of checks to make more funds available to banks.
D. encouraged banks to loan out funds to ease their reserve requirements and thus lower the demand for
Federal funds.
121.The defensive and offensive actions of the Fed differ because offensive actions are designed to:
A. tighten monetary policy and defensive actions are designed to ease monetary policy.
B. ease monetary policy and defensive actions are designed to tighten monetary policy.
C. change the current monetary policy while defensive actions are designed to reinforce the current
monetary policy.
D. reinforce the current monetary policy while defensive actions are designed to change the current
monetary policy.
122.If individuals suddenly increase their withdrawals from the banking system, the Federal funds rate should:
A. increase as bank reserves decline.

B. decrease as bank reserves decline.
C. increase as bank reserves increase.
D. decrease as bank reserves increase.
123.If the demand for bank loans suddenly declines, a defensive action on the part of the Fed to keep the Fed
funds rate constant would take the form of open market bond:
A. sales that would prevent the Fed funds rate from increasing.
B. sales that would prevent the Fed funds rate from decreasing.
C. purchases that would prevent the Fed funds rate from increasing.
D. purchases that would prevent the Fed funds rate from decreasing.
124.If the Fed funds rate rises above the Fed's target range, the Fed should take:
A. a defensive action and sell government bonds.

B. a defensive action and buy government bonds.
C. an offensive action and sell government bonds.
D. an offensive action and buy government bonds.
125.If the Fed funds rate falls below the Fed's target range, the Fed should take:

126.Suppose the Federal funds rate is 5 percent. If the Fed decides to increase the target for the Federal funds
rate from 5 percent to 6 percent, it should take:
A. a defensive action and raise reserve requirements.

B. a defensive action and reduce reserve requirements.
C. an offensive action and raise reserve requirements.
D. an offensive action and reduce reserve requirements.
127.Suppose the Federal funds rate is 5 percent. If the Fed decides to decrease the target for the Federal funds
rate from 5 percent to 4 percent, it should take:

128.Which of the following is an operating target for the Fed?
A. Sustainable growth.
B. The Federal funds rate.
C. Stable prices.
D. Stock prices.
129.Just prior to the year 2000, the Fed was concerned that people would make larger than normal bank
withdrawals out of fear of the Y2K computer bug. The Fed feared that this might disrupt the banking
system. The Fed wanted to use a defensive action to prevent any such disruption. This would take the form
of open market bond:
130.In 2008, the Fed followed an expansionary monetary policy, which was evident by the:
A. decrease in the Fed funds rate from 4 percent in January to .25 percent in December.
B. increase in the Fed funds rate from .25 percent in January to 4 percent in December.
C. decrease in the repo rate from 4 percent in January to .25 percent in December.
D. increase in the discount rate and decrease in the Fed fund rate by the same percentage points.
131.The Fed funds rate increased from 2.5 percent in February 2005 to 5.26 in February 2007. This change in
the Fed funds rate clearly indicates that during this period the Fed followed a(n):
A. expansionary fiscal policy.

B. contractionary fiscal policy.
C. expansionary monetary policy.
D. contractionary monetary policy.
132.When the Fed sells bonds, the Fed:
A. reduces the reserves and the Federal funds rate increases.

B. increases the reserves and the Federal funds rate decreases.
C. reduces the reserves and the Federal funds rate decreases.
D. increases the reserves and the Federal funds rate increases.
133.When the Fed purchases bonds, the Fed:

134.Which of the following is a Fed tool?
A. Interest rate spreads.

B. Discount rate.
C. Stock prices.
D. Fed funds rate.
135.Which of the following is an intermediate target?
A. Consumer confidence.
B. Sustainable growth.
C. Open market operation.
D. Fed funds rate.
136.The predictions of Fed behavior provided by the Taylor rule are:
A. never accurate.
B. seldom accurate.
C. reasonably accurate.
D. extremely accurate.
137.If inflation is one percentage point above the Fed's target, the Taylor rule predicts that the Fed will:
A. raise the Federal funds rate by 0.5 percentage points.

B. raise the Federal funds rate by 1.0 percentage points.
C. raise the Federal funds rate by 1.5 percentage points.
D. reduce the Federal funds rate by 1 percentage point.
138.If output falls one percentage point below its potential, the Taylor rule predicts that the Fed will:
A. reduce the Federal funds rate by 0.5 percentage points.

B. reduce the Federal funds rate by 1.0 percentage points.
C. reduce the Federal funds rate by 1.5 percentage points.
D. raise the Federal funds rate by 1 percentage point.
139.Suppose the Federal funds rate rises by 0.5 percent. If the Taylor rule is correct, this might be because
output is:
A. 1 percentage point below potential output.

B. 0.5 percentage points below potential output.
C. 0.5 percentage points above potential output.
D. 1 percentage point above potential output.
140.At the end of 2007, the Fed funds rate was at its target, 2 percent, output was about 1 percent beneath
potential, and inflation was roughly 1.5 percent. If the Taylor rule is accurate, the Fed's desired rate of
inflation at this time was:
A. 1 percent.
B. 2.5 percent.
C. 3.5 percent.
D. 5 percent.
141.Using the Taylor rule, if inflation is 3 percent, desired inflation is 2 percent, and output is 2 percentage
points above potential, the Fed will target a Fed funds rate of:
A. 6.5.
B. 4.5.
C. 3.5.
D. 3.
A. 6.5.
B. 4.5.
C. 3.5.
D. 3.
points below potential, the Fed will target a Fed funds rate of:
A. 6.5.
B. 4.5.
C. 3.5.
D. 3.
A. 6.5.
B. 4.5.
C. 2.5.
D. 1.5.
145.During 2007, the Fed funds rate was at its target 3.5 percent, inflation was 1.5 percent, and target inflation
was 2.5 percent. If the Taylor rule is accurate, the output was:
A. 1 percent below potential.

B. 1 percent above potential.
C. 1.5 percent below potential.
D. 1.5 percent above potential.
146.The Federal Reserve kept interest rates low between 2002 and 2006 because:
A. they wanted to reduce the value of the dollar and help domestic exporters.
B. they were worried about inflation creeping into the economy.
C. they wanted to avoid deflation and the resulting recession.
D. they wanted to follow the Taylor Rule.
147.Between 2002 and 2006 the Federal Reserve:
A. raised rates in order to follow the Taylor Rule.

B. left rates unchanged in order to follow the Taylor Rule.
C. lowered rates and went against the Taylor Rule.
D. abandoned the Taylor Rule in favor of the Greenspan Rule.
148.The Taylor Rule:
A. determines who receives Fed funds.

B. determines the Fed funds rate.
C. is fairly successful in describing Fed policy.
D. is one of the Fed's monetary policy tools.
149.Some experts have argued that the Fed contributed to the housing bubble by:
A. allowing banks to invest in high-risk assets, even though there was a risk of them defaulting.
B. lowering interest rates, despite the fact that the Taylor rule indicated keeping them high.
C. not regulating non bank financial institutions who were coming up with innovative mortgages.
D. following the Taylor Rule, which during the 2000s indicated that rates should be kept low.
150.Which of the following monetary policies reduces aggregate demand and output?
A. A cut in the Fed funds rate.

B. An open market sale of government securities.
C. A cut in the discount rate.
D. A cut in the reserve requirement.
151.Which of the following monetary policies raises aggregate demand and output?
A. An open market sale of government securities.

B. An increase in the Fed funds rate.
152.Which of the following monetary policies reduces aggregate demand and output?

B. An open market purchase of government securities.
D. A cut in the required reserve ratio.
153.In the fall of 2008, the Federal Reserve reduced its target for the Federal funds rate dramatically. The Fed
likely made this decision because it believed:
A. savers are not being given enough encouragement to save.

B. unemployment was too low and needed to be boosted.
C. inflation might become a problem and was moving to head it off.
D. there was threat of a recession and was trying to stimulate the economy.
154.During the latter half of 2004 and the beginning of 2007, the Fed adopted a policy that consistently
increased the Federal funds rate. The most likely goal of this policy was to:
A. decrease inflation by decreasing aggregate demand.

B. decrease inflation by increasing aggregate demand.
C. increase output by decreasing aggregate demand.
D. increase output by increasing aggregate demand.
155.Suppose that investment is not very responsive to interest rates, so that a sizable increase in interest rates
has only a minor effect on investment. In this case, monetary policy would have:
A. no effect on output.
B. a modest effect on output at best.
C. a substantial effect on output.
D. a massive effect on output.
156.Suppose that investment is very responsive to interest rates, so that even a small change in interest rates has
a substantial effect on investment. In this case, expansionary monetary policy that results in a modest drop
in interest rates will:
A. not increase output.

B. increase output only slightly.
C. increase output significantly.
D. decrease output sharply.
157.According to the AS/AD model, if the economy is in a recession and the Fed wants to increase output and
employment, it should:
A. act to increase the money supply.

B. act to decrease the money supply.
D. raise reserve requirements.
158.Other things equal, a rise in interest rates can be expected to:
A. increase the quantity of investment.

B. decrease the quantity of investment.
C. have no effect upon the quantity of investment.
D. increase equilibrium income.
159.Monetary policy that seeks to minimize the business cycle in the AS/AD model involves:
A. contractionary monetary policy throughout the business cycle.

B. expansionary monetary policy throughout the business cycle.
C. contractionary monetary policy during boom periods and expansionary monetary policy during
recession.
D. contractionary monetary policy during recession and expansionary monetary policy during boom
periods.
160.According to the AS/AD model, an expansionary monetary policy:
A. increases interest rates, raises investment, and increases income.

B. decreases interest rates, raises investment, and increases income.
C. increases interest rates, reduces investment, and decreases income.
D. decreases interest rates, reduces investment, and decreases income.
161.According to the AS/AD model, a contractionary monetary policy:

162.During a recession, policy makers who use the AS/AD model would probably recommend an open market:
A. sale of government securities that reduces interest rates.

B. purchase of government securities that reduces interest rates.
C. sale of government securities that raises interest rates.
D. purchase of government securities that raises interest rates.
163.During an inflationary period, policy makers who use the AS/AD model would probably recommend an
open market:

164.In the AS/AD model, higher interest rates are produced by:
A. an expansionary monetary policy.

B. an activist monetary policy.
C. a contractionary monetary policy.
D. a steady-as-you-go monetary policy.
165.One year the lead sentence in a Wall Street Journal article read, "Tight job markets, rising wages, and the
economy's continued strength put more pressure on the Federal Reserve to raise short-term interest rates."
If the Fed responded to this pressure, it would adopt:
A. a contractionary monetary policy that reduces output.

B. a contractionary monetary policy that raises output.
C. an expansionary monetary policy that reduces output.
D. an expansionary monetary policy that raises output.
166.The AS/AD model implies that monetary policy should be used to:
A. make adjustments so that savings equal investment.

B. keep the money supply growing at a constant rate.
C. keep the interest rate constant.
D. keep the price level constant.
167.According to the AS/AD model, a contractionary monetary policy is appropriate:
A. when saving is less than investment.

B. when saving is greater than investment.
C. when saving equals investment.
D. whatever the level of saving and investment.
168.According to the AS/AD model, a reduction in the money supply is appropriate:

169.If saving is less than investment, the appropriate countercyclical monetary policy would be:
A. a cut in the reserve requirement.

B. a cut in the discount rate.
C. an open market sale of government bonds.
D. a cut in the Fed funds rate.
170.If saving exceeds investment, the appropriate countercyclical monetary policy would be:
A. an increase in the reserve requirement.

D. an increase in the Fed funds rate.
171.If the actual Federal funds rate is 7 percent and the Fed's target Federal funds rate is 8 percent, the Fed is
most likely to adopt which of the following policies?
A. A sale of government bonds.

