Theme 7.

Monetary Policy
Directions: Each of the questions or incomplete statements below is followed by four or five suggested
answers or completions. Select the one that is the best in each case.

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Targets and Instruments of the Monetary Policy

1. Which of the following are examples of ultimate targets?
(A) Money base.
(B) Credit.
(C) Output.
(D) All of the above.
(E) No true answer.

2. Which of the following are examples of intermediate targets?

(A) Inflation.
(B) Output.
(C) Credit.
(D) All of the above.
(E) No true answer.

3. A central bank is most likely to monetize budget deficits if it targets

(A) Interest rates
(B) The money base
(C) Inflation
(D) Discount rate
(E) Unemployment

4. Interest rates can be an unreliable indicator of monetary policy if there is

(A) Money illusion
(B) Inflation targeting
(C) Credit rationing
(D) Disintermediation
(E) In all of the above cases

5. The instruments of monetary control are

I. The discount rate
II. The required reserve ratio
III. Open market transactions
IV. Foreign exchange intervention
(A) I, II, and III only
(B) II, III, and IV only
(C) I, II, and IV only
(D) I, III, and IV only
(E) I, II, III, and IV

6. Which of the following instruments of monetary control does the Central Bank use least often?
(A) The discount rate.
(B) The required reserve ratio.
(C) Open market operations.
(D) It uses them all equally.
(E) No true answer.
7. Suppose banks hold no excess reserves and reserves total $1200. When the reserve requirement is
lowered from 0.12 to 0.10, check-writing deposits
(A) Increase from $ 1000 to $ 1200
(B) Increase from $ 10,000 to $ 12,000
(C) Decrease from $ 1200 to $ 1000
(D) Decrease from $ 12,000 to $ 10,000
(E) Decrease from $ 10,000 to $ 1200

8. When the Fed decreases reserve requirements, it

(A) Increases the reserve to deposit ratio
(B) Decreases the reserve to deposit ratio
(C) Increases the monetary base
(D) Increases the monetary base
(E) Decreases the currency drain

9. Which can the Central Bank control most accurately on a day-to-day basis?
(A) Interest rates.
(B) The monetary base.
(C) Output.
(D) The money supply.
(E) Inflation.

10. Open-market operations refer to which of the following activities?

(A) The buying and selling of stocks in the New York stock market.
(B) The government's contribution to net exports.
(C) The loans made by the Federal Reserve to member commercial banks.
(D) The buying and selling of government securities by the Federal Reserve.
(E) The government's purchases and sales of municipal bonds.

11. A decrease in the Federal Reserve's discount rate lowers the cost of borrowing
(A) For banks from the Federal Reserve
(B) For individuals from the Federal Reserve
(C) For individuals from banks
(D) For banks in the fed funds market
(E) True (A) and (B)

12. An increase in the discount rate usually occurs when

(A) The Federal Reserve no longer is willing to make loans to banks
(B) Short-term market rates are due to increase
(C) Short-term market rates, such as the fed funds rate, have risen
(D) The Federal Reserve is lowering the reserve requirement
(E) The Federal Reserve buys government bonds on the open market

13. When the Central Bank increases the discount rate, it:
(A) Increases the reserve to deposit ratio
(B) Decreases the reserve to deposit ratio
(C) Increases the currency to deposit ratio
(D) Is likely to decrease the monetary base
(E) Is likely to increase the monetary base

14. The monetary base consists of

(A) Currency held by the public, plus reserves held by bank.
(B) All hard currencies, plus reserves held by banks
(C) All currency, plus demand deposits
 (D) All bank reserves
(E) The most liquid part of bank reserves

15. The monetary base in the U.S. consists of

(A) Reserves at the Federal Reserve
(B) Deposits of member banks at the Federal Reserve
(C) Eurodollars and foreign deposits at the Federal Reserve
(D) Reserves plus currency in circulation
(E) All of the above

16. Which of the following are true statements about the federal funds rate?
I. It is the same thing as the discount rate.
II. It is the interest rate that banks charge each other for short-term loans.
III. It is influenced by open market operations.
(A) I only
(B) II only
(C) III only
(D) I and II only
(E) II and III only

17. When the reserve requirement is 0.10 and the Federal Open Market Committee securities valued at
$1000 from banks, ceteris paribus, banks
(A) Hold excess reserves of $ 100
(B) Hold excess reserve of $1000
(C) Hold required reserve of $1000
(D) Increase check-writing deposits by a maximum of $1000
(E) Increase check-writing deposits by a maximum of $5000

18. If the Federal Reserve sells a significant amount of government securities in the open market, which
of the following will occur?
(A) The total amount of loans made by commercial banks will decrease.
(B) The total amount of loans made by commercial banks will increase.
(C) The money supply will increase.
(D) Rates of interest will decrease.
(E) Rates of interest and the total amount of loans made by banks will remain unchanged.

