Honors Economics- Monetary Policy
Questions and Answers
- 1.
When money is used as a standard of value, a person is
- A.
Earning more money
- B.
Purchasing a necessity
- C.
Making a financial transaction
- D.
Making price comparisons among products
- E.
Writing a check for groceries
Correct Answer
D. Making price comparisons among productsExplanation
When money is used as a standard of value, it means that it is being used to compare the prices of different products. This involves looking at the cost of various items and determining which one offers the best value for the money. This process allows individuals to make informed decisions about their purchases and choose the product that meets their needs and budget.Rate this question:
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- 2.
Which of the following characteristics of money could be found in bars of gold?
- A.
Portability
- B.
Uniformity
- C.
Stability in value
- D.
Durability
- E.
Acceptability
Correct Answer(s)
B. Uniformity
D. DurabilityExplanation
Bars of gold can be considered as a form of money because they possess the characteristics of uniformity and durability. Uniformity refers to the standardization of the bars in terms of weight, purity, and size, making them easily recognizable and interchangeable. Durability refers to the ability of the bars to withstand wear and tear over time without losing their value or physical properties. However, bars of gold may not possess other characteristics such as portability, stability in value, and acceptability as widely as other forms of money like paper currency or digital transactions.Rate this question:
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- 3.
When money is used as a medium of exchange, a person is
- A.
Making price comparisons among products
- B.
Earning more money than before
- C.
Writing a check for groceries
- D.
Holding onto their money for a future trip
Correct Answer
C. Writing a check for groceriesExplanation
When money is used as a medium of exchange, it means that it is being used to facilitate transactions between individuals or businesses. Writing a check for groceries is an example of using money as a medium of exchange, as the person is using their checkbook to transfer funds from their bank account to the grocery store in exchange for the groceries. This action demonstrates the use of money to facilitate a transaction, making it the correct answer.Rate this question:
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- 4.
The M1 definition of money includes which of the following
- A.
Currency
- B.
Demand deposits
- C.
Savings accounts and small time deposits
Correct Answer(s)
A. Currency
B. Demand depositsExplanation
The M1 definition of money includes currency and demand deposits. Currency refers to physical money such as coins and banknotes that are in circulation. Demand deposits, on the other hand, are funds held in checking accounts that can be withdrawn on demand by the account holder. Both currency and demand deposits are considered part of the M1 money supply because they are readily accessible and can be used for transactions. However, savings accounts and small time deposits are not included in the M1 definition as they are less liquid and have certain restrictions on withdrawals.Rate this question:
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- 5.
What is the result of the equation of exchange of the velocity of money remains constant and the money supply increases?
- A.
Nominal GDP must increase
- B.
Nominal GDP must decrease
- C.
Aggregate supply will shift
- D.
LRAS will shift
- E.
Aggregate demand will shift
Correct Answer
A. Nominal GDP must increaseExplanation
If the velocity of money remains constant and the money supply increases, according to the equation of exchange (MV = PQ), the increase in money supply (M) will result in an increase in nominal GDP (PQ). This is because the velocity of money (V) is constant, so any increase in money supply will directly lead to an increase in nominal GDP.Rate this question:
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- 6.
If the legal reserve requirement is 25%, the value of the simple deposit expansion multiplier is
- A.
2
- B.
4
- C.
5
- D.
10
- E.
1.0
Correct Answer
B. 4Explanation
The simple deposit expansion multiplier is determined by dividing 1 by the legal reserve requirement. In this case, since the legal reserve requirement is 25%, the simple deposit expansion multiplier would be 1 divided by 0.25, which equals 4. This means that for every dollar held in reserves, the banking system can create up to four dollars in new loans and deposits.Rate this question:
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- 7.
Which of the following is most likely to increase the velocity of money?
- A.
Decrease in price level
- B.
Decrease in interest rates
- C.
Higher frequency of paychecks
- D.
Increase in unemployment rate
- E.
Decrease in personal income
Correct Answer
C. Higher frequency of paychecksExplanation
A higher frequency of paychecks is most likely to increase the velocity of money because it means individuals are receiving their income more frequently. This can lead to increased spending and circulation of money in the economy, as people have more opportunities to make purchases and transactions. With more frequent paychecks, individuals have a steady stream of income, allowing them to spend more regularly and potentially stimulate economic activity.Rate this question:
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- 8.
