Solved Final Exam - Economics of Money, Banking and Financial Markets | ECON 2035, Exams of Economics

Download Solved Final Exam - Economics of Money, Banking and Financial Markets | ECON 2035 and more Exams Economics in PDF only on Docsity! The Economics of Money, Banking, and Financial Markets, 9e (Mishkin) Chapter 1 Why Study Money, Banking, and Financial Markets? 1.1 Why Study Financial Markets? 1) Financial markets promote economic efficiency by A) channeling funds from investors to savers. B) creating inflation. C) channeling funds from savers to investors. D) reducing investment. Answer: C 2) Financial markets promote greater economic efficiency by channeling funds from ________ to ________. A) investors; savers B) borrowers; savers C) savers; borrowers D) savers; lenders Answer: C 3) Well-functioning finbancial markets promote A) inflation. B) deflation. C) unemployment. D) growth. Answer: D 4) A key factor in producing high economic growth is A) eliminating foreign trade. B) well-functioning financial markets. C) high interest rates. D) stock market volatility. Answer: B 5) Markets in which funds are transferred from those who have excess funds available to those who have a shortage of available funds are called A) commodity markets. B) fund-available markets. C) derivative exchange markets. D) financial markets. Answer: D 6) ________ markets transfer funds from people who have an excess of available funds to people who have a shortage. A) Commodity B) Fund-available C) Financial D) Derivative exchange Answer: C 7) Poorly performing financial markets can be the cause of A) wealth. B) poverty. C) financial stability. D) financial expansion. Answer: B 8) The bond markets are important because they are A) easily the most widely followed financial markets in the United States. B) the markets where foreign exchange rates are determined. C) the markets where interest rates are determined. D) the markets where all borrowers get their funds. Answer: C 9) The price paid for the rental of borrowed funds (usually expressed as a percentage of the rental of $100 per year) is commonly referred to as the A) inflation rate. B) exchange rate. C) interest rate. D) aggregate price level. Answer: C 10) Compared to interest rates on long-term U.S. government bonds, interest rates on three-month Treasury bills fluctuate ________ and are ________ on average. A) more; lower B) less; lower C) more; higher D) less; higher Answer: A 1 11) The interest rate on Baa (medium quality) corporate bonds is ________, on average, than other interest rates, and the spread between it and other rates became ________ in the 1970s. A) lower; smaller B) lower; larger C) higher; smaller D) higher; larger Answer: D 12) Everything else held constant, a decline in interest rates will cause spending on housing to A) fall. B) remain unchanged. C) either rise, fall, or remain the same. D) rise. Answer: D 13) High interest rates might ________ purchasing a house or car but at the same time high interest rates might ________ saving. A) discourage; encourage B) discourage; discourage C) encourage; encourage D) encourage; discourage Answer: A 14) An increase in interest rates might ________ saving because more can be earned in interest income. A) encourage B) discourage C) disallow D) invalidate Answer: A 15) Everything else held constant, an increase in interest rates on student loans A) increases the cost of a college education. B) reduces the cost of a college education. C) has no effect on educational costs. D) increases costs for students with no loans. Answer: A 16) High interest rates might cause a corporation to ________ building a new plant that would provide more jobs. A) complete B) consider C) postpone D) contemplate Answer: C 17) The stock market is important because it is A) where interest rates are determined. B) the most widely followed financial market in the United States. C) where foreign exchange rates are determined. D) the market where most borrowers get their funds. Answer: B 18) Stock prices are A) relatively stable trending upward at a steady pace. B) relatively stable trending downward at a moderate rate. C) extremely volatile. D) unstable trending downward at a moderate rate. Answer: C 19) A rising stock market index due to higher share prices A) increases people's wealth, but is unlikely to increase their willingness to spend. B) increases people's wealth and as a result may increase their willingness to spend. C) decreases the amount of funds that business firms can raise by selling newly-issued stock. D) decreases people's wealth, but is unlikely to increase their willingness to spend. Answer: B 20) When stock prices fall A) an individual's wealth is not affected nor is their willingness to spend. B) a business firm will be more likely to sell stock to finance investment spending. C) an individual's wealth may decrease but their willingness to spend is not affected. D) an individual's wealth may decrease and their willingness to spend may decrease. Answer: D 21) Changes in stock prices A) do not affect people's wealth and their willingness to spend. B) affect firms' decisions to sell stock to finance investment spending. 2 A) inflation. B) recessions. C) economic recoveries. D) expansions. Answer: B 4) During a recession, output declines resulting in A) lower unemployment in the economy. B) higher unemployment in the economy. C) no impact on the unemployment in the economy. D) higher wages for the workers. Answer: B 5) Prior to all recessions since 1900, there has been a drop in A) inflation. B) the money stock. C) the growth rate of the money stock. D) interest rates. Answer: C 6) Evidence from business cycle fluctuations in the United States indicates that A) a negative relationship between money growth and general economic activity exists. B) recessions have been preceded by declines in share prices on the stock exchange. C) recessions have been preceded by dollar depreciation. D) recessions have been preceded by a decline in the growth rate of money. Answer: D 7) ________ theory relates changes in the quantity of money to changes in aggregate economic activity and the price level. A) Monetary B) Fiscal C) Financial D) Systemic Answer: A 8) A sharp increase in the growth of the money supply is likely followed by A) a recession. B) a depression. C) an increase in the inflation rate. D) no change in the economy. Answer: C 9) It is true that inflation is a A) continuous increase in the money supply. B) continuous fall in prices. C) decline in interest rates. D) continually rising price level. Answer: D 10) Which of the following is a true statement? A) Money or the money supply is defined as Federal Reserve notes. B) The average price of goods and services in an economy is called the aggregate price level. C) The inflation rate is measured as the rate of change in the federal government budget deficit. D) The aggregate price level is measured as the rate of change in the inflation rate. Answer: B 11) If ten years ago the prices of the items bought last month by the average consumer would have been much higher, then one can likely conclude that A) the aggregate price level has declined during this ten-year period. B) the average inflation rate for this ten-year period has been positive. C) the average rate of money growth for this ten-year period has been positive. D) the aggregate price level has risen during this ten-year period. Answer: A 12) From 1950-2008 the price level in the United States increased more than ________. A) twofold B) threefold C) sixfold D) ninefold Answer: C 13) Complete Milton Friedman's famous statement, "Inflation is always and everywhere a ________ phenomenon." A) recessionary B) discretionary C) repressionary D) monetary Answer: D 5 14) There is a ________ association between inflation and the growth rate of money ________. A) positive; demand B) positive; supply C) negative; demand D) negative; supply Answer: B 15) Evidence from the United States and other foreign countries indicates that A) there is a strong positive association between inflation and growth rate of money over long periods of time. B) there is little support for the assertion that "inflation is always and everywhere a monetary phenomenon." C) countries with low monetary growth rates tend to experience higher rates of inflation, all else being constant. D) money growth is clearly unrelated to inflation. Answer: A 16) Countries that experience very high rates of inflation may also have A) balanced budgets. B) rapidly growing money supplies. C) falling money supplies. D) constant money supplies. Answer: B 17) Between 1950 and 1980 in the U.S., interest rates trended upward. During this same time period, A) the rate of money growth declined. B) the rate of money growth increased. C) the government budget deficit (expressed as a percentage of GNP) trended downward. D) the aggregate price level declined quite dramatically. Answer: B 18) The management of money and interest rates is called ________ policy and is conducted by a nation's ________ bank. A) monetary; superior B) fiscal; superior C) fiscal; central D) monetary; central Answer: D 19) The organization responsible for the conduct of monetary policy in the United States is the A) Comptroller of the Currency. B) U.S. Treasury. C) Federal Reserve System. D) Bureau of Monetary Affairs. Answer: C 20) ________ policy involves decisions about government spending and taxation. A) Monetary B) Fiscal C) Financial D) Systemic Answer: B 21) When tax revenues are greater than government expenditures, the government has a budget ________. A) crisis B) deficit C) surplus D) revision Answer: C 22) A budget ________ occurs when government expenditures exceed tax revenues for a particular time period. A) deficit B) surplus C) surge D) surfeit Answer: A 23) Budgets deficits can be a concern because they might A) ultimately lead to higher inflation. B) lead to lower interest rates. C) lead to a slower rate of money growth. D) lead to higher bond prices. Answer: A 24) Budget deficits are important because deficits A) cause bank failures. B) always cause interest rates to fall. C) can result in higher rates of monetary growth. 6 D) always cause prices to fall. Answer: C 1.4 Why Study International Finance? 1) American companies can borrow funds A) only in U.S. financial markets. B) only in foreign financial markets. C) in both U.S. and foreign financial markets. D) only from the U.S. government. Answer: C 2) The price of one country's currency in terms of another country's currency is called the A) exchange rate. B) interest rate. C) Dow Jones industrial average. D) prime rate. Answer: A 3) The market where one currency is converted into another currency is called the ________ market. A) stock B) bond C) derivatives D) foreign exchange Answer: D 4) Everything else constant, a stronger dollar will mean that A) vacationing in England becomes more expensive. B) vacationing in England becomes less expensive. C) French cheese becomes more expensive. D) Japanese cars become more expensive. Answer: B 5) Which of the following is most likely to result from a stronger dollar? A) U.S. goods exported aboard will cost less in foreign countries, and so foreigners will buy more of them. B) U.S. goods exported aboard will cost more in foreign countries and so foreigners will buy more of them. C) U.S. goods exported abroad will cost more in foreign countries, and so foreigners will buy fewer of them. D) Americans will purchase fewer foreign goods. Answer: C 6) Everything else held constant, a weaker dollar will likely hurt A) textile exporters in South Carolina. B) wheat farmers in Montana that sell domestically. C) automobile manufacturers in Michigan that use domestically produced inputs. D) furniture importers in California. Answer: D 7) Everything else held constant, a stronger dollar benefits ________ and hurts ________. A) American businesses; American consumers B) American businesses; foreign businesses C) American consumers; American businesses D) foreign businesses; American consumers Answer: C 8) From 1980 to early 1985 the dollar ________ in value, thereby benefiting American ________. A) appreciated; consumers B) appreciated, businesses C) depreciated; consumers D) depreciated, businesses Answer: A 9) From 1980 to 1985 the dollar appreciated relative to the British pound. Holding everything else constant, one would expect that, when compared to 1980, A) fewer Britons traveled to the United States in 1985. B) Britons imported more wine from California in 1985. C) Americans exported more wheat to England in 1985. D) more Britons traveled to the United States in 1985. Answer: A 10) When in 1985 a British pound cost approximately $1.30, a Shetland sweater that cost 100 British pounds would have cost $130. With a weaker dollar, the same Shetland sweater would have cost A) less than $130. B) more than $130. C) $130, since the exchange rate does not affect the prices that American consumers pay for foreign goods. D) $130, since the demand for Shetland sweaters will decrease to prevent an increase in price due to the stronger dollar. Answer: B 7 2.2 Structure of Financial Markets 1) Which of the following statements about the characteristics of debt and equity is false? A) They can both be long-term financial instruments. B) They can both be short-term financial instruments. C) They both involve a claim on the issuer's income. D) They both enable a corporation to raise funds. Answer: B 2) Which of the following statements about the characteristics of debt and equities is true? A) They can both be long-term financial instruments. B) Bond holders are residual claimants. C) The income from bonds is typically more variable than that from equities. D) Bonds pay dividends. Answer: A 3) Which of the following statements about financial markets and securities is true? A) A bond is a long-term security that promises to make periodic payments called dividends to the firm's residual claimants. B) A debt instrument is intermediate term if its maturity is less than one year. C) A debt instrument is intermediate term if its maturity is ten years or longer. D) The maturity of a debt instrument is the number of years (term) to that instrument's expiration date. Answer: D 4) Which of the following is an example of an intermediate-term debt? A) A thirty-year mortgage. B) A sixty-month car loan. C) A six month loan from a finance company. D) A Treasury bond. Answer: B 5) If the maturity of a debt instrument is less than one year, the debt is called ________. A) short-term B) intermediate-term C) long-term D) prima-term Answer: A 6) Long-term debt has a maturity that is ________. A) between one and ten years. B) less than a year. C) between five and ten years. D) ten years or longer. Answer: D 7) When I purchase ________, I own a portion of a firm and have the right to vote on issues important to the firm and to elect its directors. A) bonds B) bills C) notes D) stock Answer: D 8) Equity holders are a corporation's ________. That means the corporation must pay all of its debt holders before it pays its equity holders. A) debtors B) brokers C) residual claimants D) underwriters Answer: C 9) Which of the following benefit directly from any increase in the corporation's profitability? A) a bond holder B) a commercial paper holder C) a shareholder D) a T-bill holder Answer: C 10) A financial market in which previously issued securities can be resold is called a ________ market. A) primary B) secondary C) tertiary D) used securities Answer: B 11) An important financial institution that assists in the initial sale of securities in the primary market is the A) investment bank. B) commercial bank. 10 C) stock exchange. D) brokerage house. Answer: A 12) When an investment bank ________ securities, it guarantees a price for a corporation's securities and then sells them to the public. A) underwrites B) undertakes C) overwrites D) overtakes Answer: A 13) Which of the following is not a secondary market? A) foreign exchange market B) futures market C) options market D) IPO market Answer: D 14) ________ work in the secondary markets matching buyers with sellers of securities. A) Dealers B) Underwriters C) Brokers D) Claimants Answer: C 15) A corporation acquires new funds only when its securities are sold in the A) primary market by an investment bank. B) primary market by a stock exchange broker. C) secondary market by a securities dealer. D) secondary market by a commercial bank. Answer: A 16) A corporation acquires new funds only when its securities are sold in the A) secondary market by an investment bank. B) primary market by an investment bank. C) secondary market by a stock exchange broker. D) secondary market by a commercial bank. Answer: B 17) An important function of secondary markets is to A) make it easier to sell financial instruments to raise funds. B) raise funds for corporations through the sale of securities. C) make it easier for governments to raise taxes. D) create a market for newly constructed houses. Answer: A 18) Secondary markets make financial instruments more A) solid. B) vapid. C) liquid. D) risky. Answer: C 19) A liquid asset is A) an asset that can easily and quickly be sold to raise cash. B) a share of an ocean resort. C) difficult to resell. D) always sold in an over-the-counter market. Answer: A 20) The higher a security's price in the secondary market the ________ funds a firm can raise by selling securities in the ________ market. A) more; primary B) more; secondary C) less; primary D) less; secondary Answer: A 21) When secondary market buyers and sellers of securities meet in one central location to conduct trades the market is called a(n) A) exchange. B) over-the-counter market. C) common market. D) barter market. Answer: A 22) Forty or so dealers establish a "market" in these securities by standing ready to buy and sell them. 11 A) Secondary stocks B) Surplus stocks C) U.S. government bonds D) Common stocks Answer: C 23) Which of the following statements about financial markets and securities is true? A) Many common stocks are traded over-the-counter, although the largest corporations usually have their shares traded at organized stock exchanges such as the New York Stock Exchange. B) As a corporation gets a share of the broker's commission, a corporation acquires new funds whenever its securities are sold. C) Capital market securities are usually more widely traded than shorter-term securities and so tend to be more liquid. D) Because of their short-terms to maturity, the prices of money market instruments tend to fluctuate wildly. Answer: A 24) A financial market in which only short-term debt instruments are traded is called the ________ market. A) bond B) money C) capital D) stock Answer: B 25) Equity instruments are traded in the ________ market. A) money B) bond C) capital D) commodities Answer: C 2.3 Financial Market Instruments 1) Prices of money market instruments undergo the least price fluctuations because of A) the short terms to maturity for the securities. B) the heavy regulations in the industry. C) the price ceiling imposed by government regulators. D) the lack of competition in the market. Answer: A 2) U.S. Treasury bills pay no interest but are sold at a ________. That is, you will pay a lower purchase price than the amount you receive at maturity. A) premium B) collateral C) default D) discount Answer: D 3) U.S. Treasury bills are considered the safest of all money market instruments because there is no risk of ________. A) defeat B) default C) desertion D) demarcation Answer: B 4) A debt instrument sold by a bank to its depositors that pays annual interest of a given amount and at maturity pays back the original purchase price is called A) commercial paper. B) a negotiable certificate of deposit. C) a municipal bond. D) federal funds. Answer: B 5) A short-term debt instrument issued by well-known corporations is called A) commercial paper. B) corporate bonds. C) municipal bonds. D) commercial mortgages. Answer: A 6) ________ are short-term loans in which Treasury bills serve as collateral. A) Repurchase agreements B) Negotiable certificates of deposit C) Federal funds D) U.S. government agency securities Answer: A 7) Collateral is ________ the lender receives if the borrower does not pay back the loan. A) a liability B) an asset 12 B) financial intermediation. C) liquidity services. D) transaction costs. Answer: D 4) Economies of scale enable financial institutions to A) reduce transactions costs. B) avoid the asymmetric information problem. C) avoid adverse selection problems. D) reduce moral hazard. Answer: A 5) An example of economies of scale in the provision of financial services is A) investing in a diversified collection of assets. B) providing depositors with a variety of savings certificates. C) spreading the cost of borrowed funds over many customers. D) spreading the cost of writing a standardized contract over many borrowers. Answer: D 6) Financial intermediaries provide customers with liquidity services. Liquidity services A) make it easier for customers to conduct transactions. B) allow customers to have a cup of coffee while waiting in the lobby. C) are a result of the asymmetric information problem. D) are another term for asset transformation. Answer: A 7) The process where financial intermediaries create and sell low-risk assets and use the proceeds to purchase riskier assets is known as A) risk sharing. B) risk aversion. C) risk neutrality. D) risk selling. Answer: A 8) The process of asset transformation refers to the conversion of A) safer assets into risky assets. B) safer assets into safer liabilities. C) risky assets into safer assets. D) risky assets into risky liabilities. Answer: C 9) Reducing risk through the purchase of assets whose returns do not always move together is A) diversification. B) intermediation. C) intervention. D) discounting. Answer: A 10) The concept of diversification is captured by the statement A) don't look a gift horse in the mouth. B) don't put all your eggs in one basket. C) it never rains, but it pours. D) make hay while the sun shines. Answer: B 11) Risk sharing is profitable for financial institutions due to A) low transactions costs. B) asymmetric information. C) adverse selection. D) moral hazard. Answer: A 12) Typically, borrowers have superior information relative to lenders about the potential returns and risks associated with an investment project. The difference in information is called A) moral selection. B) risk sharing. C) asymmetric information. D) adverse hazard Answer: C 13) If bad credit risks are the ones who most actively seek loans and, therefore, receive them from financial intermediaries, then financial intermediaries face the problem of A) moral hazard. B) adverse selection. C) free-riding. D) costly state verification. 