Final Exam Part 4

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Final Exam Part 4 - Quiz


Econ 3229 Study Guide


Questions and Answers
  • 1. 

    If capital flows freely between countries and a country has a fixed exchange rate, one thing you know is that the country:

    • A.

      Exports more than it imports

    • B.

      Must have ample gold reserves

    • C.

      Cannot have a domestic monetary policy

    • D.

      Must be running large trade deficits

    Correct Answer
    C. Cannot have a domestic monetary policy
    Explanation
    If capital flows freely between countries and a country has a fixed exchange rate, it means that the country cannot control its domestic monetary policy. This is because a fixed exchange rate requires the country to maintain the value of its currency relative to other currencies, and this can only be achieved by adjusting the money supply. Therefore, the country cannot independently set interest rates or control inflation through monetary policy.

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  • 2. 

    If the inflation rate in country A is 3.5% and the inflation rate in country B is 3.0%, we should expect the percentage change in the number of units of country A's currency per unit of country B's currency to be:

    • A.

      +0.5%

    • B.

      -0.5%

    • C.

      + 16.7%

    • D.

      +6.5%

    Correct Answer
    B. -0.5%
    Explanation
    When the inflation rate in country A is higher than in country B, it means that the purchasing power of country A's currency is decreasing at a faster rate compared to country B's currency. As a result, we should expect the number of units of country A's currency per unit of country B's currency to decrease. This decrease can be calculated by subtracting the inflation rate of country B from the inflation rate of country A, which in this case would be 3.5% - 3.0% = 0.5%. Therefore, the percentage change in the number of units of country A's currency per unit of country B's currency is -0.5%.

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  • 3. 

    If country A wants to fix its exchange rate with country B, then:

    • A.

      Country A's inflation rate will have to match country B's

    • B.

      Country A's monetary policy must be conducted so the inflation rate in country A matches the inflation rate in country B

    • C.

      Country A's monetary policy will not be able to be used to address domestic issues

    • D.

      All of the answers given are correct

    Correct Answer
    D. All of the answers given are correct
    Explanation
    All of the answers given are correct because fixing the exchange rate between two countries requires the inflation rate in both countries to match. This means that country A's inflation rate will have to match country B's, and country A's monetary policy must be conducted in a way that ensures the inflation rate in country A matches the inflation rate in country B. Additionally, when a country fixes its exchange rate with another country, it restricts its ability to use monetary policy to address domestic issues. Therefore, all of the given answers are correct in explaining the requirements for fixing the exchange rate between country A and country B.

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  • 4. 

    International capital mobility:

    • A.

      Contributes to the rigidity of exchange rates

    • B.

      Contributes to the equalization of expected returns across countries

    • C.

      Eliminates arbitrage opportunities

    • D.

      Makes interest rates equal across countries

    Correct Answer
    B. Contributes to the equalization of expected returns across countries
    Explanation
    International capital mobility refers to the ability of capital to flow freely between countries. When capital can move easily across borders, it allows investors to seek out the highest returns on their investments, regardless of the country. This leads to the equalization of expected returns across countries, as investors will move their capital to countries with higher expected returns, which in turn increases the investment in those countries. This equalization of expected returns helps to align interest rates and investment opportunities, reducing the differences between countries and promoting stability in the global financial system.

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  • 5. 

    If the bonds of two different countries are identical, their expected returns will:

    • A.

      Be equal if capital flows freely internationally

    • B.

      Always be equal

    • C.

      Be equal only if the exchange rate between the two countries is fixed

    • D.

      Be equal only if the inflation rate is the same in each country

    Correct Answer
    A. Be equal if capital flows freely internationally
    Explanation
    If the bonds of two different countries are identical, their expected returns will be equal if capital flows freely internationally. This is because when capital flows freely, investors can easily move their investments from one country to another, seeking higher returns. As a result, the demand for bonds in both countries will be equalized, leading to equal expected returns. However, if capital is restricted or there are barriers to international investment, the expected returns may not be equal as the flow of capital will be constrained.

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  • 6. 

    When arbitrage occurs across countries with flexible exchange rates and when the bonds in each country are identical and there are no barriers to capital flows:

    • A.

      The interest rates on the bonds will be identical

    • B.

      The prices of the bonds will be identical

    • C.

      The inflation rates in each country will be identical

    • D.

      None of the answers provided is correct

    Correct Answer
    D. None of the answers provided is correct
    Explanation
    When arbitrage occurs across countries with flexible exchange rates and when the bonds in each country are identical and there are no barriers to capital flows, the interest rates on the bonds will not necessarily be identical. The interest rates can differ due to various factors such as differences in inflation expectations, risk perceptions, and market conditions. Similarly, the prices of the bonds will not necessarily be identical as they can be influenced by supply and demand dynamics in each country. Additionally, the inflation rates in each country will not necessarily be identical as they can be affected by various factors such as monetary policy, fiscal policy, and economic conditions. Therefore, none of the answers provided is correct.

