Practice Exam IV Econ 1040 Key 1. Which is not a function of the

Practice Exam IV Econ 1040

Key

1. Which is not a function of the Fed?

A.

Conducting monetary policy.

B.

Serving as a lender of last resort.

C.

Providing financial services such as check clearing to commercial banks.

D.

Financing U.S. budget deficits.

Financing U.S. budget deficits is the job of the Treasury Department.

AACSB: Reflective Thinking

BLOOMS TAXONOMY: Knowledge

Colander - Chapter 14 #49

Difficulty: Medium

Learning Objective: 14-2

Topic: Federal Reserve

2. The monetary base includes:

A.

currency and coin in circulation plus checkable deposits.

B.

currency and coin in circulation only.

C.

vault cash plus checkable deposits.

D.

currency and cash plus commercial bank deposits at the Fed.

The monetary base represents the liabilities or IOUs of the Fed, which include vault cash plus commercial bank deposits at the Fed.




Difficulty: Hard


Topic: Monetary Base

3. To increase the nation's money supply, the Fed can:

A.

increase the required reserve ratio.

B.

decrease the discount rate.

C.

increase the discount rate.

D.

sell bonds.

A cut in the discount rate reduces the cost that banks pay when they borrow from the Fed and is usually a signal that the Fed wants banks to engage in additional lending.


BLOOMS TAXONOMY: Comprehension


Difficulty: Easy


Topic: Discount Rate

4. If the Fed simultaneously reduces the discount rate and the required reserve ratio, the money supply will:

A.

contract.

B.

remain unchanged.

C.

expand.

D.

take on a value that cannot be determined from the information given.

Both policies increase bank reserves and thereby expand the money supply.






Topic: Monetary Policy

5. The Federal funds rate:

A.

is always slightly higher than the discount rate.

B.

can never be close to zero.

C.

may sometimes have to be targeted at zero.

D.

is an intermediate target.

The Federal Funds rate has become the Fed's operating target, and in response to the 2008 financial crisis, the Fed lowered the rate to almost zero to jumpstart the economy.




Difficulty: Easy


Topic: Federal Funds Rate

6. A reduction in the Federal funds rate could be caused by an:

A.

open market sale of government securities.

B.

increase in the reserve requirement.

C.

increase in the discount rate.

D.

increase in the excess reserves of the banking system.

An increase in the reserves of the banking system increases the availability of credit in the Federal funds market and reduces the

Federal funds rate.




Difficulty: Hard



7. If the Fed funds rate is below the Fed's target range the Fed should:

A.

follow expansionary policy.

B.

follow contractionary policy.

C.

print money.

D.

do nothing.

The Fed funds rate being below the Fed's target would mean that money supply is loose and the Fed should follow a contractionary monetary policy.







8. Suppose the Federal funds rate is 5 percent. If the Fed decides to decrease the target for the Federal funds rate from 5 percent to 4 percent, it should take:

A.

a defensive action and raise reserve requirements.

B.

a defensive action and reduce reserve requirements.

C.

an offensive action and raise reserve requirements.

D.

an offensive action and reduce reserve requirements.

Because the Fed is changing the existing monetary policy when it changes the target range for the Federal funds rate, it must take an offensive action. Because it must decrease the Federal funds rate to meet the new target, it should adopt an expansionary monetary policy.




Difficulty: Hard



9. Which of the following is an operating target for the Fed?

A.

Sustainable growth.

B.

The Federal funds rate.

C.

Stable prices.

D.

Stock prices.

The Federal funds rate is the only real operating target for the Fed.




Difficulty: Easy


Topic: Federal Fund Rate

10. Which of the following is a Fed tool?

A.

Interest rate spreads.

B.

Discount rate.

C.

Stock prices.

D.

Fed funds rate.

The Fed tools are the open market operations, discount rate, and reserve requirements.






Topic: Tools of Monetary Policy

11. Suppose that investment is not very responsive to interest rates, so that a sizable increase in interest rates has only a minor effect on investment. In this case, monetary policy would have:

A.

no effect on output.

