Practice Questions for final exam – Econ 351– These are mostly from the material
covered in the last half of course
True / False (Answer A for true and B for false)
1. NAIRU is defined as the rate of inflation at which we expect unemployment to begin
increasing.
2. According to the Fisher effect, higher real rates of interest cause inflation to go down
due to weaker aggregate demand.
3. It takes longer for Fiscal Policy authorities to turn the implement policy than it does
for Monetary Authorities.
4. The main measure of inflation used by the fed to gauge inflationary pressures is the
headline inflation number, the CPI (consumer price index)..
5. We argued, using the Taylor Rule, when the federal funds rate falls below 3%, Fed
policy is considered easy (accommodative).
6. According to the Fisher effect, if inflationary expectations rise, then real rates of
interest will rise as well.
7. During the late 1990s, the unemployment rate in the US fell below 4 percent!
8. By overheating, we mean either that the unemployment rate is too low or GDP growth
is too fast, or a combination of both.
9. If the current price of a US Treasury bond is 110, then that bond is selling at a
premium.
10. The Fed tends to care more about the over all rate inflation as opposed to the core
rate of inflation.
11. One reason the bond market rallies is the safe haven argument – that is, when the
financial waters get rough and murky, investors tend to prefer the safe haven of US
Treasuries.
12. If I expect interest rates to rise in the future, then I should sell bonds now.
13. If the spread between rates on Ford bonds and comparable US Treasuries rises then
we say that the risk premium on Ford bonds has risen.
14. The risk structure of interest rates is
A) the structure of how interest rates move over time.
B) the relationship among interest rates of different bonds with the same maturity.
C) the relationship among the term to maturity of different bonds.
D) the relationship among interest rates on bonds with different maturities.
15. Which of the following long-term bonds has the highest interest rate?
A) Corporate Aaa bonds
B) U.S. Treasury bonds
C) Corporate Aa bonds
D) Corporate Baa bonds
16. The risk premium on corporate bonds becomes smaller if
A) the riskiness of corporate bonds increases.
B) the liquidity of corporate bonds increases.
C) the liquidity of corporate bonds decreases.
D) the riskiness of corporate bonds decreases.
E) both (b) and (d) occur.
17. If the expected path of one-year interest rates over the next four years is 5 percent, 4
percent, 2 percent, 1 percent, then the expectations theory predicts that today's interest
rate on the four-year bond is
A) 1 percent. B) 2 percent. C) 3 percent. D) 4 percent. E) 5 percent.
18. If the yield curve is flat for short maturities and then slopes downward for longer
maturities, the liquidity premium theory (assuming a mild preference for shorter-term
bonds) indicates that the market is predicting.
A) a rise in short-term interest rates in the near future and a decline further out in the
future.
B) constant short-term interest rates in the near future and a decline further out in the
future.
C) a decline in short-term interest rates in the near future and a rise further out in the
future.
D) a decline in short-term interest rates in the near future and an even steeper decline
further out in the future.
19. Technical analysts try to find patterns in stock prices by looking at charts and thus,
are often referred to as chart watchers.
20. In class we argued that long rates react more to changes in inflationary expectations
relative to short rates. This higher volatility helps explain why the yield curve is
‘typically’ upward sloping.
21. The liquidity premium theory of the term structure helps explain why on average, the
Treasury yield curve typically slopes upward. The liquidity premium theory relies on the
fact that the longer the maturity, the less liquid the bond and thus, the higher the interest
rate (lower the price), since investors require a ‘liquidity premium’ in order to purchase
the longer-term security.
22. One reason China has such a large appetite for US Treasuries is due to the fact they
peg their currency to the US dollar. Recently, there has been pressure on the yuan
(Chinese currency) to appreciate and in order to offset that pressure, Chinese authorities
buy US dollars and subsequently, use those dollars to buy US Treasuries.
23. The risk structure of interest rates is
A) the structure of how risks in buying bonds move over time.
B) the relationship among interest rates of different bonds with the same maturity.
C) the relationship among the term to maturity of different bonds.
D) the relationship among interest rates on bonds with different maturities.
24.
The risk premium on corporate bonds (yield on corporate’s minus yield of
Treasuries) becomes smaller if
A) the riskiness of corporate bonds increases.
B) the liquidity of corporate bonds increases.
C) the liquidity of corporate bonds decreases.
D) the riskiness of corporate bonds decreases.
E) both (b) and (d) occur.
25. If productivity growth falls and with it, inflationary expectations rise, then the bond
market should rally (according to the Fisher effect).
26. The slope of the yield curve has gotten more reliable, through time, in terms of its
ability to predict recessions (i.e., it has improved through time as a reliable forward
economic indicator).
27. According to a previous HW assignment on the yield curve, the slope of the yield
curve is typically higher during recoveries than it is during recessions.
28. Hubris is one reason that E. Asian countries called in the IMF to bail them out.
29. During the credit crunch of 1998, Greenspan was worried about the credit markets:
The demand for commercial paper and corporate bonds rose dramatically causing the
yields on commercial paper and corporate bonds to rise dramatically.
30. During the Russian crisis the US T-bill market rallied.
31. The Fed cut in September of 1998, the first of three in a seven week period, came as
a complete surprise to many, if not all, investors.
32. The Fed’s second interest rate cut in October of 1998 was not effective in lowering
the commercial paper - bill spread
33. The credit crunch, in general, pushed interest rates higher in emerging economies.
34. One similarity between the Asian and Russian crises was that capital flowed into US
bond markets.
35. During the credit crunch of 1998, the spread between the commercial paper rate and
US T-bill rose dramatically up until the Fed’s surprise cut in October.
36. During the credit crunch of 1998, most foreign bond markets rallied.
37. The Fed cut in October of 1998, the second of three in a seven week period, came as
a complete surprise to many, if not all, investors.
38. The Fed’s first interest rate cut in September of 1998 was not effective in lowering
the commercial paper - bill spread.
39. The Russian default in August of 1998 came as a complete surprise to many
investors.
40. The role of banks during the credit crunch of 1998 is consistent with banks being a
spare tire.
L = - [α (π-π*)2 + β ( y-y*)2 ]
41. According to the loss function above, where the variables and parameters are defined
as in class, missing your inflation target by 100 basis points on the upside is just as costly
to social welfare as missing your inflation target by 100 basis points on the downside.
42. According to the loss function above, Paul Volcker’s β is bigger than his α consistent
with the notion that Paul Volcker is an inflation hawk.
43. We discussed that in the context of the loss function above, all policy makers have
their own personalized α’s and β’s and that what really matters is their relative
magnitude. That is, we argued that if α/β is greater than 1, then the policymaker is
considered to be dovish and would more than likely vote for policy easing in a
stagflation environment relative to a hawk, whose α/β is less than one.
44. According to the Taylor rule, if we are hitting our target for inflation and GDP
growth, then the federal funds rate should be set at 4%
45. The Taylor principle is a principle of fighting inflation by raising nominal interest
rates faster than inflation rises so that the real federal funds rate rises. For example, if the
actual inflation rate rises by 100 basis points then the Taylor principle tells us to raise the
federal funds rate by 150 basis points, all else constant.
46. The 2003 – 2004 period was when Alan Greenspan arguably had interest rates too
low for too long as he (and the FOMC) set the federal funds rate target at 1%. Taylor
(from the Taylor rule) arguesthat this rate (1%) was below the implied fed funds rate
from the Taylor rule. Given that GDP was at potential (target) and that actual inflation
was 1% where the target or optimal inflation rate is 2%, the Fed, according to the Taylor
rule should have had the federal funds target set at 2%.