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  • 7. 

    Which of the following statements is incorrect?

    • A.

      A country cannot be open to international capital flows, control its domestic interest rate and fix its exchange rate

    • B.

      A country can be open to international capital flows and control its own domestic interest rate but it can't fix its exchange rate

    • C.

      A country can be open to international capital flows, control its domestic interest rate, and fix its exchange rate

    • D.

      A country cannot be open to international capital flows if it expects to control its own domestic interest rate and to fix its exchange rate

    Correct Answer
    C. A country can be open to international capital flows, control its domestic interest rate, and fix its exchange rate
    Explanation
    The correct answer is that a country can be open to international capital flows, control its domestic interest rate, and fix its exchange rate. This means that a country can allow foreign investments, have control over its interest rates, and also have a fixed exchange rate. This statement contradicts the first option, which states that a country cannot have all three of these factors simultaneously.

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  • 8. 

    The United States would be characterized as having:

    • A.

      A controlled domestic interest rate, a closed capital market and a flexible exchange rate

    • B.

      A controlled domestic interest rate, an open capital market and a flexible exchange rate

    • C.

      No control over the domestic interest rate, an open capital market and a flexible exchange rate

    • D.

      A controlled domestic interest rate, an open capital market and a fixed exchange rate

    Correct Answer
    B. A controlled domestic interest rate, an open capital market and a flexible exchange rate
    Explanation
    The United States would be characterized as having a controlled domestic interest rate because the Federal Reserve has the ability to adjust interest rates to control inflation and stimulate or slow down economic growth. It also has an open capital market, meaning that foreign investors are able to freely invest in the US market. Lastly, the US has a flexible exchange rate, which means that the value of the US dollar is determined by market forces and can fluctuate in response to supply and demand.

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  • 9. 

    Which of the following would be an example of a capital outflow control?

    • A.

      Mexico limiting the number of U.S. dollars an American can bring into the country

    • B.

      Mexico limiting the number of U.S. dollars its citizens can purchase before leaving on their vacation to the U.S.

    • C.

      Mexico limiting the number of pesos its citizens can take out of the country

    • D.

      All of the answers given would be examples of capital outflow controls

    Correct Answer
    C. Mexico limiting the number of pesos its citizens can take out of the country
    Explanation
    This answer is correct because it describes a situation where Mexico is limiting the amount of its own currency, pesos, that its citizens can take out of the country. This restriction on the outflow of pesos can be considered a capital outflow control as it aims to regulate the movement of funds from the country.

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  • 10. 

    If foreigners are restricted in their ability to buy investments in a country then that government is imposing:

    • A.

      Controls on capital inflows

    • B.

      Controls on capital outflows

    • C.

      Controls on both capital inflows and outflows

    • D.

      Fixed exchange rates

    Correct Answer
    A. Controls on capital inflows
    Explanation
    If foreigners are restricted in their ability to buy investments in a country, it means that the government is imposing controls on capital inflows. This means that the government is regulating and limiting the amount of foreign capital that can enter the country through investments. By imposing these controls, the government aims to manage and control the flow of foreign investment in order to protect the country's economy and maintain stability.

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  • 11. 

    If the Fed desired to fix the euro/dollar exchange rate, they would have to:

    • A.

      Get the European Central Bank to also agree to fixed exchange rates

    • B.

      Maintain ample reserves of dollars

    • C.

      Be willing to exchange dollars for euros whenever anyone asked

    • D.

      Impose capital controls

    Correct Answer
    C. Be willing to exchange dollars for euros whenever anyone asked
    Explanation
    To fix the euro/dollar exchange rate, the Fed would need to be willing to exchange dollars for euros whenever anyone asked. This means that the Fed would be committed to providing euros in exchange for dollars at the fixed rate, ensuring that there is a constant supply of euros available in the market. This willingness to exchange currencies is crucial in maintaining a fixed exchange rate and ensuring stability in the foreign exchange market.

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  • 12. 

    If the Fed decides to maintain a fixed euro/dollar exchange rate when they purchase euros:

    • A.

      They increase the number of dollars

    • B.

      Downward pressure is put on domestic interest rates

    • C.

      The domestic money supply increases

    • D.

      All of the answers given are correct

    Correct Answer
    D. All of the answers given are correct
    Explanation
    When the Fed decides to maintain a fixed euro/dollar exchange rate by purchasing euros, they increase the number of dollars in circulation. This increase in the money supply puts downward pressure on domestic interest rates. Therefore, all of the given answers are correct.

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  • 13. 

    The focus for most central banks today is:

    • A.

      The quantity of M1

    • B.

      Interest rates

    • C.

      The quantity of M2

    • D.

      Controlling the size of the money multiplier

    Correct Answer
    B. Interest rates
    Explanation
    Central banks today primarily focus on interest rates. This is because central banks use interest rates as a tool to control inflation, stimulate economic growth, and maintain price stability. By adjusting interest rates, central banks can influence borrowing costs, which in turn affects consumer spending, business investment, and overall economic activity. Interest rates also play a crucial role in managing exchange rates and capital flows. Therefore, central banks closely monitor and adjust interest rates to achieve their monetary policy objectives.