B.

a modest effect on output at best.

C.

a substantial effect on output.

D.

a massive effect on output.

If investment is insensitive to interest rates, aggregate demand will also be insensitive, reducing the effectiveness of monetary policy.




Difficulty: Hard


Topic: AS/AD model

12. The curve most economists use to follow the relationship between the interest rates and bonds' time to maturity is the:

A.

effective supply of money curve.

B.

aggregate demand curve.

C.

yield curve.

D.

demand of money curve.

The curve that shows the relationship between the interest rates and the bonds' time to maturity is the yield curve.






Topic: Yield Curve

13. Which of the following gives the correct relationship between nominal and real interest rates?

A.

Real interest rate = nominal interest rate + expected inflation rate.

B.

Nominal interest rate = real interest rate + expected inflation rate.

C.

Nominal interest rate + real interest rate = expected inflation rate.

D.

Nominal interest rate = real interest rate - expected inflation.

The real interest rate equals the nominal interest rate adjusted for expected inflation.






Topic: Nominal Interest Rates

14. When people expect higher inflation, usually nominal interest rates will:

A.

fall.

B.

rise.

C.

remain unchanged.

D.

move erratically.

If lenders expect higher inflation, they will raise nominal interest rates so as to preserve purchasing power.






Topic: Nominal Interest Rates

15. Monetary regimes:

A.

do not set policy on the basis of a predetermined framework.

B.

rely on the discretion of monetary policy officials.

C.

use predetermined rules to set monetary policy.

D.

produce greater variation in expected inflation than individual monetary policies.

A monetary regime is a predetermined statement of the policy that will be followed in a given situation.




Difficulty: Easy


Topic: Monetary Regimes

16. Why are financial-sector crises scarier than collapses in other sectors of the economy?

A.

The financial sector is the biggest sector.

B.

Financial-sector crises happen more often than collapses in other sectors.

C.

Most people work in the financial sector.

D.

If the financial sector fails, it can bring the whole economy down with it.

All other sectors in the economy depend on a financial sector that functions to its full extent in terms of getting access to credit. The financial sector was in serious danger of collapsing in 2007/2008, which is why policymakers took immediate action to fix the financial sector, and prevent another Great Depression.






Topic: Financial Sector

17. Which of the following is not a stage of a financial crisis?

A.

The forming of an asset bubble.

B.

The public announcement by the government of a financial crisis occurring.

C.

The bursting of an asset bubble.

D.

The collapse of the financial sector.

In order to understand the 1930s crisis, the 2008 crisis, and any future financial crisis, it is useful to break them down into stages. We can understand that they all have something in common, with slight variations. The main part of a crisis is the bubble, creation and bursting, and this will lead to a crash in the financial sector.




Difficulty: Easy


Topic: Stages of Financial Crisis

18. Suppose the people in my town hear a rumor that their local bank is in trouble and all rush to withdraw money from the bank. This is referred to as:

A.

leverage.

B.

a moral hazard problem.

C.

a bad precedent problem.

D.

a bank run.

See definition of bank run in the text.




Difficulty: Easy


Topic: Bank Run

19. When there is unsustainable rapidly rising prices of some type of financial asset, such as stock, we refer to this a(n):

A.

liquidity trap.

B.

bubble.

C.

bad-precedent problem.

D.

moral-hazard problem.

See definition of bubble in the text.




Difficulty: Easy


Topic: Bubble

Colander - Chapter 15

20. Refer to the graph above. Suppose the demand curve shifts from D

0 the following would be the correct outcome?

to D

1.

If we used the standard supply and demand, which of

A.

The quantity on the market will end up at Q

B.

The price of the good will stay constant at P

C.

The price of the good will rise to P

1

D.


1

1

, and there is equilibrium.

0

, and there will be disequilibrium.


, and there will be a shortage at P

1

.

In a standard supply and demand model, the initial rise in the price is the end of the story, and the rise in price brings the market back to equilibrium.






