Week 12: Assignment 12: Solution

Q1. An _________ in government expenditure __________ rate of interest which further

__________ private investment.
A. increase; decreases; increases
B. increase; increases; decreases
C. decrease; increases; increases
D. decrease; decreases; decreases
Answer: B. increase; increases; decreases
Explanation: An increase in government expenditure primarily shifts the IS curve to the
right, indicating higher income and output levels. Consequently, the higher interest rates can
discourage private investment, causing it to decrease.
Q2. When price level is increased (nominal money supply remaining same) the real money
supply _______ and the LM curve shifts _________.
A. increases; rightwards
B. decreases; rightwards
C. decreases; leftwards
D. increases; leftwards
Answer: C. decreases; leftwards
Explanation: When the price level increases (with the nominal money supply remaining the
same), the real money supply decreases. This is because a higher price level reduces the
purchasing power of a given amount of money, which means people can buy less with the
same amount of money. As a result, the LM curve shifts leftwards.
Q3. The delay between recognition of need for action and policy decision is called
__________.
A. Decision lag
B. Recognition lag
C. Information lag
D. Action lag
Answer: A. Decision lag
Explanation: (Factual Question)
Q4. Decision lags in monetary policy are ___ than/to fiscal policy; Action lags in monetary
policy are ___ than/to fiscal policy.
longer; longer
shorter; shorter
equal; longer
shorter; longer
Answer: B. shorter; shorter
Explanation: Monetary policy decisions, which are made by central banks, can be
implemented more quickly compared to fiscal policy decisions, which typically require
legislative action and government budget processes. This is why decision lags and action lags
are generally shorter in monetary policy.
Q5. As per Hierarchical mandates,
A. equal importance is given to price stability and economic growth.
B. no importance is given to economic growth.
C. economic growth can be pursued as long as price stability is achieved first.
D. price stability can be pursued as long as economic growth is achieved first.
Answer: C. economic growth can be pursued as long as price stability is achieved first.
Explanation: (Factual Question)
Q6. Which of the following is not a goal of monetary policy?
A. Interest rate targeting
B. Price stability
C. Financial market stability
D. Economic growth
Answer: A. Interest rate targeting
Explanation: Interest rate targeting is a tool not a goal
Q7. Which of the following is not an advantage of inflation targeting
A. Increased accountability of central banks.
B. Reduced inflation rates and expectations.
C. Simplicity and clarity regarding a numerical target for inflation rate.
D. Inflation outcomes are revealed without any substantial lag.
Answer: D. Inflation outcomes are revealed without any substantial lag.
Explanation: (Factual question)
Q8. The first country to adopt inflation targeting was
A. the United Kingdom.
B. Canada.
C. New Zealand.
D. Australia.
Answer: C. New Zealand.
Explanation: (Factual Question)
Q9. According to Tobinʹs q theory, when q is ________, firms will not purchase new
investment goods because the market value of firms is ________ relative to the cost of
capital.
A. low; low
B. low; high
 C. high; low
D. high; high
Answer: A. low; low
Explanation: Tobin's q theory suggests that when "q" is low, indicating that a firm's market
value of assets is less than the cost of replacing them, firms are unlikely to invest in new
capital goods because it doesn't make economic sense to buy new assets at a higher cost than
their market value.
Q10. Because of the balance sheet channel, an expansionary monetary policy causes a
________ in net worth, which ________ the adverse selection problem in credit markets.
A. decline; increases
B. rise; increases
C. rise; reduces
D. decline; reduces
Answer: C. rise; reduces
Explanation: An expansionary monetary policy, typically characterized by lower interest
rates, increases the market value of assets held by individuals and firms, leading to a rise in
their net worth. This improved financial standing is advantageous in credit markets because it
reduces the adverse selection problem. With higher net worth, borrowers are perceived as less
risky by lenders, as they have valuable collateral to secure their loans. This decreased risk
perception enables lenders to distinguish between high-risk and low-risk borrowers more
easily and fosters increased credit access, promoting economic activity.