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  • 14. 

    Most central banks, including the Fed and the ECB, provide discount loans at a rate:

    • A.

      Equal to the target interest rate

    • B.

      Below the target interest rate

    • C.

      Above the target interest rate

    • D.

      That is equal to the overnight interbank lending rate

    Correct Answer
    C. Above the target interest rate
    Explanation
    Central banks provide discount loans at a rate above the target interest rate. This is because the discount rate is typically higher than the target interest rate set by the central bank. The purpose of providing discount loans at a higher rate is to discourage banks from relying too heavily on central bank funding and to incentivize them to seek funds from other sources first. By setting the discount rate above the target interest rate, central banks aim to maintain control over the money supply and encourage banks to borrow from each other in the interbank market rather than relying on the central bank.

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  • 15. 

    The ways the Fed can inject reserves into the banking system include:

    • A.

      An increase in the size of the Fed's balance sheet through purchasing securities

    • B.

      Increasing the discount rate

    • C.

      Making loans to non-bank corporations

    • D.

      An increase in the size of the Fed's balance sheet through selling securities

    Correct Answer
    A. An increase in the size of the Fed's balance sheet through purchasing securities
    Explanation
    The correct answer is an increase in the size of the Fed's balance sheet through purchasing securities. When the Fed purchases securities, such as government bonds, from banks or other financial institutions, it pays for them by crediting the banks' reserve accounts. This increases the reserves available to the banking system, providing liquidity and stimulating lending and economic activity. By expanding its balance sheet through these purchases, the Fed effectively injects reserves into the banking system.

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  • 16. 

    The tools of monetary policy available to the Fed include each of the following, except the:

    • A.

      Currency-to-deposit ratio

    • B.

      Discount rate

    • C.

      Target federal funds rate

    • D.

      Reserve requirement

    Correct Answer
    A. Currency-to-deposit ratio
    Explanation
    The currency-to-deposit ratio is not a tool of monetary policy available to the Fed. The currency-to-deposit ratio refers to the proportion of currency (cash) held by individuals and businesses compared to the amount of money deposited in banks. It is a measure of the public's preference for holding cash versus depositing it in banks. While the Fed may monitor this ratio as an indicator of public demand for cash, it is not directly controlled or influenced by the Fed as a tool of monetary policy.

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  • 17. 

    Which of the following statements is most correct?

    • A.

      The FOMC sets the federal funds rate

    • B.

      The discount rate is the primary policy tool of the FOMC

    • C.

      The FOMC sets the target federal funds rate

    • D.

      The difference between the target and actual federal funds rate is the dealer's spread

    Correct Answer
    C. The FOMC sets the target federal funds rate
    Explanation
    The correct answer is that the FOMC sets the target federal funds rate. The FOMC, or Federal Open Market Committee, is responsible for setting monetary policy in the United States. One of the key tools they use is the federal funds rate, which is the interest rate at which banks lend reserves to each other overnight. The FOMC sets a target rate for the federal funds rate, and then uses various tools, including open market operations, to try to achieve that target rate. The actual federal funds rate may fluctuate around the target rate, but the FOMC's goal is to keep it as close to the target as possible.

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  • 18. 

    Which of the following would be categorized as an unconventional monetary policy tool?

    • A.

      Discount window lending

    • B.

      Lending to nonbanks

    • C.

      Federal funds rate target

    • D.

      Deposit rate

    Correct Answer
    B. Lending to nonbanks
    Explanation
    Lending to nonbanks would be categorized as an unconventional monetary policy tool because it involves providing loans to financial institutions that are not traditional banks. This tool is used by central banks to inject liquidity into the financial system and stimulate economic activity. Unlike discount window lending, which involves providing loans to traditional banks, lending to nonbanks targets a wider range of financial institutions such as investment banks, mortgage lenders, and other non-depository institutions. This tool is considered unconventional because it expands the scope of monetary policy beyond traditional banking channels.

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  • 19. 

    If the market federal funds rate were below the target rate, the response from the Fed would likely be to:

    • A.

      Raise the required reserve rate

    • B.

      Purchase U.S. Treasury securities

    • C.

      Sell U.S. Treasury securities

    • D.

      Raise the discount rate

    Correct Answer
    C. Sell U.S. Treasury securities
    Explanation
    When the market federal funds rate is below the target rate, it means that there is excess liquidity in the market. In order to reduce this liquidity and bring the market rate closer to the target rate, the Federal Reserve would likely sell U.S. Treasury securities. By selling these securities, the Fed would decrease the money supply in the market, which would increase the market federal funds rate and bring it closer to the target rate. This action is a contractionary monetary policy measure aimed at tightening the money supply and controlling inflation.

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  • 20. 

