Question 1

According to the Taylor rule, does the target for the federal funds rate respond differently for an increase in inflation caused by an increase in aggregate demand and for an increase in inflation caused by a decrease in short-run aggregate supply? Explain whether there is or is not a difference in how the target for the federal funds rate changes.

Accepted Answer

The target for the federal funds rate responds differently. The current inflation rate and the inflation gap are the same in both cases, but the output gap differs. The output gap (percentage difference between real GDP and potential real GDP) will be positive for the inflation caused by an increase in aggregate demand, but negative for the inflation caused by a decrease in short-run aggregate supply. The target for the federal funds rate will be higher in the case of the increase in inflation caused by an increase in aggregate demand.

Question 2

An increase in the interest rate should ________ the demand for dollars and the value of the dollar, and net exports should ________.

Accepted Answer

A)   decrease; decrease
B)   decrease; increase
C)   increase; decrease
D)   increase; increase
E)   increase; not change C

Question 3

The Fed's two main monetary policy targets are

Accepted Answer

A)   the money supply and the inflation rate.
B)   the money supply and the interest rate.
C)   the interest rate and real GDP.
D)   the inflation rate and real GDP. B

Question 4

Which of the following situations is one in which the Fed will potentially pursue expansionary monetary policy?

Accepted Answer

A)   Potential GDP is forecasted to be higher than equilibrium GDP.
B)   Potential GDP is forecasted to be lower than equilibrium GDP.
C)   Aggregate demand is growing too fast to keep the economy at full employment.
D)   Aggregate demand is growing too slowly and the economy is in danger of producing GDP above full employment.

Question 5

Figure 26-7 
-Refer to Figure 26-7. Suppose the economy is in a recession and the Fed pursues an expansionary monetary policy. Using the static AD-AS model in the figure above, this would be depicted as a movement from

Accepted Answer

A)   A to B.
B)   B to C.
C)   C to B.
D)   A to E.
E)   C to D.

Question 6

The situation in which short-term interest rates are pushed to zero, leaving the central bank unable to lower them further is known as

Accepted Answer

A)   the Taylor rule.
B)   a liquidity trap.
C)   a zero-sum game.
D)   an interest rate panic.

Question 7

Expansionary monetary policy to prevent real GDP from falling below potential real GDP would cause the inflation rate to be relatively ________ and real GDP to be relatively ________.

Accepted Answer

A)   higher; higher
B)   higher; lower
C)   lower; higher
D)   lower; lower

Question 8

Most economists believe that the best monetary policy target is

Accepted Answer

A)   an interest rate.
B)   the money supply.
C)   total bank reserves.
D)   the discount rate.

Question 9

The Taylor rule predicted a federal funds rate which was ________ that set when Paul Volcker was chairman of the Fed, and a rate which was ________ that set when Arthur Burns chaired the Fed.

Accepted Answer

A)   greater than; equal to
B)   greater than; less than
C)   less than; equal to
D)   less than; greater than

Question 10

What actions should the Fed take if it believes the economy is about to experience a high rate of inflation?

Accepted Answer

The answer of What actions should the Fed take if...

Question 11

The Federal Reserve System's four monetary policy goals are

Accepted Answer

A)   low government budget deficits, low current account deficits, high employment, and a high foreign exchange value of the dollar.
B)   low rate of bank failures, high reserve ratios, price stability, and economic growth.
C)   price stability, high employment, economic growth, and stability of financial markets and institutions.
D)   price stability, low government budget deficits, low current account deficits, and low rate of bank failures.

Question 12

An increase in the demand for Treasury bills will

Accepted Answer

A)   increase the price of Treasury bills.
B)   increase the interest rate on Treasury bills.
C)   increase the opportunity cost of holding money vs. Treasury bills.
D)   eventually cause households to hold less money.

Question 13

Falling interest rates can

Accepted Answer

A)   increase a firm's stock price, which causes firms to issue more stock shares, and thus increases funds for investment.
B)   raise the cost of borrowing for firms and decrease investment.
C)   raise the cost of buying new homes and fewer new homes will be purchased.
D)   lower the cost of buying new homes and fewer new homes will be purchased.

Question 14

Suppose you buy a house for $250,000. One year later, the market price for the house has fallen to $200,000. What is the return on your investment in the house if you made a down payment of 10 percent and took out a mortgage loan for the other 90 percent?

Accepted Answer

The answer of Suppose you buy a house for $250,000....

Question 15

According to the Taylor rule, the Fed should set the target for the federal funds rate equal to the sum of the equilibrium real federal funds rate, the current inflation rate, one-half times the ________, and one-half times the ________.

Accepted Answer

A)   interest rate gap; inflation gap
B)   interest rate gap; output gap
C)   inflation gap; output gap
D)   unemployment gap; government-spending gap

Question 16

When the Federal Reserve increases the money supply, at the previous equilibrium interest rate households and firms will now have

Accepted Answer

A)   more money than they want to hold.
B)   less money than they want to hold.
C)   the amount of money that they want to hold.
D)   to sell Treasury bills.

Question 17

Write out the expression for the Taylor rule. Use the Taylor rule to explain how a decline in real GDP below potential GDP will affect the Federal Reserve's target for the federal funds rate.

Accepted Answer

The answer of Write out the expression for the Taylor...

Question 18

Which of the following is true about the Federal Reserve and its ability to prevent recessions? The Federal Reserve

Accepted Answer

A)   does not try to eliminate recessions, but instead focuses on preventing inflation.
B)   can fine tune the economy and realistically hope to keep the economy from experiencing recessions.
C)   cannot realistically fine tune the economy, but seeks to keep recessions shorter and milder than they would otherwise be.
D)   cannot realistically fine tune the economy and has little to no effect on the magnitude and length of recessions.

Question 19

The smaller the fraction of an investment financed by borrowing,

Accepted Answer

A)   the greater the potential return and potential loss on that investment.
B)   the smaller the potential return and potential loss on that investment.
C)   the greater the potential return and the smaller the potential loss on that investment.
D)   the smaller the potential return and the greater the potential loss on that investment.

Question 20

Figure 26-11 
-Refer to Figure 26-11. In the dynamic model of AD-AS in the figure above, if the economy is at point A in year 1 and is expected to go to point B in year 2, the Federal Reserve would most likely

Accepted Answer

A)   increase interest rates.
B)   decrease interest rates.
C)   not change interest rates.
D)   decrease the inflation rate.

Exam 26: Monetary Policy

An increase in the interest rate should the demand for dollars and the value of the dollar, and net exports should .