Vault cash and reserve accounts are similiar in that each
- A.
Earns no interest
- B.
Provides for bank's use of large amounts of cash
- C.
Is maintained by bank at a fixed percentage set by federal reserve
- D.
Is part of the money supply
- E.
Is kept on account at federal reserve
Correct Answer
D. Is part of the money supplyExplanation
Vault cash and reserve accounts are similar in that each is part of the money supply. Both vault cash and reserve accounts are considered part of the money supply because they are both held by banks and can be used to facilitate transactions and meet the demand for cash by customers. The money supply includes all forms of money that are in circulation and held by individuals, businesses, and banks. Vault cash refers to the physical cash held by a bank in its vault, while reserve accounts refer to the deposits held by banks at the Federal Reserve. Both forms contribute to the overall money supply in the economy.Rate this question:
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- 9.
The reserve requirement for the banking system is 20%. Currently, Third National Bank has no excess reserves. Then, Behroz deposits $100 in her checking account at Third National. A) Explain, without using a mathematical formula, why Behroz's deposit can lead to an increase in the money supply that is greater than $100. B) Discuss 2 limitations of this process.
- 10.
Suppose the required reserve ratio is .20. A) What would be the value of the deposit expansion multiplier? B) Discuss why it is unlikely that a new deposit of $1,000 would result in the money supply fully increasing as indicated by the deposit expansion multiplier.
- 11.
Reserves, the money supply and interest rates are most likely to change in which of the following ways when the Fed sells bonds?
- A.
Reserves: increase, MS: increase, IR: increase
- B.
Reserves: increase, MS: increase, IR: decrease
- C.
Reserves: decrease, MS: increase, IR: decrease
- D.
Reserves: decrease, MS: decrease, IR: increase
- E.
Reserves: decrease, MS: decrease, IR: decrease
Correct Answer
D. Reserves: decrease, MS: decrease, IR: increaseExplanation
When the Fed sells bonds, it decreases the reserves held by banks. As a result, the money supply (MS) decreases because there is less money available for lending and spending. Additionally, when the money supply decreases, interest rates (IR) tend to increase as borrowing becomes more expensive. Therefore, the correct answer is Reserves: decrease, MS: decrease, IR: increase.Rate this question:
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- 12.
Which of the following actions by the Fed will result in an increase in bank's excess reserves?
- A.
Buying bonds on an open market
- B.
Selling bonds on an open market
- C.
Increasing the discount rate
- D.
Increasing the reserve requirement
- E.
Increasing the federal funds rate
Correct Answer
A. Buying bonds on an open marketExplanation
Buying bonds on an open market by the Fed will result in an increase in bank's excess reserves. When the Fed buys bonds, it injects money into the banking system. This increases the reserves held by banks, including excess reserves, which are reserves held by banks above the required amount. Therefore, buying bonds on an open market increases the amount of money available for banks to lend and increases their excess reserves.Rate this question:
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- 13.
The Fed has 3 primary tools to expand or contract the money supply. A) List the 3 tools. B) Which tool does the Fed use most often? C) Explain why the Fed uses the tool you indicated in B.
- 14.
Suppose the Fed buys $400,000 worth of securities from the securities dealers on the open market. If the reserve requirement is 20% and the banks hold no excess reserves, what will happen to the total money supply?
- A.
It will be unchanged
- B.
It will contract by $2,000,000
- C.
It will contract by $800,000
- D.
It will expand by $2,000,000
- E.
It will expand by $800,000
Correct Answer
D. It will expand by $2,000,000Explanation
When the Fed buys $400,000 worth of securities from the securities dealers, it injects money into the banking system. The reserve requirement is 20%, which means that banks are required to hold 20% of their deposits as reserves. Since the banks hold no excess reserves, they will need to increase their reserves by $80,000 (20% of $400,000). This increase in reserves allows the banks to lend out more money. Using the money multiplier effect, assuming a multiplier of 5, the initial injection of $400,000 will lead to a total expansion of $2,000,000 in the money supply. Therefore, the correct answer is that the total money supply will expand by $2,000,000.Rate this question:
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- 15.