    If the current market federal funds rate equals the target rate and the demand for reserves decreases, the likely response in the federal funds market will be:

    • A.

      The market federal funds rate will decrease

    • B.

      The market federal funds rate will equal the target rate

    • C.

      The market federal funds rate will increase

    • D.

      Nothing; the Fed would act immediately and the market would not be affected

    Correct Answer
    A. The market federal funds rate will decrease
    Explanation
    If the demand for reserves decreases and the current market federal funds rate equals the target rate, there will be an excess supply of reserves in the market. This means that banks will have more reserves than they need to meet their requirements. As a result, banks will have less incentive to borrow funds from each other, leading to a decrease in the federal funds rate.

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  • 21. 

    One reason the target federal funds rate may not equal the actual federal funds rate is because:

    • A.

      There is no way that the Fed could keep the actual rate at the target rate

    • B.

      The target rate changes with the demand for reserves

    • C.

      Attaining the target rate involves forecasting reserve demand and forecasts are subject to error

    • D.

      None of the answers is correct; the target and the actual federal funds rates are always equal

    Correct Answer
    C. Attaining the target rate involves forecasting reserve demand and forecasts are subject to error
    Explanation
    The target federal funds rate may not equal the actual federal funds rate because attaining the target rate involves forecasting reserve demand and forecasts are subject to error. This means that the Federal Reserve may not accurately predict the amount of reserves that banks will need, leading to a difference between the target rate and the actual rate.

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  • 22. 

    Discount lending ties into the Fed's function of:

    • A.

      Lender of last resort

    • B.

      Open market operations

    • C.

      The government's bank

    • D.

      Regulation of banking

    Correct Answer
    A. Lender of last resort
    Explanation
    Discount lending refers to the practice of the Federal Reserve providing short-term loans to commercial banks and other financial institutions in times of financial distress or liquidity shortages. This function aligns with the concept of the "lender of last resort," as it ensures that banks have access to funds when they are unable to obtain them from other sources. By offering discount loans, the Fed helps stabilize the banking system and prevents potential bank failures, which could have a detrimental impact on the overall economy.

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  • 23. 

    The Fed will make a discount loan to a bank during a crisis:

    • A.

      No matter what condition the bank is in

    • B.

      Only if the bank is sound financially and can provide collateral for the loan

    • C.

      But if the bank doesn't have collateral the interest rate is higher

    • D.

      Only if the bank would fail without the loan

    Correct Answer
    B. Only if the bank is sound financially and can provide collateral for the loan
    Explanation
    During a crisis, the Federal Reserve will only make a discount loan to a bank if the bank is financially stable and able to offer collateral for the loan. This requirement ensures that the bank has the means to repay the loan and reduces the risk for the Federal Reserve. If the bank does not have collateral, the interest rate on the loan will be higher, further protecting the Federal Reserve's interests. The condition of the bank and its ability to provide collateral are crucial factors in determining whether the Federal Reserve will provide a discount loan during a crisis.

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  • 24. 

    The types of loans the Fed makes consist of each of the following, except:

    • A.

      Primary credit

    • B.

      Conditional credit

    • C.

      Seasonal credit

    • D.

      Secondary credit

    Correct Answer
    B. Conditional credit
    Explanation
    The question asks for the type of loan that the Fed does not make. The Fed offers primary credit, seasonal credit, and secondary credit. However, conditional credit is not a type of loan offered by the Fed.

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  • 25. 

    Secondary credit provided by the Fed is designed for:

    • A.

      Banks who qualify for a lower interest than what is available under primary credit

    • B.

      Banks that are in trouble and cannot obtain a loan from anyone else

    • C.

      Banks that want to borrow without putting up collateral

    • D.

      Foreign banks

    Correct Answer
    B. Banks that are in trouble and cannot obtain a loan from anyone else
    Explanation
    The correct answer is "Banks that are in trouble and cannot obtain a loan from anyone else." This is because secondary credit is a form of borrowing provided by the Federal Reserve to banks that are experiencing financial difficulties and are unable to secure loans from other sources. It is a last resort option for troubled banks to access funds and stabilize their operations.

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  • 26. 

    Seasonal credit provided by the Fed is not as common as it used to be because:

    • A.

      There are fewer banks in seasonal areas

    • B.

      Other sources for long-term loans have developed for banks in seasonal areas

    • C.

      Seasonal credit has been replaced by secondary credit

    • D.

      Seasonal credit is being replaced by primary credit

    Correct Answer
    B. Other sources for long-term loans have developed for banks in seasonal areas
    Explanation
    The reason why seasonal credit provided by the Fed is not as common as it used to be is because other sources for long-term loans have developed for banks in seasonal areas. This means that banks in seasonal areas now have alternative options for obtaining long-term loans, making them less reliant on seasonal credit from the Fed. As a result, the demand for seasonal credit has decreased and it has been replaced by these other sources of funding.

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  • 27. 

    The Fed is reluctant to change the required reserve rate because:

    • A.