B. A purchase of government bonds.
C. A reduction in the reserve requirement.
D. A more expansionary monetary policy.
172.If the actual Federal funds rate is 9 percent and the Fed's target Federal funds rate is 8 percent, the Fed is

B. An increase in the discount rate.
D. A more contractionary monetary policy.
173.The effective supply curve of money is:
A. downward sloping because as interest rates rise, the Fed will not supply as much money at lower interest
rates.
B. upward sloping because as interest rates rise, the Fed is willing to increase the quantity of money
supplied.
C. vertical because the Fed adjusts the supply of money to changes in the demand for money at a targeted
interest rate.
D. horizontal because the Fed adjusts the supply of money to changes in the demand for money at a targeted
interest rate.
174.If the Fed is targeting an interest rate, creating an effective supply curve of money and the demand for
money increases the Fed will:

B. decrease the money supply.
C. raise the Fed funds rate to reduce money demand.
D. raise the Fed funds rate to increase money demand.
175.If the Fed is targeting an interest rate, creating an effective supply curve of money and the demand for
money decreases the Fed will:
A. sell government bonds.

B. buy government bonds.
C. set a higher Fed funds rate.
D. set a lower Fed funds rate.
176.The Fed targets the interest rate because it:
A. has poor control of the amount of money in the economy.

B. has no control of the money supply.
C. chooses to create an effective supply curve of money at the current interest rate.
D. chooses to create an effective supply curve of money at the target interest rate.
177.The curve most economists use to follow the relationship between the interest rates and bonds' time to
maturity is the:
A. effective supply of money curve.

B. aggregate demand curve.
C. yield curve.
D. demand of money curve.
178.Refer to the graph above. Which of the curves represents an inverted yield curve?
A. A
B. B
C. C
D. D
179.Refer to the graph above. Which of the curves represents a normal yield curve?
A. A
B. B
C. C
D. D
180.The standard discussion of monetary policy is based on the assumption that:
A. long-term rates will fall when the Fed pushes up short-term interest rates.
B. long-term rates will rise when the Fed pushes up short-term interest rates.
C. short-term rates will fall when the Fed pushes up long-term interest rates.
D. short-term rates will rise when the Fed pushes up long-term interest rates.
181.The standard discussion of monetary policy is based on the assumption that:
A. the entire yield curve shifts up when the Fed sells government bonds.
B. the entire yield curve shifts down when the Fed sells government bonds.
C. the yield curve becomes inverted when the Fed buys government bonds.
D. the yield curve becomes steeper when the Fed buys government bonds.
182.When an economy faces an inverted yield curve, compared to short-term bonds the long-term bonds:
A. are riskier.
B. pay lower interest rates.
C. pay higher interest rates.
D. are a safe investment.
183.Tools that the Fed uses to increase the money supply that are beyond the traditional tools are called:
A. contractionary tools.
B. fiscal tools.
C. quantitative easing tools.
D. qualitative easing tools.
184.Which of the following would not be considered an example of quantitative easing?
A. The Fed buys bonds from banks at a zero Fed funds rate.
B. The Fed buys mortgage backed securities.
C. The Fed buys money market funds.
D. The Fed sells bonds to banks.
185.Which of the following gives the correct relationship between nominal and real interest rates?
A. Real interest rate = nominal interest rate + expected inflation rate.

B. Nominal interest rate = real interest rate + expected inflation rate.
C. Nominal interest rate + real interest rate = expected inflation rate.
D. Nominal interest rate = real interest rate - expected inflation.
186.Suppose you are a lender and you expect inflation to be 4 percent over the next year because inflation was
4 percent in the last year. If you want to earn a real return of 2 percent on any loans you make, you will set
the interest rate on your loans equal to:
A. 2 percent.
B. 4 percent.
C. 6 percent.
D. 10 percent.
187.Suppose you are a borrower and you expect inflation to be 6 percent over the next year because inflation
was 6 percent in the last year. If you do not want to pay more than 2 percent in real terms for any loan you
take out, you will not borrow if the interest rate is greater than:
A. 2 percent.
B. 6 percent.
C. 8 percent.
D. 14 percent.
188.The observation that nominal interest rates have increased implies that:
A. the expected inflation rate must have gone up.

B. the real interest rate must have gone up.
C. either the expected inflation rate went up, the real interest rate went up, or both.
D. either the expected inflation rate went down, the real interest rate went down, or both.
189.Suppose the nominal interest rate in Brazil is 40 percent and the expected inflation rate is 150 percent. The
real interest rate is:
A. -110 percent.
B. -190 percent.
C. 110 percent.
D. 190 percent.
190.Suppose the real interest rate in Brazil is 40 percent, actual inflation is 20 percent, and expected inflation is
20 percent. The nominal interest must then be:
A. 20 percent.
B. 40 percent.
C. 60 percent.
D. 80 percent.
191.When people expect higher inflation, usually nominal interest rates will:
A. fall.
B. rise.
C. remain unchanged.
D. move erratically.
192.Suppose a contractionary monetary policy raises nominal interest rates. If this is the case, it follows that the
contractionary monetary policy must have:
A. reduced expected inflation.

B. increased expected inflation.
C. increased expected inflation more than it reduced real interest rates.
D. increased real interest rates more than it reduced expected inflation.
193.Suppose an expansionary monetary policy reduces nominal interest rates. If this is the case, it follows that
the expansionary monetary policy must have:

C. increased expected inflation less than it reduced real interest rates.
D. reduced real interest rates less than it increased expected inflation.
194.The distinction between real and nominal interest rates:
A. makes it easier to assess the impact of monetary policy.

B. makes it harder to assess the impact of monetary policy.
C. does not affect the assessment of monetary policy since nominal interest rates are observable.
D. does not affect the assessment of monetary policy since real interest rates are observable.
195.As financial markets develop new and complex financial instruments, the Fed has:
A. more control over the long-term interest rate.

B. less control over the long-term interest rate.
C. no control over the short-term interest rate.
D. full control over the short-term interest rate.
196.A difference between a monetary regime and monetary policy is that a monetary regime:
A. responds to changes in the economy while a monetary policy does not.

B. does not respond to change in the economy while a monetary policy does.
C. depends on the economic conditions while the monetary policy does not.
D. is not favored while monetary policy is.
197.Monetary regimes:
A. do not set policy on the basis of a predetermined framework.

B. rely on the discretion of monetary policy officials.
C. use predetermined rules to set monetary policy.
D. produce greater variation in expected inflation than individual monetary policies.
198.Monetary regimes are:
A. more effective than monetary policies because they produce smaller changes in inflationary
expectations.
B. less effective than monetary policies because they produce smaller changes in inflationary expectations.
C. less effective than monetary policies because they give policy makers greater discretion.
D. more effective than monetary policies because they give policy makers greater discretion.
ch14 Key
1. In the AS/AD model, an increase in the money supply causes an increase in the interest rate and an
increase in investment spending.
FALSE
An increase in the money supply increases the credit available to banks, which depresses interest rates
and increases business investment.
AACSB: Reflective Thinking

BLOOMS TAXONOMY: Comprehension
Colander - Chapter 14 #1
Difficulty: Medium
Learning Objective: 14-1
Topic: AS/AD model
2. A contractionary monetary policy decreases the money supply and the interest rate, which decreases
investment and output.
FALSE
A contractionary monetary policy decreases the money supply and increases the interest rate, which
decreases investment and output.

BLOOMS TAXONOMY: Knowledge
Difficulty: Easy
Topic: Monetary Policy
3. The Fed's duties include acting as a lender of last resort and supervising or regulating a variety of
financial institutions.
TRUE
The Fed lends to banks that have no other alternative. It also oversees the operations of many financial
institutions.

Difficulty: Medium
Topic: Federal Reserve
4. The three tools of monetary policy are open market operations, setting prices, and setting the velocity of
money.
FALSE
The Fed does conduct open market operations, but it does not set the price level or the velocity of
money. The last two variables are determined by the aggregate behavior of firms and households.

Difficulty: Easy
5. An increase in the federal funds rate is a signal that the Fed wants a tighter monetary policy.
TRUE
A higher federal funds rate is a signal to banks that the Fed wants to increase interest rates and pursue a
tighter monetary policy.

Difficulty: Medium
Topic: Federal Funds Rate
6. The Federal funds rate is the rate banks charge one another for overnight loans.
TRUE
The Federal funds rate is the rate banks pay when they borrow from one another.

Difficulty: Medium
7. A decrease in the Federal funds rate is an indication that monetary policy is expansionary.
TRUE
The Federal funds rate falls when excess reserves within the banking system increase. The increase in
excess reserves is an indication that monetary policy is contractionary.

Difficulty: Medium
8. The Taylor Rule relates changes in the money supply to changes in interest rates.
FALSE
The Taylor Rule examines the relationship between inflation, output, and the Federal funds rate.

Difficulty: Easy
Topic: Taylor Rule
9. The art of monetary policy is acting in accordance with the Taylor Rule.
FALSE
Monetary policy is about deciding what model to use based on the situation that is encountered. It does
not involve having to strictly follow the Taylor Rule.

Difficulty: Easy
Topic: Taylor Rule
10. According to the Taylor Rule, if current inflation is 2.5 percent, the target inflation rate is 2 percent, and
output is 1 percent above potential, the Fed will target the Federal funds rate at 5.25 percent.
TRUE
Target rate = 2 + 2.5 + (0.5)(2.5 - 2) + 0.5 (1).

BLOOMS TAXONOMY: Synthesis
Difficulty: Medium
Topic: Taylor Rule
11. The Fed targets the interest rate by adjusting the money demand so that its targeted interest rate will
equalize the supply and demand for money.
FALSE
The Fed targets the interest rate by adjusting the money supply and not the money demand.

Difficulty: Medium
12. The difference between a standard and an inverted yield curve is that when the yield curve is inverted,
the longer term bond pays a lower interest rate than a short-term bond.
TRUE
When the yield curve is inverted, the long-term bonds pay a lower interest rate.

Difficulty: Hard
Topic: Yield Curve
13. The Federal Reserve has control over the long term interest rate.
FALSE
The Fed can control the short term rate, but it can only hope that the long term interest rate will move in
the direction it wants. The Fed will take steps to try to influence the direction of the long term interest
rate.

Difficulty: Medium
Topic: Long Term Interest Rates
14. It would be practical for the Fed to buy bonds even when the Fed funds rate is zero.
TRUE
This is what is referred to as quantitative easing and is done when the Fed cannot use conventional tools
to stimulate the economy.

Difficulty: Medium
Topic: Quantitative Easing
15. Who determines U.S. monetary policy?
A. Congress.
B. The President.
C. The Internal Revenue Service.
D. The Federal Reserve.
The Fed controls monetary policy through its ability to influence the banking system, credit, and the
money supply.

Difficulty: Easy
16. Monetary policy is one of the two main macroeconomic tools governments use to control the aggregate
economy, the other being:
A. fiscal policy.
B. foreign policy.
C. trade policy.
D. immigration policy.
Fiscal policy affects the aggregate economy through changes in taxes and government outlays.

Difficulty: Easy
17. Which of the following is not directly affected by monetary policy?
A. The money supply.

B. The banking system.
C. The availability of credit.
D. The budget deficit.
The budget deficit is determined directly by fiscal policy. Monetary policy does affect the budget deficit
through its effects on interest rates, but this is an indirect effect.

Difficulty: Medium
18. Monetary policy directly affects:
A. social spending.
B. tax rates.
C. the availability of credit.
D. the antitrust laws.
By altering bank reserves, the Fed can influence the availability of credit.

Difficulty: Easy
19. Expansionary monetary policy is always expected to increase:
A. nominal income but never real income.