15 Answer: B 14) The problem created by asymmetric information before the transaction occurs is called ________, while the problem created after the transaction occurs is called ________. A) adverse selection; moral hazard B) moral hazard; adverse selection C) costly state verification; free-riding D) free-riding; costly state verification Answer: A 15) Adverse selection is a problem associated with equity and debt contracts arising from A) the lender's relative lack of information about the borrower's potential returns and risks of his investment activities. B) the lender's inability to legally require sufficient collateral to cover a 100% loss if the borrower defaults. C) the borrower's lack of incentive to seek a loan for highly risky investments. D) the borrower's lack of good options for obtaining funds. Answer: A 16) An example of the problem of ________ is when a corporation uses the funds raised from selling bonds to fund corporate expansion to pay for Caribbean cruises for all of its employees and their families. A) adverse selection B) moral hazard C) risk sharing D) credit risk Answer: B 17) Studies of the major developed countries show that when businesses go looking for funds to finance their activities they usually obtain these funds from A) government agencies. B) equities markets. C) financial intermediaries. D) bond markets. Answer: C 18) The countries that have made the least use of securities markets are ________ and ________; in these two countries finance from financial intermediaries has been almost ten times greater than that from securities markets. A) Germany; Japan B) Germany; Great Britain C) Great Britain; Canada D) Canada; Japan Answer: A 19) Although the dominance of ________ over ________ is clear in all countries, the relative importance of bond versus stock markets differs widely. A) financial intermediaries; securities markets B) financial intermediaries; government agencies C) government agencies; financial intermediaries D) government agencies; securities markets Answer: A 2.6 Types of Financial Intermediaries 1) Financial institutions that accept deposits and make loans are called ________ institutions. A) investment B) contractual savings C) depository D) underwriting Answer: C 2) Thrift institutions include A) banks, mutual funds, and insurance companies. B) savings and loan associations, mutual savings banks, and credit unions. C) finance companies, mutual funds, and money market funds. D) pension funds, mutual funds, and banks. Answer: B 3) Which of the following is a depository institution? A) A life insurance company B) A credit union C) A pension fund D) A mutual fund Answer: B 4) Which of the following is a depository institution? A) A life insurance company B) A mutual savings bank C) A pension fund D) A finance company 16 Answer: B 5) Which of the following financial intermediaries is not a depository institution? A) A savings and loan association B) A commercial bank C) A credit union D) A finance company Answer: D 6) The primary assets of credit unions are A) municipal bonds. B) business loans. C) consumer loans. D) mortgages. Answer: C 7) The primary liabilities of a commercial bank are A) bonds. B) mortgages. C) deposits. D) commercial paper. Answer: C 8) The primary liabilities of depository institutions are A) premiums from policies. B) shares. C) deposits. D) bonds. Answer: C 9) ________ institutions are financial intermediaries that acquire funds at periodic intervals on a contractual basis. A) Investment B) Contractual savings C) Thrift D) Depository Answer: B 10) Which of the following is a contractual savings institution? A) A life insurance company B) A credit union C) A savings and loan association D) A mutual fund Answer: A 11) Contractual savings institutions include A) mutual savings banks. B) money market mutual funds. C) commercial banks. D) life insurance companies. Answer: D 12) Which of the following are not contractual savings institutions? A) Life insurance companies B) Credit unions C) Pension funds D) State and local government retirement funds Answer: B 13) Which of the following is not a contractual savings institution? A) A life insurance company B) A pension fund C) A savings and loan association D) A fire and casualty insurance company Answer: C 14) The primary assets of a pension fund are A) money market instruments. B) corporate bonds and stock. C) consumer and business loans. D) mortgages. Answer: B 17 D) the Securities and Exchange Commission. Answer: A 13) Asymmetric information is a universal problem. This would suggest that financial regulations A) in industrial countries are an unqualified failure. B) differ significantly around the world. C) in industrialized nations are similar. D) are unnecessary. Answer: C The Economics of Money, Banking, and Financial Markets, 9e (Mishkin) Chapter 3 What Is Money? 3.1 Meaning of Money 1) To an economist, ________ is anything that is generally accepted in payment for goods and services or in the repayment of debt. A) wealth B) income C) money D) credit Answer: C 2) Money is A) anything that is generally accepted in payment for goods and services or in the repayment of debt. B) a flow of earnings per unit of time. C) the total collection of pieces of property that are a store of value. D) always based on a precious metal like gold or silver. Answer: A 3) Currency includes A) paper money and coins. B) paper money, coins, and checks. C) paper money and checks. D) paper money, coins, checks, and savings deposits. Answer: A 4) Even economists have no single, precise definition of money because A) money supply statistics are a state secret. B) the Federal Reserve does not employ or report different measures of the money supply. C) the "moneyness" or liquidity of an asset is a matter of degree. D) economists find disagreement interesting and refuse to agree for ideological reasons. Answer: C 5) The total collection of pieces of property that serve to store value is a person's A) wealth. B) income. C) money. D) credit. Answer: A 6) A person's house is part of her A) money. B) income. C) liabilities. D) wealth. Answer: D 7) ________ is used to make purchases while ________ is the total collection of pieces of property that serve to store value. A) Money; income B) Wealth; income C) Income; money D) Money; wealth Answer: D 8) ________ is a flow of earnings per unit of time. A) Income B) Money C) Wealth D) Currency Answer: A 9) An individual's annual salary is her A) money. B) income. C) wealth. 20 D) liabilities. Answer: B 10) When we say that money is a stock variable, we mean that A) the quantity of money is measured at a given point in time. B) we must attach a time period to the measure. C) it is sold in the equity market. D) money never loses purchasing power. Answer: A 11) The difference between money and income is that A) money is a flow and income is a stock. B) money is a stock and income is a flow. C) there is no difference money and income are both stocks.money and income are both stocks. D) there is no difference money and income are both flows.money and income are both stocks. Answer: B 12) Which of the following is a true statement? A) Money and income are flow variables. B) Money is a flow variable. C) Income is a flow variable. D) Money and income are stock variables. Answer: C 13) Which of the following statements uses the economists' definition of money? A) I plan to earn a lot of money over the summer. B) Betsy is rich she has a lot of money.money and income are both stocks. C) I hope that I have enough money to buy my lunch today. D) The job with New Company gave me the opportunity to earn more money. Answer: C 3.2 Functions of Money 1) Of money's three functions, the one that distinguishes money from other assets is its function as a A) store of value. B) unit of account. C) standard of deferred payment. D) medium of exchange. Answer: D 2) If peanuts serve as a medium of exchange, a unit of account, and a store of value, then peanuts are A) bank deposits. B) reserves. C) money. D) loanable funds. Answer: C 3) ________ are the time and resources spent trying to exchange goods and services. A) Bargaining costs. B) Transaction costs. C) Contracting costs. D) Barter costs. Answer: B 4) Compared to an economy that uses a medium of exchange, in a barter economy A) transaction costs are higher. B) transaction costs are lower. C) liquidity costs are higher. D) liquidity costs are lower. Answer: A 5) When compared to exchange systems that rely on money, disadvantages of the barter system include: A) the requirement of a double coincidence of wants. B) lowering the cost of exchanging goods over time. C) lowering the cost of exchange to those who would specialize. D) encouraging specialization and the division of labor. Answer: A 6) The conversion of a barter economy to one that uses money A) increases efficiency by reducing the need to exchange goods and services. B) increases efficiency by reducing the need to specialize. C) increases efficiency by reducing transactions costs. D) does not increase economic efficiency. Answer: C 21 7) Which of the following statements best explains how the use of money in an economy increases economic efficiency? A) Money increases economic efficiency because it is costless to produce. B) Money increases economic efficiency because it discourages specialization. C) Money increases economic efficiency because it decreases transactions costs. D) Money cannot have an effect on economic efficiency. Answer: C 8) When economists say that money promotes ________, they mean that money encourages specialization and the division of labor. A) bargaining B) contracting C) efficiency D) greed Answer: C 9) Money ________ transaction costs, allowing people to specialize in what they do best. A) reduces B) increases C) enhances D) eliminates Answer: A 10) For a commodity to function effectively as money it must be A) easily standardized, making it easy to ascertain its value. B) difficult to make change. C) deteriorate quickly so that its supply does not become too large. D) hard to carry around. Answer: A\ 11) All of the following are necessary criteria for a commodity to function as money except A) it must deteriorate quickly. B) it must be divisible. C) it must be easy to carry. D) it must be widely accepted. Answer: A 12) Whatever a society uses as money, the distinguishing characteristic is that it must A) be completely inflation proof. B) be generally acceptable as payment for goods and services or in the repayment of debt. C) contain gold. D) be produced by the government. Answer: B 13) All but the most primitive societies use money as a medium of exchange, implying that A) the use of money is economically efficient. B) barter exchange is economically efficient. C) barter exchange cannot work outside the family. D) inflation is not a concern. Answer: A 14) Kevin purchasing concert tickets with his debit card is an example of the ________ function of money. A) medium of exchange B) unit of account C) store of value D) specialization Answer: A 15) When money prices are used to facilitate comparisons of value, money is said to function as a A) unit of account. B) medium of exchange. C) store of value. D) payments-system ruler. Answer: A 16) A problem with barter exchange when there are many goods is that in a barter system A) transactions costs are minimized. B) there exists a multiple number of prices for each good. C) there is only one store of value. D) exchange of services is impossible. Answer: B 17) In a barter economy the number of prices in an economy with N goods is A) [N(N - 1)]/2. B) N(N/2). C) 2N. D) N(N/2) - 1. 22 D) paper money Answer: A 4) Paper currency that has been declared legal tender but is not convertible into coins or precious metals is called ________ money. A) commodity B) fiat C) electronic D) funny Answer: B 5) When paper currency is decreed by governments as legal tender, legally it must be ________. A) paper currency backed by gold B) a precious metal such as gold or silver C) accepted as payment for debts D) convertible into an electronic payment Answer: C 6) The evolution of the payments system from barter to precious metals, then to fiat money, then to checks can best be understood as a consequence of the fact that A) paper is more costly to produce than precious metals. B) precious metals were not generally acceptable. C) precious metals were difficult to carry and transport. D) paper money is less accepted than checks. Answer: C 7) Compared to checks, paper currency and coins have the major drawbacks that they A) are easily stolen. B) are hard to counterfeit. C) are not the most liquid assets. D) must be backed by gold. Answer: A 8) Introduction of checks into the payments system reduced the costs of exchanging goods and services. Another advantage of checks is that A) they provide convenient receipts for purchases. B) they can never be stolen. C) they are more widely accepted than currency. D) the funds from a deposited check are available for use immediately. Answer: A 9) The evolution of the payments system from barter to precious metals, then to fiat money, then to checks can best be understood as a consequence of A) government regulations designed to improve the efficiency of the payments system. B) government regulations designed to promote the safety of the payments system. C) innovations that reduced the costs of exchanging goods and services. D) competition among firms to make it easier for customers to purchase their products. Answer: C 10) Compared to an electronic payments system, a payments system based on checks has the major drawback that A) checks are less costly to process. B) checks take longer to process, meaning that it may take several days before the depositor can get her cash. C) fraud may be more difficult to commit when paper receipts are eliminated. D) legal liability is more clearly defined. Answer: B 11) Which of the following sequences accurately describes the evolution of the payments system? A) Barter, coins made of precious metals, paper currency, checks, electronic funds transfers B) Barter, coins made of precious metals, checks, paper currency, electronic funds transfers C) Barter, checks, paper currency, coins made of precious metals, electronic funds transfers D) Barter, checks, paper currency, electronic funds transfers Answer: A 12) During the past two decades an important characteristic of the modern payments system has been the rapidly increasing use of A) checks and decreasing use of currency. B) electronic fund transfers. C) commodity monies. D) fiat money. Answer: B 13) Which of the following is not a form of e-money? A) a debit card B) a credit card C) a stored-value card 25 D) a smart card Answer: B 14) A smart card is the equivalent of A) cash. B) savings bonds. C) savings deposits. D) certificates of deposit. Answer: A 15) An electronic payments system has not completely replaced the paper payments system because of all of the following reasons except A) expensive equipment is necessary to set up the system. B) security concerns. C) privacy concerns. D) transportation costs. Answer: D 16) In explaining the evolution of money A) government regulation is the most important factor. B) commodity money, because it is valued more highly, tends to drive out paper money. C) new forms of money evolve to lower transaction costs. D) paper money is always backed by gold and therefore more desirable than checks. Answer: C 3.4 Measuring Money 1) Recent financial innovation makes the Federal Reserve's job of conducting monetary policy A) easier, since the Fed now knows what to consider money. B) more difficult, since the Fed now knows what to consider money. C) easier, since the Fed no longer knows what to consider money. D) more difficult, since the Fed no longer knows what to consider money. Answer: D 2) Defining money becomes ________ difficult as the pace of financial innovation ________. A) less; quickens B) more; quickens C) more; slows D) more; stops Answer: B 3) Monetary aggregates are A) measures of the money supply reported by the Federal Reserve. B) measures of the wealth of individuals. C) never redefined since "money" never changes. D) reported by the Treasury Department annually. Answer: A 4) ________ is the narrowest monetary aggregate that the Fed reports. A) M0 B) M1 C) M2 D) M3 Answer: B 5) The currency component includes paper money and coins held in ________. A) bank vaults B) ATMs C) the hands of the nonbank public D) the central bank Answer: C 6) The components of the U.S. M1 money supply are demand and checkable deposits plus A) currency. B) currency plus savings deposits. C) currency plus travelers checks. D) currency plus travelers checks plus money market deposits. Answer: C 7) The M1 measure of money includes A) small denomination time deposits. B) traveler's checks. C) money market deposit accounts. D) money market mutual fund shares. Answer: B 26 8) Which of the following is not included in the measure of M1? A) NOW accounts. B) Demand deposits. C) Currency. D) Savings deposits. Answer: D 9) Which of the following is not included in the M1 measure of money but is included in the M2 measure of money? A) Currency