      Changes in the rate have a small impact on the actual quantity of money

    • B.

      The money multiplier is not impacted by the required reserve rate

    • C.

      The time lag between changing the required reserve rate and changes in the money supply can be too long

    • D.

      Small changes in the required reserve rate can have too big of an impact on the money multiplier and the level of deposits

    Correct Answer
    D. Small changes in the required reserve rate can have too big of an impact on the money multiplier and the level of deposits
    Explanation
    The Fed is reluctant to change the required reserve rate because small changes in the required reserve rate can have too big of an impact on the money multiplier and the level of deposits. This means that even a slight adjustment in the reserve rate can result in a significant change in the overall money supply, which can have unintended consequences on the economy. The Fed prefers to avoid such drastic fluctuations and instead maintains a stable reserve rate to ensure a more predictable and controlled monetary policy.

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  • 28. 

    Which of the following features would characterize a good monetary policy instrument?

    • A.

      Observable only to monetary policy officials

    • B.

      Tightly linked to monetary policy objectives

    • C.

      Controllable and rigid

    • D.

      Difficult to change

    Correct Answer
    B. Tightly linked to monetary policy objectives
    Explanation
    A good monetary policy instrument should be tightly linked to monetary policy objectives. This means that the instrument should directly contribute to achieving the desired goals of the monetary policy, such as price stability or economic growth. By being closely aligned with these objectives, the instrument can effectively influence the economy and help the central bank in implementing its monetary policy.

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  • 29. 

    From 1979 to 1982, the Fed targeted bank reserves as the monetary policy tool. One side effect of this strategy was:

    • A.

      The inflation rate increased to over 18 percent in 1983

    • B.

      Many banks failed that otherwise may not have

    • C.

      Interest rates rose very high

    • D.

      Inflation remained high for most of the 1980's

    Correct Answer
    C. Interest rates rose very high
    Explanation
    During the period from 1979 to 1982, the Federal Reserve used bank reserves as the main tool for implementing monetary policy. As a result, one of the unintended consequences was that interest rates increased significantly. This can be attributed to the fact that targeting bank reserves limited the availability of funds in the banking system, leading to a scarcity of money supply. Consequently, the increased demand for borrowing caused interest rates to rise as lenders sought to capitalize on the limited supply of funds.

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  • 30. 

    Which of the following statements is not correct?

    • A.

      The current target of the FOMC is the federal funds rate

    • B.

      If the Fed were to target the quantity of reserves, a decrease in reserve demand would result in a lower federal funds rate

    • C.

      The Fed currently sets both an interest rate and a quantity target for monetary policy

    • D.

      If the Fed were to target the quantity of reserves, an increase in reserve demand would raise the federal funds rate

    Correct Answer
    C. The Fed currently sets both an interest rate and a quantity target for monetary policy
    Explanation
    The statement that is not correct is "The Fed currently sets both an interest rate and a quantity target for monetary policy." This is incorrect because currently, the Fed only sets an interest rate target for monetary policy, which is the federal funds rate. The Fed does not have a quantity target for reserves.

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  • 31. 

    A good definition for intermediate targets of monetary policy would be:

    • A.

      Instruments under the direct control of central bankers but one step removed from operational targets

    • B.

      Instruments that are not under the direct control of the central banks but lie between operational instruments and objectives

    • C.

      The quantity or non-price targets of monetary policy

    • D.

      The real goals of monetary policy

    Correct Answer
    B. Instruments that are not under the direct control of the central banks but lie between operational instruments and objectives
    Explanation
    Intermediate targets of monetary policy refer to instruments that are not directly controlled by central banks but are positioned between operational instruments (such as interest rates) and the ultimate objectives of monetary policy (such as price stability or economic growth). These intermediate targets serve as indicators or benchmarks that central bankers use to guide and assess the effectiveness of their policy actions. By monitoring and influencing these intermediate targets, central banks aim to achieve their broader policy goals.

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  • 32. 

    Over the last few decades, central bankers have:

    • A.

      Mostly abandoned intermediate targets

    • B.

      Greatly increased their focus on intermediate targets

    • C.

      Found that the links between the operating instruments and intermediate targets have become more stable

    • D.

      Developed more intermediate targets

    Correct Answer
    A. Mostly abandoned intermediate targets
    Explanation
    Central bankers have mostly abandoned intermediate targets because they have found that the links between the operating instruments and intermediate targets have become more stable. This means that they no longer need to rely on intermediate targets to achieve their desired outcomes. Additionally, central bankers have also developed more intermediate targets, allowing them to have a more comprehensive approach to monetary policy. This shift in focus has led to a greater emphasis on other tools and strategies in order to effectively manage the economy.

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  • 33. 

    The components of the formula for the Taylor rule includes each of the following, except:

    • A.

      The target federal funds rate

    • B.

      The current inflation rate

    • C.

      The 30-year U.S. Treasury bond rate

    • D.