B. real income but never nominal income.
C. nominal income.
D. real income.
Expansionary monetary policy increases aggregate demand. The increase in aggregate demand leads to
an increase in real output, an increase in the price level, or both. In all of these cases, nominal income
rises.

Difficulty: Medium
Topic: AS/AD model
20. A monetary policy that reduces both real and nominal income:
A. must be expansionary.
B. must be contractionary.
C. cannot be expansionary or contractionary.
D. could be expansionary or contractionary.
Contractionary monetary policy decreases aggregate demand. The decrease in aggregate demand leads
to a decrease in real output, a decrease in the price level, or both. In all three cases, nominal income
falls.

Difficulty: Easy
Topic: AS/AD model
21. Monetary policy affects:
A. only inflation.
B. only output.
C. both inflation and output.
D. neither inflation nor output.
Monetary policy affects aggregate demand and hence both inflation and output.

Difficulty: Medium
Topic: AS/AD model
22. Assuming an economy is initially at potential output, an expansionary monetary policy will:
A. not affect output in the long run.

B. not affect output in either the short run or the long run.
C. affect output, but only in the long run.
D. affect output in both the short run and the long run.
In the long run, an expansionary monetary policy does not affect potential output and is translated
instead into higher prices, not higher output.

Difficulty: Hard
Topic: AS/AD model
23. If the SAS curve is upward sloping but not vertical, monetary policy that affects nominal income but not
real income must result in the shift of:

This is only possible if the shift in the AD curve is completely offset by a shift in the SAS curve.

Difficulty: Medium
Topic: AS/AD model
24. An expansionary monetary policy that affects the price level but not real output must result in the shift
of:

Since an expansionary policy reduces interest rates and increases aggregate demand, the AD curve
shifts out. Since this particular policy affects the price level but not real output, it must produce
inflationary pressures that shift the SAS curve up to the point at which output is unchanged.

Difficulty: Medium
Topic: AS/AD model
25. In the AS/AD model, an expansionary monetary policy has the greatest effect on the price level when it:
A. increases both nominal and real income.

B. increases real income but not nominal income.
C. increases nominal income but not real income.
D. doesn't increase real or nominal income.
In this case the entire increase in aggregate demand resulting from the expansionary monetary policy is
translated into higher prices with no change in real output.

Difficulty: Medium
Topic: AS/AD model
A. affects both inflation and output.

B. affects output but not inflation.
C. affects inflation but not output.
D. doesn't affect output or inflation.
In this case, changes in aggregate demand resulting from expansionary or contractionary monetary
policy are translated entirely into output changes with no change in the price level.

Difficulty: Medium
Topic: AS/AD model
27. If nominal income increases by 3 percent and real income increases by 4 percent, the price level must:
Since the percentage change in real income equals the percentage change in nominal income minus the
percentage change in the price level, it follows that the price level must fall by 1 percent.
AACSB: Analytic
BLOOMS TAXONOMY: Evaluation
Difficulty: Easy
Topic: AS/AD model
28. If nominal income increases by 4 percent and the price level increases by 3 percent, real income must:
percentage change in the price level, it follows that real income must rise by 1 percent.
AACSB: Analytic
Difficulty: Easy
Topic: AS/AD model
29. If real income increases by 4 percent and the price level increases by 3 percent, nominal income must:
percentage change in the price level, it follows that nominal income must rise by 7 percent.
AACSB: Analytic
Difficulty: Easy
Topic: AS/AD model
Colander - Chapter 14
30. Refer to the graph above. Monetary policy that shifts the AD curve from AD0 to AD2 is
A. expansionary.
B. contractionary.
C. neither expansionary nor contractionary since it does not affect output.
D. neither expansionary nor contractionary since it does not affect inflation.
Contractionary monetary policy would reduce economic activity and shift the AD curve in.

Difficulty: Easy
Topic: AS/AD model
31. Refer to the graph above. Monetary policy that shifts the AD curve from AD0 to AD1 and moves the
economy from A to B:
A. increases nominal output but not real output in the short run.
B. increases both real and nominal output in the short run.
C. increases real output but not nominal output in the short run.
D. doesn't increase real or nominal output in the short run.
Since both real output and the price level rise, nominal output also rises.

Difficulty: Easy
Topic: AS/AD model
32. Refer to the graph above. Suppose the economy is initially at O but then the Fed adopts an expansionary
monetary policy. The immediate effect of this policy will be to move the economy to:
A. A.
B. B.
C. C.
D. D.
In the short run, the increase in aggregate demand resulting from the expansionary monetary policy will
cause output to rise in some industries and prices to rise in others.

Difficulty: Medium
Topic: AS/AD model
monetary policy. The long term effect of this policy will be to move the economy to:
A. A.
B. B.
C. C.
D. D.
In the long run, the decrease in aggregate demand resulting from the contractionary monetary policy
will force down input prices until a new long-run equilibrium is reached at D.

Difficulty: Medium
Topic: AS/AD model
monetary policy. This policy will cause the economy to move to:
A. A in the short run and the long run.

B. B in the short run and the long run.
C. A in the short run and C in the long run.
D. B in the short run and D in the long run.
In the short run, the decrease in aggregate demand resulting from the contractionary monetary policy
will cause output to fall in some industries and output prices to fall in others. In the long run, the
decrease in aggregate demand resulting from the contractionary monetary policy will force down input
prices until a new long-run equilibrium is reached at D.

Difficulty: Hard
Topic: AS/AD model
35. In the AS/AD model, a contractionary monetary policy:
A. reduces investment but increases aggregate demand.

B. increases both investment and aggregate demand.
C. reduces both investment and aggregate demand.
D. increases investment but reduces aggregate demand.
A policy that contracts the money supply will raise interest rates and reduce investment and aggregate
demand.

Difficulty: Easy
Topic: AS/AD model
36. If a contractionary monetary policy reduces nominal income but not real income, it must be true that
prices:
A. are perfectly flexible.

B. are at least partially flexible.
C. are completely inflexible.
D. have not fully adjusted to the change in aggregate demand.
If real income is not affected by the contractionary monetary policy, it must be because the drop in
aggregate demand caused by the contractionary monetary policy is translated entirely into lower prices.

Difficulty: Medium
Topic: AS/AD model
A. affects both nominal and real income.

B. affects real income but not nominal income.
C. affects nominal income but not real income.
D. doesn't affect real or nominal income.
In this case, changes in aggregate demand resulting from expansionary or contractionary monetary
policy are translated entirely into output changes with no change in the price level.

Difficulty: Medium
Topic: AS/AD model
38. Central banks are responsible for:
A. both monetary policy and fiscal policy.

B. monetary policy but not fiscal policy.
C. fiscal policy but not monetary policy.
D. neither monetary policy nor fiscal policy.
Central banks control the ability to create money but have no power over taxes or government spending,
so they control only monetary policy.

Difficulty: Medium
Topic: Central Banks
39. An effect of an expansionary monetary policy is to:
A. reduce investment spending.

B. shift the aggregate demand curve to the left.
D. lower interest rates.
Expansionary monetary policy increases aggregate demand by reducing interest rates. The aggregate
demand curve shifts to the right.

Difficulty: Medium
Topic: AS/AD model
40. The effect of an expansionary monetary policy results in a shift of the aggregate demand to the right.
The effect of the monetary policy on the aggregate demand is:
A. direct from the money supply to the aggregate demand.

B. indirect through the short-term and long-term interest rates.
C. direct from the money supply to the aggregate supply.
D. indirect through the government expenditures.
The effect of the monetary policy on aggregate demand is indirect through the short-term and long-term
interest rates. The interest rates affect the supply and demand of loanable funds and investment. Since
investment is a component of the aggregate demand, the changes in investment will shift the aggregate
demand.

Difficulty: Medium
Topic: AS/AD model
41. Refer to the graph above. When the Fed conducts an expansionary monetary policy, it:
A. shifts the money supply from M0 to M1.

B. shifts the money supply from M0 to M2.
C. neither the money supply nor money demand shifts.
D. shifts money demand from D0 to D1.
Expansionary monetary policy would increase the quantity of money supply from M0 to M1.

Difficulty: Medium
Topic: Money Market
42. Refer to the graph above. An economy is initially at M0 and the Fed conducts an expansionary
monetary policy. This is represented by a movement from:
A. A to C.
B. A to B.
C. C to D.
D. D to A.
Expansionary monetary policy would increase the quantity of money supplied from M0 to M1 and move
the equilibrium from A to B.

Difficulty: Medium
Topic: Money Market
43. Refer to the graph above. An example of the Fed conducting a contractionary monetary policy is shown
by a change in interest rates from:
A. i0 to i1.
B. i0 to i2.
C. i2 to i1.
D. i2 to i0.
Contractionary monetary policy would decrease the quantity of money supplied from M0 to M2 and
increase the interest rate from i0 to i2.

BLOOMS TAXONOMY: Analysis
Difficulty: Medium
Topic: Money Market
44. The central bank in the U.S. does all the following except:
A. act as a financial adviser to the government.

B. loan money to corporations.
C. loan money to banks.
D. issue coin and currency.
The central bank is a banker's bank. It does not loan money to individuals or corporations.

Difficulty: Medium
Topic: Central Bank
45. Congress has the power to do all of the following to the Fed except:
A. reduce the Fed's budget.

B. confirm the president's nominee to the Chair of the Federal Reserve.
C. confirm the president's nominee to the Board of Governors.
D. audit Federal Reserve District banks.
The Fed does not depend upon Congressional appropriations for its operating budget.

Difficulty: Hard
46. Unlike the practice in many other countries, in the United States:
A. only monetary policy is used to influence the economy, and fiscal policy is not allowed.
B. only fiscal policy is used to influence the economy, and monetary policy is not allowed.
C. the agency responsible for monetary policy is not directly controlled by the government.
D. the agency responsible for fiscal policy is not directly controlled by the government.
The Fed is a semi-autonomous agency that is not under the direct control of the President or Congress.

Difficulty: Easy
47. When Ben Bernanke steps down as chairman of the Federal Reserve's Board of Governors, his
successor will be:
A. elected by the public.

B. selected by commercial banks.
C. appointed by the President.
D. appointed by the Board of Governors.
The Chairman of the Fed is appointed by the President to a four-year term.

Difficulty: Easy
48. In the fall of 2008 the Federal Reserve lowered its target for the Federal funds rate to close to 0 percent.
What is the name of the group within the Federal Reserve that made this decision?
A. Federal Advisory Committee.

B. Federal Deposit Insurance Corporation.
C. Federal Funds Operating Group.
D. Federal Open Market Committee
See description of Federal Open Market Committee in the text.

Difficulty: Easy
Topic: Federal Open Market Committee
49. Which is not a function of the Fed?
A. Conducting monetary policy.

B. Serving as a lender of last resort.
C. Providing financial services such as check clearing to commercial banks.
D. Financing U.S. budget deficits.
Financing U.S. budget deficits is the job of the Treasury Department.

Difficulty: Medium
50. How many regional banks are in the Federal Reserve System?
A. 6.
B. 8.
C. 12.
D. 15.
See the text, especially the figure of the structure of the Fed.

Difficulty: Easy
51. When there are no vacancies, how many people serve on the Board of Governors of the Federal Reserve
System?
A. 5.
B. 7.
C. 11.
D. 12.
The Fed has seven governors all of whom the President appoints.

Difficulty: Easy
52. The body that oversees the 12 regional Federal Banks is the:

B. Board of Governors.
C. U.S. Congress.
D. Federal Advisory Council.
The Board of Governors oversees the operations of the 12 regional Federal Reserve Banks and the
conduct of U.S. monetary policy. The FOMC is the policy-making body of the Fed. See the figure in the
text for the relationship between the Board of Governors and regional banks.