B) Traveler's checks C) Demand deposits D) Small-denomination time deposits Answer: D 10) Which of the following is included in both M1 and M2? A) Currency B) Savings deposits C) Small-denomination time deposits D) Money market deposit accounts Answer: A 11) Which of the following is not included in the monetary aggregate M2? A) Currency B) Savings bonds C) Traveler's checks D) Checking deposits Answer: B 12) Which of the following is included in M2 but not in M1? A) NOW accounts B) Demand deposits C) Currency D) Money market mutual fund shares (retail) Answer: D 13) Of the following, the largest is A) money market deposit accounts. B) demand deposits. C) M1. D) M2. Answer: D 14) If an individual redeems a U.S. savings bond for currency A) M1 stays the same and M2 decreases. B) M1 increases and M2 increases. C) M1 increases and M2 stays the same. D) M1 stays the same and M2 stays the same. Answer: B 15) If an individual moves money from a small-denomination time deposit to a demand deposit account, A) M1 increases and M2 stays the same. B) M1 stays the same and M2 increases. C) M1 stays the same and M2 stays the same. D) M1 increases and M2 decreases. Answer: A 16) If an individual moves money from a demand deposit account to a money market deposit account, A) M1 decreases and M2 stays the same. B) M1 stays the same and M2 increases. C) M1 stays the same and M2 stays the same. D) M1 increases and M2 decreases. Answer: A 17) If an individual moves money from a savings deposit account to a money market deposit account, A) M1 decreases and M2 stays the same. B) M1 stays the same and M2 increases. C) M1 stays the same and M2 stays the same. D) M1 increases and M2 decreases. Answer: C 18) If an individual moves money from currency to a demand deposit account, A) M1 decreases and M2 stays the same. B) M1 stays the same and M2 increases. C) M1 stays the same and M2 stays the same. D) M1 increases and M2 stays the same. 27 11) A credit market instrument that pays the owner a fixed coupon payment every year until the maturity date and then repays the face value is called a A) simple loan. B) fixed-payment loan. C) coupon bond. D) discount bond. Answer: C 12) A ________ pays the owner a fixed coupon payment every year until the maturity date, when the ________ value is repaid. A) coupon bond; discount B) discount bond; discount C) coupon bond; face D) discount bond; face Answer: C 13) The ________ is the final amount that will be paid to the holder of a coupon bond. A) discount value B) coupon value C) face value D) present value Answer: C 14) When talking about a coupon bond, face value and ________ mean the same thing. A) par value B) coupon value C) amortized value D) discount value Answer: A 15) The dollar amount of the yearly coupon payment expressed as a percentage of the face value of the bond is called the bond's A) coupon rate. B) maturity rate. C) face value rate. D) payment rate. Answer: A 16) If a $5,000 coupon bond has a coupon rate of 13 percent, then the coupon payment every year is A) $650. B) $1,300. C) $130. D) $13. Answer: A 17) An $8,000 coupon bond with a $400 coupon payment every year has a coupon rate of A) 5 percent. B) 8 percent. C) 10 percent. D) 40 percent. Answer: A 18) All of the following are examples of coupon bonds except A) Corporate bonds B) U.S. Treasury bills C) U.S. Treasury notes D) U.S. Treasury bonds Answer: B 19) A bond that is bought at a price below its face value and the face value is repaid at a maturity date is called a A) simple loan. B) fixed-payment loan. C) coupon bond. D) discount bond. Answer: D 20) A ________ is bought at a price below its face value, and the ________ value is repaid at the maturity date. A) coupon bond; discount B) discount bond; discount C) coupon bond; face D) discount bond; face Answer: D 21) A discount bond A) pays the bondholder a fixed amount every period and the face value at maturity. B) pays the bondholder the face value at maturity. C) pays all interest and the face value at maturity. 30 D) pays the face value at maturity plus any capital gain. Answer: B 22) Examples of discount bonds include A) U.S. Treasury bills. B) corporate bonds. C) U.S. Treasury notes. D) municipal bonds. Answer: A 23) Which of the following are true for discount bonds? A) A discount bond is bought at par. B) The purchaser receives the face value of the bond at the maturity date. C) U.S. Treasury bonds and notes are examples of discount bonds. D) The purchaser receives the par value at maturity plus any capital gains. Answer: B 24) The interest rate that equates the present value of payments received from a debt instrument with its value today is the A) simple interest rate. B) current yield. C) yield to maturity. D) real interest rate. Answer: C 25) Economists consider the ________ to be the most accurate measure of interest rates. A) simple interest rate. B) current yield. C) yield to maturity. D) real interest rate. Answer: C 26) For simple loans, the simple interest rate is ________ the yield to maturity. A) greater than B) less than C) equal to D) not comparable to Answer: C 27) If the amount payable in two years is $2420 for a simple loan at 10 percent interest, the loan amount is A) $1000. B) $1210. C) $2000. D) $2200. Answer: C 28) For a 3-year simple loan of $10,000 at 10 percent, the amount to be repaid is A) $10,030. B) $10,300. C) $13,000. D) $13,310. Answer: D 29) If $22,050 is the amount payable in two years for a $20,000 simple loan made today, the interest rate is A) 5 percent. B) 10 percent. C) 22 percent. D) 25 percent. Answer: A 30) If a security pays $110 next year and $121 the year after that, what is its yield to maturity if it sells for $200? A) 9 percent B) 10 percent C) 11 percent D) 12 percent Answer: B 31) The present value of a fixed-payment loan is calculated as the ________ of the present value of all cash flow payments. A) sum B) difference C) multiple D) log Answer: A 32) Which of the following are true for a coupon bond? A) When the coupon bond is priced at its face value, the yield to maturity equals the coupon rate. 31 B) The price of a coupon bond and the yield to maturity are positively related. C) The yield to maturity is greater than the coupon rate when the bond price is above the par value. D) The yield is less than the coupon rate when the bond price is below the par value. Answer: A 33) The price of a coupon bond and the yield to maturity are ________ related; that is, as the yield to maturity ________, the price of the bond ________. A) positively; rises; rises B) negatively; falls; falls C) positively; rises; falls D) negatively; rises; falls Answer: D 34) The yield to maturity is ________ than the ________ rate when the bond price is ________ its face value. A) greater; coupon; above B) greater; coupon; below C) greater; perpetuity; above D) less; perpetuity; below Answer: B 35) A $10,000 8 percent coupon bond that sells for $10,000 has a yield to maturity of A) 8 percent. B) 10 percent. C) 12 percent. D) 14 percent. Answer: A 36) Which of the following $1,000 face-value securities has the highest yield to maturity? A) A 5 percent coupon bond selling for $1,000 B) A 10 percent coupon bond selling for $1,000 C) A 12 percent coupon bond selling for $1,000 D) A 12 percent coupon bond selling for $1,100 Answer: C 37) Which of the following $5,000 face-value securities has the highest to maturity? A) A 6 percent coupon bond selling for $5,000 B) A 6 percent coupon bond selling for $5,500 C) A 10 percent coupon bond selling for $5,000 D) A 12 percent coupon bond selling for $4,500 Answer: D 38) Which of the following $1,000 face-value securities has the highest yield to maturity? A) A 5 percent coupon bond with a price of $600 B) A 5 percent coupon bond with a price of $800 C) A 5 percent coupon bond with a price of $1,000 D) A 5 percent coupon bond with a price of $1,200 Answer: A 39) Which of the following $1,000 face-value securities has the lowest yield to maturity? A) A 5 percent coupon bond selling for $1,000 B) A 10 percent coupon bond selling for $1,000 C) A 15 percent coupon bond selling for $1,000 D) A 15 percent coupon bond selling for $900 Answer: A 40) Which of the following bonds would you prefer to be buying? A) A $10,000 face-value security with a 10 percent coupon selling for $9,000 B) A $10,000 face-value security with a 7 percent coupon selling for $10,000 C) A $10,000 face-value security with a 9 percent coupon selling for $10,000 D) A $10,000 face-value security with a 10 percent coupon selling for $10,000 Answer: A 41) A coupon bond that has no maturity date and no repayment of principal is called a A) consol. B) cabinet. C) Treasury bill. D) Treasury note. Answer: A 42) The price of a consol equals the coupon payment A) times the interest rate. B) plus the interest rate. C) minus the interest rate. D) divided by the interest rate. Answer: D 32 D) Prices and returns for short-term bonds are more volatile than those for longer-term bonds. Answer: A 12) Which of the following are generally true of all bonds? A) The longer a bond's maturity, the greater is the rate of return that occurs as a result of the increase in the interest rate. B) Even though a bond has a substantial initial interest rate, its return can turn out to be negative if interest rates rise. C) Prices and returns for short-term bonds are more volatile than those for longer term bonds. D) A fall in interest rates results in capital losses for bonds whose terms to maturity are longer than the holding period. Answer: B 13) The riskiness of an asset's returns due to changes in interest rates is A) exchange-rate risk. B) price risk. C) asset risk. D) interest-rate risk. Answer: D 14) Interest-rate risk is the riskiness of an asset's returns due to A) interest-rate changes. B) changes in the coupon rate. C) default of the borrower. D) changes in the asset's maturity. Answer: A 15) Prices and returns for ________ bonds are more volatile than those for ________ bonds, everything else held constant. A) long-term; long-term B) long-term; short-term C) short-term; long-term D) short-term; short-term Answer: B 16) There is ________ for any bond whose time to maturity matches the holding period. A) no interest-rate risk B) a large interest-rate risk C) rate-of-return risk D) yield-to-maturity risk Answer: A 4.3 The Distinction Between Real and Nominal Interest Rates 1) The ________ interest rate is adjusted for expected changes in the price level. A) ex ante real B) ex post real C) ex post nominal D) ex ante nominal Answer: A 2) The ________ interest rate more accurately reflects the true cost of borrowing. A) nominal B) real C) discount D) market Answer: B 3) The nominal interest rate minus the expected rate of inflation A) defines the real interest rate. B) is a less accurate measure of the incentives to borrow and lend than is the nominal interest rate. C) is a less accurate indicator of the tightness of credit market conditions than is the nominal interest rate. D) defines the discount rate. Answer: A 4) When the ________ interest rate is low, there are greater incentives to ________ and fewer incentives to ________. A) nominal; lend; borrow B) real; lend; borrow C) real; borrow; lend D) market; lend; borrow Answer: C 5) The interest rate that describes how well a lender has done in real terms after the fact is called the A) ex post real interest rate. B) ex ante real interest rate. C) ex post nominal interest rate. D) ex ante nominal interest rate. Answer: A 35 6) The ________ states that the nominal interest rate equals the real interest rate plus the expected rate of inflation. A) Fisher equation B) Keynesian equation C) Monetarist equation D) Marshall equation Answer: A 7) If the nominal rate of interest is 2 percent, and the expected inflation rate is -10 percent, the real rate of interest is A) 2 percent. B) 8 percent. C) 10 percent. D) 12 percent. Answer: D 8) In which of the following situations would you prefer to be the lender? A) The interest rate is 9 percent and the expected inflation rate is 7 percent. B) The interest rate is 4 percent and the expected inflation rate is 1 percent. C) The interest rate is 13 percent and the expected inflation rate is 15 percent. D) The interest rate is 25 percent and the expected inflation rate is 50 percent. Answer: B 9) In which of the following situations would you prefer to be the borrower? A) The interest rate is 9 percent and the expected inflation rate is 7 percent. B) The interest rate is 4 percent and the expected inflation rate is 1 percent. C) The interest rate is 13 percent and the expected inflation rate is 15 percent. D) The interest rate is 25 percent and the expected inflation rate is 50 percent. Answer: D 10) If you expect the inflation rate to be 15 percent next year and a one-year bond has a yield to maturity of 7 percent, then the real interest rate on this bond is A) 7 percent. B) 22 percent. C) -15 percent. D) -8 percent. Answer: D 11) If you expect the inflation rate to be 12 percent next year and a one-year bond has a yield to maturity of 7 percent, then the real interest rate on this bond is A) -5 percent. B) -2 percent. C) 2 percent. D) 12 percent. Answer: A 12) If you expect the inflation rate to be 4 percent next year and a one year bond has a yield to maturity of 7 percent, then the real interest rate on this bond is A) -3 percent. B) -2 percent. C) 3 percent. D) 7 percent. Answer: C 13) The interest rate on Treasury Inflation Protected Securities is a direct measure of A) the real interest rate. B) the nominal interest rate. C) the rate of inflation. D) the rate of deflation. Answer: A 14) Assuming the same coupon rate and maturity length, the difference between the yield on a Treasury Inflation Protected Security and the yield on a nonindexed Treasury security provides insight into A) the nominal interest rate. B) the real interest rate. C) the nominal exchange rate. D) the expected inflation rate. Answer: D 15) Assuming the same coupon rate and maturity length, when the interest rate on a Treasury Inflation Protected Security is 3 percent, and the yield on a nonindexed Treasury bond is 8 percent, the expected rate of inflation is A) 3 percent. B) 5 percent. C) 8 percent. D) 11 percent. Answer: B The Economics of Money, Banking, and Financial Markets, 9e (Mishkin) Chapter 5 The Behavior of Interest Rates 36 5.1 Determinants of Asset Demand 1) Pieces of property that serve as a store of value are called A) assets. B) units of account. C) liabilities. D) borrowings. Answer: A 2) Of the four factors that influence asset demand, which factor will cause the demand for all assets to increase when it increases, everything else held constant? A) wealth B) expected returns C) risk D) liquidity Answer: A 3) If wealth increases, the demand for stocks ________ and that of long-term bonds ________, everything else held constant. A) increases; increases B) increases; decreases C) decreases; decreases D) decreases; increases Answer: A 4) Everything else held constant, a decrease in wealth A) increases the demand for stocks. B) increases the demand for bonds. C) reduces the demand for silver. D) increases the demand for gold. Answer: C 5) An increase in an asset's expected return relative to that of an alternative asset, holding everything else constant, ________ the quantity demanded of the asset. A) increases B) decreases C) has no effect on D) erases Answer: A 6) Everything else held constant, if the expected return on ABC stock rises from 5 to 10 percent and the expected return on CBS stock is unchanged, then the expected return of holding CBS stock ________ relative to ABC stock and the demand for CBS stock ________. A) rises; rises B) rises; falls C) falls; rises D) falls; falls Answer: D 7) Everything else held constant, if the expected return on U.S. Treasury bonds falls from 10 to 5 percent and the expected return on GE stock rises from 7 to 8 percent, then the expected return of holding GE stock ________ relative to U.S. Treasury bonds and the demand for GE stock ________. A) rises; rises B) rises; falls C) falls; rises D) falls; falls Answer: A 8) If housing prices are expected to increase, then, other things equal, the demand for houses will ________ and that of Treasury bills will ________. A) increase; increase B) increase; decrease C) decrease; decrease D) decrease; increase Answer: B 9) If stock prices are expected to drop dramatically, then, other things equal, the demand for stocks will ________ and that of Treasury bills will ________. A) increase; increase B) increase; decrease C) decrease; decrease D) decrease; increase Answer: D 10) Everything else held constant, if the expected return on RST stock declines from 12 to 9 percent and the expected return on XYZ stock declines from 8 to 7 percent, then the expected return of holding RST stock ________ relative to XYZ stock and demand for XYZ stock ________. A) rises; rises B) rises; falls C) falls; rises D) falls; falls Answer: C 37 C) below; supply; fall D) above; supply; rise Answer: B 9) A situation in which the quantity of bonds supplied exceeds the quantity of bonds demanded is called a condition of excess supply; because people want to sell ________ bonds than others want to buy, the price of bonds will ________. A) fewer; fall B) fewer; rise C) more; fall D) more; rise Answer: C 10) If the price of bonds is set ________ the equilibrium price, the quantity of bonds demanded exceeds the quantity of bonds supplied, a condition called excess ________. A) above; demand B) above; supply C) below; demand D) below; supply Answer: C 5.3 Changes in Equilibrium Interest Rates 1) A movement along the bond demand or supply curve occurs when ________ changes. A) bond price B) income C) wealth D) expected return Answer: A 2) When the price of a bond decreases, all else equal, the bond demand curve ________. A) shifts right B) shifts left C) does not shift D) inverts Answer: C 3) During business cycle expansions when income and wealth are rising, the demand for bonds ________ and the demand curve shifts to the ________, everything else held constant. A) falls; right B) falls; left C) rises; right D) rises; left Answer: C 4) Everything else held constant, when households save less, wealth and the demand for bonds ________ and the bond demand curve shifts ________. A) increase; right B) increase; left C) decrease; right D) decrease; left Answer: D 5) Everything else held constant, if interest rates are expected to fall in the future, the demand for long-term bonds today ________ and the demand curve shifts to the ________. A) rises; right B) rises; left C) falls; right D) falls; left Answer: A 6) Holding the expected return on bonds constant, an increase in the expected return on common stocks would ________ the demand for bonds, shifting the demand curve to the ________. A) decrease; left B) decrease; right C) increase; left D) increase; right Answer: A 7) Everything else held constant, an increase in expected inflation, lowers the expected return on ________ compared to ________ assets. A) bonds; financial B) bonds; real C) physical; financial D) physical; real Answer: B 8) Everything else held constant, an increase in the riskiness of bonds relative to alternative assets causes the demand for bonds to ________ and the demand 40 curve to shift to the ________. A) rise; right B) rise; left C) fall; right D) fall; left Answer: D 9) Everything else held constant, when stock prices become less volatile, the demand curve for bonds shifts to the ________ and the interest rate ________. A) right; rises B) right; falls C) left; falls D) left; rises Answer: D 10) Everything else held constant, when stock prices become ________ volatile, the demand curve for bonds shifts to the ________ and the interest rate ________. A) more; right; rises B) more; right; falls C) less; left; falls D) less; left; does not change Answer: B 11) Everything else held constant, an increase in the liquidity of bonds results in a ________ in demand for bonds and the demand curve shifts to the ________. A) rise; right B) rise; left C) fall; right D) fall; left Answer: A 12) Everything else held constant, when bonds become less widely traded, and as a consequence the market becomes less liquid, the demand curve for bonds shifts to the ________ and the interest rate ________. A) right; rises B) right; falls C) left; falls D) left; rises Answer: D 13) The reduction of brokerage commissions for trading common stocks that occurred in 1975 caused the demand for bonds to ________ and the demand curve to shift to the ________. A) fall; right B) fall, left C) rise; right D) rise; left Answer: B 14) Factors that decrease the demand for bonds include A) an increase in the volatility of stock prices. B) a decrease in the expected returns on stocks. C) a decrease in the inflation rate. D) a decrease in the riskiness of stocks. Answer: D 15) During a recession, the supply of bonds ________ and the supply curve shifts to the ________, everything else held constant. A) increases; left B) increases; right C) decreases; left D) decreases; right Answer: C 16) In a business cycle expansion, the ________ of bonds increases and the ________ curve shifts to the ________ as business investments are expected to be more profitable. A) supply; supply; right B) supply; supply; left C) demand; demand; right D) demand; demand; left Answer: A 17) When the expected inflation rate increases, the real cost of borrowing ________ and bond supply ________, everything else held constant. A) increases; increases B) increases; decreases C) decreases; increases D) decreases; decreases Answer: C 18) An increase in the expected inflation rate causes the supply of bonds to ________ and the supply curve to shift to the ________, everything else held 41 constant. A) increase; left B) increase; right C) decrease; left D) decrease; right Answer: B 19) Higher government deficits ________ the supply of bonds and shift the supply curve to the ________, everything else held constant. A) increase; left B) increase; right C) decrease; left D) decrease; right Answer: B 20) Factors that can cause the supply curve for bonds to shift to the right include A) an expansion in overall economic activity. B) a decrease in expected inflation. C) a decrease in government deficits. D) a business cycle recession. Answer: A 21) When the inflation rate is expected to increase, the ________ for bonds falls, while the ________ curve shifts to the right, everything else held constant. A) demand; demand B) demand; supply C) supply; demand D) supply; supply Answer: B 22) When the expected inflation rate increases, the demand for bonds ________, the supply of bonds ________, and the interest rate ________, everything else held constant. A) increases; increases; rises B) decreases; decreases; falls C) increases; decreases; falls D) decreases; increases; rises Answer: D 23) Everything else held constant, when the inflation rate is expected to rise, interest rates will ________; this result has been termed the ________. A) fall; Keynes effect B) fall; Fisher effect C) rise; Keynes effect D) rise; Fisher effect Answer: D 24) The economist Irving Fisher, after whom the Fisher effect is named, explained why interest rates ________ as the expected rate of inflation ________, everything else held constant. A) rise; increases B) rise; stabilizes C) fall; stabilizes D) fall; increases Answer: A 25) Everything else held constant, during a business cycle expansion, the supply of bonds shifts to the ________ as businesses perceive more profitable investment opportunities, while the demand for bonds shifts to the ________ as a result of the increase in wealth generated by the economic expansion. A) right; left B) right; right C) left; left D) left; right Answer: B 26) When the economy slips into a recession, normally the demand for bonds ________, the supply of bonds ________, and the interest rate ________, everything else held constant. A) increases; increases; rises B) decreases; decreases; falls C) increases; decreases; falls D) decreases; increases; rises Answer: B 27) When an economy grows out of a recession, normally the demand for bonds ________ and the supply of bonds ________, everything else held constant. A) increases; increases B) increases; decreases C) decreases; decreases D) decreases; increases Answer: A 28) Deflation causes the demand for bonds to ________, the supply of bonds to ________, and bond prices to ________, everything else held constant. 42 46) In the figure above, a factor that could cause the supply of bonds to increase (shift to the right) is: A) a decrease in government budget deficits. B) a decrease in expected inflation. C) expectations of more profitable investment opportunities. D) a business cycle recession. Answer: C 47) In the figure above, a factor that could cause the demand for bonds to shift to the right is: A) an increase in the riskiness of bonds relative to other assets. B) an increase in the expected rate of inflation. C) expectations of lower interest rates in the future. D) a decrease in wealth. Answer: C 48) In the figure above, the price of bonds would fall from P2 to P1 if A) there is a business cycle recession. B) there is a business cycle expansion. C) inflation is expected to increase in the future. D) inflation is expected to decrease in the future. Answer: B 5.4 Supply and Demand in the Market for Money: The Liquidity Preference Framework 1) In Keynes's liquidity preference framework, individuals are assumed to hold their wealth in two forms: A) real assets and financial assets. B) stocks and bonds. C) money and bonds. D) money and gold. Answer: C 2) In Keynes's liquidity preference framework, A) the demand for bonds must equal the supply of money. B) the demand for money must equal the supply of bonds. C) an excess demand of bonds implies an excess demand for money. D) an excess supply of bonds implies an excess demand for money. Answer: D 3) In Keynes's liquidity preference framework, if there is excess demand for money, there is A) excess demand for bonds. B) equilibrium in the bond market. C) excess supply of bonds. D) too much money. Answer: C 4) The bond supply and demand framework is easier to use when analyzing the effects of changes in ________, while the liquidity preference framework provides a simpler analysis of the effects from changes in income, the price level, and the supply of ________. A) expected inflation; bonds B) expected inflation; money C) government budget deficits; bonds D) government budget deficits; money Answer: B 5) Keynes assumed that money has ________ rate of return. A) a positive 45 B) a negative C) a zero D) an increasing Answer: C 6) In his Liquidity Preference Framework, Keynes assumed that money has a zero rate of return; thus, A) when interest rates rise, the expected return on money falls relative to the expected return on bonds, causing the demand for money to fall. B) when interest rates rise, the expected return on money falls relative to the expected return on bonds, causing the demand for money to rise. C) when interest rates fall, the expected return on money falls relative to the expected return on bonds, causing the demand for money to fall. D) when interest rates fall, the expected return on money falls relative to the expected return on bonds, causing the demand for money to rise. Answer: A 7) In Keynes's liquidity preference framework, as the expected return on bonds increases (holding everything else unchanged), the expected return on money ________, causing the demand for ________ to fall. A) falls; bonds B) falls; money C) rises; bonds D) rises; money Answer: B 8) The opportunity cost of holding money is A) the level of income. B) the price level. C) the interest rate. D) the discount rate. Answer: C 9) An increase in the interest rate A) increases the demand for money. B) increases the quantity of money demanded. C) decreases the demand for money. D) decreases the quantity of money demanded. Answer: D 10) If there is an excess supply of money A) individuals sell bonds, causing the interest rate to rise. B) individuals sell bonds, causing the interest rate to fall. C) individuals buy bonds, causing interest rates to fall. D) individuals buy bonds, causing interest rates to rise. Answer: C 11) When the interest rate is above the equilibrium interest rate, there is an excess ________ money and the interest rate will ________. A) demand for; rise B) demand for; fall C) supply of; fall D) supply of; rise Answer: C 12) In the market for money, an interest rate below equilibrium results in an excess ________ money and the interest rate will ________. A) demand for; rise B) demand for; fall C) supply of; fall D) supply of; rise Answer: A 5.5 Changes in Equilibrium Interest Rates in the Liquidity Preference Framework 1) In the Keynesian liquidity preference framework, an increase in the interest rate causes the demand curve for money to ________, everything else held constant. A) shift right B) shift left C) stay where it is D) invert Answer: C 2) A lower level of income causes the demand for money to ________ and the interest rate to ________, everything else held constant. A) decrease; decrease B) decrease; increase C) increase; decrease D) increase; increase Answer: A 3) When real income ________, the demand curve for money shifts to the ________ and the interest rate ________, everything else held constant. A) falls; right; rises B) rises; right; rises 46 C) falls; left; rises D) rises; left; rises Answer: B 4) A business cycle expansion increases income, causing money demand to ________ and interest rates to ________, everything else held constant. A) increase; increase B) increase; decrease C) decrease; decrease D) decrease; increase Answer: A 5) In the Keynesian liquidity preference framework, a rise in the price level causes the demand for money to ________ and the demand curve to shift to the ________, everything else held constant. A) increase; left B) increase; right C) decrease; left D) decrease; right Answer: B 6) When the price level ________, the demand curve for money shifts to the ________ and the interest rate ________, everything else held constant. A) falls; left; falls B) rises; right; falls C) falls; left; rises D) rises; right; rises Answer: D 7) A rise in the price level causes the demand for money to ________ and the interest rate to ________, everything else held constant. A) decrease; decrease B) decrease; increase C) increase; decrease D) increase; increase Answer: D 8) When the price level falls, the ________ curve for nominal money ________, and interest rates ________, everything else held constant. A) demand; decreases; fall B) demand; increases; rise C) supply; increases; rise D) supply; decreases; fall Answer: A 9) A decline in the expected inflation rate causes the demand for money to ________ and the demand curve to shift to the ________, everything else held constant. A) decrease; right B) decrease; left C) increase; right D) increase; left Answer: B 10) When the Fed decreases the money stock, the money supply curve shifts to the ________ and the interest rate ________, everything else held constant. A) right; rises B) right; falls C) left; falls D) left; rises Answer: D 11) When the Fed ________ the money stock, the money supply curve shifts to the ________ and the interest rate ________, everything else held constant. A) decreases; right; rises B) increases; right; falls C) decreases; left; falls D) increases; left; rises Answer: B 12) ________ in the money supply creates excess ________ money, causing interest rates to ________, everything else held constant. A) A decrease; demand for; rise B) An increase; demand for; fall C) An increase; supply of; rise D) A decrease; supply of; fall Answer: A 13) ________ in the money supply creates excess demand for ________, causing interest rates to ________, everything else held constant. A) An increase; money; rise B) An increase; bonds; fall C) A decrease; bonds; rise D) A decrease; money; fall Answer: B 47 A) interest rate will fall. B) interest rate will rise. C) interest rate will fall immediately below the initial level when the money supply grows. D) interest rate will rise immediately above the initial level when the money supply grows. Answer: D 29) In the figure above, illustrates the effect of an increased rate of money supply growth at time period 0. From the figure, one can conclude that the A) liquidity effect is smaller than the expected inflation effect and interest rates adjust quickly to changes in expected inflation. B) liquidity effect is larger than the expected inflation effect and interest rates adjust quickly to changes in expected inflation. C) liquidity effect is larger than the expected inflation effect and interest rates adjust slowly to changes in expected inflation. D) liquidity effect is smaller than the expected inflation effect and interest rates adjust slowly to changes in expected inflation. Answer: A 30) In the figure above, illustrates the effect of an increased rate of money supply growth at time period 0. From the figure, one can conclude that the A) Fisher effect is dominated by the liquidity effect and interest rates adjust slowly to changes in expected inflation. B) liquidity effect is dominated by the Fisher effect and interest rates adjust slowly to changes in expected inflation. C) liquidity effect is dominated by the Fisher effect and interest rates adjust quickly to changes in expected inflation. D) Fisher effect is smaller than the expected inflation effect and interest rates adjust quickly to changes in expected inflation. Answer: C 31) The figure above illustrates the effect of an increased rate of money supply growth at time period T0. From the figure, one can conclude that the A) liquidity effect is smaller than the expected inflation effect and interest rates adjust quickly to changes in expected inflation. B) liquidity effect is larger than the expected inflation effect and interest rates adjust quickly to changes in expected inflation. C) liquidity effect is larger than the expected inflation effect and interest rates adjust slowly to changes in expected inflation. D) liquidity effect is smaller than the expected inflation effect and interest rates adjust slowly to changes in expected inflation. Answer: C 32) The figure above illustrates the effect of an increased rate of money supply growth at time period T0. From the figure, one can conclude that the A) Fisher effect is dominated by the liquidity effect and interest rates adjust slowly to changes in expected inflation. B) liquidity effect is dominated by the Fisher effect and interest rates adjust slowly to changes in expected inflation. C) liquidity effect is dominated by the Fisher effect and interest rates adjust quickly to changes in expected inflation. D) Fisher effect is smaller than the expected inflation effect and interest rates adjust quickly to changes in expected inflation. Answer: A 50 33) The figure above illustrates the effect of an increased rate of money supply growth at time period T0. From the figure, one can conclude that the A) liquidity effect is smaller than the expected inflation effect and interest rates adjust quickly to changes in expected inflation. B) liquidity effect is larger than the expected inflation effect and interest rates adjust quickly to changes in expected inflation. C) liquidity effect is larger than the expected inflation effect and interest rates adjust slowly to changes in expected inflation. D) liquidity effect is smaller than the expected inflation effect and interest rates adjust slowly to changes in expected inflation. Answer: D 34) The figure above illustrates the effect of an increased rate of money supply growth at time period T0. From the figure, one can conclude that the A) Fisher effect is dominated by the liquidity effect and interest rates adjust slowly to changes in expected inflation. B) liquidity effect is dominated by the Fisher effect and interest rates adjust slowly to changes in expected inflation. C) liquidity effect is dominated by the Fisher effect and interest rates adjust quickly to changes in expected inflation. D) Fisher effect is smaller than the expected inflation effect and interest rates adjust quickly to changes in expected inflation. Answer: A 35) Interest rates increased continuously during the 1970s. The most likely explanation is A) banking failures that reduced the money supply. B) a rise in the level of income. C) the repeated bouts of recession and expansion. D) increasing expected rates of inflation. Answer: D The Economics of Money, Banking, and Financial Markets, 9e (Mishkin) Chapter 6 The Risk and Term Structure of Interest Rates 6.1 Risk Structure of Interest Rates 1) 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. Answer: B 2) The risk that interest payments will not be made, or that the face value of a bond is not repaid when a bond matures is A) interest rate risk. B) inflation risk. C) moral hazard. D) default risk. Answer: D 3) Bonds with no default risk are called A) flower bonds. B) no-risk bonds. C) default-free bonds. D) zero-risk bonds. Answer: C 4) Which of the following bonds are considered to be default-risk free? A) Municipal bonds B) Investment-grade bonds C) U.S. Treasury bonds D) Junk bonds Answer: C 5) U.S. government bonds have no default risk because A) they are backed by the full faith and credit of the federal government. 51 B) the federal government can increase taxes to pay its obligations. C) they are backed with gold reserves. D) they can be exchanged for silver at any time. Answer: B 6) The spread between the interest rates on bonds with default risk and default-free bonds is called the A) risk premium. B) junk margin. C) bond margin. D) default premium. Answer: A 7) If the probability of a bond default increases because corporations begin to suffer large losses, then the default risk on corporate bonds will ________ and the expected return on these bonds will ________, everything else held constant. A) decrease; increase B) decrease; decrease C) increase; increase D) increase; decrease Answer: D 8) A bond with default risk will always have a ________ risk premium and an increase in its default risk will ________ the risk premium. A) positive; raise B) positive; lower C) negative; raise D) negative; lower Answer: A 9) If a corporation begins to suffer large losses, then the default risk on the corporate bond will A) increase and the bond's return will become more uncertain, meaning the expected return on the corporate bond will fall. B) increase and the bond's return will become less uncertain, meaning the expected return on the corporate bond will fall. C) decrease and the bond's return will become less uncertain, meaning the expected return on the corporate bond will fall. D) decrease and the bond's return will become less uncertain, meaning the expected return on the corporate bond will rise. Answer: A 10) If the possibility of a default increases because corporations begin to suffer losses, then the default risk on corporate bonds will ________, and the bonds' returns will become ________ uncertain, meaning that the expected return on these bonds will decrease, everything else held constant. A) increase; less B) increase; more C) decrease; less D) decrease; more Answer: B 11) Other things being equal, an increase in the default risk of corporate bonds shifts the demand curve for corporate bonds to the ________ and the demand curve for Treasury bonds to the ________. A) right; right B) right; left C) left; right D) left; left Answer: C 12) An increase in the riskiness of corporate bonds will ________ the price of corporate bonds and ________ the price of Treasury bonds, everything else held constant. A) increase; increase B) reduce; reduce C) reduce; increase D) increase; reduce Answer: C 13) An increase in the riskiness of corporate bonds will ________ the yield on corporate bonds and ________ the yield on Treasury securities, everything else held constant. A) increase; increase B) reduce; reduce C) increase; reduce D) reduce; increase Answer: C 14) An increase in default risk on corporate bonds ________ the demand for these bonds, but ________ the demand for default-free bonds, everything else held constant. A) increases; lowers B) lowers; increases C) does not change; greatly increases D) moderately lowers; does not change Answer: B 15) As default risk increases, the expected return on corporate bonds ________, and the return becomes ________ uncertain, everything else held constant. 