      The inflation gap

    Correct Answer
    C. The 30-year U.S. Treasury bond rate
    Explanation
    The components of the Taylor rule are the target federal funds rate, the current inflation rate, and the inflation gap. The 30-year U.S. Treasury bond rate is not included in the formula for the Taylor rule. The Taylor rule is a monetary policy guideline that suggests how central banks should adjust interest rates in response to changes in economic conditions. It is based on the premise that central banks should respond to inflation and economic output. The 30-year U.S. Treasury bond rate is not directly related to these factors and therefore is not included in the formula.

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  • 34. 

    If each of the coefficients in front of the inflation gap and the output gap in the formula for the Taylor rule is 0.5, this implies:

    • A.

      That the Fed assumes that inflation and output are right on target

    • B.

      That inflation and output are one half a percent off of their targets

    • C.

      The Fed is giving equal weight to objectives of inflation and output

    • D.

      That the Fed will not accept higher inflation unless unemployment falls by twice the inflation rate

    Correct Answer
    C. The Fed is giving equal weight to objectives of inflation and output
    Explanation
    The given correct answer suggests that if each coefficient in front of the inflation gap and the output gap in the formula for the Taylor rule is 0.5, it implies that the Fed is giving equal weight to the objectives of inflation and output. This means that the Fed considers both inflation and output equally important in its decision-making process.

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  • 35. 

    Given the following formula for the Taylor rule: Target federal funds rate = 2 + current inflation + ½(inflation gap) +½(output gap) If the current rate of inflation is 5% and the target rate of inflation is 2%, and output is 3% above its potential, the target federal funds rate would be:

    • A.

      6.5%

    • B.

      2.5%

    • C.

      3.5%

    • D.

      10.5%

    Correct Answer
    D. 10.5%
    Explanation
    The formula for the Taylor rule states that the target federal funds rate is equal to 2% (target rate of inflation) + 5% (current rate of inflation) + 0.5*(5% - 2%) (inflation gap) + 0.5*(3%) (output gap). Simplifying this, we get 2% + 5% + 0.5% + 1.5% = 9%. Therefore, the target federal funds rate would be 9%, not 10.5%.

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  • 36. 

    A central bank's sale of securities from its portfolio will:

    • A.

      Decrease the size of its balance sheet

    • B.

      Have no impact at all on the balance sheet

    • C.

      Only change the composition of its liabilities

    • D.

      Only change the composition of its assets

    Correct Answer
    A. Decrease the size of its balance sheet
    Explanation
    When a central bank sells securities from its portfolio, it is essentially reducing its assets. As a result, the total size of its balance sheet decreases. This is because the securities held by the central bank are considered assets, and when they are sold, the central bank no longer holds them, leading to a decrease in the overall size of its balance sheet.

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  • 37. 

    Consider a $2 billion open market purchase of U.S. Treasury securities by the Federal Reserve. The Fed's balance sheet will specifically show:

    • A.

      Only an increase in the asset of securities of $2 billion

    • B.

      Only show an increase in the liability of reserves of $2 billion

    • C.

      No change in the size of the balance sheet, just the composition of assets will change from cash to securities

    • D.

      An increase in the asset category of securities and the liability category of reserves by $2 billion

    Correct Answer
    D. An increase in the asset category of securities and the liability category of reserves by $2 billion
    Explanation
    When the Federal Reserve conducts an open market purchase of U.S. Treasury securities, it buys these securities from the market, which increases its assets. At the same time, the Federal Reserve pays for these securities by creating reserves in the banking system, which increases its liabilities. Therefore, the correct answer is that the Fed's balance sheet will show an increase in the asset category of securities and the liability category of reserves by $2 billion.

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  • 38. 

    An open market sale of U.S. Treasury securities by the Fed will cause the Banking System's balance sheet to show:

    • A.

      Only an increase in liabilities

    • B.

      Only a decrease in assets

    • C.

      No net change in assets or liabilities, only a change in the composition of assets with securities decreasing and reserves increasing

    • D.

      No net change in assets or liabilities, only a change in the composition of assets with securities increasing and reserves decreasing

    Correct Answer
    D. No net change in assets or liabilities, only a change in the composition of assets with securities increasing and reserves decreasing
    Explanation
    When the Fed conducts an open market sale of U.S. Treasury securities, it means that the Fed is selling these securities to the public. As a result, the banking system's balance sheet will show no net change in assets or liabilities because the sale of securities is offset by a decrease in reserves. However, there will be a change in the composition of assets, with securities increasing and reserves decreasing. This means that the banking system will hold more securities and less reserves after the sale, but the overall value of assets and liabilities will remain the same.

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  • 39. 

    The Fed sells German bonds to commercial banks. Which of the following best describes the impact on the Fed's and the Banking System's balance sheets resulting from this transaction?

    • A.

      The Fed's assets and liabilities increase, the banking systems assets and liabilities decrease

    • B.