Difficulty: Medium
53. The group that is comprised of 5 Presidents of Fed regional banks and 7 Fed governors that gathers
around a table to discuss whether to increase interest rates is the:

B. Federal Depository Insurance Corporation.
C. Federal Advisory Council.
D. National Federal Reserve Bank.
The FOMC is responsible for the conduct of U.S. monetary policy.

Difficulty: Medium
54. The explicit functions given to the Fed by the Congress include all of the following except:
A. regulating financial institutions.

B. serving as a lender of last resort to financial institutions.
C. providing banking services to the U.S. government.
D. holding the nominal interest rate no more than 2 percent above the real interest rate.
Fighting unemployment and inflation are policy goals of the Fed and are not among the six explicit
functions given to the Fed by Congress.

Difficulty: Easy
55. Most decisions about monetary policy are made by:
A. the Chairman of the Fed only.

B. the President.
C. the President and Congress.
D. the Federal Open Market Committee.
The FOMC is the Fed's chief policy-making body.

Difficulty: Hard
56. All of the following are components of the Federal Reserve System except the:
A. twelve regional Federal Reserve banks.

B. Federal Open Market Committee.
C. Federal Deposit Insurance Corporation.
D. Board of Governors.
The FDIC is a separate agency

Difficulty: Medium
57. Which of the following is not something the Fed can change directly?
A. The reserve requirement.

C. Open market operations.
D. The prime rate.
The prime rate is controlled by commercial banks, and while it can be influenced by monetary policy, it
is not a tool of monetary policy.

Difficulty: Medium
Topic: Tools of Monetary Policy
58. Which is NOT something the Fed can do to conduct monetary policy?
A. Change the exchange rate.

B. Change the reserve requirement.
C. Change the discount rate.
D. Execute open market operations.
Changing the exchange rate is not a tool of the Fed's monetary policy though occasionally it does try to
influence the exchange rate.

Difficulty: Easy
59. The monetary base includes:
A. currency and coin in circulation plus checkable deposits.

B. currency and coin in circulation only.
C. vault cash plus checkable deposits.
D. currency and cash plus commercial bank deposits at the Fed.
The monetary base represents the liabilities or IOUs of the Fed, which include vault cash plus
commercial bank deposits at the Fed.

Difficulty: Hard
Topic: Monetary Base
60. The monetary base is comprised of:
A. currency held by the public.

B. vault cash.
C. commercial bank deposits at the Fed.
D. all of the options listed here.
The monetary base includes the liabilities of the Fed, which consist of vault cash, currency held by the
public, and commercial bank deposits at the Fed.

Difficulty: Medium
61. The reserve requirement is the:
A. maximum ratio of reserves to deposits that a bank can have.

B. minimum ratio of reserves to deposits that a bank can have.
C. maximum level of reserves a bank can have.
D. minimum level of reserves a bank can have.
The reserve requirement gives the minimum fraction of bank deposits that can be held in the form of
reserves.

Difficulty: Easy
Topic: Reserve Requirement
62. By law, a commercial bank is allowed to lend out all its:
A. deposits.
B. excess reserves.
C. required reserves.
D. demand (checkable) deposits.
Banks are required by the Fed to hold required reserves, but they can lend out any reserves in excess of
their required reserves.

Difficulty: Easy
Topic: Excess Reserves
63. The Federal Open Market Committee:
A. makes decisions that influence the amount of excess reserves available to banks.
B. reports directly to Congress.
C. makes decisions that influence the nation's fiscal policy.
D. determines who may buy and sell government bonds.
The open market operations of the Fed affect the money supply because they alter bank reserves.

Difficulty: Easy
64. One of the duties of the Fed is to:
A. change the demand for money.

B. define the market interest rate.
C. offer financial advising to the government.
D. offer financial advising to the public.
The Fed duties consist of creation of money and financial advisor of the government.

Difficulty: Medium
65. Fed watchers are:
A. financial advisers for the government, telling them when raising taxes will raise revenue and when it
won't.
B. part of the Fed governor system and are given voting power on the FOMC.
C. individuals or organizations whose sole occupation is to follow the Fed's FOMC.
D. individuals or organizations whose sole occupation is to predict the future of the interest rates.
Fed watchers are individuals or organizations whose sole occupation is to follow what the Fed is doing
through its chief body, the FOMC.

Difficulty: Easy
66. The reserve requirement for large banks on customer deposits in checking accounts is around:
A. 2 percent.
B. 5 percent.
C. 10 percent.
D. 15 percent.
See the text.

Difficulty: Medium
Topic: Reserve Requirement
67. Although rarely used, which of the following is an instrument the Fed has to conduct monetary policy?
A. The corporate income tax.

B. The tax on unearned income.
C. The discount rate.
D. The interest rate on Treasury bonds.
Changes in the discount rate alter the level of excess reserves in the banking system and in this way
affect the money supply.

Difficulty: Easy
Topic: Discount Rate
A. increase reserve requirements.

B. decrease reserve requirements.
C. decrease the discount rate.
D. buy government securities in the open market.
An increase in the reserve requirement reduces the excess reserves of the banking system. This reduces
the availability of credit and hence the money supply.

Difficulty: Medium
69. When the Fed increases the reserve requirement, it:
A. expands the money supply because banks have more to lend.

B. expands the money supply because banks have less to lend.
C. contracts the money supply because banks have more to lend.
D. contracts the money supply because banks have less to lend.
An increase in the reserve requirement forces banks to hold more of their deposits in the form of
reserves, and this reduces the supply of credit.

Difficulty: Medium
70. If the Federal Reserve reduced its reserve requirement from 6.5 percent to 5 percent. This policy would
most likely:
A. increase both the money multiplier and the money supply.

B. increase the money multiplier but decrease the money supply.
C. decrease the money multiplier but increase the money supply.
D. decrease both the money multiplier and the money supply.
Any decrease in the reserve requirement generates excess reserves and results in greater bank lending
and an expansion of the money supply. Because a reduction in the reserve requirement increases bank
lending, it also reduces the reserve ratio, which increases the money multiplier ((1 + c)/(r + c)).

Difficulty: Medium
71. When the Fed decreases the reserve requirement, the money supply:
A. expands and the money multiplier contracts.

B. expands and so does the money multiplier.
C. contracts and so does the money multiplier.
D. contracts and the money multiplier expands.
A cut in the reserve requirement increases the money multiplier because it allows banks to lend out
more of each additional dollar of deposits. This increases the supply of credit.

Difficulty: Medium
72. If the Fed increases the required reserves, financial institutions will likely lend out:
A. more than before, increasing the money supply.

B. less than before, decreasing the money supply.
C. more than before, decreasing the money supply.
D. less than before, increasing the money supply.
As required reserves increase, the bank system is forced to hold more reserves, which reduces both
lending and the money supply.

Difficulty: Medium
Topic: Open Market Operations
73. If the Fed decreases the reserve requirement, it:
A. decreases the amount of excess reserves and this eventually increases the money supply.
B. decreases the amount of excess reserves and this eventually decreases the money supply.
C. increases the amount of excess reserves and this eventually increases the money supply.
D. increases the amount of excess reserves and this eventually decreases the money supply.
With a lower reserve requirement, banks will have to hold fewer reserves so more loans will be
extended and the money supply will increase.

Difficulty: Hard
74. Suppose the reserve requirement is 20% and there are no cash holdings or excess reserves. A $1 billion
purchase of government securities by the Fed will:
A. increase the potential amount of checkable deposits in the banking system by $5 billion.
B. increase the potential amount of checkable deposits in the banking system by $1 billion.
C. reduce the potential amount of checkable deposits in the banking system by $1 billion.
D. reduce the potential amount of checkable deposits in the banking system by $5 billion.
The money multiplier equals (1 + c)/(r + c), which equals 5 in this case. Since a $1 billion purchase
of government securities injects $1 billion of reserves into the banking system, demand deposits can
increase by a maximum of $5 billion.
AACSB: Analytic
Difficulty: Medium
75. Suppose the reserve requirement is 20 percent and there are no cash holdings or excess reserves. A $1
billion sale of government securities by the Fed will:
A. increase checkable deposits in the banking system by $5 billion.

B. increase checkable deposits in the banking system by $1 billion.
C. reduce checkable deposits in the banking system by $1 billion.
D. reduce checkable deposits in the banking system by $5 billion.
The approximate money multiplier equals (1 + c)/(r + c), which equals 5 in this case. Since a $1 billion
sale of government securities removes $1 billion of reserves from the banking system, demand deposits
will decrease by $5 billion.
AACSB: Analytic
Difficulty: Medium
76. If the reserve requirement is 0.1 and the ratio of money people hold as cash relative to deposits is 0.2,
the money multiplier will be:
A. 2.
B. 3.
C. 4.
D. 5.
The money multiplier is equal to (1 + c)/(r + c), which equals 4 in this case.
AACSB: Analytic
Difficulty: Medium
Topic: Money Multiplier
77. If the cash-to-deposit ratio is 0.1 and the money multiplier is 2.5, the reserve requirement is:
A. 0.14.
B. 0.24.
C. 0.34.
D. 0.44.
The approximate money multiplier is (1 + c)/(r + c) = 1.10/(r + 0.10) = 2.5. Solving for r = 0.34.
AACSB: Analytic
Difficulty: Hard
78. Assuming that r = .05 and c = .25, the money multiplier is:
A. 4.07.
B. 4.17.
C. 4.27.
D. 4.37.
The money multiplier is (1 + c)/(r + c) = (1.25)/(0.30) = 4.17.
AACSB: Analytic
Difficulty: Medium
79. Assuming that r = .05 and c = .25, if reserves fall by 100, the money supply will decline by:
A. 400.
B. 407.
C. 417.
D. 427.
Since the money multiplier (1 + c)/(r + c) is 4.17, a fall in reserves by 100 will decrease money supply
by 4.17 x 100 = 417.
AACSB: Analytic
Difficulty: Medium
80. Assuming that r = .05 and c = .2, how much would reserves need to be increased to increase the money
supply by 500?
A. 25.17.
B. 100.17.
C. 104.17.
D. 204.17.
Since the approximate money multiplier (1 + c)/(r + c) is 4.8, to increase money supply by 500, reserves
need to be increased by 104.17.
AACSB: Analytic
Difficulty: Medium
81. Which of the following is an example of a direct expansionary monetary policy action?
A. Raising the discount rate.

B. Lowering the prime rate.
C. Selling bonds.
D. Reducing the reserve requirement.
If the reserve requirement is reduced, there would be more excess reserves for the banks to loan out, and
through the multiplier effect the money supply would increase. The prime rate is not a monetary policy
variable but rather an interest rate controlled by commercial banks.

Difficulty: Easy
82. The discount rate is the interest rate:
A. commercial banks charge their largest customers.

B. the Fed charges on loans to individuals.
C. the Fed charges on loans to commercial banks.
D. the interest rate commercial banks charge one another for overnight loans.
The discount rate is the interest rate banks pay when they borrow from the Fed.

Difficulty: Easy
83. To increase the nation's money supply, the Fed can:
A. increase the required reserve ratio.

D. sell bonds.
A cut in the discount rate reduces the cost that banks pay when they borrow from the Fed and is usually
a signal that the Fed wants banks to engage in additional lending.

Difficulty: Easy
84. When the Fed reduces the discount rate, this sends a signal to banks that the Fed wants:
A. the money supply to expand.

B. the money supply to contract.
C. the Federal funds rate to increase.
D. to reduce the reserve requirement.
A reduction in the discount rate is a signal that the Fed wants easier credit conditions.