52 D) reduce; increase Answer: A 36) The risk premium on corporate bonds reflects the fact that corporate bonds have a higher default risk and are ________ U.S. Treasury bonds. A) less liquid than B) less speculative than C) tax-exempt unlike D) lower-yielding than Answer: A 37) Which of the following statements is true? A) State and local governments cannot default on their bonds. B) Bonds issued by state and local governments are called municipal bonds. C) All government issued bonds local, state, and federal are federal income tax exempt.money and income are both stocks. money and income are both stocks. D) The coupon payment on municipal bonds is usually higher than the coupon payment on Treasury bonds. Answer: B 38) Everything else held constant, if the tax-exempt status of municipal bonds were eliminated, then A) the interest rates on municipal bonds would still be less than the interest rate on Treasury bonds. B) the interest rate on municipal bonds would equal the rate on Treasury bonds. C) the interest rate on municipal bonds would exceed the rate on Treasury bonds. D) the interest rates on municipal, Treasury, and corporate bonds would all increase. Answer: C 39) Municipal bonds have default risk, yet their interest rates are lower than the rates on default-free Treasury bonds. This suggests that A) the benefit from the tax-exempt status of municipal bonds is less than their default risk. B) the benefit from the tax-exempt status of municipal bonds equals their default risk. C) the benefit from the tax-exempt status of municipal bonds exceeds their default risk. D) Treasury bonds are not default-free. Answer: C 40) Everything else held constant, an increase in marginal tax rates would likely have the effect of ________ the demand for municipal bonds, and ________ the demand for U.S. government bonds. A) increasing; increasing B) increasing; decreasing C) decreasing; increasing D) decreasing; decreasing Answer: B 41) Everything else held constant, the interest rate on municipal bonds rises relative to the interest rate on Treasury securities when A) income tax rates are lowered. B) income tax rates are raised. C) municipal bonds become more widely traded. D) corporate bonds become riskier. Answer: A 42) Everything else held constant, if income tax rates were lowered, then A) the interest rate on municipal bonds would fall. B) the interest rate on Treasury bonds would rise. C) the interest rate on municipal bonds would rise. D) the price of Treasury bonds would fall. Answer: C 43) Everything else held constant, abolishing all taxes will A) increase the interest rate on corporate bonds. B) reduce the interest rate on municipal bonds. C) increase the interest rate on municipal bonds. D) increase the interest rate on Treasury bonds. Answer: C 44) Which of the following statements are true? A) An increase in tax rates will increase the demand for Treasury bonds, lowering their interest rates. B) Because the tax-exempt status of municipal bonds was of little benefit to bond holders when tax rates were low, they had higher interest rates than U.S. government bonds before World War II. C) Interest rates on municipal bonds will be higher than comparable bonds without the tax exemption. D) Because coupon payments on municipal bonds are exempt from federal income tax, the expected after-tax return on them will be higher for individuals in lower income tax brackets. Answer: B 45) The Bush tax cut reduced the top income tax bracket from 39% to 35% over a ten-year period. Supply and demand analysis predicts the impact of this change was a ________ interest rate on municipal bonds and a ________ interest rate on Treasury bonds. A) higher; lower B) lower; lower C) higher; higher D) lower; higher 55 Answer: A 46) Three factors explain the risk structure of interest rates: A) liquidity, default risk, and the income tax treatment of a security. B) maturity, default risk, and the income tax treatment of a security. C) maturity, liquidity, and the income tax treatment of a security. D) maturity, default risk, and the liquidity of a security. Answer: A 6.2 Term Structure of Interest Rates 1) The term structure of interest rates is A) the relationship among interest rates of different bonds with the same maturity. B) the structure of how interest rates move over time. C) the relationship among the term to maturity of different bonds. D) the relationship among interest rates on bonds with different maturities. Answer: D 2) A plot of the interest rates on default-free government bonds with different terms to maturity is called A) a risk-structure curve. B) a default-free curve. C) a yield curve. D) an interest-rate curve. Answer: C 3) Differences in ________ explain why interest rates on Treasury securities are not all the same. A) risk B) liquidity C) time to maturity D) tax characteristics Answer: C 4) Typically, yield curves are A) gently upward sloping. B) mound shaped. C) flat. D) bowl shaped. Answer: A 5) When yield curves are steeply upward sloping, A) long-term interest rates are above short-term interest rates. B) short-term interest rates are above long-term interest rates. C) short-term interest rates are about the same as long-term interest rates. D) medium-term interest rates are above both short-term and long-term interest rates. Answer: A 6) When yield curves are flat, A) long-term interest rates are above short-term interest rates. B) short-term interest rates are above long-term interest rates. C) short-term interest rates are about the same as long-term interest rates. D) medium-term interest rates are above both short-term and long-term interest rates. Answer: C 7) When yield curves are downward sloping, A) long-term interest rates are above short-term interest rates. B) short-term interest rates are above long-term interest rates. C) short-term interest rates are about the same as long-term interest rates. D) medium-term interest rates are above both short-term and long-term interest rates. Answer: B 8) An inverted yield curve A) slopes up. B) is flat. C) slopes down. D) has a U shape. Answer: C 9) Economists' attempts to explain the term structure of interest rates A) illustrate how economists modify theories to improve them when they are inconsistent with the empirical evidence. B) illustrate how economists continue to accept theories that fail to explain observed behavior of interest rate movements. C) prove that the real world is a special case that tends to get short shrift in theoretical models. D) have proved entirely unsatisfactory to date. Answer: A 10) According to the expectations theory of the term structure, the interest rate on a long-term bond will equal the ________ of the short-term interest rates that 56 people expect to occur over the life of the long-term bond. A) average B) sum C) difference D) multiple Answer: A 11) If bonds with different maturities are perfect substitutes, then the ________ on these bonds must be equal. A) expected return B) surprise return C) surplus return D) excess return Answer: A 12) If the expected path of one-year interest rates over the next five years is 4 percent, 5 percent, 7 percent, 8 percent, and 6 percent, then the expectations theory predicts that today's interest rate on the five-year bond is A) 4 percent. B) 5 percent. C) 6 percent. D) 7 percent. Answer: C 13) If the expected path of 1-year interest rates over the next four years is 5 percent, 4 percent, 2 percent, and 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. Answer: C 14) If the expected path of 1-year interest rates over the next five years is 1 percent, 2 percent, 3 percent, 4 percent, and 5 percent, the expectations theory predicts that the bond with the highest interest rate today is the one with a maturity of A) two years. B) three years. C) four years. D) five years. Answer: D 15) If the expected path of 1-year interest rates over the next five years is 2 percent, 4 percent, 1 percent, 4 percent, and 3 percent, the expectations theory predicts that the bond with the lowest interest rate today is the one with a maturity of A) one year. B) two years. C) three years. D) four years. Answer: A 16) Over the next three years, the expected path of 1-year interest rates is 4, 1, and 1 percent. The expectations theory of the term structure predicts that the current interest rate on 3-year bond is A) 1 percent. B) 2 percent. C) 3 percent. D) 4 percent. Answer: B 17) According to the expectations theory of the term structure A) the interest rate on long-term bonds will exceed the average of short-term interest rates that people expect to occur over the life of the long-term bonds, because of their preference for short-term securities. B) interest rates on bonds of different maturities move together over time. C) buyers of bonds prefer short-term to long-term bonds. D) buyers require an additional incentive to hold long-term bonds. Answer: B 18) According to the expectations theory of the term structure A) when the yield curve is steeply upward sloping, short-term interest rates are expected to remain relatively stable in the future. B) when the yield curve is downward sloping, short-term interest rates are expected to remain relatively stable in the future. C) investors have strong preferences for short-term relative to long-term bonds, explaining why yield curves typically slope upward. D) yield curves should be equally likely to slope downward as slope upward. Answer: D 19) According to the segmented markets theory of the term structure A) bonds of one maturity are close substitutes for bonds of other maturities, therefore, interest rates on bonds of different maturities move together over time. B) the interest rate for each maturity bond is determined by supply and demand for that maturity bond. C) investors' strong preferences for short-term relative to long-term bonds explains why yield curves typically slope downward. D) because of the positive term premium, the yield curve will not be observed to be downward-sloping. Answer: B 57 40) In actual practice, short-term interest rates and long-term interest rates usually move together; this is the major shortcoming of the A) segmented markets theory. B) expectations theory. C) liquidity premium theory. D) separable markets theory. Answer: A 41) The ________ of the term structure states the following: the interest rate on a long-term bond will equal an average of short-term interest rates expected to occur over the life of the long-term bond plus a term premium that responds to supply and demand conditions for that bond. A) segmented markets theory B) expectations theory C) liquidity premium theory D) separable markets theory Answer: C 42) A particularly attractive feature of the ________ is that it tells you what the market is predicting about future short-term interest rates by just looking at the slope of the yield curve. A) segmented markets theory B) expectations theory C) liquidity premium theory D) separable markets theory Answer: C 43) The steeply upward sloping yield curve in the figure above indicates that A) short-term interest rates are expected to rise in the future. B) short-term interest rates are expected to fall moderately in the future. C) short-term interest rates are expected to fall sharply in the future. D) short-term interest rates are expected to remain unchanged in the future. Answer: A 44) The steeply upward sloping yield curve in the figure above indicates that ________ interest rates are expected to ________ in the future. A) short-term; rise B) short-term; fall moderately C) short-term; remain unchanged D) long-term; fall moderately Answer: A 60 45) The U-shaped yield curve in the figure above indicates that short-term interest rates are expected to A) rise in the near-term and fall later on. B) fall sharply in the near-term and rise later on. C) fall moderately in the near-term and rise later on. D) remain unchanged in the near-term and rise later on. Answer: B 46) The U-shaped yield curve in the figure above indicates that the inflation rate is expected to A) remain constant in the near-term and fall later on. B) fall sharply in the near-term and rise later on. C) rise moderately in the near-term and fall later on. D) remain constant in the near-term and rise later on. Answer: B 47) The mound-shaped yield curve in the figure above indicates that short-term interest rates are expected to A) rise in the near-term and fall later on. B) fall moderately in the near-term and rise later on. C) fall sharply in the near-term and rise later on. D) remain unchanged in the near-term and fall later on. Answer: A 48) The mound-shaped yield curve in the figure above indicates that the inflation rate is expected to A) remain constant in the near-term and fall later on. B) fall moderately in the near-term and rise later on. C) rise moderately in the near-term and fall later on. D) remain unchanged in the near-term and rise later on. Answer: C 49) An inverted yield curve predicts that short-term interest rates A) are expected to rise in the future. 61 B) will rise and then fall in the future. C) will remain unchanged in the future. D) will fall in the future. Answer: D 50) When short-term interest rates are expected to fall sharply in the future, the yield curve will A) slope up. B) be flat. C) be inverted. D) be an inverted U shape. Answer: C 51) If investors expect interest rates to fall significantly in the future, the yield curve will be inverted. This means that the yield curve has a ________ slope. A) steep upward B) slight upward C) flat D) downward Answer: D 52) When the yield curve is flat or downward-sloping, it suggest that the economy is more likely to enter A) a recession. B) an expansion. C) a boom time. D) a period of increasing output. Answer: A 53) A ________ yield curve predicts a future increase in inflation. A) steeply upward sloping B) slight upward sloping C) flat D) downward sloping Answer: A The Economics of Money, Banking, and Financial Markets, 9e (Mishkin) Chapter 7 The Stock Market, the Theory of Rational Expectations, and the Efficient Market Hypothesis 7.1 Computing the Price of Common Stock 1) A stockholder's ownership of a company's stock gives her the right to A) vote and be the primary claimant of all cash flows. B) vote and be the residual claimant of all cash flows. C) manage and assume responsibility for all liabilities. D) vote and assume responsibility for all liabilities. Answer: B 2) Stockholders are residual claimants, meaning that they A) have the first priority claim on all of a company's assets. B) are liable for all of a company's debts. C) will never share in a company's profits. D) receive the remaining cash flow after all other claims are paid. Answer: D 3) Periodic payments of net earnings to shareholders are known as A) capital gains. B) dividends. C) profits. D) interest. Answer: B 4) The value of any investment is found by computing the A) present value of all future sales. B) present value of all future liabilities. C) future value of all future expenses. D) present value of all future cash flows. Answer: D 5) In the one-period valuation model, the value of a share of stock today depends upon A) the present value of both dividends and the expected sales price. B) only the present value of the future dividends. C) the actual value of the dividends and expected sales price received in one year. D) the future value of dividends and the actual sales price. Answer: A 62 B) lowered C) had no impact on D) decreased Answer: A 9) In October 2008, the stock market crashed, falling by ________ from its peak value a year earlier. A) over 40% B) over 30% C) over 50% D) over 25% Answer: A 7.3 The Theory of Rational Expectations 1) Economists have focused more attention on the formation of expectations in recent years. This increase in interest can probably best be explained by the recognition that A) expectations influence the behavior of participants in the economy and thus have a major impact on economic activity. B) expectations influence only a few individuals, have little impact on the overall economy, but can have important effects on a few markets. C) expectations influence many individuals, have little impact on the overall economy, but can have distributional effects. D) models that ignore expectations have little predictive power, even in the short run. Answer: A 2) The view that expectations change relatively slowly over time in response to new information is known in economics as A) rational expectations. B) irrational expectations. C) slow-response expectations. D) adaptive expectations. Answer: D 3) If expectations of the future inflation rate are formed solely on the basis of a weighted average of past inflation rates, then economics would say that expectation formation is A) irrational. B) rational. C) adaptive. D) reasonable. Answer: C 4) If expectations are formed adaptively, then people A) use more information than just past data on a single variable to form their expectations of that variable. B) often change their expectations quickly when faced with new information. C) use only the information from past data on a single variable to form their expectations of that variable. D) never change their expectations once they have been made. Answer: C 5) If during the past decade the average rate of monetary growth has been 5% and the average inflation rate has been 5%, everything else held constant, when the Federal Reserve announces that the new rate of monetary growth will be 10%, the adaptive expectation forecast of the inflation rate is A) 5%. B) between 5 and 10%. C) 10%. D) more than 10%. Answer: A 6) The major criticism of the view that expectations are formed adaptively is that A) this view ignores that people use more information than just past data to form their expectations. B) it is easier to model adaptive expectations than it is to model rational expectations. C) adaptive expectations models have no predictive power. D) people are irrational and therefore never learn from past mistakes. Answer: A 7) In rational expectations theory, the term "optimal forecast" is essentially synonymous with A) correct forecast. B) the correct guess. C) the actual outcome. D) the best guess. Answer: D 8) If a forecast is made using all available information, then economists say that the expectation formation is A) rational. B) irrational. C) adaptive. D) reasonable. Answer: A 9) If a forecast made using all available information is not perfectly accurate, then it is A) still a rational expectation. 