19. The Federal Reserve controls

(A) The monetary base through open market operations
(B) The monetary base through reserve requirements on deposit accounts
(C) The money multiplier through open market operations
(D) The money multiplier through reserve requirements on deposit accounts
(E) The money multiplier through the discount rate

20. The money supply will increase as a result of which of the following?
(A) A decrease in the required reserve ratio.
(B) An increase in the discount rate.
(C) The selling of bonds by the Federal Reserve.
(D) An increase in the fraction of deposits that must be held by banks.
(E) Open market operations involving the sale of government securities.

21. When the reserve requirement on checking deposits is 0.10 and the Federal Reserve purchases
government securities valued at $100,000, the Ml money supply
(A) Is unchanged
(B) Increases by $100,000
 (C) Increases by $1,000,000
(D) Increases by an amount determined by the money multiplier
(E) Increases by $10,000

22. One way in which the Federal Reserve works to change the Unites States money supply is by
changing the
(A) Number of banks in operation
(B) Velocity of money
(C) Price level
(D) Prime rate
(E) Discount rate

23. If monetary authorities want to reduce commercial bank lending they should:
I. Take actions to reduce commercial bank reserves
II. Take actions to increase commercial bank reserves
III. Lower the legal reserve ratio
(A) Only I is true
(B) Only II is true
(C) Only III is true
(D) I and II are true
(E) I, II, and III are true

24. If the currency-deposit ratio is 5% and the reserve-deposit ratio is 30% then the money multiplier is
(A) 1.3 (B) 3 (C) 4 (D) 20 (E) 6

25. If the currency-deposit ratio is 1/2 and the reserve-deposit ratio 1/4, the money multiplier will be
(A) 0.75 (B) 0.25 (C) 5/3 (D) 1 (E) 2

26. If the Central Bank buys $1 mln of government bonds from commercial banks, the reserves of
commercial banks would:
(A) Decrease by $1 mln.
(B) Increase by $1 mln.
(C) Increase by less than $1 mln.
(D) Increase by more than $1 mln.
(E) Not be altered.

27. If the monetary base is denoted by B, rr is the ratio of reserves to deposits, and cr is the ratio of
currency to deposits, then the money supply is equal to
(A) (rr + 1) divided by (rr + cr) multiplied by B
(B) (cr + 1) divided by (cr + rr) multiplied by B
(C) (rr + cr) divided by (rr + 1) multiplied by B
(D) 1 divided by rr multiplied by B
(E) (rr + cr) divided by (cr + 1) multiplied by B

28. If the public's demand for currency increased relative to its demand for deposits, the
(A) Reserve requirement ratio would decrease
(B) Currency-deposit ratio would increase
(C) Reserve-deposit ratio would increase
(D) Money multiplier would increase
(E) Money multiplier would stay the same

29. Suppose the Federal Reserve buys $400,000 worth of securities from the securities dealers on the
open market. If the reserve requirement is 20 percent 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.

30. When cr = 0.05 and rr = 0.20, a $100 increase in the monetary base will result in a maximum increase
in the M1 money supply of
(A) $100 (B) $400 (C) $420 (D) $500 (E) $600

31. When the Central Bank makes an open-market sale, it

(A) Increases the money multiplier
(B) Increases the currency to deposit ratio
(C) Increases the monetary base
(D) Decreases the monetary base
(E) Decreases the money multiplier

32. If a central bank sells government securities to commercial banks, the immediate result is
(A) A decrease in the level of short-term interest rates
(B) A decrease in bank reserves
(C) An increase in the national debt
(D) An increase in the amount of currency held by the nonbank public
(E) An increase in the minimum reserves-to-deposits ratio required of banks

33. If the central bank purchases bonds from the public in the amount of $10 million, the effect on the
money supply would be the same as the effect of
(A) The sale of $10 million in bonds by the central bank to commercial banks
(B) The purchase of $10 million in U.S. bonds by foreigners
(C) The purchase of $10 million in bonds by the central bank from commercial banks
(D) The withdrawal of $10 million from the money market
(E) Printing of $10 million of new money