      The Fed's assets increase and its liabilities both increase. For the banking system, the value of assets and liabilities do not change, only the composition of assets changes

    • C.

      The Fed's assets and liabilities do not change, only the compositions of the assets change. For the banking system, assets and liabilities increase

    • D.

      The Fed's assets and liabilities both decrease. For the banking system, the value of assets and liabilities do not change, only the composition of assets changes

    Correct Answer
    D. The Fed's assets and liabilities both decrease. For the banking system, the value of assets and liabilities do not change, only the composition of assets changes
    Explanation
    When the Fed sells German bonds to commercial banks, it receives cash in exchange for the bonds. This cash is considered an asset for the Fed, but since it no longer holds the bonds, its assets decrease. Additionally, the Fed's liabilities also decrease because it no longer owes the bond to the commercial banks. On the other hand, for the banking system, the value of assets and liabilities does not change because the cash received from the Fed replaces the German bonds in their assets. Therefore, only the composition of assets changes for the banking system.

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  • 40. 

    When the Fed makes a discount loan, the impact on the Fed's balance sheet is:

    • A.

      An increase in liabilities with no change in assets

    • B.

      An increase in assets and a decrease in liabilities

    • C.

      A decrease in assets and an increase in liabilities

    • D.

      The same as that of an open market purchase

    Correct Answer
    D. The same as that of an open market purchase
    Explanation
    When the Fed makes a discount loan, it increases its assets by lending money to a bank, and at the same time, it increases its liabilities because it now owes that amount of money to the bank. This is the same impact as an open market purchase, where the Fed buys securities from the market, increasing its assets, and pays for them by creating new reserves, increasing its liabilities. Therefore, the correct answer is "The same as that of an open market purchase."

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  • 41. 

    Tom decides to withdraw $300 out of his checking account. The impact of this transaction on the Fed's balance sheet will be:

    • A.

      No change in total assets or total liabilities, but an increase in the liability of currency and a decrease in the liability of reserves by $300 respectively

    • B.

      No change in total assets but the liability of currency increases by $300

    • C.

      Total assets decrease by $300 and the liability of currency increases by $300

    • D.

      No change in either total assets or total liabilities

    Correct Answer
    A. No change in total assets or total liabilities, but an increase in the liability of currency and a decrease in the liability of reserves by $300 respectively
    Explanation
    When Tom withdraws $300 from his checking account, there is no change in the total assets or total liabilities of the Fed's balance sheet. However, there is an increase in the liability of currency by $300, as the Fed now owes Tom that amount in cash. At the same time, there is a decrease in the liability of reserves by $300, as the reserves held by the Fed to back up Tom's checking account have decreased. Overall, this transaction has no impact on the total assets or total liabilities of the Fed's balance sheet.

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  • 42. 

    The term for turning reserves into bank deposits is called:

    • A.

      Discounting

    • B.

      Balance sheet adjustment

    • C.

      Multiple deposit creation

    • D.

      Spreading

    Correct Answer
    C. Multiple deposit creation
    Explanation
    Multiple deposit creation refers to the process by which a bank can create additional deposits in the banking system through the lending and borrowing activities. When a bank receives a deposit, it is able to lend a portion of that deposit to borrowers, who in turn deposit the borrowed funds into their own accounts in other banks. This process continues, resulting in the creation of multiple deposits from a single initial deposit. Therefore, multiple deposit creation accurately describes the process of turning reserves into bank deposits.

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  • 43. 

    If Bank A sells a $100,000 U.S. Treasury bond to the Fed, Bank A's excess reserves will:

    • A.

      Increase by less than $100,000

    • B.

      Not change

    • C.

      Decrease by less than $100,000

    • D.

      Increase by $100,000

    Correct Answer
    D. Increase by $100,000
    Explanation
    When Bank A sells a $100,000 U.S. Treasury bond to the Fed, it receives $100,000 in return. This increases Bank A's reserves by $100,000, which are considered excess reserves because they are above the required reserve amount. Therefore, the correct answer is that Bank A's excess reserves will increase by $100,000.

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  • 44. 

    Bank A has checkable deposits of $100 million, vault cash equaling $1 million and deposits at the Fed equaling $14 million. If the required reserve rate is ten percent what is the maximum amount Bank A could lend?

    • A.

      $85 million

    • B.

      $15 million

    • C.

      $14 million

    • D.

      $5 million

    Correct Answer
    D. $5 million
    Explanation
    Bank A has checkable deposits of $100 million. The required reserve rate is ten percent. This means that Bank A is required to hold ten percent of its checkable deposits as reserves. Therefore, Bank A must hold $10 million as reserves.

    Bank A has vault cash equaling $1 million and deposits at the Fed equaling $14 million. These two amounts together equal $15 million, which is greater than the required reserve of $10 million.

    The maximum amount Bank A could lend is calculated by subtracting the required reserve from the total reserves. Therefore, the maximum amount Bank A could lend is $15 million - $10 million, which equals $5 million.

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  • 45. 