Difficulty: Medium
85. When the Fed lowered the discount rate in late 2008 the action was ultimately designed to:

B. increase the prime rate.
C. decrease the monetary base.
D. increase the reserve requirement.
The discount rate is the interest rate the Fed charges commercial banks when it lends to them. The lower
this rate, the more likely banks are to borrow and the less likely they are to hold excess reserves to meet
reserve shortfalls. This tends to increase the money supply.

Difficulty: Easy
86. Suppose the approximate money multiplier in the U.S. is 3. Suppose further that if the Fed changes the
discount rate by 1 percentage point, banks change their reserves by 400. To reduce the money supply by
4200 the Fed should:
A. reduce the discount rate by 10.5 percentage points.

B. raise the discount rate by 10.5 percentage points.
C. reduce the discount rate by 3.5 percentage points.
D. raise the discount rate by 3.5 percentage points.
Because the money multiplier is 3, a 1 percentage point increase in the discount rate reduces the money
supply by 1,200 (400 * 3). Thus, for the money supply to decrease by 4,200 the discount rate must be
raised by 3.5 percentage points (4,200/1,200).
AACSB: Analytic
Difficulty: Hard
87. Suppose the money multiplier in the U.S. is 3. Suppose further that if the Fed changes the discount rate
by 1 percentage point, banks change their reserves by 300. To increase the money supply by 2700 the
Fed should:
A. reduce the discount rate by 3 percentage points.

B. reduce the discount rate by 10 percentage points.
C. raise the discount rate by 3 percentage points.
D. raise the discount rate by 10 percentage points.
Because the money multiplier is 3, a 1 percentage point cut in the discount rate raises the money supply
by 900 (300 * 3). Thus, for the money supply to increase by 2,700 the discount rate must be reduced by
3 percentage points (2,700/900).
AACSB: Analytic
Difficulty: Hard
88. The primary tool of monetary policy is:
A. the discount rate.

B. the reserve requirement.
C. the prime rate.
D. open market operations.
Open market operations are conducted on a day-to-day basis by the Fed in order to meet its objectives
for monetary policy. The Federal funds rate is an operating target for monetary policy.

Difficulty: Medium
89. Open market operations are related to:
A. actions taken by the Fed to close or merge weakened banks.

B. changes in the reserve requirement.
C. changes in the discount rate.
D. the Fed's buying and selling of government securities.
The Fed conducts open market operations when it buys or sells government securities.

Difficulty: Easy
90. Which of the following Fed actions increases the money supply?
A. Decreasing the amount of loans made to commercial banks.

B. Buying government securities in the open market.
C. Selling government securities in the open market.
D. Increasing reserve requirements.
Buying government securities adds reserves from the banking system and increases the availability of
credit, causing an increase in the money supply.

Difficulty: Medium
Topic: Reserves
91. Suppose the money multiplier in the U.S. is 2.5. If the Fed wants to reduce the money supply by 1000 it
should:

To reduce money supply the Fed must sell securities. Since the multiplier is 2.5 the government has to
sell securities worth 400.
AACSB: Analytic
Difficulty: Medium
92. Suppose the money multiplier in the U.S. is 2.5. If the Fed wants to reduce the money supply by 1,500 it
should:
A. raise the required reserve ratio to 0.2.

B. raise the discount rate by 2 percentage points.
C. buy government securities worth 600.
To reduce money supply the Fed must sell securities. Since the multiplier is 2.5 the government has to
sell securities worth 600. There is not enough information to find the reserve ratio or the discount rate
policy.
AACSB: Analytic
Difficulty: Medium
93. Suppose the money multiplier in the U.S. is 4. If the Fed wants to expand the money supply by 600 it
should:

To expand money supply the Fed must buy securities. Since the multiplier is 4 the government has to
buy securities worth 150.
AACSB: Analytic
Difficulty: Medium
A. decrease the reserve requirement.

D. buy bonds.
An increase in the discount rate raises the cost that banks pay when they borrow from the Fed and is
usually a signal that the Fed wants banks to engage in less lending.

Difficulty: Easy
95. Federal Reserve sales of government securities:
A. increase bank reserves and increase the money supply.

B. decrease bank reserves and decrease the money supply.
C. decrease bank reserves and increase the money supply.
D. increase bank reserves and decrease the money supply.
Open market sales of government securities reduce the reserves of the banking system. As reserves fall,
banks must replenish them by either issuing fewer loans or calling in old loans, both of which reduce
the money supply.

Difficulty: Medium
96. Which of the following Fed policies would help the economy out of a recession?
A. Open market purchases of government securities.

B. Open market sales of government securities.
D. An increase in reserve requirements.
An open market purchase of government securities increases banks reserves. Banks tend to lend out
these new funds, thereby expanding money supply, reducing interest rate, and shifting to the right
aggregate demand. This will increase output.

Difficulty: Medium
97. If the Fed simultaneously raises the discount rate and the reserve requirement, the money supply will:
A. contract.
C. expand.
Both policies decrease bank reserves and thereby contract the money supply.

Difficulty: Medium
Topic: Money Supply
98. If the Fed simultaneously lowers the reserve requirement and sells government bonds, the money supply
will:
A. contract.
C. expand.
D. move in a way that cannot be determined from the information given.
The decrease in the reserve requirement increases excess reserves, which should increase the money
supply. The sale of government bonds, however, lowers bank reserves and thereby contracts the money
supply. Without more information, the change in the money supply cannot be predicted.

Difficulty: Hard
99. If the Fed simultaneously reduces the discount rate and the required reserve ratio, the money supply
will:
A. contract.
C. expand.
Both policies increase bank reserves and thereby expand the money supply.

Difficulty: Medium
100. Banks can borrow reserves from each other through:
A. the Fed funds market.

B. the Federal Open Market Committee.
C. open market purchases.
D. secondary reserves.
The Fed funds market is where banks needing reserves can borrow from banks with excess reserves.

Difficulty: Easy
Topic: Federal Funds Market
101. The Federal funds rate:
A. is always slightly higher than the discount rate.

B. can never be close to zero.
C. may sometimes have to be targeted at zero.
D. is an intermediate target.
The Federal Funds rate has become the Fed's operating target, and in response to the 2008 financial
crisis, the Fed lowered the rate to almost zero to jumpstart the economy.

Difficulty: Easy
102. When the Fed sells bonds, the:
A. Federal funds rate increases.

B. reserve requirement falls.
C. discount rate increases.
D. discount rate decreases.
An open market sale of government securities reduces the excess reserves in the banking system, which
should decrease the supply of funds in the Federal funds market and increase the Federal funds rate.

Difficulty: Medium
103. If the level of excess reserves in the banking system drops suddenly, we might expect that the:
A. discount rate would rise.

B. Federal funds rate would rise.
C. required reserve ratio would fall.
D. prime rate would fall.
The level of excess reserves determines the flow of funds into the Federal funds market. When excess
reserves are low, so is the supply of Federal funds, so the Federal funds rate should be high.

Difficulty: Medium
104. When the Fed targets a higher interest rate, this change in policy involves open market:
A. purchases of government securities that reduced reserves.

B. purchases of government securities that increased reserves.
C. sales of government securities that reduced reserves.
D. sales of government securities that increased reserves.
The Federal funds rate increases when excess reserves within the commercial banking system contract.
Such a contraction can be brought on by Fed open market sales of government securities because these
sales reduce commercial bank reserves.

Difficulty: Medium
105. Who buys and sells in the Fed funds market?
A. Only commercial banks and depository institutions.

B. All large financial institutions.
C. Financial institutions and large corporations.
D. Anyone with a computer and an Internet connection can participate.
Only depository institutions buy and sell Federal funds.

Difficulty: Medium
Topic: Federal Funds Market
106. What tool of monetary policy will the Fed use to increase the Federal funds rate from 1% to 1.25%?
A. Open-market operations.
C. A change in reserve requirements.
D. Margin requirements.
The Federal funds target is used to guide the trading desk in whether to add or subtract reserves from
the banking system.

Difficulty: Medium
107. The interest rate banks charge each other to borrow excess reserves is called the:
A. discount rate.
B. required reserve ratio.
C. prime rate.
D. Federal funds rate.
The Federal funds rate is the interest rate charged by banks on loans they make to other banks.

Difficulty: Easy
108. The Fed announces what it is doing with monetary policy in terms of a target for:
A. discount rate.
B. reserve requirement.
C. Federal funds rate.
D. monetary base.
The Fed uses the Federal funds rate because it is an indication of the level of excess reserves in the
banking system.

Difficulty: Easy
109. An increase in the Federal funds rate could be caused by:
A. an open market purchase of government securities.

B. an increase in the reserve requirement.
C. a cut in the discount rate.
D. an increase in the excess reserves of the banking system.
A higher reserve requirement will reduce the reserves of the banking system and reduce the availability
of credit in the Federal funds market. This will increase the Federal funds rate.

Difficulty: Hard
110. A reduction in the Federal funds rate could be caused by an:
A. open market sale of government securities.

B. increase in the reserve requirement.
C. increase in the discount rate.
D. increase in the excess reserves of the banking system.
An increase in the reserves of the banking system increases the availability of credit in the Federal funds
market and reduces the Federal funds rate.

Difficulty: Hard
111. A reduction in the Federal funds rate could be caused by:
A. lower than expected bank deposits.

C. higher than expected loan demand.
If reserves are higher than expected, banks are likely to have more excess reserves than they would like.
If banks can't lend out these reserves to their customers, they will try to lend them out in the Federal
funds market, which will push down the Federal funds rate.

Difficulty: Medium
112. An increase in the Federal funds rate could be caused by:
A. higher than expected bank deposits.

C. lower than expected loan demand.
If withdrawals are higher than expected, banks reserves will be lower than expected, increasing the
demand for Federal funds and raising the Federal funds rate.

Difficulty: Hard
113. If the Fed funds rate is above the Fed's target range the Fed should:

C. print money.
D. do nothing.
The Fed funds rate being above the Fed's target would mean that money supply is tight and the Fed
should follow an expansionary monetary policy.

Difficulty: Medium
114. If the Fed funds rate is below the Fed's target range the Fed should:

C. print money.
D. do nothing.
The Fed funds rate being below the Fed's target would mean that money supply is loose and the Fed
should follow a contractionary monetary policy.

Difficulty: Medium
115. Suppose the Fed funds rate is above the Fed's target range. The Fed will:
A. buy bonds.
B. sell bonds.
D. increase the discount rate.
The Fed funds rate being above the Fed's target would mean that monetary policy is too tight, so the Fed
should follow an expansionary monetary policy like buying bonds.

Difficulty: Medium
116. Suppose the Fed funds rate is below the Fed's target range. The Fed could:
A. buy bonds.
B. reduce the reserve requirement.
D. cut the discount rate.
The Fed funds rate being below the Fed's target would mean that monetary policy is too loose, so the
Fed should follow a contractionary monetary policy like raising the reserve requirement.

Difficulty: Medium
117. If the Fed wants a tighter monetary policy, it might:

A sale of government securities reduces the reserves in the banking system and forces up the Federal
funds rate.

Difficulty: Medium
118. If the Fed wants an easier monetary policy, it might:

A purchase of government securities injects reserves into the banking system, which reduces the Federal
funds rate.

Difficulty: Medium
119. When the Fed took action in late 2008 to significantly decrease the Federal funds rate, these operations
are best considered as:
A. offensive actions.
B. defensive actions.
C. both offensive and defensive actions.
D. neither offensive nor defensive actions.
The goal of offensive actions is to make monetary policy either more expansionary or more
contractionary (the latter in this case). Defensive actions maintain the current monetary policy stance
and thus would not be associated with changes in the Federal funds rate.

