1.

If potential output equals 5,500 and short-run equilibrium output equals 4,500, there is a(n) ______ gap and
the Bank of Canada, according to Taylor rule, will _____ interest rates in order to close the gap.
A. Recessionary; raise.
B. Recessionary; lower.
C. Recessionary; not change.
D. Inflationary; raise.
E. Inflationary; lower.
2. What policy or policies should the Bank of Canada adopt in order to minimize Alberta’s GDP
fluctuation? For simplicity, suppose the Bank of Canada considers Alberta only, not the rest of
Canada.
A) Increase monetary base.
B) Decrease target overnight interest rate.
C) Conduct SPRA.
D) Encourage banks to hold a lower reserve ratio.
E) All of the answers are correct.

3. Suppose the damage from the flood is short term because Alberta still has its oil sands and natural
resources intact. In order to assist the recovery, the Alberta provincial government has decided to
increase spending on fixing roads, schools and houses. How will this fiscal policy affect Alberta?
For simplicity, BB=SBB=0 before the flood.
A) Its SBB will remain constant because the damage is short term.
B) Its BB will become a negative value.
C) Its net export is likely to improve.
D) If the Bank of Canada helps by selling bonds, the present value of bonds will rise.
E) All of the answers are correct.

4. If China has a recession, it is likely that the Canadian dollar will ___ because our commodity exports to
them will _______. In response, the Bank of Canada should ____ the target overnight interest rate if it
wants to minimize GDP fluctuations.
A) Appreciate; decrease; decrease.
B) Appreciate; increase; decrease.
C) Depreciate; increase; increase.
D) Depreciate; decrease; decrease.
E) Depreciate; decrease; increase.

5. If the Bank of Canada sells bonds in the open market, the price of bonds will ___, the money
supply will ___ and the inflation rate will ____.
A) Rise; rise; rise
B) Rise; fall; fall
C) Rise; fall; rise
D) Fall; fall; fall
E) Fall; rise; fall

6. Since 2013, the Bank of Japan has pushed down the value of the Japanese yen. It can
accomplish this by…
A) Cutting interest rates.
B) Selling bonds in the open market.
C) Encouraging banks to hold a higher reserve ratio.
D) Encouraging the public to have a higher currency drain ratio.
 E) Both A and B are correct.

7. Continue with the previous question: In the short run, what is (are) likely to happen as the
yen depreciates?
A) Japan’s net exports will improve.
B) The Japanese will be more likely to take vacations overseas.
C) Japan’s debt-to-GDP ratio will rise.
D) Japan’s investment confidence will fall.
E) All of the answers are correct.

8. Continue with the previous question: In the long run, what is (are) likely to happen as the yen
depreciates?
A) Japan’s production costs will fall.
B) Japan will have a balance of payments surplus.
C) Other countries, such as South Korea and Singapore, will also devalue their currencies.
D) Japan’s price level will rise and may lead to a real exchange rate depreciation.
E) All of the answers are correct.
9. In the short run, if the central bank increases interest rates, then consumption and investment will
______, aggregate demand will ______, and short-run equilibrium output will _______, and potential
output is ________.
A) Increase; shift right; increase; decreased
B) Increase; not shift; increase; unchanged
C) Decrease; shift right; increase; unchanged
D) Decrease; shift left; decrease; unchanged
E) Decrease; not shift; decrease; unchanged

10. In the short run, the outcome of higher energy prices and raising interest rates is that
A. Output may increase or decrease or remain the same.
B. Output will always decrease.
C. The price level will always decrease.
D. The price level may increase, decrease or remain the same.
E. Both B) and D) are correct.
11. In the monetary transmission mechanism, what will follow after an increase in the money supply?
A. Consumption and investment will rise but net exports will fall.
B. Consumption and investment will fall but net exports will rise.
C. Consumption and investment will rise but net exports will remain constant.
D. Consumption, investment and net exports will fall.
E. Consumption, investment and net exports will rise.

The Taylor rule states that a central bank can monitor price stability (low inflation) and output stability
(GDP being close to the potential output Yp) by an equation that links the interest rate with these two
objectives. For Canada, suppose this has been estimated to be as follows: i = i0 + 1.2(π - π*) - 0.3(UR -
URn), where the unemployment rate UR difference from its natural level substitutes for the output gap.

Suppose the inflation target is π* = 2%, the natural rate of unemployment is UR n = 7%, and the
equilibrium rate of interest that is compatible with these two is i0 = 8%. Also, suppose that the level of
inflation π changes with the changes in interest rate according to the following formula: π = π* - Δi. Keep
all answers to 2 decimal places.