Topic: Supply And Demand Model

21. Refer to the graph above. Suppose we incorporate extrapolative expectations into our supply and demand model and demanders expect the price to continue to rise. Which of the following would be the correct outcome when the demand curve shifts from D

0

to

D

1

?

A.

The quantity on the market will end up at Q

1


B.

The market will continue to move away from equilibrium as a result of the small price adjustment to P

C.


1.

D.

1


The price of the good will initially rise to P

3

.

The increase in prices to P

1

leads people to expect further price increases. This will shift the demand curve to D and the expectation of higher price increases.

2

and the resulting higher price will lead people to expect further price increases, and will shift the demand curve out again, which leads to higher prices




Difficulty: Hard


Topic: Extrapolative Expectations

Colander - Chapter 15

22. Refer to the graph above. If we are using the standard AD/AS model, and there is a decrease in aggregate demand from AD

AD

1

, where does the economy end up at to achieve equilibrium?

0

to

A.

Y

B.

Y

C.

Y

2

0

1

.

.

.

D.

Y

3

.

If we look at a standard model, with no expectational accelerator present, the excess aggregate supply as shown by the gap A-A' would be eliminated and the economy will reach point B at P

1

and Y

1

.






Topic: Expectational Accelerator

23. Prior to the beginning of the 21 st century, what was Freddie Mac and Fannie Mae's role in the economy?

A.

They oversaw the Federal Deposit Insurance Program.

B.

They were the dominant player in the secondary mortgage market.

C.

They regulated lending practices for commercial banks.

D.

They acted as a lender of last resort for commercial banks.

These companies bought safe mortgages and pooled these mortgages together and sold slices of income from these mortgages as a security.




Difficulty: Easy


Topic: Securitization

24. Which of the following does not explain why financial institutions felt comfortable with riskier mortgage securities leading up to the financial crisis?

A.

Credit rating agencies gave these securitized mortgages a "seal of approval."

B.

House prices were expected to keep rising.

C.

Consumers were becoming over-leveraged.

D.

As long as the mortgages were bundled together, the diversification reduced the risk.

The fact that consumer debt burden was rising would not be a reason to be comfortable with taking on more mortgages. It would be a source of concern.






Topic: Securitization

25. Buying on "margin" occurs when:

A.

banks borrow from the Federal Reserve.

B.

people put down payments on purchases of automobiles and houses.

C.

people borrow money from stockbrokers to buy shares they could not afford on their own.

D.

people borrow money from banks using their stock as collateral.

See definition of margin buying in the text.




Difficulty: Easy


Topic: Margin Buying

26. When the stock market crashed in 1929, most economists thought that:

A.

an extremely deep depression was just about to begin.

B.

stocks were going to bounce back immediately to previous highs.

C.

a major fiscal expansion was needed immediately.

D.

a mild recession would ensue.

Even if the stock market bubble had been significant, individuals believed that the economy would eventually move in a positive direction, because it had before. However it took a financial meltdown in the banking sector to push the economy into a depression.






Topic: Bubble

27. As a result of the financial meltdown in the 1930s, the government created deposit insurance. This would be considered to be part of the:

A.

treatment stage.

B.

triage stage.

C.

intervention stage.

D.

rehabilitation stage.

The government as a result of the Great Depression set up various structures to prevent financial markets from freezing up in the future. Deposit Insurance was one of these systems.




Difficulty: Easy


Topic: Rehabilitation Stage

28. The use of quantitative easing to alleviate the 2008 crisis could fall under which of the following stages?

A.

Treatment.

B.

Rehabilitation.

C.

Triage.

D.

Intoxication.

The financial markets were in danger of collapsing and the Federal Reserve took steps to stabilize the banking system, and this involved expanding monetary policy as much as they could.




Difficulty: Easy


Topic: Quantitative Easing

29. Which of the following does NOT explain why the Glass-Steagall regulations lost their effectiveness?

A.

Over time, non bank financial firms were able to borrow directly from the public, rather than having to borrow from commercial banks.

B.

The Federal Reserve created regulations that ran counter to what the government was trying to do.

C.

With the advent of new financial instruments, regulated banks lost business to unregulated institutions, and credit began to flow through unregulated systems.