Which of the following does the Fed use most often to combat a recession?
- A.
Selling securities
- B.
Buying securities
- C.
Reducing the reserve requirement
- D.
Increasing the discount rate
- E.
Increasing the federal funds rate
Correct Answer
B. Buying securitiesExplanation
During a recession, the Fed often uses the strategy of buying securities to combat the economic downturn. By purchasing government bonds or other financial assets from banks and financial institutions, the Fed injects money into the economy, increasing the money supply. This stimulates economic activity by lowering interest rates, making it easier for businesses and individuals to borrow money and invest. The increased liquidity in the market helps to boost consumer spending and business investment, ultimately aiding in the recovery from the recession.Rate this question:
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- 16.
To reduce inflation, the Fed could
- A.
Expand the money supply in order to raise interest rates, which increases investment
- B.
Expand the money supply in order to lower interest rates, which increases investment
- C.
Contract the money supply in order to lower interest rates, which increases investment
- D.
Contract the money supply in order to raise interest rates, which decreases investment
- E.
Buy bonds and decrease the discount rate to encourage borrowing
Correct Answer
D. Contract the money supply in order to raise interest rates, which decreases investmentExplanation
Contracting the money supply refers to the process of reducing the amount of money available in the economy. This can be done by the Federal Reserve (Fed) selling government bonds, increasing reserve requirements for banks, or raising interest rates. When the money supply is contracted, interest rates tend to increase. Higher interest rates make borrowing more expensive, which reduces investment and spending. Therefore, contracting the money supply in order to raise interest rates would decrease investment and help reduce inflation.Rate this question:
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- 17.
Which of the following combinations of monetary policy actions would definitely cause a decrease in aggregate demand?
- A.
Discount rate: decrease, OMO: buy bonds, RRR: decrease
- B.
Discount rate: decrease, OMO: sell bonds, RRR: decrease
- C.
Discount rate: increase, OMO: buy bonds, RRR: increase
- D.
Discount rate: increase, OMO: sell bonds, RRR: decrease
- E.
Discount rate: increase, OMO: sell bonds, RRR: increase
Correct Answer
E. Discount rate: increase, OMO: sell bonds, RRR: increaseExplanation
An increase in the discount rate would make borrowing more expensive for banks, which would in turn lead to a decrease in lending and investment. Selling bonds through open market operations (OMO) would reduce the money supply in the economy, further decreasing spending and investment. Increasing the required reserve ratio (RRR) would also reduce the amount of money that banks can lend, leading to a decrease in aggregate demand. Therefore, this combination of monetary policy actions would definitely cause a decrease in aggregate demand.Rate this question:
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- 18.
Expansionary Monetary Policy results in which of the following in the short run?
- A.
The money supply increases
- B.
The interest rate decreases
- C.
The interest rate increases
- D.
Bond prices decreases
Correct Answer(s)
A. The money supply increases
B. The interest rate decreasesExplanation
Expansionary Monetary Policy refers to the actions taken by a central bank to stimulate economic growth. In the short run, when expansionary monetary policy is implemented, the money supply increases. This is done through measures such as lowering interest rates, buying government bonds, or reducing reserve requirements for banks. As a result of the increased money supply, the interest rate decreases. Lower interest rates encourage borrowing and investment, which helps to boost economic activity. Therefore, the correct answer is that in the short run, expansionary monetary policy leads to an increase in the money supply and a decrease in the interest rate.Rate this question:
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- 19.
Suppose the economy is experiencing rising unemployment, slowing increases in real GDP and modest inflation. The Fed decides to follow an expansionary policy. A) Describe what this policy might include. B) If the policy is effective, explain the short-run effect it would have on each of the following: I. Interest rates II. Investment III. Price level IV. GDP V. Employment
- 20.
The Fed Board of Governors determines that it is appropriate to follow a contractionary policy. A) Would the monetary policy be to increase or decrease the money supply? B) Describe the policy the Fed is likely to take and explain how its action achieves the goal following a contractionary policy. C) If the policy is effective, explain the short-run effect it would have on each of the following: I. Interest rates II. Investment III. Price level IV. GDP V. Employment
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