Difficulty: Easy
120. When the Fed raised interest rates between 2004 and 2007, the Federal Reserve:
A. bought U.S. government securities, thereby creating and supplying additional Federal funds.
B. sold U.S. government securities, thereby contracting funds to the Federal funds market.
C. speeded up the clearing of checks to make more funds available to banks.
D. encouraged banks to loan out funds to ease their reserve requirements and thus lower the demand for
Federal funds.
When the Fed sells securities, it contracts reserves, which are what Federal funds are. As in any other
market, a lower supply tends to increase price. In this case, it increased the Federal funds rate.

Difficulty: Hard
121. The defensive and offensive actions of the Fed differ because offensive actions are designed to:
A. tighten monetary policy and defensive actions are designed to ease monetary policy.
B. ease monetary policy and defensive actions are designed to tighten monetary policy.
C. change the current monetary policy while defensive actions are designed to reinforce the current
monetary policy.
D. reinforce the current monetary policy while defensive actions are designed to change the current
monetary policy.
Offensive actions seek to alter the direction of monetary policy while defensive actions reinforce the
existing direction.

Difficulty: Medium
122. If individuals suddenly increase their withdrawals from the banking system, the Federal funds rate
should:
A. increase as bank reserves decline.

B. decrease as bank reserves decline.
C. increase as bank reserves increase.
D. decrease as bank reserves increase.
A sudden withdrawal from the banking system reduces the excess reserves of the system and forces up
the Federal funds rate.

Difficulty: Hard
123. If the demand for bank loans suddenly declines, a defensive action on the part of the Fed to keep the
Fed funds rate constant would take the form of open market bond:
The drop in bank loans will increase excess reserves, which will tend to push the Fed funds rate down.
To prevent this, the Fed would have to sell bonds to eliminate the excess reserves.

Difficulty: Medium
124. If the Fed funds rate rises above the Fed's target range, the Fed should take:

If the Fed has a target range for the Fed funds rate, it is using this rate as an operating target for
monetary policy. Given that it has set its monetary policy, any action to bring the Fed funds rate back
into the target range (i.e. a purchase of government bonds) would be defensive.

Difficulty: Hard
125. If the Fed funds rate falls below the Fed's target range, the Fed should take:

If the Fed has a target range for the Fed funds rate, it is using this rate as an intermediate target for
monetary policy. Given that it has set its monetary policy, any action to bring the Fed funds rate back
into the target range (i.e. a sale of government bonds) would be defensive.

Difficulty: Hard
126. Suppose the Federal funds rate is 5 percent. If the Fed decides to increase the target for the Federal
funds rate from 5 percent to 6 percent, it should take:

Because the Fed is changing the existing monetary policy when it changes the target range for the
Federal funds rate, it must take an offensive action. Because it must increase the Federal funds rate to
meet the new target, it should adopt a contractionary monetary policy.

Difficulty: Hard
127. Suppose the Federal funds rate is 5 percent. If the Fed decides to decrease the target for the Federal
funds rate from 5 percent to 4 percent, it should take:

Because the Fed is changing the existing monetary policy when it changes the target range for the
Federal funds rate, it must take an offensive action. Because it must decrease the Federal funds rate to
meet the new target, it should adopt an expansionary monetary policy.

Difficulty: Hard
128. Which of the following is an operating target for the Fed?
A. Sustainable growth.
B. The Federal funds rate.
C. Stable prices.
D. Stock prices.
The Federal funds rate is the only real operating target for the Fed.

Difficulty: Easy
Topic: Federal Fund Rate
129. Just prior to the year 2000, the Fed was concerned that people would make larger than normal bank
withdrawals out of fear of the Y2K computer bug. The Fed feared that this might disrupt the banking
system. The Fed wanted to use a defensive action to prevent any such disruption. This would take the
form of open market bond:
Larger than normal withdrawals would reduce excess reserves, which would tend to push the Fed funds
rate up. To prevent this, the Fed would have to buy bonds to replenish bank reserves.

Difficulty: Medium
130. In 2008, the Fed followed an expansionary monetary policy, which was evident by the:
A. decrease in the Fed funds rate from 4 percent in January to .25 percent in December.
B. increase in the Fed funds rate from .25 percent in January to 4 percent in December.
C. decrease in the repo rate from 4 percent in January to .25 percent in December.
D. increase in the discount rate and decrease in the Fed fund rate by the same percentage points.
During 2008 the Fed followed an expansionary monetary policy that can be observed in the severe
reduction of the Fed funds rate.

Difficulty: Easy
131. The Fed funds rate increased from 2.5 percent in February 2005 to 5.26 in February 2007. This change
in the Fed funds rate clearly indicates that during this period the Fed followed a(n):
A. expansionary fiscal policy.

B. contractionary fiscal policy.
C. expansionary monetary policy.
D. contractionary monetary policy.
During 2005-2007, the Fed followed a contractionary monetary policy that can be observed in the
higher Fed funds rates during this period.

Difficulty: Medium
132. When the Fed sells bonds, the Fed:

An open market sale of government securities reduces the excess reserves in the banking system, which
decreases the supply of funds in the Federal funds market and raises the Federal funds rate.

Difficulty: Medium
133. When the Fed purchases bonds, the Fed:

An open market purchase of government securities increases the excess reserves in the banking system,
which increases the supply of funds in the Federal funds market and decreases the Federal funds rate.

Difficulty: Medium
134. Which of the following is a Fed tool?
A. Interest rate spreads.

B. Discount rate.
C. Stock prices.
D. Fed funds rate.
The Fed tools are the open market operations, discount rate, and reserve requirements.

Difficulty: Medium
135. Which of the following is an intermediate target?
A. Consumer confidence.
B. Sustainable growth.
C. Open market operation.
D. Fed funds rate.
The Fed intermediate targets are the consumer confidence, stock prices, interest rate spreads, and
housing starts among others.

Difficulty: Medium
136. The predictions of Fed behavior provided by the Taylor rule are:
A. never accurate.
B. seldom accurate.
C. reasonably accurate.
D. extremely accurate.
The Taylor rule predicts Fed behavior reasonably well but is by no means perfect.

Difficulty: Easy
Topic: Taylor Rule
137. If inflation is one percentage point above the Fed's target, the Taylor rule predicts that the Fed will:
A. raise the Federal funds rate by 0.5 percentage points.

B. raise the Federal funds rate by 1.0 percentage points.
C. raise the Federal funds rate by 1.5 percentage points.
D. reduce the Federal funds rate by 1 percentage point.
The Taylor rule predicts the Fed will raise (lower) the Federal funds rate by 0.5 percentage point for
each percentage point inflation is above (below) the Fed's target.
AACSB: Analytic
Difficulty: Hard
Topic: Taylor Rule
138. If output falls one percentage point below its potential, the Taylor rule predicts that the Fed will:
A. reduce the Federal funds rate by 0.5 percentage points.

B. reduce the Federal funds rate by 1.0 percentage points.
C. reduce the Federal funds rate by 1.5 percentage points.
D. raise the Federal funds rate by 1 percentage point.
The Taylor rule predicts the Fed will raise (lower) the Federal funds rate by 0.5 percentage points for
each percentage point output is above (below) its potential.
AACSB: Analytic
Difficulty: Hard
Topic: Taylor Rule
139. Suppose the Federal funds rate rises by 0.5 percent. If the Taylor rule is correct, this might be because
output is:
A. 1 percentage point below potential output.

B. 0.5 percentage points below potential output.
C. 0.5 percentage points above potential output.
D. 1 percentage point above potential output.
The Taylor rule predicts the Fed will raise (lower) the Federal funds rate by 0.5 percentage points for
each percentage point output is above (below) its potential.
AACSB: Analytic
Difficulty: Hard
Topic: Taylor Rule
140. At the end of 2007, the Fed funds rate was at its target, 2 percent, output was about 1 percent beneath
potential, and inflation was roughly 1.5 percent. If the Taylor rule is accurate, the Fed's desired rate of
inflation at this time was:
A. 1 percent.
B. 2.5 percent.
C. 3.5 percent.
D. 5 percent.
According to the Taylor rule, the Federal funds rate equals 2 plus the current inflation rate plus half
the difference between actual and desired inflation plus half the percentage difference between actual
output and potential output. Solving for the desired inflation rate, we find that desired inflation equals
twice the difference between the current inflation rate and the Federal funds rate, plus the percentage
difference between actual output and potential output plus the current inflation rate plus 4, which equals
3.5 percent in this case. Equivalently, Fed funds rate = 2 = 2 + 1.5 + 0.5(1.5 - target inflation rate) +
0.5(-1). Solving for target inflation = (1.5 + 0.75 - 0.5)/0.5 = 3.5 percent.
AACSB: Analytic
Difficulty: Hard
Topic: Taylor Rule
141. Using the Taylor rule, if inflation is 3 percent, desired inflation is 2 percent, and output is 2 percentage
A. 6.5.
B. 4.5.
C. 3.5.
D. 3.
The Taylor rule says that the Fed will target a Fed funds rate equal to 2 + actual inflation + 0.5 x (actual
inflation less desired inflation) + 0.5 x (percent deviation of aggregate output from potential). In this
case, 2 + 3 + 0.5 x (3 - 2) + 0.5 x 2 equals 6.5.
AACSB: Analytic
Difficulty: Medium
Topic: Taylor Rule
A. 6.5.
B. 4.5.
C. 3.5.
D. 3.
case, 2 + 1 + 0.5 x (1 - 2) + 0.5 x 2 equals 3.5.
AACSB: Analytic
Difficulty: Medium
Topic: Taylor Rule
A. 6.5.
B. 4.5.
C. 3.5.
D. 3.
case, 2 + 3 + 0.5 x (3 - 2) + 0.5 x -2 equals 4.5.
AACSB: Analytic
Difficulty: Medium
Topic: Taylor Rule
A. 6.5.
B. 4.5.
C. 2.5.
D. 1.5.
case, 2 + 1 + 0.5 x (1 - 2) + 0.5 x -2 equals 1.5.
AACSB: Analytic
Difficulty: Medium
Topic: Taylor Rule
145. During 2007, the Fed funds rate was at its target 3.5 percent, inflation was 1.5 percent, and target
inflation was 2.5 percent. If the Taylor rule is accurate, the output was:
A. 1 percent below potential.

B. 1 percent above potential.
C. 1.5 percent below potential.
D. 1.5 percent above potential.
According to the Taylor rule, the Federal funds rate equals 2 plus the current inflation rate plus half the
difference between actual and desired inflation plus half the percentage difference between actual output
and potential output. Or, 3.5 = 2 + 1.5 + 0.5(1.5 - 2.5) + 0.5(percentage deviation in output). Solving for
percentage deviation in output = (3.5 - 2 - 1.5 + 0.5)/0.5 = 1 percent.
AACSB: Analytic
Difficulty: Hard
Topic: Taylor Rule
146. The Federal Reserve kept interest rates low between 2002 and 2006 because:
A. they wanted to reduce the value of the dollar and help domestic exporters.
B. they were worried about inflation creeping into the economy.
C. they wanted to avoid deflation and the resulting recession.
D. they wanted to follow the Taylor Rule.
The Federal Reserve does not always have to follow the Taylor Rule, and even though the Taylor Rule
indicated keeping rates high, the Fed was worried about the low price levels in the economy.

Difficulty: Medium
Topic: Taylor Rule
147. Between 2002 and 2006 the Federal Reserve:
A. raised rates in order to follow the Taylor Rule.

B. left rates unchanged in order to follow the Taylor Rule.
C. lowered rates and went against the Taylor Rule.
D. abandoned the Taylor Rule in favor of the Greenspan Rule.
The Federal Reserve over that period of time was concerned about the risks of recession to the
economy, even though the Taylor Rule suggested interest rates being increased.

Difficulty: Easy
Topic: Taylor Rule
148. The Taylor Rule:
A. determines who receives Fed funds.