34. The Federal Reserve can increase the money supply by

(A) Selling gold reserves to the banks
(B) Borrowing reserves from foreign governments
(C) Selling foreign currency holdings
(D) Buying government bonds on the open market
(E) Buying gold from foreign central banks

Types, Mechanism and Effectiveness of Monetary Policy

35. Which of the following macroeconomic stabilization policies is most likely to be proposed by
Keynesians
(A) Increase money supply growth during a period of low unemployment and high inflation
(B) Increase money supply growth during a period of high unemployment and low inflation
(C) Increase money supply growth during a period of high unemployment and deflation
(D) Increase money supply growth during a period of low unemployment and low inflation
(E) Never increase money supply growth under any conditions

36. If the Central bank wants to decrease the supply of money which policy combinations will be the
most efficient?
Reserve Requirements Open-Market Operations Discount Rate
(A) Increase Sell securities Decrease
(B) Increase Sell securities Raise
(C) Decrease Buy securities Raise
 (D) Decrease Buy securities Decrease
(E) Increase Buy securities Raise

37. To counteract a recession, the Federal Reserve should

(A) Raise the reserve requirement and the discount rate
(B) Sell securities on the open market and raise the discount rate
(C) Sell securities on the open market and lower the discount rate
(D) Buy securities on the open market and raise the discount rate
(E) Buy securities on the open market and lower the discount rate

38. Expansionary monetary policy ______ investment.

(A) Increases
(B) Decreases
(C) Does not affect
(D) Could increase or decrease
(E) It depends on other factors

39. The initial effect of an increase in the money supply is to

(A) increase the price level
(B) decrease the price level
(C) increase the interest rate
(D) decrease the interest rate
(E) decrease the level of output

40. The long run effect of an increase in the money supply is to

(A) increase the price level
(B) decrease the price level
(C) increase the interest rate
(D) decrease the interest rate
(E) increase the level of output

41. If the Federal Reserve lowers the reserve requirement, which of the following would most likely
occur?
(A) Imports will rise, decreasing the trade deficit
(B) The rate of saving will increase
(C) Unemployment and inflation will both increase
(D) Businesses will purchase more factories and equipment
(E) The budget deficit will increase

42. An increase in the money supply is most likely to have which of the following short-run
effects on real interest rates and real output?
Real interest rates Real output
(A) Decrease Decrease
(B) Decrease Increase
(C) Increase Increase
(D) No change Increase
(E) Increase Decrease

43. An increase in the interest rate at which the central bank lends to commercial banks would normally
lead to
(A) Decreased commercial-bank reserves, increased levels of other interest rates, and a lower level of
economic activity
(B) Decreased commercial-bank reserves, reduced levels of other interest rates, and a higher level of
economic activity
 (C) Increased commercial-bank reserves, increased levels of other interest rates, and a higher level of
economic activity
(D) Increased commercial bank reserves, reduced levels of other interest rates, and a higher level of
economic activity
(E) Increased commercial-bank reserves, reduced levels of other interest rates, and a lower level of
economic activity

44. When the Federal Reserve is expanding the money supply

(A) Bank lending should increase and interest-sensitive spending should decrease
(B) Bank lending should decrease and interest-sensitive spending should decrease
(C) Bank lending should decrease and interest-sensitive spending should increase
(D) Bank lending should increase and interest-sensitive spending should increase
(E) Bank lending should increase but spending stay unchanged

45. According to both monetarists and Keynesians, which of the following happens when the Federal
Reserve reduces the discount rate?
(A) The demand for money decreases and market interest rates decrease.
(B) The demand for money increases and market interest rates increase.
(C) The supply of money increases and market interest rates decrease.
(D) The supply of money increases and market interest rates increase.
(E) Both the demand for money and the supply of money increase and market interest rates increase.

46. Which of the following best describes how an increase in the money supply shifts aggregate demand?
(A) the money supply shifts right, the interest rate rises, investment and consumption decrease,
aggregate demand shifts left
(B) the money supply shifts right, the interest rate falls, investment and consumption increase,
aggregate demand shifts right
(C) the money supply shifts right, prices rise, spending falls, aggregate demand shifts left
(D) the money supply shifts right, prices fall, spending increases, aggregate demand shifts right
(E) the money supply shifts right, prices rise, spending increases, aggregate demand shifts right

47. Increase in money supply in the long run

(A) Encourages investment and consumption
(B) Discourages investment and consumption
(C) Discourages investment and encourages consumption
(D) Encourages investment and discourages consumption
(E) Has no effect on investment and consumption