12. Assume that we start with π=π* and UR=UR n. What is the value of i?
A) 4%.
B) 5%.
 C) 6%.
D) 7%.
E) 8%.

13. Now suppose a drop in investment confidence leads to an increase in Unemployment Rate to 8%.
Let us put aside inflation rates for now. According to Taylor rule, what interest rate should the
Bank of Canada now set?
A) 3.3%.
B) 4.4%.
C) 5.5%.
D) 6.6%.
E) 7.7%.

14. Replace the expression for π shown above (that links π to the change in interest rate) into the
Taylor rule and solve for the new interest rate that will now combine the anticipated increase in
inflation as well as the increase in the unemployment rate. What is the new interest rate that the
BOC should set?
A) 3.55%.
B) 4.88%.
C) 5.72%.
D) 6.85%.
E) 7.86%.

15. Following from the previous question: What is the new π value?
A) 1.45%.
B) 2.14%.
C) 3.33%.
D) 4.12%.
E) 5.67%.

16. Compare your new interest rate with i0 = 8%: For this change in the interest rate, the Bank of
Canada has to ____ bonds through open market operations and the Canadian dollar is likely to
____ as a result.
A) Buy; appreciate
B) Buy; depreciate
C) Sell; appreciate
D) Sell; depreciate
E) Buy; stay constant
Assume that the following data characterize a hypothetical economy: money supply = $200 billion;
quantity of money demanded for transactions = $150 billion; quantity of money demanded as an asset =
$10 billion at 13 percent interest, increasing by $10 billion for each 2-percentage point fall in the interest
rate.

17. What is the equilibrium interest rate?

A) 4%.
B) 5%.
C) 6%.
D) 7%.
E) 8%.

18. At the equilibrium interest rate, what is the quantity of money demanded as an asset?
 A) $30 billion.
B) $35 billion.
C) $40 billion.
D) $45 billion.
E) $50 billion.
19. The demand for money is given as Md = 1,910 - 110i, where Md is the quantity of money demanded (in
billions of dollars) and i is the interest rate in percentage points. For example, if i = 2%, leave i = 2. The
supply of money is set at $700 billion. Suppose that all demand deposits are held in commercial banks, and
that all commercial banks have a fractional reserve ratio equal to 50%. The initial equilibrium interest rate
is equal to _____, and if the Bank of Canada wants the interest rate to be 9%, it should ____ bonds in the
amount of ____ billion of dollars.
A) 3%; buy; $700
B) 5%; sell; $700
C) 11%; buy; $110
D) 11%; sell; $700
E) 11%; buy; $220
20. If the reserve ratio of all commercial banks is 0.2 and the currency deposit ratio of the public is 0.2, then an
open market sale of bonds by the central bank of $100 million will result in
A) $250 million increase in money supply.
B) $300 million increase in money supply.
C) $250 million decrease in money supply.
D) $300 million decrease in money supply.
E) None of the above is correct.
A simplified economy is specified as below, with all values in billions of US$.

Consumption expenditure: C = 290 + 0.8(Y-T) (Net) Taxes: 0.2Y

Investment expenditure: I = 350 Exports: 170
Government expenditure: G = 510 Imports: 0.4Y
21. What is equilibrium Y?
A) $1,445.67.
B) $1,600.
C) $1,636.60.
D) $1,736.84.
E) $3,300.
22. The goods market multiplier is equal to ___.
A) 1.32
B) 1.67
C) 2.50
D) 2.78
E) 5.00

23. Suppose that potential Yp is equal to $2,447. What is the change in G that is required to close
this output gap?
A) $145.27.
B) $169.40.
C) $538.00.
D) $758.58.
E) $1,001.33.

24. Continue with the previous question: Suppose the government can also choose to
change taxes in order to close the output gap. In this case, the government should ____
taxes and the amount of tax changes will be _______ the amount of change in G you
have found in the previous question.
A) Cut; larger than
B) Cut; equal to
C) Raise; larger than
D) Raise; equal to
E) Raise; smaller than

25. Instead of fiscal policies, the central bank of the country can use monetary policies to
close the output gap. This central bank should ___ its target overnight interest rates by
_______ bonds and letting its currency_____.
A) Increase; buying; depreciate
B) Increase; selling; appreciate
C) Increase; buying; depreciate
D) Decrease; buying; depreciate
E) Decrease; selling; appreciate