65 B) not a rational expectation. C) an adaptive expectation. D) a second-best expectation. Answer: A 10) If additional information is not used when forming an optimal forecast because it is not available at that time, then expectations are A) obviously formed irrationally. B) still considered to be formed rationally. C) formed adaptively. D) formed equivalently. Answer: B 11) An expectation may fail to be rational if A) relevant information was not available at the time the forecast is made. B) relevant information is available but ignored at the time the forecast is made. C) information changes after the forecast is made. D) information was available to insiders only. Answer: B 12) According to rational expectations theory, forecast errors of expectations A) are more likely to be negative than positive. B) are more likely to be positive than negative. C) tend to be persistently high or low. D) are unpredictable. Answer: D 13) Rational expectations forecast errors will on average be ________ and therefore ________ be predicted ahead of time. A) positive; can B) positive; cannot C) negative; can D) zero; cannot Answer: D 14) People have a strong incentive to form rational expectations because A) they are guaranteed of success in the stock market. B) it is costly not to do so. C) it is costly to do so. D) everyone wants to be rational. Answer: B 15) If market participants notice that a variable behaves differently now than in the past, then, according to rational expectations theory, we can expect market participants to A) change the way they form expectations about future values of the variable. B) begin to make systematic mistakes. C) no longer pay close attention to movements in this variable. D) give up trying to forecast this variable. Answer: A 16) According to rational expectations, A) expectations of inflation are viewed as being an average of past inflation rates. B) expectations of inflation are viewed as being an average of expected future inflation rates. C) expectations formation indicates that changes in expectations occur slowly over time as past data change. D) expectations will not differ from optimal forecasts using all available information. Answer: D 7.4 The Efficient Market Hypothesis: Rational Expectations in Financial Markets 1) The theory of rational expectations, when applied to financial markets, is known as A) monetarism. B) the efficient markets hypothesis. C) the theory of strict liability. D) the theory of impossibility. Answer: B 2) According to the efficient markets hypothesis, the current price of a financial security A) is the discounted net present value of future interest payments. B) is determined by the highest successful bidder. C) fully reflects all available relevant information. D) is a result of none of the above. Answer: C 66 3) If the optimal forecast of the return on a security exceeds the equilibrium return, then A) the market is inefficient. B) no unexploited profit opportunities exist. C) the market is in equilibrium. D) the market is myopic. Answer: A 4) Another way to state the efficient markets condition is: in an efficient market, A) unexploited profit opportunities will be quickly eliminated. B) unexploited profit opportunities will never exist. C) arbitragers guarantee that unexploited profit opportunities never exist. D) every financial market participant must be well informed about securities. Answer: A 5) ________ occurs when market participants observe returns on a security that are larger than what is justified by the characteristics of that security and take action to quickly eliminate the unexploited profit opportunity. A) Arbitrage B) Mediation C) Asset capitalization D) Market intercession Answer: A 6) The efficient markets hypothesis suggests that if an unexploited profit opportunity arises in an efficient market, A) it will tend to go unnoticed for some time. B) it will be quickly eliminated. C) financial analysts are your best source of this information. D) prices will reflect the unexploited profit opportunity. Answer: B 7) Financial markets quickly eliminate unexploited profit opportunities through changes in A) dividend payments. B) tax laws. C) asset prices. D) monetary policy. Answer: C 8) The elimination of unexploited profit opportunities requires that ________ market participants be well informed. A) all B) a few C) zero D) many Answer: B 9) If in an efficient market all prices are correct and reflect market fundamentals, which of the following is a false statement? A) A stock that has done poorly in the past is more likely to do well in the future. B) One investment is as good as any other because the securities' prices are correct. C) A security's price reflects all available information about the intrinsic value of the security. D) Security prices can be used by managers to assess their cost of capital accurately. Answer: A 10) According to the efficient markets hypothesis, purchasing the reports of financial analysts A) is likely to increase one's returns by an average of 10%. B) is likely to increase one's returns by about 3 to 5%. C) is not likely to be an effective strategy for increasing financial returns. D) is likely to increase one's returns by an average of about 2 to 3%. Answer: C 11) You have observed that the forecasts of an investment advisor consistently outperform the other reported forecasts. The efficient markets hypothesis says that future forecasts by this advisor A) may or may not be better than the other forecasts. Past performance is no guarantee of the future. B) will always be the best of the group. C) will definitely be worse in the future. What goes up must come down. D) will be worse in the near future, but improve over time. Answer: A 12) Which of the following types of information most likely allows the exploitation of a profit opportunity? A) Financial analysts' published recommendations B) Technical analysis C) Hot tips from a stockbroker D) Insider information Answer: D 67 7) In an agreement to exchange dollars for euros in three months at a price of $0.90 per euro, the price is the A) spot exchange rate. B) money exchange rate. C) forward exchange rate. D) fixed exchange rate. Answer: C 8) When the value of the British pound changes from $1.25 to $1.50, the pound has ________ and the U.S. dollar has ________. A) appreciated; appreciated B) depreciated; appreciated C) appreciated; depreciated D) depreciated; depreciated Answer: C 9) When the value of the British pound changes from $1.50 to $1.25, then the pound has ________ and the U.S. dollar has ________. A) appreciated; appreciated B) depreciated; appreciated C) appreciated; depreciated D) depreciated; depreciated Answer: B 10) When the value of the dollar changes from £0.5 to £0.75, then the British pound has ________ and the U.S. dollar has ________. A) appreciated; appreciated B) depreciated; appreciated C) appreciated; depreciated D) depreciated; depreciated Answer: B 11) When the value of the dollar changes from £0.75 to £0.5, then the British pound has ________ and the U.S. dollar has ________. A) appreciated; appreciated B) depreciated; appreciated C) appreciated; depreciated D) depreciated; depreciated Answer: C 12) When the exchange rate for the Mexican peso changes from 9 pesos to the U.S. dollar to 10 pesos to the U.S. dollar, then the Mexican peso has ________ and the U.S. dollar has ________. A) appreciated; appreciated B) depreciated; appreciated C) appreciated; depreciated D) depreciated; depreciated Answer: B 13) When the exchange rate for the Mexican peso changes from 10 pesos to the U.S dollar to 9 pesos to the U.S. dollar, then the Mexican peso has ________ and the U.S. dollar has ________. A) appreciated; appreciated B) depreciated; appreciated C) appreciated; depreciated D) depreciated; depreciated Answer: C 14) On January 25, 2009, one U.S. dollar traded on the foreign exchange market for about 0.75 euros. Therefore, one euro would have purchased about ________ U.S. dollars. A) 0.75 B) 1.00 C) 1.33 D) 1.75 Answer: C 15) On January 25, 2009, one U.S. dollar traded on the foreign exchange market for about 49.0 Indian rupees. Thus, one Indian rupee would have purchased about ________ U.S. dollars. A) 0.02 B) 1.20 C) 7.00 D) 49.0 Answer: A 16) On January 25, 2009, one U.S. dollar traded on the foreign exchange market for about 1.15 Swiss francs. Therefore, one Swiss franc would have purchased about ________ U.S. dollars. A) 0.30 B) 0.87 C) 1.15 D) 3.10 Answer: B 70 17) On January 25, 2009, one U.S. dollar traded on the foreign exchange market for about 3.33 Romanian new lei. Therefore, one Romanian new lei would have purchased about ________ U.S. dollars. A) 0.30 B) 1.86 C) 2.86 D) 3.33 Answer: A 18) If the U.S. dollar appreciates from 1.25 Swiss franc per U.S. dollar to 1.5 francs per dollar, then the franc depreciates from ________ U.S. dollars per franc to ________ U.S. dollars per franc. A) 0.80; 0.67 B) 0.67; 0.80 C) 0.50; 0.33 D) 0.33; 0.50 Answer: A 19) If the British pound appreciates from $0.50 per pound to $0.75 per pound, the U.S. dollar depreciates from ________ per dollar to ________ per dollar. A) £2; £2.5 B) £2; £1.33 C) £2; £1.5 D) £2; £1.25 Answer: B 20) If the Japanese yen appreciates from $0.01 per yen to $0.02 per yen, the U.S. dollar depreciates from ________ per dollar to ________ per dollar. A) 100¥; 50¥ B) 10¥; 5¥ C) 5¥; 10¥ D) 50¥; 100¥ Answer: A 21) If the dollar appreciates from 1.5 Brazilian reals per dollar to 2.0 reals per dollar, the real depreciates from ________ per real to ________ per real. A) $0.67; $0.50 B) $0.33; $0.50 C) $0.75; $0.50 D) $0.50; $0.67 E) $0.50; $0.75 Answer: A 22) When the exchange rate for the British pound changes from $1.80 per pound to $1.60 per pound, then, holding everything else constant, the pound has ________ and ________ expensive. A) appreciated; British cars sold in the United States become more B) appreciated; British cars sold in the United States become less C) depreciated; American wheat sold in Britain becomes more D) depreciated; American wheat sold in Britain becomes less Answer: C 23) If the dollar depreciates relative to the Swiss franc A) Swiss chocolate will become cheaper in the United States. B) American computers will become more expensive in Switzerland. C) Swiss chocolate will become more expensive in the United States. D) Swiss computers will become cheaper in the United States. Answer: C 24) Everything else held constant, when a country's currency appreciates, the country's goods abroad become ________ expensive and foreign goods in that country become ________ expensive. A) more; less B) more; more C) less; less D) less; more Answer: A 25) Everything else held constant, when a country's currency depreciates, its goods abroad become ________ expensive while foreign goods in that country become ________ expensive. A) more; less B) more; more C) less; less D) less; more Answer: D 17.2 Exchange Rates in the Long Run 1) According to the law of one price, if the price of Colombian coffee is 100 Colombian pesos per pound and the price of Brazilian coffee is 4 Brazilian reals per pound, then the exchange rate between the Colombian peso and the Brazilian real is: A) 40 pesos per real. 71 B) 100 pesos per real. C) 25 pesos per real. D) 0.4 pesos per real. Answer: C 2) The starting point for understanding how exchange rates are determined is a simple idea called ________, which states: if two countries produce an identical good, the price of the good should be the same throughout the world no matter which country produces it. A) Gresham's law B) the law of one price C) purchasing power parity D) arbitrage Answer: B 3) The ________ states that exchange rates between any two currencies will adjust to reflect changes in the price levels of the two countries. A) theory of purchasing power parity B) law of one price C) theory of money neutrality D) quantity theory of money Answer: A 4) The theory of PPP suggests that if one country's price level rises relative to another's, its currency should A) depreciate. B) appreciate. C) float. D) do none of the above. Answer: A 5) The theory of PPP suggests that if one country's price level falls relative to another's, its currency should A) depreciate. B) appreciate. C) float. D) do none of the above. Answer: B 6) The theory of PPP suggests that if one country's price level falls relative to another's, its currency should A) depreciate in the long run. B) appreciate in the long run. C) appreciate in the short run. D) depreciate in the short run. Answer: B 7) The theory of purchasing power parity cannot fully explain exchange rate movements because A) all goods are identical even if produced in different countries. B) monetary policy differs across countries. C) some goods are not traded between countries. D) fiscal policy differs across countries. Answer: C 8) The theory of purchasing power parity states that exchange rates between any two currencies will adjust to reflect changes in A) the trade balances of the two countries. B) the current account balances of the two countries. C) fiscal policies of the two countries. D) the price levels of the two countries. Answer: D 9) If the real exchange rate between the United States and Japan is ________, then it is cheaper to buy goods in Japan than in the United States. A) greater than 1.0 B) greater than 0.5 C) less than 0.5 D) less than 1.0 Answer: A 10) According to PPP, the real exchange rate between two countries will always equal ________. A) 0.0 B) 0.5 C) 1.0 D) 1.5 Answer: C 11) The theory of PPP suggests that if one country's price level rises relative to another's, its currency should A) depreciate in the long run. B) appreciate in the long run. C) depreciate in the short run. D) appreciate in the short run. Answer: A 72 4) As the relative expected return on dollar assets increases, foreigners will want to hold more ________ assets and less ________ assets, everything else held constant. A) foreign; foreign B) foreign; dollar C) dollar; foreign D) dollar; dollar Answer: C 5) When Americans or foreigners expect the return on ________ assets to be high relative to the return on ________ assets, there is a higher demand for dollar assets and a correspondingly lower demand for foreign assets. A) dollar; dollar B) dollar; foreign C) foreign; dollar D) foreign; foreign Answer: B 6) When Americans or foreigners expect the return on ________ assets to be high relative to the return on ________ assets, there is a ________ demand for dollar assets, everything else held constant. A) dollar; foreign; constant B) dollar; foreign; higher C) foreign; dollar; higher D) foreign; dollar; constant Answer: B 7) When Americans or foreigners expect the return on dollar assets to be high relative to the return on foreign assets, there is a ________ demand for dollar assets and a correspondingly ________ demand for foreign assets. A) higher; higher B) higher; lower C) lower; higher D) lower; lower Answer: B 8) Everything else held constant, when the current value of the domestic currency increases, the ________ domestic assets ________. A) demand for; increases B) quantity demanded of; increases C) demand for; decreases D) quantity demanded of; decreases Answer: D 9) Everything else held constant, when the current value of the domestic exchange rate increases, the ________ of domestic assets ________. A) quantity supplied; does not change B) supply; decreases C) quantity supplied; increases D) supply; increases Answer: A 17.4 Explaining Changes in Exchange Rates 1) An increase in the domestic interest rate causes the demand for domestic assets to ________ and the domestic currency to ________, everything else held constant. A) increase; appreciate B) increase; depreciate C) decrease; appreciate D) decrease; depreciate Answer: A 2) An increase in the domestic interest rate causes the demand for domestic assets to shift to the ________ and the domestic currency to ________, everything else held constant. A) right; appreciate B) right; depreciate C) left; appreciate D) left; depreciate Answer: A 3) A decrease in the domestic interest rate causes the demand for domestic assets to ________ and the domestic currency to ________, everything else held constant. A) increase; appreciate B) increase; depreciate C) decrease; appreciate D) decrease; depreciate Answer: D 4) A decrease in the domestic interest rate causes the demand for domestic assets to shift to the ________ and the domestic currency to ________, everything else held constant. A) right; appreciate 75 B) right; depreciate C) left; appreciate D) left; depreciate Answer: D 5) ________ in the domestic interest rate causes the demand for domestic assets to increase and the domestic currency to ________, everything else held constant. A) An increase; appreciate B) An increase; depreciate C) A decrease; appreciate D) A decrease; depreciate Answer: A 6) ________ in the domestic interest rate causes the demand for domestic assets to shift to the right and the domestic currency to ________, everything else held constant. A) An increase; appreciate B) An increase; depreciate C) A decrease; appreciate D) A decrease; depreciate Answer: A 7) ________ in the domestic interest rate causes the demand for domestic assets to decrease and the domestic currency to ________, everything else held constant. A) An increase; appreciate B) An increase; depreciate C) A decrease; appreciate D) A decrease; depreciate Answer: D 8) ________ in the domestic interest rate causes the demand for domestic assets to shift to the left and the domestic currency to ________, everything else held constant. A) An increase; appreciate B) An increase; depreciate C) A decrease; appreciate D) A decrease; depreciate Answer: D 9) ________ in the domestic interest rate causes the demand for domestic assets to ________ and the domestic currency to appreciate, everything else held constant. A) An increase; increase B) An increase; decrease C) A decrease; increase D) A decrease; decrease Answer: A 10) ________ in the domestic interest rate causes the demand for domestic assets to shift to the ________ and the domestic currency to appreciate, everything else held constant. A) An increase; right B) An increase; left C) A decrease; right D) A decrease; left Answer: A 11) ________ in the domestic interest rate causes the demand for domestic assets to ________ and the domestic currency to depreciate, everything else held constant. A) An increase; increase B) An increase; decrease C) A decrease; increase D) A decrease; decrease Answer: D 12) ________ in the domestic interest rate causes the demand for domestic assets to shift to the ________ and the domestic currency to depreciate, everything else held constant. A) An increase; right B) An increase; left C) A decrease; right D) A decrease; left Answer: D 13) Suppose that the Federal Reserve enacts expansionary policy. Everything else held constant, this will cause the demand for U.S. assets to ________ and the U.S. dollar to ________. A) increase; appreciate B) decrease; appreciate C) increase; depreciate D) decrease; depreciate 76 Answer: D 14) Suppose that the Federal Reserve conducts an open market sale. Everything else held constant, this will cause the demand for U.S. assets to ________ and the U.S. dollar will ________. A) increase; appreciate B) increase; depreciate C) decrease; appreciate D) decrease; depreciate Answer: A 15) An increase in the foreign interest rate causes the demand for domestic assets to ________ and the domestic currency to ________, everything else held constant. A) increase; appreciate B) increase; depreciate C) decrease; appreciate D) decrease; depreciate Answer: D 16) An increase in the foreign interest rate causes the demand for domestic assets to shift to the ________ and the domestic currency to ________, everything else held constant. A) right; appreciate B) right; depreciate C) left; appreciate D) left; depreciate Answer: D 17) A decrease in the foreign interest rate causes the demand for domestic assets to ________ and the domestic currency to ________, everything else held constant. A) increase; appreciate B) increase; depreciate C) decrease; appreciate D) decrease; depreciate Answer: A 18) A decrease in the foreign interest rate causes the demand for domestic assets to shift to the ________ and the domestic currency to ________, everything else held constant. A) right; appreciate B) right; depreciate C) left; appreciate D) left; depreciate Answer: A 19) ________ in the foreign interest rate causes the demand for domestic assets to increase and the domestic currency to ________, everything else held constant. A) An increase; appreciate B) An increase; depreciate C) A decrease; appreciate D) A decrease; depreciate Answer: C 20) ________ in the foreign interest rate causes the demand for domestic assets to shift to the right and the domestic currency to ________, everything else held constant. A) An increase; appreciate B) An increase; depreciate C) A decrease; appreciate D) A decrease; depreciate Answer: C 21) ________ in the foreign interest rate causes the demand