D.

As regulations became too successful, people wanted to eliminate these regulations in order to pursue the magic of the free market.

The Glass-Steagall act though successful when implemented in the 1930s, became irrelevant over time, as financial markets became deregulated and non bank lenders found ways to avoid these regulations.


BLOOMS TAXONOMY: Evaluation




Topic: Law of Diminishing Control

30. When the government bails out one sector, other sectors go to Congress and ask for bailout money. This is referred as:

A.

the law of diminishing control.

B.

a moral hazard problem.

C.

a bad precedent problem.

D.

quantitative easing.

See definition of bad precedent problem in the text.




Difficulty: Easy


Topic: Bad Precedent Problem

31. A budget deficit is defined as:

A.

a shortfall of revenues compared to expenditures.

B.

a shortfall of expenditures compared to revenue.

C.

accumulated deficits minus accumulated surpluses.

D.

accumulated surpluses minus accumulated deficits.

See the definition of a deficit in the text.




Difficulty: Easy


Topic: Deficits

32. Suppose that the economy has a structural deficit of $100 billion and a budget deficit of $100 billion. It follows that output:

A.

must equal potential output.

B.

must be above potential output.

C.

must be below its potential output.

D.

could be at, above, or below potential output.

Since the structural deficit equals the budget deficit, the passive budget must be zero, implying that output must equal potential output.

AACSB: Analytic

BLOOMS TAXONOMY: Evaluation




Topic: Deficits

33. Use the following table to determine which statement is true .

A.

The budget deficit in 1950 was $2.3 billion.

B.

From 1946 to 1950, the U.S. debt was $2.3 billion.

C.

From 1945 to 1950, the debt rose by $2.3 billion.

D.

In 1950, the U.S. debt was $2.3 billion.

A debt is accumulated surpluses and deficits. Since you don't know the existing debt in 1945, you cannot calculate the debt in 1950.

You can, however, calculate the change in the debt from 1945 to 1950 by adding up the deficits and surpluses between 1946 and 1950.


BLOOMS TAXONOMY: Analysis




Topic: Debt

34. A constant debt to GDP ratio in a growing economy is consistent with:

A.

a continual surplus.

B.

a continual deficit.

C.

a balanced budget.

D.

a falling level of total debt.

If GDP is rising, the debt can rise (i.e. the budget can be in continual deficit) by the same percent as the rise in GDP and still maintain a constant debt to GDP ratio.






Topic: Debt to GDP Ratio

35. Politicians who support a "lockbox" for Social Security argue that:

A.

taxes need to be increased in order to solidify the Social Security system.

B.

the Social Security surplus should never be used to reduce the government debt.

C.

the Social Security surplus should be used to purchase government bonds and reduce government debt.

D.

the existing Social Security program is viable and should not be changed.

Supporters of a lockbox want to use the existing surplus in Social Security to reduce government debt and in this way reduce the burden of the debt when Social Security begins to incur deficits.





Learning Objective: 17-A

Topic: Social Security

36. The imbalance between aggregate supply and aggregate demand caused by the retirement of the baby boomers could be reduced by all of the following except :

A.

increased saving.

B.

increased productivity.

C.

higher inflation.

D.

shorter work weeks.

Shorter work weeks will reduce aggregate supply, creating an even greater gap between aggregate demand and aggregate supply.







37. Which of the following would make the impending Social Security problem worse?

A.

Raising social security taxes.

B.

Raising the age at which one is eligible to receive payments.

C.

An increase in the average age at which people die.

D.

Taxing social security payments received.

Longer life expectancy means higher Social Security payments.







38. An unfunded pension system is viable as long as:

A.

the population's age structure changes considerably.

B.

the population's age structure does not change considerably.

C.

the annual death rate changes considerably.

D.

the workforce level varies greatly over long periods of time.

The unfunded system works as long as the population's age distribution, the annual death rate, and the number of people working do not change much.






Topic: Social Securit

Practice Exam IV Econ 1040 Key 1. Which is not a function of the

Practice Exam IV Econ 1040

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