Chapter 26
Monetary Policy
1. The demand for money that households keep for emergency purposes is known as the
a. precautionary demand.
b. emergency demand.
c. speculative demand.
d. temporary demand.
ANS
a. Correct. The demand for money that households keep for emergency purposes is
known as the precautionary demand.
b. Incorrect. This is a meaningless term.
c. Incorrect. This is the money people hold in response to interest rates.
d. Incorrect. This is a meaningless term.
2. The quantity of money held in response to interest rates is the
a. transactions motive for holding money.
b. precautionary motive for holding money.
c. speculative motive for holding money.
d. unit-of-account motive for holding money.
ANS
a. Incorrect. This is money people hold from predictable expenses.
b. Incorrect. This is money people hold for unpredictable expenses.
c. Correct. The quantity of money held in response to interest rates is the speculative
motive for holding money.
d. Incorrect. This is a meaningless term.
3. The speculative demand for money
a. varies inversely with income.
b. is only concerned with active money.
c. involves holding money for unexpected problems.
d. varies directly with the transactions demand for money.
e. varies inversely with the interest rate.
ANS
a. Incorrect. The speculative demand for money varies inversely with the interest rate.
b. Incorrect. This is a meaningless concept.
c. Incorrect. This is precautionary demand.
d. Incorrect. The speculative demand for money varies inversely with the interest rate.
e. Correct. The speculative demand for money varies inversely with the interest rate.
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4. Other things being equal, the quantity of money that people wish to hold can be
expected to
a. increase as the interest rate increases.
b. decrease as the interest rate increases.
c. decrease as real GDP increases.
d. none of the answers are correct..
ANS
a. Incorrect. The quantity of money that people wish to hold can be expected to decrease
as the interest rate increases.
b. Correct. The reason for inverse relationship is the speculative demand.
c. Incorrect. The quantity of money that people wish to hold can be expected to decrease
as the interest rate increases.
d. Incorrect. Answer b. is correct.
5. A decrease in the interest rate, other things being equal, causes a (an)
a. upward movement along the demand curve for money.
b. downward movement along the demand curve for money.
c. rightward shift of the demand curve for money.
d. leftward shift of the demand curve for money.
ANS
a. Incorrect. A decrease in the interest rate, other things being equal, causes a
downward movement along the demand curve for money.
b. Correct. A decrease in the interest rate, other things being equal, causes a
downward movement along the demand curve for money.
c. Incorrect. A decrease in the interest rate, other things being equal, causes a
downward movement along the demand curve for money.
d. Incorrect. A decrease in the interest rate, other things being equal, causes a
downward movement along the demand curve for money.
6. Which of the following statements is true?
a. The speculative demand for money at possible interest rates gives the demand for
money curve its upward slope.
b. There is an inverse relationship between the quantity of money demanded and the
interest rate.
c. According to the quantity theory of money, any change in the money supply will have
no effect on the price level.
d. All of the answers are correct.
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ANS
a. Incorrect. This is the reason for the downward slope.
b. Correct. Because of speculative demand there is an inverse relationship between the
quantity of money demanded and the interest rate.
c. Incorrect. The change in the money supply operates through the transmission mechanism
to affect the price level.
d. Incorrect. Answer b. is correct.
Exhibit 12 Money market demand and supply curves
MS1
MS2
(percent)
Interest Rate
8
E1
6
E2
4
MD
2
0
200
400
600
800
Quantity of Money
(billions of dollars)
7. In Exhibit 12, assume an equilibrium with an interest rate of 15 percent and the money
supply at $100 billion. The Fed uses its policy tools to move the economy to a new
equilibrium at E2 with money supply of $150 billion and an interest rate of 10 percent.
This change could be the result of a(an)
a. open market sale of securities by the Fed.
b. higher discount rate set by the Fed.
c. higher required-reserve ratio set by the Fed.
d. open market purchase of securities by the Fed.
ANS
a. Incorrect. An open market sale reduces excess reserves in the banking system and
decreases the money supply.
b. Incorrect. A higher discount rate discourages borrowing to meet the required reserve
ration and decrease the money supply.
c. Incorrect. A higher required reserve ratio reduces excess reserves and decreases the
money supply.
d. Correct. An open market purchase injects excess reserves into the banking system and
increases the money supply.