for domestic assets to decrease and the domestic currency to ________, everything else held constant. A) An increase; appreciate B) An increase; depreciate C) A decrease; appreciate D) A decrease; depreciate Answer: B 22) ________ in the foreign interest rate causes the demand for domestic assets to shift to the left and the domestic currency to ________, everything else held constant. A) An increase; appreciate B) An increase; depreciate C) A decrease; appreciate D) A decrease; depreciate Answer: B 23) ________ in the foreign interest rate causes the demand for domestic assets to ________ and the domestic currency to appreciate, everything else held 77 Answer: D 42) Suppose a report was released today that showed the Euro-Zone inflation rate is running above the European Central Bank's inflation rate target. This leads people to expect that the European Central Bank will enact contractionary policy in the near future. Everything else held constant, the release of this report would immediately cause the demand for U.S. assets to ________ and the U.S. dollar will ________. A) increase; appreciate B) increase; depreciate C) decrease; appreciate D) decrease; depreciate Answer: A 43) Suppose that the latest Consumer Price Index (CPI) release shows a higher inflation rate in the U.S. than was expected. Everything else held constant, the release of the CPI report would immediately cause the demand for U.S. assets to ________ and the U.S. dollar would ________. A) increase; appreciate B) increase; depreciate C) decrease; appreciate D) decrease; depreciate Answer: D 44) In the long run, a one-time percentage increase in the money supply is matched by the same one-time percentage rise in the price level, leaving unchanged the real money supply and ________. This proposition is called money ________. A) other economic variables such as interest rates; neutrality B) the nominal exchange rate; neutrality C) all other economic variables such as interest rates; illusion D) the nominal exchange rate; illusion Answer: A 45) Money neutrality means that in the long run the domestic interest rate remains unchanged from an increase in the money supply, implying that the fall in the exchange rate is greater in the ________ run than in the ________ run, a phenomenon called exchange rate overshooting. A) short; short B) short; long C) long; short D) long; long Answer: B 46) Evidence from the United States during the period 1973-2002 indicates that the value of the dollar and the measure of the ________ interest rate rose and fell together. A) real B) nominal C) expected D) actual Answer: A 47) During the beginning on the subprime crisis in the United States when the effects of the crisis were mostly confined within the United States, the U. S. dollar ________ because demand for U.S. assets ________. A) appreciated; increased B) depreciated; increased C) appreciated; decreased D) depreciated; decreased Answer: D 48) When the effects of the subprime crisis started to spread more quickly throughout the rest of the world, the U.S. dollar ________ because demand for U.S. assets ________. A) appreciated; increased B) depreciated; increased C) appreciated; decreased D) depreciated; decreased Answer: A The Economics of Money, Banking, and Financial Markets, 9e (Mishkin) Chapter 22 Aggregate Demand and Supply Analysis 22.1 Aggregate Demand 1) The aggregate demand curve is the total quantity of an economy's A) intermediate goods demanded at all price levels. B) intermediate goods demanded at a particular price level. C) final goods and services demanded at a particular price level. D) final goods and services demanded at different price levels. Answer: D 2) The total quantity of an economy's final goods and services demanded at different price levels is A) the aggregate supply curve. B) the aggregate demand curve. C) the Phillips curve. 80 D) the aggregate expenditure function. Answer: B 3) The aggregate demand curve slopes downward because a decrease in the price level means ________ in the real money supply and therefore a ________ level of real spending. A) an increase; higher B) an increase; lower C) a decrease; lower D) a decrease; higher Answer: A 4) The quantity theory of money is derived from A) the concept of velocity. B) the Keynesian monetary transmission mechanism. C) the equation of exchange. D) the money supply. Answer: C 5) As approached through the quantity theory of money, aggregate demand is derived from A) the equation of exchange. B) its three component parts: consumer expenditure, investment spending, and government spending. C) its four component parts: consumer expenditure, investment spending, government spending, and net exports. D) the spending multiplier. Answer: A 6) According to the quantity theory of money, an increase in the money supply ________ aggregate ________, everything else held constant. A) increases; demand B) decreases; demand C) decreases; supply D) increases; supply Answer: A 7) According to the quantity theory of money, a decrease in the money supply, ________ aggregate ________, everything else held constant. A) increases; demand B) decreases; demand C) decreases; supply D) increases; supply Answer: B 8) One way to derive aggregate demand is by looking at its four component parts, which are: A) consumer expenditures, planned investment spending, government spending, and net exports. B) consumer expenditures, actual investment spending, government spending, and net exports. C) consumer expenditures, planned investment spending, government spending, and gross exports. D) consumer expenditures, planned investment spending, government spending, and taxes. Answer: A 9) By analyzing aggregate demand through its component parts, we can conclude that, everything else held constant, a decline in the price level causes A) a decline in the real money supply, an increase in interest rates, a decline in investment spending, and a decline in aggregate output demand. B) a decline in the real money supply, a decline in interest rates, an increase in investment spending, and an increase in aggregate output demand. C) an increase in the real money supply, a decline in interest rates, an increase in investment spending, and an increase in aggregate output demand. D) an increase in the real money supply, an increase in interest rates, a decline in investment spending, and a decline in aggregate output demand. Answer: C 10) By looking at aggregate demand via its component parts, we can conclude that the aggregate demand curve is downward sloping because A) a lower price level, holding the nominal quantity of money constant, leads to a larger quantity of money in real terms, causes the interest rate to fall, and stimulates planned investment spending. B) a lower price level, holding the nominal quantity of money constant, leads to a larger quantity of money in nominal terms, causes the interest rate to rise, and stimulates planned investment spending. C) a higher price level, holding the nominal quantity of money constant, leads to a larger quantity of money in real terms, causes the interest rate to fall, and stimulates planned investment spending. D) a higher price level, holding the nominal quantity of money constant, leads to a smaller quantity of money in real terms, causes the interest rate to fall, and stimulates planned investment spending. Answer: A 11) By looking at aggregate demand through its component parts, we can conclude that a ________ price level ________ the real quantity of money, ________ higher spending. A) lower; expands; encouraging B) higher; contracts; encouraging C) lower; contracts; discouraging D) higher; expands; encouraging Answer: A 12) By analyzing aggregate demand via its component parts, we can conclude that changes in the money supply A) have no effect on aggregate demand. B) affect aggregate demand in the opposite direction of the change in government spending. 81 C) affect aggregate demand in the same direction as the change in government spending. D) affect the quantity of aggregate output demand. Answer: C 13) Everything else held constant, an increase in government spending ________ aggregate ________. A) increases; demand B) decreases; demand C) decreases; supply D) increases; supply Answer: A 14) Everything else held constant, a decrease in government spending ________ aggregate ________. A) increases; demand B) decreases; demand C) decreases; supply D) increases; supply Answer: B 15) Everything else held constant, a decrease in net taxes ________ aggregate ________. A) increases; demand B) decreases; demand C) decreases; supply D) increases; supply Answer: A 16) Everything else held constant, an increase in net taxes ________ aggregate ________. A) increases; demand B) decreases; demand C) decreases; supply D) increases; supply Answer: B 17) Everything else held constant, a balanced budget increase in government spending (that is, an increase in government spending that is matched by an identical increase in net taxes) will A) increase aggregate demand, but not by as much as if just government spending increases. B) increase aggregate demand by more than if just government spending increases. C) not affect aggregate demand. D) decrease aggregate demand. Answer: A 18) Everything else held constant, an increase in net exports ________ aggregate ________. A) increases; demand B) decreases; demand C) decreases; supply D) increases; supply Answer: A 19) Everything else held constant, a decrease in net exports ________ aggregate ________. A) increases; demand B) decreases; demand C) decreases; supply D) increases; supply Answer: B 20) Everything else held constant, an increase in planned investment expenditure ________ aggregate ________. A) increases; demand B) decreases; demand C) decreases; supply D) increases; supply Answer: A 21) Everything else held constant, a decrease in planned investment expenditure ________ aggregate ________. A) increases; demand B) decreases; demand C) decreases; supply D) increases; supply Answer: B 22) Everything else held constant, aggregate demand increases when A) taxes are cut. B) government spending is reduced. C) animal spirits decrease. D) the money supply is reduced. Answer: A 82 D) A technological improvement that increases worker productivity. Answer: D 22.3 Equilibrium in Aggregate Supply and Demand Analysis 1) The fact that an economy always returns to the natural rate level of output is known as A) the excess demand hypothesis. B) the price-adjustment mechanism. C) the self-correcting mechanism. D) the natural rate of unemployment. Answer: C 2) Assuming the economy is starting at the natural rate of output and everything else held constant, the effect of ________ in aggregate ________ is a rise in both the price level and output in the short-run, but in the long-run the only effect is a rise in the price level. A) a decrease; supply B) a decrease; demand C) an increase; supply D) an increase; demand Answer: D 3) The aggregate demand-aggregate supply framework indicates that the long-run effect of a ________ in the money supply is an increase in ________, everything else held constant. A) fall; aggregate output B) fall; the price level C) rise; aggregate output D) rise; the price level Answer: D 4) Suppose the economy is producing at the natural rate of output. Assuming a fixed natural rate of output and everything else held constant, the development of a new, more productive technology will cause ________ in the unemployment rate in the short run and ________ in the aggregate price level in the short run. A) an increase; an increase B) a decrease; a decrease C) a decrease; an increase D) no change; no change Answer: B 5) Suppose the economy is producing at the natural rate of output. Assuming a fixed natural rate of output and everything else held constant, the development of a new, more productive technology will cause ________ in the unemployment rate in the long run and ________ in the aggregate price level in the short run. A) an increase; an increase B) a decrease; a decrease C) no change; a decrease D) no change; no change Answer: C 6) Suppose the economy is producing at the natural rate of output. Assuming a fixed natural rate of output and everything else held constant, the development of a new, more productive technology will cause ________ in the unemployment rate and ________ in the aggregate price level in the long run. A) an increase; an increase B) a decrease; a decrease C) a decrease; an increase D) no change; no change Answer: D 7) Suppose the economy is producing at the natural rate of output. An increase in consumer and business confidence will cause ________ in real GDP in the short run and ________ in the aggregate price level in the short run, everything else held constant. A) an increase; an increase B) a decrease; a decrease C) no change; an increase D) no change; a decrease Answer: A 8) Suppose the economy is producing at the natural rate of output. An increase in consumer and business confidence will cause ________ in real GDP in the long run and ________ in the aggregate price level in the long run, everything else held constant. A) an increase; an increase B) a decrease; a decrease C) no change; an increase D) no change; a decrease Answer: C 9) Suppose the economy is producing at the natural rate of output. A decrease in consumer and business confidence will cause ________ in real GDP in the short run and ________ in the aggregate price level in the short run, everything else held constant. A) an increase; an increase B) a decrease; a decrease C) no change; an increase D) no change; a decrease 85 Answer: B 10) Suppose the economy is producing at the natural rate of output. A decrease in consumer and business confidence will cause ________ in real GDP in the long run and ________ in the aggregate price level in the long run, everything else held constant. A) an increase; an increase B) a decrease; a decrease C) no change; an increase D) no change; a decrease Answer: D 11) Suppose the economy is producing at the natural rate of output. An open market purchase of bonds by the Fed will cause ________ in real GDP the the short run and ________ in the aggregate price level in the short run, everything else held constant. A) an increase; an increase B) a decrease; a decrease C) no change; an increase D) no change; a decrease Answer: A 12) Suppose the economy is producing at the natural rate of output. An open market purchase of bonds by the Fed will cause ________ in real GDP in the long run and ________ in the aggregate price level in the long run, everything else held constant. A) an increase; an increase B) a decrease; a decrease C) no change; an increase D) no change; a decrease Answer: C 13) Suppose the economy is producing at the natural rate of output. An open market sale of bonds by the Fed will cause ________ in real GDP in the short run and ________ in the aggregate price level in the short run, everything else held constant. A) an increase; an increase B) a decrease; a decrease C) no change; an increase D) no change; a decrease Answer: B 14) Suppose the economy is producing at the natural rate of output. An open market sale of bonds by the Fed will cause ________ in real GDP in the long run and ________ in the aggregate price level in the long run, everything else held constant. A) an increase; an increase B) a decrease; a decrease C) no change; an increase D) no change; a decrease Answer: D 15) Suppose the U.S. economy is producing at the natural rate of output. A depreciation of the U.S. dollar will cause ________ in real GDP in the short run and ________ in the aggregate price level in the short run, everything else held constant. (Assume the depreciation causes no effects in the supply side of the economy.) A) an increase; an increase B) a decrease; a decrease C) no change; an increase D) no change; a decrease Answer: A 16) Suppose the U.S. economy is producing at the natural rate of output. A depreciation of the U.S. dollar will cause ________ in real GDP in the short run and ________ in the aggregate price level in the long run, everything else held constant. (Assume the depreciation causes no effects in the supply side of the economy.) A) an increase; an increase B) a decrease; a decrease C) no change; an increase D) no change; a decrease Answer: C 17) Suppose the U.S. economy is producing at the natural rate of output. An appreciation of the U.S. dollar will cause ________ in real GDP in the short run and ________ in the aggregate price level in the short run, everything else held constant. (Assume the appreciation causes no effects in the supply side of the economy.) A) an increase; an increase B) a decrease; a decrease C) no change; an increase D) no change; a decrease Answer: B 18) Suppose the U.S. economy is producing at the natural rate of output. An appreciation of the U.S. dollar will cause ________ in real GDP in the short run and ________ in the aggregate price level in the long run, everything else held constant. (Assume the appreciation causes no effects in the supply side of the economy.) A) an increase; an increase B) a decrease; a decrease C) no change; an increase 86 D) no change; a decrease Answer: D 19) Suppose the economy is producing below the natural rate of output and the government is suffering from large budget deficits. To deal with the deficit problem, suppose the government takes a policy action to reduce the size of the deficits. This policy action will cause ________ in the unemployment rate in the short run and ________ in the aggregate price level in the short run, everything else held constant. A) an increase; an increase B) a decrease; a decrease C) a decrease; an increase D) an increase; a decrease Answer: D 20) Suppose the economy is producing at the natural rate of output and the government passes legislation that severely restricts a company's ability to reduce production costs via outsourcing. Everything else held constant, this policy action will cause ________ in the unemployment rate in the short run and ________ in the aggregate price level in the short run. A) an increase; an increase B) a decrease; a decrease C) a decrease; an increase D) no change; no change Answer: A 21) Suppose the U.S. economy is operating at potential output. A negative supply shock that is accommodated by an open market purchase by the Federal Reserve will cause ________ in real GDP in the long run and ________ in the aggregate price level in the long run, everything else held constant. A) no change; an increase B) no change; a decrease C) an increase; an increase D) a decrease; a decrease Answer: A 22) A theory of aggregate economic fluctuations called real business cycle theory holds that A) changes in the real money supply are the only demand shocks that affect the natural rate of output. B) aggregate demand shocks do affect the natural rate of output. C) aggregate supply shocks do affect the natural rate of output. D) changes in net exports are the only demand shocks that affect the natural rate of output. Answer: C 23) This theory views shocks to tastes (workers' willingness to work, for example) and technology (productivity) as the major driving forces behind short-run fluctuations in the business cycle because these shocks lead to substantial short-run fluctuations in the natural rate of output. A) The natural rate hypothesis B) Hysteresis C) Real business cycle theory D) The Phillips curve model Answer: C 24) Because shifts in aggregate demand are not viewed as being particularly important to aggregate output fluctuations, they do not see much need for activist policy to eliminate high unemployment. "They" refers to proponents of A) the natural rate hypothesis. B) monetarism. C) the Phillips curve model. D) real business cycle theory. Answer: D 25) A group of economists believe that the natural rate of output is affected by aggregate ________ shocks. They contend that the natural rate level of unemployment and output are subject to ________, a departure from full employment levels as a result of past