B. determines the Fed funds rate.
C. is fairly successful in describing Fed policy.
D. is one of the Fed's monetary policy tools.
The Taylor Rule has been successful in describing Fed policy, but the Fed is under no obligation to
follow the Taylor Rule when implementing policy.

Difficulty: Medium
Topic: Taylor Rule
149. Some experts have argued that the Fed contributed to the housing bubble by:
A. allowing banks to invest in high-risk assets, even though there was a risk of them defaulting.
B. lowering interest rates, despite the fact that the Taylor rule indicated keeping them high.
C. not regulating non bank financial institutions who were coming up with innovative mortgages.
D. following the Taylor Rule, which during the 2000s indicated that rates should be kept low.
The Taylor Rule from 2002 onwards indicated raising interest rates. The Fed lowered rates which
encouraged people to leverage and also to make gains off housing investments. It was only in 2006
when the Fed was worried about inflation, did we see a following of the Taylor Rule. The raising of the
rates in turn started to slow down the demand for housing.

Difficulty: Difficult
Topic: Taylor Rule
150. Which of the following monetary policies reduces aggregate demand and output?

B. An open market sale of government securities.
C. A cut in the discount rate.
An open market sale of bonds increases the supply of bonds, driving down bond prices and pushing up
interest rates. Higher interest rates in turn reduce investment, aggregate demand, and output.

Difficulty: Medium
Topic: AS/AD model
151. Which of the following monetary policies raises aggregate demand and output?
A. An open market sale of government securities.

B. An increase in the Fed funds rate.
A cut in the reserve requirement increases bank reserves, causing banks to reduce interest rates in order
to lend out their excess reserves. Lower interest rates in turn stimulate investment, aggregate demand,
and output.

Difficulty: Medium
Topic: AS/AD model
152. Which of the following monetary policies reduces aggregate demand and output?

B. An open market purchase of government securities.
D. A cut in the required reserve ratio.
An increase in the discount rate is a signal from the Fed that banks should tighten up their lending.
Since banks generally respond to this signal, interest rates will rise, causing investment, aggregate
demand, and output to decline.

Difficulty: Medium
Topic: AS/AD model
153. In the fall of 2008, the Federal Reserve reduced its target for the Federal funds rate dramatically. The
Fed likely made this decision because it believed:
A. savers are not being given enough encouragement to save.

B. unemployment was too low and needed to be boosted.
C. inflation might become a problem and was moving to head it off.
D. there was threat of a recession and was trying to stimulate the economy.
The Fed was fighting a recession in 2008 and 2009, which had occurred due to the financial crisis. This
was a drastic step but it was seen as necessary to stimulate the economy.

Difficulty: Medium
154. During the latter half of 2004 and the beginning of 2007, the Fed adopted a policy that consistently
increased the Federal funds rate. The most likely goal of this policy was to:
A. decrease inflation by decreasing aggregate demand.

B. decrease inflation by increasing aggregate demand.
C. increase output by decreasing aggregate demand.
D. increase output by increasing aggregate demand.
By increasing the Federal funds rate, the Fed sought to increase bank lending rates, which would reduce
business investment and in this way decrease aggregate demand. This reduction in aggregate demand
would in turn reduce inflationary pressure.

Difficulty: Easy
Topic: AS/AD model
155. Suppose that investment is not very responsive to interest rates, so that a sizable increase in interest
rates has only a minor effect on investment. In this case, monetary policy would have:
A. no effect on output.
B. a modest effect on output at best.
C. a substantial effect on output.
D. a massive effect on output.
If investment is insensitive to interest rates, aggregate demand will also be insensitive, reducing the
effectiveness of monetary policy.

Difficulty: Hard
Topic: AS/AD model
156. Suppose that investment is very responsive to interest rates, so that even a small change in interest
rates has a substantial effect on investment. In this case, expansionary monetary policy that results in a
modest drop in interest rates will:
A. not increase output.

B. increase output only slightly.
C. increase output significantly.
D. decrease output sharply.
If investment is very sensitive to interest rates, aggregate demand will also be very sensitive, so that
even a small drop in interest rates will increase investment, aggregate demand, and output sharply.

Difficulty: Hard
Topic: AS/AD model
157. According to the AS/AD model, if the economy is in a recession and the Fed wants to increase output
and employment, it should:
A. act to increase the money supply.

B. act to decrease the money supply.
D. raise reserve requirements.
A policy that increases the money supply will reduce interest rates and stimulate investment, output, and
employment.

Difficulty: Easy
Topic: AS/AD model
158. Other things equal, a rise in interest rates can be expected to:
A. increase the quantity of investment.

B. decrease the quantity of investment.
C. have no effect upon the quantity of investment.
D. increase equilibrium income.
Higher interest rates increase the cost of borrowing, making it more expensive for businesses to borrow
to finance new investment projects.

Difficulty: Medium
Topic: AS/AD model
159. Monetary policy that seeks to minimize the business cycle in the AS/AD model involves:
A. contractionary monetary policy throughout the business cycle.

B. expansionary monetary policy throughout the business cycle.
C. contractionary monetary policy during boom periods and expansionary monetary policy during
recession.
D. contractionary monetary policy during recession and expansionary monetary policy during boom
periods.
Countercyclical policy is designed to dampen the business cycle.

Difficulty: Hard
Topic: AS/AD model
160. According to the AS/AD model, an expansionary monetary policy:

Expansionary monetary policy depresses interest rates by increasing the money supply. Lower interest
rates raise investment and output by making it cheaper for businesses to borrow and invest.

Difficulty: Medium
Topic: AS/AD model
161. According to the AS/AD model, a contractionary monetary policy:

Contractionary monetary policy raises interest rates by reducing the money supply. Higher interest rates
depress investment and output by making it more expensive for businesses to borrow and invest.

Difficulty: Medium
Topic: AS/AD model
162. During a recession, policy makers who use the AS/AD model would probably recommend an open
market:

An open market purchase of government securities increases the demand for bonds, driving up bond
prices and depressing interest rates. Lower interest rates in turn stimulate investment and output.

Difficulty: Medium
Topic: AS/AD model
163. During an inflationary period, policy makers who use the AS/AD model would probably recommend an
open market:

An open market sale of government securities increases the supply of bonds, driving down bond prices
and increasing interest rates. Higher interest rates in turn depress investment and output.

Difficulty: Medium
Topic: AS/AD model
164. In the AS/AD model, higher interest rates are produced by:
A. an expansionary monetary policy.

B. an activist monetary policy.
C. a contractionary monetary policy.
D. a steady-as-you-go monetary policy.
Higher interest rates in the AS/AD model are produced by a contractionary monetary policy designed to
lower investment and decrease output.

Difficulty: Medium
Topic: AS/AD model
165. One year the lead sentence in a Wall Street Journal article read, "Tight job markets, rising wages, and
the economy's continued strength put more pressure on the Federal Reserve to raise short-term interest
rates." If the Fed responded to this pressure, it would adopt:
A. a contractionary monetary policy that reduces output.

B. a contractionary monetary policy that raises output.
C. an expansionary monetary policy that reduces output.
D. an expansionary monetary policy that raises output.
To reduce real growth, the Fed adopts a contractionary monetary policy that raises real interest rates.
Since investment demand is negatively related to interest rates, investment spending would decline,
lowering aggregate demand and real output.

Difficulty: Medium
Topic: AS/AD model
166. The AS/AD model implies that monetary policy should be used to:
A. make adjustments so that savings equal investment.

B. keep the money supply growing at a constant rate.
C. keep the interest rate constant.
D. keep the price level constant.
In the AS/AD model, monetary policy affects the economy through changes in interest rates. These
changes alter investment, saving, and equilibrium income.

Difficulty: Hard
Topic: AS/AD model
167. According to the AS/AD model, a contractionary monetary policy is appropriate:

When saving is less than investment, investment is excessive and so is aggregate demand. A
contractionary monetary policy that raises interest rates and reduces investment and aggregate demand
eliminates the excess investment.

Difficulty: Hard
Topic: AS/AD model
168. According to the AS/AD model, a reduction in the money supply is appropriate:

contractionary monetary policy that raises interest rates and reduces investment and aggregate demand
eliminates the excess investment.

Difficulty: Hard
Topic: AS/AD model
169. If saving is less than investment, the appropriate countercyclical monetary policy would be:
A. a cut in the reserve requirement.

D. a cut in the Fed funds rate.
contractionary monetary policy, like an open market sale of government bonds, raises interest rates and
eliminates the excessive investment and aggregate demand.

Difficulty: Hard
Topic: AS/AD model
170. If saving exceeds investment, the appropriate countercyclical monetary policy would be:
A. an increase in the reserve requirement.

D. an increase in the Fed funds rate.
When saving exceeds investment, investment is inadequate and so is aggregate demand. An

expansionary monetary policy, like a cut in the discount rate, reduces interest rates and boosts
investment and aggregate demand.

Difficulty: Hard
Topic: AS/AD model
171. If the actual Federal funds rate is 7 percent and the Fed's target Federal funds rate is 8 percent, the Fed is

B. A purchase of government bonds.
D. A more expansionary monetary policy.
Since the interest rate is too low relative to the Fed's target, the Fed should push interest rates up using a
contractionary monetary policy such as a sale of government bonds.

Difficulty: Easy
172. If the actual Federal funds rate is 9 percent and the Fed's target Federal funds rate is 8 percent, the Fed is

B. An increase in the discount rate.
D. A more contractionary monetary policy.
Since the interest rate is too high relative to the Fed's target, the Fed should push interest rates down
using an expansionary monetary policy such as a reduction in the reserve requirement.

Difficulty: Easy
173. The effective supply curve of money is:
A. downward sloping because as interest rates rise, the Fed will not supply as much money at lower
interest rates.
B. upward sloping because as interest rates rise, the Fed is willing to increase the quantity of money
supplied.
C. vertical because the Fed adjusts the supply of money to changes in the demand for money at a
targeted interest rate.
D. horizontal because the Fed adjusts the supply of money to changes in the demand for money at a
targeted interest rate.
The effective supply curve of money is horizontal because the Fed targets an interest rate and adjusts
supply to meet demand at that interest rate.

Difficulty: Easy
Topic: Effective Supply Curve
174. If the Fed is targeting an interest rate, creating an effective supply curve of money and the demand for
money increases the Fed will:

B. decrease the money supply.
C. raise the Fed funds rate to reduce money demand.
D. raise the Fed funds rate to increase money demand.
supply to meet demand at that interest rate. So, when the demand for money increases, it must also
increase the supply of money.

Difficulty: Easy
175. If the Fed is targeting an interest rate, creating an effective supply curve of money and the demand for
money decreases the Fed will:
A. sell government bonds.

B. buy government bonds.
C. set a higher Fed funds rate.
D. set a lower Fed funds rate.
supply to meet demand at that interest rate. So, when the demand for money decreases, the Fed must
also decrease the supply of money. It will likely sell bonds to do so.

Difficulty: Medium
176. The Fed targets the interest rate because it:
A. has poor control of the amount of money in the economy.

B. has no control of the money supply.
C. chooses to create an effective supply curve of money at the current interest rate.
D. chooses to create an effective supply curve of money at the target interest rate.
When the Fed targets the interest rate, it is just choosing another approach to manage the money supply.
The Fed will adjust the money supply through OMO according to the targeted interest rate.

Difficulty: Easy
Topic: Targeting Interest Rates
177. The curve most economists use to follow the relationship between the interest rates and bonds' time to
maturity is the:
A. effective supply of money curve.

B. aggregate demand curve.
C. yield curve.
D. demand of money curve.
The curve that shows the relationship between the interest rates and the bonds' time to maturity is the
yield curve.