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8. According to Keynesians, an increase in the money supply will
a. decrease the interest rate, and increase investment, aggregate demand, prices, real
GDP, and employment.
b. decrease the interest rate, and decrease investment, aggregate demand,
prices, real GDP, and employment.
c. increase the interest rate, and decrease investment, aggregate demand,
prices, real GDP, and employment.
d. only increase prices.
ANS
a. Correct. This is the Keynesian transmission mechanism.
b. Incorrect. An increase in the money supply will decrease the interest rate and increase
investment.
c. Incorrect. An increase in the money supply decreases the interest rate.
d. Incorrect. Investment, aggregate demand, real GDP and employment also increase.
9. While the classicists believed that both velocity and output are stable, Keynesians
believe
a. velocity is stable and output is variable.
b. velocity and output are both variable.
c. output is stable and velocity is variable.
d. the same as the classical economists that both output and velocity are stable.
ANS
a. Incorrect. Keynesians believe velocity and output are both variable.
b. Correct. Keynesians believe velocity and output are both variable.
c. Incorrect. Keynesians believe velocity and output are both variable.
d. Incorrect. Keynesians believe velocity and output are both variable.
Exhibit 13 Money, investment and product markets
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10. In Exhibit 13, when the money supply increases from S1 to S2, the equilibrium
interest rate
a. remains unchanged.
b. increases from i2 to i1, increasing investment spending from I1 to I2.
c. increases from i2 to i1, decreasing investment spending from I2 to I1.
d. decreases from i1 to i2, increasing investment spending from I1 to I2.
ANS
a. Incorrect. The equilibrium rate decreases from i1 to i2, increasing investment spending
from I1 to I2.
b. Incorrect. The equilibrium rate decreases from i1 to i2, increasing investment spending
from I1 to I2.
c. Incorrect. The equilibrium rate decreases from i1 to i2, increasing investment spending
from I1 to I2.
d. Correct. The equilibrium rate decreases from i1 to i2, increasing investment spending
from I1 to I2.
11. In Exhibit 13, if the interest rate falls from i1 to i2, investment spending will
a. increase, and aggregate demand will shift from AD1 to AD2.
b. decrease, and aggregate demand will shift from AD2 to AD1.
c. remain the same, and aggregate demand will shift from AD2 to AD3.
d. increase, and aggregate demand will shift from AD2 to AD1.
ANS
a. Correct. If the interest rate falls from i1 to i2, investment spending will increase, and
aggregate demand will shift from AD1 to AD2.
b. Incorrect. If the interest rate falls from i1 to i2, investment spending will increase, and
aggregate demand will shift from AD1 to AD2.
c. Incorrect. If the interest rate falls from i1 to i2, investment spending will increase, and
aggregate demand will shift from AD1 to AD2.
d. Incorrect. If the interest rate falls from i1 to i2, investment spending will increase, and
aggregate demand will shift from AD1 to AD2.
12. In Exhibit 13, a shift in aggregate demand from AD1 to AD2
a. cannot raise real GDP because the economy is at full employment.
b. cannot raise real GDP because the aggregate supply curve is upward sloping at GDP2.
c. will raise real GDP because the economy is operating below the full-employment level.
d. will cause the interest rate to increase from i2 to i1.
ANS
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a. Incorrect. Between AD1 and AD2, the economy is not at full employment.
b. Incorrect. The upward-sloping aggregate supply curve does not mean real GDP cannot
increase.
c. Correct. A shift in aggregate demand from AD1 to AD2 will raise real GDP because the
economy is operating below the full-employment level.
d. Incorrect. The shift is caused by a decrease in the interest rate.
13. The Monetarist transmission mechanism through which monetary policy affects the
price level, real GDP, and employment depends on the
a. indirect impact of changes on the interest rate.
b. indirect impact of changes on profit expectations.
c. direct impact of changes in fiscal policy on aggregate demand.
d. direct impact of changes in the money supply on aggregate demand.
ANS
a. Incorrect. Monetarists believe in the direct impact of changes in the money supply on
aggregate demand.
b. Incorrect. Monetarists believe in the direct impact of changes in the money supply on
aggregate demand.
c. Incorrect. Monetarists believe in the direct impact of changes in the money supply on
aggregate demand.
d. Correct. Monetarists believe in the direct impact of changes in the money supply on
aggregate demand.