high unemployment. A) supply; hysterisis B) supply; systerisis C) demand; hysterisis D) demand; systerisis Answer: C 26) A reduction of aggregate demand may raise the natural rate of unemployment above the full employment level, meaning that the self-correcting mechanism will only be able to return the economy to the natural rate level of output and unemployment not to the full employment levels. Such a view is consistent withmoney and income are both stocks. A) monetarism. B) hysterisis. C) Keynesianism. D) real business cycle theory. Answer: B 27) According to aggregate demand and supply analysis, America's involvement in the Vietnam War had the effect of A) increasing aggregate output, lowering unemployment, and raising the price level. B) decreasing aggregate output, lowering unemployment, and lowering the price level. C) increasing aggregate output, raising unemployment, and raising the price level. D) decreasing aggregate output, raising unemployment, and lowering the price level. Answer: A 87 24.3 Views of Inflation 1) According to aggregate demand and supply analysis, inflation is caused by A) supply shocks. B) expansionary fiscal policies. C) expansionary monetary policies. D) rising prices. Answer: C 2) According to aggregate demand and supply analysis, a continually increasing money supply causes a ________ in aggregate demand, everything else held constant. A) continual increase B) continual decrease C) one-time increase D) one-time decrease Answer: A 3) According to aggregate demand and supply analysis of inflation and with everything else held constant, a continually increasing money supply causes A) aggregate demand to increase along a stationary aggregate supply curve, leading to continually increasing aggregate output and prices. B) aggregate supply to decrease along a stationary aggregate demand curve, leading to continually contracting aggregate output and prices. C) aggregate demand to increase continually as aggregate supply decreases continually, leading to higher and higher price levels. D) aggregate demand to decrease continually as aggregate supply increases continually, leading to higher and higher price levels. Answer: C 4) Aggregate demand and supply analysis conclude that continuously growing ________ will cause the price level to rise continually, thus generating inflation. A) money supply B) government spending C) interest rates D) consumer expenditure Answer: A 5) According to aggregate demand and supply analysis and with everything else held constant, a continuous increase in the money supply causes A) the price level to increase, but has no lasting effect on the inflation rate. B) the price level to fall. C) inflation. D) output to increase, but leaves the price level and inflation unchanged. Answer: C 6) According to aggregate demand and supply analysis, an increase in government spending will cause aggregate demand to ________, causing output to ________ , everything else held constant. A) increase; fall B) increase; rise C) decrease; fall D) decrease; rise Answer: B 7) Aggregate demand and supply analysis indicates that negative supply shocks A) decrease the price level, but cannot decrease the inflation rate. B) increase the price level, but cannot increase the inflation rate. C) increase both the price level and the inflation rate. D) decrease both the price level and the inflation rate. Answer: B 8) Suppose that the economy is at the natural rate of output. In the absence of accommodating policy and everything else held constant, the net result of a negative supply shock is that A) the economy returns to full employment at the initial price level. B) the economy returns to full employment at a higher price level. C) the economy returns to full employment at a lower price level. D) aggregate output increases above the natural rate level, but only temporarily. Answer: A 24.4 Origins of Inflationary Monetary Policy 1) To say that inflation is a monetary phenomenon seems to beg the question: A) Why does inflationary monetary policy occur? B) Why do politicians seek reelection? C) Why is the Fed independent? D) Why does the U.S. Treasury print so much money? Answer: A 2) The combination of a successful wage push by workers and the government's commitment to high employment leads to A) demand-pull inflation. B) supply-side inflation. C) supply-shock inflation. 90 D) cost-push inflation. Answer: D 3) If the Fed responds by increasing the money supply in response to a successful wage push by workers, monetary policy is said to be A) accomplishing. B) nonaccommodating. C) nonaccomplishing. D) accommodating. Answer: D 4) If workers do not believe that policymakers are serious about fighting inflation, they are most likely to push for higher wages, which will ________ aggregate ________ and lead to unemployment or inflation or both, everything else held constant. A) decrease; demand B) increase; demand C) decrease; supply D) increase; supply Answer: C 5) Workers will have greater incentives to push for higher wages when government policymakers place greater concern on ________ than ________ and are thus ________ likely to adopt accommodative policies. A) inflation; unemployment; less B) inflation; unemployment; more C) unemployment; inflation; less D) unemployment; inflation; more Answer: D 6) In the absence of an accommodating monetary policy, a push by workers to get higher wages will cause A) cost-push inflation. B) demand-pull inflation. C) higher unemployment. D) a lower price level. Answer: C 7) If workers believe that government policymakers will increase aggregate demand to avoid a politically unpopular increase in unemployment when workers demand higher wages, then workers will not fear higher unemployment and their wage demands will result in A) demand-pull inflation. B) hyperinflation. C) deflation. D) cost-push inflation. Answer: D 8) If policymakers set a target for unemployment that is too low because it is less than the natural rate of unemployment, this can set the stage for a higher rate of money growth and A) cost-push inflation. B) demand-pull inflation. C) cost-pull inflation. D) demand-push inflation. Answer: B 9) Theoretically, one can distinguish a demand-pull inflation from a cost-push inflation by comparing A) how fast prices rise relative to wages. B) the unemployment rate with its natural rate level. C) when prices rise relative to wages. D) government debt to real GDP. Answer: B 10) Demand-pull inflation can result when A) policymakers set an unemployment target that is too high. B) a persistent budget deficit is financed by selling bonds to the public. C) a persistent budget deficit is financed by selling bonds to the central bank. D) workers get numerous wage increases. Answer: C 11) Which of the following is least likely to lead to inflationary monetary policy? A) Rising unemployment B) Expanding federal budget deficits C) Declining oil prices D) Conflict in the Middle East Answer: C 12) Which of the following is most likely to lead to inflationary monetary policy? A) Declining oil prices B) Resolution of conflict in the Middle East C) The enactment of a free-trade agreement with Mexico D) Rising unemployment 91 Answer: D 13) Which of the following is most likely to lead to inflationary monetary policy? A) Declining oil prices B) Resolution of conflict in the Middle East C) The enactment of a free-trade agreement with Mexico D) Rising government budget deficits Answer: D 14) Methods of financing government spending are described by an expression called the government budget constraint, which states the following: A) the government budget deficit must equal the sum of the change in the monetary base and the change in government bonds held by the public. B) the government budget deficit must equal the difference between the change in the monetary base and the change in government bonds held by the public. C) the government budget deficit must equal the difference between the change in the monetary base and the change in government bonds held by the Fed. D) the government budget deficit must equal the difference between the change in the monetary base and the change in government bonds held by the Treasury. Answer: A 15) Methods of financing government spending are described by an expression called the government budget constraint, which states the following: A) DEFICIT = (G - T) = ΔMB + ΔBONDS.MB + ΔMB + ΔBONDS.BONDS. B) DEFICIT = (G - T) = ΔMB + ΔBONDS.MB - ΔMB + ΔBONDS.BONDS. C) DEFICIT = (G - T) = ΔMB + ΔBONDS.BONDS - ΔMB + ΔBONDS.MB. D) DEFICIT = (G - T) = ΔMB + ΔBONDS.MB/ΔMB + ΔBONDS.BONDS. Answer: A 16) If the government finances its spending by issuing debt to the public, the monetary base will ________ and the money supply will ________. A) increase; increase B) increase; decrease C) decrease; increase D) not change; not change Answer: D 17) If the government finances its spending by selling bonds to the central bank, the monetary base will ________ and the money supply will ________. A) increase; increase B) increase; decrease C) decrease; decrease D) not change; not change Answer: A 18) Financing government spending with taxes A) causes both reserves and the monetary base to rise. B) causes both reserves and the monetary base to decline. C) causes reserves to rise, but the monetary base to decline. D) has no net effect on the monetary base. Answer: D 19) Financing government spending by selling bonds to the public, which pays for the bonds with currency, A) leads to a permanent decline in the monetary base. B) leads to a permanent increase in the monetary base. C) leads to a temporary increase in the monetary base. D) has no net effect on the monetary base. Answer: D 20) The financing of government spending by issuing debt A) causes both reserves and the monetary base to rise. B) causes both reserves and the monetary base to decline. C) causes reserves to rise, but the monetary base to decline. D) has no net effect on the monetary base. Answer: D 21) The finance of government spending through a Treasury sale of bonds which are then purchased by the Fed A) causes both reserves and the monetary base to rise. B) causes both reserves and the monetary base to decline. C) causes reserves to rise, but the monetary base to decline. D) has no net effect on the monetary base. Answer: A 22) This method of financing government spending is frequently called printing money because high-powered money (the monetary base) is created in the process. A) Financing government spending with taxes. B) The finance of government spending through a Treasury sale of bonds that are then purchased by the Fed. C) Financing government spending by selling bonds to the public, which pays for the bonds with currency. D) Financing government spending by selling bonds to the public, which pays for the bonds with checks. Answer: B 23) Only when budget deficits are financed by money creation does the increased government spending lead to ________ in the ________. A) a decrease; monetary base 92 5) The time it takes for a policy to have an impact on the economy, once it has been implemented, is called the A) implementation lag. B) effectiveness lag. C) legislative lag. D) data lag. E) inside lag. Answer: B 6) The ________ lag is the time it takes for policymakers to obtain the data that tell them what is happening to the economy, while the ________ lag is the time it takes for policymakers to be sure of what the data are signaling about the future course of the economy. A) data; recognition B) recognition; data C) data; implementation D) implementation; recognition Answer: A 7) The ________ lag is the time it takes for policymakers to be sure of what the data are signaling about the future course of the economy, while the ________ lag represents the time it takes to pass legislation to implement a particular (fiscal) policy. A) data; recognition B) recognition; legislative C) data; legislative D) implementation; legislative Answer: B 8) The ________ lag represents the time it takes to pass legislation to implement a particular (fiscal) policy, while the ________ lag is the time it takes for policymakers to change policy instruments once they have decided on the new policy. A) legislative; effectiveness B) legislative; recognition C) legislative; implementation D) implementation; legislative Answer: C 9) The ________ lag is the time it takes for policymakers to change policy instruments once they have decided on the new policy, while the ________ lag is the time it takes for the policy to actually have an impact on the economy. A) recognition; implementation B) legislative; effectiveness C) implementation; recognition D) implementation; effectiveness Answer: D 10) The ________ lag is the time it takes for policymakers to obtain the information that tells them what is happening to the economy, while the ________ lag represents the time it takes to implement a particular fiscal policy. A) data; legislative B) recognition; data C) data; implementation D) recognition; legislative Answer: A 11) The ________ lag is the time it takes for policymakers to be sure of what the information is signaling about the future course of the economy, while the ________ lag is the time it takes for policymakers to change policy instruments once they have decided on the new policy. A) recognition; implementation B) recognition; legislative C) data; legislative D) data; implementation Answer: A 12) Of the five time lags that prevent a discretionary policy from returning aggregate output to full employment instantaneously, two do not slow the effectiveness of monetary policy themoney and income are both stocks. A) implementation and effectiveness lags. B) legislative and effectiveness lags. C) legislative and implementation lags. D) recognition and effectiveness lags. Answer: C 13) Advocates of discretionary policy usually view ________ policy as having a shorter effectiveness lag than ________ policy, but there is substantial uncertainty about how long this lag is. A) fiscal; incomes B) fiscal; monetary C) monetary; incomes D) monetary; fiscal Answer: B 14) Advocates of discretionary policy usually view ________ policy as having a longer effectiveness lag than ________ policy, but there is substantial uncertainty about how long this lag is. A) fiscal; incomes 95 B) fiscal; monetary C) monetary; incomes D) monetary; fiscal Answer: D 15) Economists usually view ________ policy as having a shorter implementation lag than ________ policy, but there is substantial uncertainty about how long this lag is. A) fiscal; incomes B) fiscal; monetary C) monetary; incomes D) monetary; fiscal Answer: D 16) Economists usually view ________ policy as having a longer implementation lag than ________ policy, but there is substantial uncertainty about how long this lag is. A) fiscal; incomes B) fiscal; monetary C) monetary; incomes D) monetary; fiscal Answer: B 17) If output adjusts ________ to the natural rate level, and if time lags between policy actions and changes in aggregate output are relatively ________, then the case for discretionary policy is strengthened. A) slowly; short B) slowly; long C) quickly; short D) quickly; long Answer: A 18) If output adjusts ________ to the natural rate level, and if time lags between policy actions and changes in aggregate output are relatively ________, then the case for discretionary policy is weakened. A) slowly; short B) slowly; long C) quickly; short D) quickly; long Answer: D 19) Advocates of nondiscretionary policy contend that a discretionary policy of shifting the aggregate ________ curve will be costly because it produces ________ volatility in both the price level and output. A) supply; less B) supply; more C) demand; less D) demand; more Answer: D 20) Some economists contend that a policy of shifting the aggregate demand curve will be costly because it produces more volatility in both the price level and output. These economists likely are advocates of ________ policy. A) supply-side B) discretionary C) demand-management D) nondiscretionary Answer: D 21) The existence of lags prevents the instantaneous adjustment of the economy to policies changing aggregate demand, thereby strengthening the case for ________ policy. A) supply-side B) nondiscretionary C) discretionary D) demand-management Answer: B 22) Which of the following views are consistent with the case for nondiscretionary macroeconomic policy? A) Even with time lags, discretionary policy moves the economy to full employment before the economy's self-correcting mechanism would. B) The wage and price adjustment process being extremely slow, a nondiscretionary policy results in a large loss of output. C) Workers will come to expect expansionary policies whenever the economy moves below full employment. D) A discretionary, accommodating policy of shifting the aggregate demand curve will produce less volatility in both the price level and output due to the short time it takes to shift aggregate demand. Answer: C 23) If expectations about policy affect how wages are set, then the case for a(n) ________ policy is much stronger. A) discretionary B) nondiscretionary C) interventionist D) stabilization Answer: B 96 24) Advocates of nondiscretionary policy emphasize the importance of a constant money growth rate rule more than the balanced-budget amendment or restrictions on union power because A) they regard excessive money growth as the cause of inflation. B) they believe that excessive government spending, not excessive monetary growth, is the cause of inflation. C) they believe that while unions cause inflation, they are too politically powerful to deal with. D) they regard high tax rates as the cause of inflation. Answer: A 25) Advocates of nondiscretionary policy contend that a policy of shifting the aggregate demand curve will be costly because it produces more volatility in both the price level and output. Thus they favor A) a policy of variable money supply growth. B) supply-side policy. C) demand-management policy. D) a constant-money-growth-rate rule. Answer: D 26) A credible, nonaccommodating policy rule has the ________ that it makes a cost-push by workers ________ likely and thus helps to reduce the output loss from controlling inflation. A) advantage; less B) advantage; more C) disadvantage; less D) disadvantage; more Answer: A The Economics of Money, Banking, and Financial Markets, 9e (Mishkin) Chapter 13 Central Banks and the Federal Reserve System 13.1 The Price Stability Goal and The Nominal Anchor 1) The most common definition that monetary policymakers use for price stability is A) low and stable deflation. B) an inflation rate of zero percent. C) high and stable inflation. D) low and stable inflation. Answer: D 2) Price stability is desirable because A) inflation creates uncertainty, making it difficult to plan for the future. B) everyone is better off when prices are stable. C) price stability increases the profitability of the Fed. D) it guarantees full employment. Answer: A 3) Inflation results in A) ease of planning for the future. B) ease of comparing prices over time. C) lower nominal interest rates. D) difficulty interpreting relative price movements. Answer: D 4) Economists believe that countries recently suffering hyperinflation have experienced A) reduced growth. B) increased growth. C) reduced prices. D) lower interest rates. Answer: A 5) A nominal variable, such as the inflation rate or the money supply, which ties down the price level to achieve price stability is called ________ anchor. A) a nominal B) a real C) an operating D) an intermediate Answer: A 6) A central feature of monetary policy strategies in all countries is the use of a nominal variable that monetary policymakers use as an intermediate target to achieve an ultimate goal such as price stability. Such a variable is called a nominal A) anchor. B) benchmark. C) tether. D) guideline. Answer: A 7) A central feature of monetary policy strategies in all countries is the use of a nominal anchor, which is a nominal variable that monetary policymakers use as an 97