Difficulty: Medium
Topic: Yield Curve
178. Refer to the graph above. Which of the curves represents an inverted yield curve?
A. A
B. B
C. C
D. D
An inverted yield curve has lower interest rates at longer maturities.

Difficulty: Medium
Topic: Yield Curve
179. Refer to the graph above. Which of the curves represents a normal yield curve?
A. A
B. B
C. C
D. D
A normal yield curve has higher interest rates at longer maturities.

Difficulty: Medium
Topic: Yield Curve
180. The standard discussion of monetary policy is based on the assumption that:
A. long-term rates will fall when the Fed pushes up short-term interest rates.
B. long-term rates will rise when the Fed pushes up short-term interest rates.
C. short-term rates will fall when the Fed pushes up long-term interest rates.
D. short-term rates will rise when the Fed pushes up long-term interest rates.
The standard discussion assumes long-term rates move with short-term rates. The Fed can control the
short-term interest rate.

Difficulty: Medium
Topic: Long Term Interest Rates
181. The standard discussion of monetary policy is based on the assumption that:
A. the entire yield curve shifts up when the Fed sells government bonds.
B. the entire yield curve shifts down when the Fed sells government bonds.
C. the yield curve becomes inverted when the Fed buys government bonds.
D. the yield curve becomes steeper when the Fed buys government bonds.
The standard discussion assumes long-term rates move with short term rates. So, the entire yield curve
shifts up when the Fed increases short-term rates by selling government bonds.

Difficulty: Medium
Topic: Yield Curve
182. When an economy faces an inverted yield curve, compared to short-term bonds the long-term bonds:
A. are riskier.
B. pay lower interest rates.
C. pay higher interest rates.
D. are a safe investment.
During an inverted yield curve, the long term bonds pay lower interest rates.

Difficulty: Medium
Topic: Yield Curve
183. Tools that the Fed uses to increase the money supply that are beyond the traditional tools are called:
A. contractionary tools.
B. fiscal tools.
C. quantitative easing tools.
D. qualitative easing tools.
See definition of quantitative easing in the text.

Difficulty: Easy
184. Which of the following would not be considered an example of quantitative easing?
A. The Fed buys bonds from banks at a zero Fed funds rate.
B. The Fed buys mortgage backed securities.
C. The Fed buys money market funds.
D. The Fed sells bonds to banks.
Quantitative easing is used to stimulate the economy when conventional tools are not effective. Selling
bonds would be used to slow down the economy.

Difficulty: Medium
185. Which of the following gives the correct relationship between nominal and real interest rates?
A. Real interest rate = nominal interest rate + expected inflation rate.

B. Nominal interest rate = real interest rate + expected inflation rate.
C. Nominal interest rate + real interest rate = expected inflation rate.
D. Nominal interest rate = real interest rate - expected inflation.
The real interest rate equals the nominal interest rate adjusted for expected inflation.

Difficulty: Medium
Topic: Nominal Interest Rates
186. Suppose you are a lender and you expect inflation to be 4 percent over the next year because inflation
was 4 percent in the last year. If you want to earn a real return of 2 percent on any loans you make, you
will set the interest rate on your loans equal to:
A. 2 percent.
B. 4 percent.
C. 6 percent.
D. 10 percent.
The nominal interest rate is the sum of the real interest rate and expected inflation.
AACSB: Analytic
Difficulty: Easy
187. Suppose you are a borrower and you expect inflation to be 6 percent over the next year because inflation
was 6 percent in the last year. If you do not want to pay more than 2 percent in real terms for any loan
you take out, you will not borrow if the interest rate is greater than:
A. 2 percent.
B. 6 percent.
C. 8 percent.
D. 14 percent.
The nominal interest rate is the sum of the real interest rate and expected inflation.
AACSB: Analytic
Difficulty: Easy
188. The observation that nominal interest rates have increased implies that:
A. the expected inflation rate must have gone up.

B. the real interest rate must have gone up.
C. either the expected inflation rate went up, the real interest rate went up, or both.
D. either the expected inflation rate went down, the real interest rate went down, or both.
Either expected inflation or real interest rates must have risen.

Difficulty: Hard
189. Suppose the nominal interest rate in Brazil is 40 percent and the expected inflation rate is 150 percent.
The real interest rate is:
A. -110 percent.
B. -190 percent.
C. 110 percent.
D. 190 percent.
Real interest rate = Nominal interest rate - expected inflation rate = 40 percent -150 percent = -110
percent.
AACSB: Analytic
Difficulty: Medium
Topic: Real Interest Rates
190. Suppose the real interest rate in Brazil is 40 percent, actual inflation is 20 percent, and expected
inflation is 20 percent. The nominal interest must then be:
A. 20 percent.
B. 40 percent.
C. 60 percent.
D. 80 percent.
Nominal interest rate = Real interest rate + Expected inflation = 40 percent + 20 percent = 60 percent.
AACSB: Analytic
Difficulty: Easy
191. When people expect higher inflation, usually nominal interest rates will:
A. fall.
B. rise.
C. remain unchanged.
D. move erratically.
If lenders expect higher inflation, they will raise nominal interest rates so as to preserve purchasing
power.

Difficulty: Medium
192. Suppose a contractionary monetary policy raises nominal interest rates. If this is the case, it follows that
the contractionary monetary policy must have:

C. increased expected inflation more than it reduced real interest rates.
D. increased real interest rates more than it reduced expected inflation.
A contractionary monetary policy normally raises real interest rates and reduces expected inflation.
If nominal interest rates rise, it follows that real interest rates must have gone up more than expected
inflation went down.

Difficulty: Hard
193. Suppose an expansionary monetary policy reduces nominal interest rates. If this is the case, it follows
that the expansionary monetary policy must have:

C. increased expected inflation less than it reduced real interest rates.
D. reduced real interest rates less than it increased expected inflation.
An expansionary monetary policy normally reduces real interest rates and raises expected inflation. If
nominal interest rates fall, it follows that real interest rates must have gone down more than expected
inflation went up.

Difficulty: Hard
194. The distinction between real and nominal interest rates:
A. makes it easier to assess the impact of monetary policy.

B. makes it harder to assess the impact of monetary policy.
C. does not affect the assessment of monetary policy since nominal interest rates are observable.
D. does not affect the assessment of monetary policy since real interest rates are observable.
Since real interest rates are unobservable because expected inflation is unobservable, the impact of
monetary policy is more difficult to assess.

Difficulty: Medium
Topic: Real and Nominal Interest Rates
195. As financial markets develop new and complex financial instruments, the Fed has:
A. more control over the long-term interest rate.

B. less control over the long-term interest rate.
C. no control over the short-term interest rate.
D. full control over the short-term interest rate.
The development of new financial instruments provides the public with numerous sources of credit.
The Fed has found that its ability to control the long-term rate has lessened due to these new financial
instruments.

Difficulty: Hard
Topic: Long Term Interest Rate
196. A difference between a monetary regime and monetary policy is that a monetary regime:
A. responds to changes in the economy while a monetary policy does not.

B. does not respond to change in the economy while a monetary policy does.
C. depends on the economic conditions while the monetary policy does not.
D. is not favored while monetary policy is.
A monetary policy responds to changes in the economy, while a monetary regime is a predetermined
policy to be followed independently of changes in the economy.

Difficulty: Hard
Topic: Monetary Regimes
197. Monetary regimes:
A. do not set policy on the basis of a predetermined framework.

B. rely on the discretion of monetary policy officials.
C. use predetermined rules to set monetary policy.
D. produce greater variation in expected inflation than individual monetary policies.
A monetary regime is a predetermined statement of the policy that will be followed in a given situation.

Difficulty: Easy
198. Monetary regimes are:
A. more effective than monetary policies because they produce smaller changes in inflationary
expectations.
B. less effective than monetary policies because they produce smaller changes in inflationary
expectations.
C. less effective than monetary policies because they give policy makers greater discretion.
D. more effective than monetary policies because they give policy makers greater discretion.
By establishing predetermined rules for monetary policy, monetary regimes reduce uncertainty about
expected inflation and in this way limit fluctuations in inflationary expectations.

Difficulty: Medium
ch14 Summary
Category # of
Questions
AACSB: Analytic 28
AACSB: Reflective Thinking 170
BLOOMS TAXONOMY: Analysis 5
BLOOMS TAXONOMY: Comprehension 104
BLOOMS TAXONOMY: Evaluation 28
BLOOMS TAXONOMY: Knowledge 60
BLOOMS TAXONOMY: Synthesis 1
Colander - Chapter 14 202
Difficulty: Difficult 1
Difficulty: Easy 53
Difficulty: Hard 38
Difficulty: Medium 106
Learning Objective: 14-1 50
Topic: AS/AD model 42
Topic: Central Bank 1
Topic: Central Banks 1
Topic: Discount Rate 7
Topic: Effective Supply Curve 3
Topic: Excess Reserves 1
Topic: Federal Fund Rate 1
Topic: Federal Funds Market 2
Topic: Federal Funds Rate 35
Topic: Federal Open Market Committee 1
Topic: Federal Reserve 15
Topic: Long Term Interest Rate 1
Topic: Long Term Interest Rates 2
Topic: Monetary Base 3
Topic: Monetary Policy 15
Topic: Monetary Regimes 3
Topic: Money Market 3
Topic: Money Multiplier 5
Topic: Money Supply 1
Topic: Nominal Interest Rates 6
Topic: Open Market Operations 12
Topic: Quantitative Easing 3
Topic: Real and Nominal Interest Rates 1
Topic: Real Interest Rates 3
Topic: Reserve Requirement 2
Topic: Reserves 1
Topic: Targeting Interest Rates 1
Topic: Taylor Rule 17
Topic: Tools of Monetary Policy 4
Topic: Yield Curve 6

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ch14

A. The money supply.

A. nominal income but never real income.

A. not affect output in the long run.

A. both the AD and SAS curves.

A. both the AD and SAS curves.

A. increases both nominal and real income.

A. affects both inflation and output.

A. A in the short run and the long run.

A. reduces investment but increases aggregate demand.

A. are perfectly flexible.

A. affects both nominal and real income.

A. both monetary policy and fiscal policy.

A. reduce investment spending.

A. direct from the money supply to the aggregate demand.

A. shifts the money supply from M0 to M1.

A. act as a financial adviser to the government.

A. reduce the Fed's budget.

A. elected by the public.

A. Federal Advisory Committee.

A. Conducting monetary policy.

A. Federal Open Market Committee.

A. Federal Open Market Committee.

A. regulating financial institutions.

A. the Chairman of the Fed only.

A. twelve regional Federal Reserve banks.

A. The reserve requirement.

A. Change the exchange rate.

A. currency and coin in circulation plus checkable deposits.

A. currency held by the public.

A. maximum ratio of reserves to deposits that a bank can have.

A. change the demand for money.

A. The corporate income tax.

A. increase reserve requirements.

A. expands the money supply because banks have more to lend.

A. increase both the money multiplier and the money supply.

A. expands and the money multiplier contracts.

A. more than before, increasing the money supply.

A. increase checkable deposits in the banking system by $5 billion.

A. Raising the discount rate.

A. commercial banks charge their largest customers.

A. increase the required reserve ratio.

A. the money supply to expand.

A. increase the money supply.

A. reduce the discount rate by 10.5 percentage points.

A. reduce the discount rate by 3 percentage points.

A. the discount rate.

A. actions taken by the Fed to close or merge weakened banks.

A. Decreasing the amount of loans made to commercial banks.

A. buy government securities worth 250.

A. raise the required reserve ratio to 0.2.

A. buy government securities worth 150.

A. decrease the reserve requirement.

A. increase bank reserves and increase the money supply.

A. Open market purchases of government securities.

A. the Fed funds market.

A. is always slightly higher than the discount rate.