14. The equation of exchange states
a. MV = PQ.
b. MP = VQ.
c. MP = V/Q.
d. V = M/PQ.
ANS
a. Incorrect. The equation of exchange states MP = VQ.
b. Correct. The equation of exchange states MP = VQ.
c. Incorrect. The equation of exchange states MP = VQ.
d. Incorrect. The equation of exchange states MP = VQ.
15. The quantity theory of money assumes that the velocity of money
a. is constant.
b. will rise if the money supply rises and fall if the money supply falls.
c. will rise if the money supply rises, but it will not change if the money supply falls.
d. will fall if the money supply rises, and it will rise if the money supply falls.
ANS
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a. Correct. The quantity theory of money assumes that the velocity of money is constant.
b. Incorrect. The quantity theory of money assumes that the velocity of money is constant.
c. Incorrect. The quantity theory of money assumes that the velocity of money is constant.
d. Incorrect. The quantity theory of money assumes that the velocity of money is constant.
16. The transactions demand for money is the demand for money by households for
a. rainy day spending.
b. predictable spending purposes.
c. liquidity purposes.
d. investing purposes.
ANS
a. Incorrect. This is the reason for the precautionary demand for money.
b. Correct. The transactions demand for money is the demand for money by households
for predictable spending purposes.
c. Incorrect. This concept concerns the ease with which money can be spent directly in
the marketplace.
d. Incorrect. This is the reason for the speculative demand for money.
17. People react to an excess supply of money by
a. selling bonds, thus driving up the interest rate.
b. selling bonds, thus driving down the interest rate.
c. buying bonds, thus driving up the interest rate.
d. buying bonds, thus driving down the interest rate.
ANS
a. Incorrect. People react to an excess supply of money by buying bonds, thus driving
down the interest rate.
b. Incorrect. People react to an excess supply of money by buying bonds, thus driving
down the interest rate.
c. Incorrect. People react to an excess supply of money by buying bonds, thus driving
down the interest rate.
d. Correct. People react to an excess supply of money by buying bonds, thus driving
down the interest rate.
18. The belief that the velocity of money is not constant but highly predictable is
associated with the
a. classical school.
b. Keynesian school.
c. supply-side school.
d. rational expectations school.
e. monetarist school.
ANS
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a. Incorrect. The belief that the velocity of money is not constant but highly predictable is
associated with the monetarist school.
b. Incorrect. The belief that the velocity of money is not constant but highly predictable is
associated with the monetarist school.
c. Incorrect. The belief that the velocity of money is not constant but highly predictable is
associated with the monetarist school.
d. Incorrect. The belief that the velocity of money is not constant but highly predictable
is associated with the monetarist school.
e. Correct. The belief that the velocity of money is not constant but highly predictable is
associated with the monetarist school.
19. The monetary rule is the view of the
a. Keynesians that monetary policy is most important.
b. Monetarists that monetary policy is most important.
c. Classical economists that monetary policy is most important.
d. Monetarists that the Fed should expand the money supply at a constant rate.
ANS
a. Incorrect. The monetary rule is the view of the Monetarists that the Fed should expand
the money supply at a constant rate.
b. Incorrect. The monetary rule is the view of the Monetarists that the Fed should expand
the money supply at a constant rate.
c. Incorrect. The monetary rule is the view of the Monetarists that the Fed should expand
the money supply at a constant rate.
d. Correct. The monetary rule is the view of the Monetarists that the Fed should expand
the money supply at a constant rate.
20. Which of the following statements is true?
a. Keynesians advocate increasing the money supply during economic recessions but
decreasing the money supply during economic expansions.
b. Monetarists advocate increasing the money supply by a constant rate year after year.
c. Keynesians argue that the crowding-out effect is rather insignificant.
d. Monetarists argue that the crowding-out effect is rather large.
e. All of the answers are correct.
ANS
a. Incorrect. Each answer is correct.
b. Incorrect. Each answer is correct.
c. Incorrect. Each answer is correct.
d. Incorrect. Each answer is correct.
e. Correct. Each answer is correct
.
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