    If the required reserve rate is ten percent and banks do not hold any excess reserves and there are no changes in currency holdings, a $1 million open market purchased by the Fed will result in deposit creation of:

    • A.

      $9 million

    • B.

      $90 million

    • C.

      $10 million

    • D.

      $900,000

    Correct Answer
    C. $10 million
    Explanation
    If the required reserve rate is ten percent, it means that banks are required to hold ten percent of their deposits as reserves. In this scenario, since there are no excess reserves, the banks will need to hold $100,000 ($1 million multiplied by 10%) as reserves. The remaining $900,000 ($1 million minus $100,000) can be used to create new loans and deposits. Since the initial purchase was $1 million, this amount will be multiplied by the money multiplier, which is the inverse of the reserve ratio. In this case, the money multiplier is 1/0.1, which equals 10. Therefore, the deposit creation will be $10 million ($1 million multiplied by 10).

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  • 46. 

    If the Fed were to increase the required reserve rate from ten percent to twenty percent, the simple deposit expansion multiplier would:

    • A.

      Double

    • B.

      Increase by 10 percent

    • C.

      Decrease by a factor of ten

    • D.

      Be half as large as it was before the increase

    Correct Answer
    D. Be half as large as it was before the increase
    Explanation
    If the Fed increases the required reserve rate from ten percent to twenty percent, it means that banks will have to hold a larger portion of their deposits as reserves. This will reduce the amount of money that banks can lend out, as they will have less excess reserves available. As a result, the simple deposit expansion multiplier, which determines the maximum amount of money that can be created through the lending process, will be half as large as it was before the increase.

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  • 47. 

    Assume that the required reserve rate is ten percent, banks want to hold excess reserves in an amount that equals three percent of deposits, and the public withdraws ten percent of every deposit in cash. An open market purchase of $1 million by the Fed will see banking system deposits increase by:

    • A.

      More than $1 million but less than $10 million

    • B.

      Exactly $1 million

    • C.

      Less than $1 million

    • D.

      More than $10 million but less than $20 million

    Correct Answer
    A. More than $1 million but less than $10 million
    Explanation
    When the Fed conducts an open market purchase of $1 million, the banking system deposits will increase by more than $1 million but less than $10 million. This is because of the multiple effects of the purchase. Initially, the $1 million will be deposited into the banking system, increasing deposits by $1 million. However, due to the required reserve rate of ten percent, banks are required to hold ten percent of deposits as reserves. Therefore, $100,000 will be held as required reserves, and the remaining $900,000 will be available as excess reserves. Additionally, since the public withdraws ten percent of every deposit in cash, $90,000 will be withdrawn, leaving the final increase in banking system deposits between $1 million and $10 million.

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  • 48. 

    Which of the following best completes the statement? If people increase their currency holdings, all else the same, the monetary base:

    • A.

      Does not change but the quantity of M2 will decrease

    • B.

      Increases as does the quantity of M2

    • C.

      Decreases as does the quantity of M2

    • D.

      Does not change and neither does M2

    Correct Answer
    A. Does not change but the quantity of M2 will decrease
    Explanation
    When people increase their currency holdings, the monetary base does not change because currency is part of the monetary base. However, the quantity of M2 will decrease because M2 includes currency held by the public as well as other types of money such as checking accounts and savings accounts. So, when currency holdings increase, the proportion of other types of money in M2 decreases, resulting in a decrease in the overall quantity of M2.

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  • 49. 

    If M = the quantity of money, m the money multiplier, MB the Monetary Base, C = Currency, D = Deposits, R = Reserves, RR = required reserves, and ER = Excess reserves, then C + R would equal:

    • A.

      M

    • B.

      R

    • C.

      MB

    • D.

      ER

    Correct Answer
    C. MB
    Explanation
    The correct answer is MB. MB refers to the Monetary Base, which includes both currency (C) and reserves (R). Therefore, the sum of currency and reserves (C + R) would equal the Monetary Base (MB).

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  • 50. 

    If M = the quantity of money, m the money multiplier, MB the Monetary Base, C = Currency, D = Deposits, R = Reserves, RR equals required reserves, rD = the required reserve rate and ER = Excess reserves, then C + D would equal:

    • A.

      MB times m

    • B.

      R/ER

    • C.

      D rD

    • D.

      C/D

    Correct Answer
    A. MB times m
    Explanation
    The equation C + D represents the total money supply in an economy, which includes both currency in circulation (C) and deposits in banks (D). The equation MB times m represents the monetary base (MB) multiplied by the money multiplier (m). The monetary base refers to the total amount of currency in circulation plus the reserves held by banks. The money multiplier represents the ratio of the money supply to the monetary base. Therefore, the equation MB times m accurately represents the relationship between the monetary base and the total money supply.

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  • Current Version
  • May 11, 2023
    Quiz Edited by
    ProProfs Editorial Team
  • May 05, 2012
    Quiz Created by
    Tpc43b
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