48. An expansionary monetary policy is ineffective. This means

(A) Prices are rigid
(B) Exchange rate is flexible
(C) Demand for money is horizontal
(D) Supply of money is vertical
(E) All of the above

49. Under which of the following circumstances would increasing the money supply be most effective in
increasing real gross domestic product?
Business Interest Rates Employment Optimism
(A) High Full High
(B) High Less than full High
(C) Low Full High
(D) Low Full Low
(E) Low Less than full Low
50. An increase in the money supply will have the greatest effect on real gross domestic product if
(A) The marginal propensity to consume is low
(B) There is full employment in the economy
(C) Investment spending is not sensitive to changes in interest rates
(D) The quantity of money demanded is not very sensitive to interest rates
(E) The required reserve ratio is high

51. The less sensitive money demand is to changes in the interest rate, the more an increase in the money
stock will
(A) Increase aggregate demand and lower interest rates
(B) Decrease aggregate demand and lower interest rates
(C) Increase aggregate demand and raise interest rates
(D) Decrease aggregate demand and raise interest rates
(E) None of the above

52. The purchase of bonds by the Federal Reserve will have the greatest effect on real gross national
product if which of the following situations exists in an economy?
(A) The required reserve ratio is high, and the interest rate has a large effect on investment spending.
(B) The required reserve ratio is high, and the interest rate has a small effect on investment spending.
(C) The required reserve ratio is low, and the interest rate has a large effect on investment spending.
(D) The required reserve ratio is low, and the marginal propensity to consume is low.
(E) The marginal propensity to consume is high, and the interest rate has a small effect on investment
spending.

53. If an increase in the nominal money supply results in no change in the level of money income, then
which of the following is true?
(A) The price level must have risen.
(B) Real income must have declined.
(C) Interest rates must have increased.
(D) Government expenditure must have risen.
(E) The velocity of money must have fallen.

54. Which of the following is most likely to increase the velocity of money?
(A) Higher frequency of paychecks
(B) Decrease in the price level
(C) Decrease in interest rates
(D) Decrease in personal income
(E) Increase in the unemployment rate

55. An increase in the money supply has a small effect upon equilibrium output when
(A) The demand for money and investment spending is interest-insensitive
(B) The demand for money and investment spending is interest-sensitive
(C) The demand for money is interest-sensitive and investment demand is interest-insensitive
(D) The demand for money is interest-insensitive and investment demand is interest-sensitive
(E) The demand for money is interest-insensitive, while interest sensitivity of investment demand
does’t matter

56. A change in the money supply has a greater effect upon equilibrium income
(A) The more interest-sensitive private sector spending is
(B) The less interest-sensitive private sector spending is
(C) The smaller the expenditure multiplier is
(D) The more interest-sensitive money holdings are to the rate of interest
(E) The more income-sensitive money demand is
57. The neutrality of money refers to the situation where
(A) money has not been the cause of war.
(B) increases in interest rates are matched by decreases in the price of bonds.
(C) increases in interest rates are matched by increases in the price of bonds.
(D) increases in the money supply eventually result in no change in real output.
(E) decreases in the money supply result in increases in the interest rate in the short run.

58. True statements about expansionary monetary policy in the long run include which of the following?
I. Price level increases to match the increase in the money supply.
II. The nominal interest rate equals the real interest rate plus the expected inflation rate.
III. The real output level has not permanently increased.
(A) I only
(B) II only
(C) III only
(D) I and II only
(E) I, II and III

Fiscal and Monetary Policy Mix

59. Which of the following policy combinations is most likely to cure a severe recession?
Open-Market Operations Taxes Government Spending
(A) Buy securities Increase Decrease
(B) Buy securities Decrease Increase
(C) Buy securities Decrease Decrease
(D) Sell securities Decrease Decrease
(E) Sell securities Increase Increase

60. In order to reduce or eliminate crowding out, expansionary fiscal policy can be accompanied by
(A) An increase in government spending
(B) A decrease in investment
(C) Expansionary monetary policy
(D) Contractionary monetary policy
(E) An increase in the interest rate

61. An expansive monetary and fiscal policy shifts

(A) Aggregate demand to the right
(B) Aggregate demand to the left
(C) Aggregate supply to the right
(D) Aggregate supply to the left
(E) Both aggregate demand and aggregate supply to the right

62. When autonomous consumption increases and money supply decreases, in the short run:
(A) Real output definitely decreases
(B) Real output definitely increases
(C) Investment definitely decreases
(D) Investment definitely increases
(E) Real output would definitely not change

63. During a mild recession if policymakers want to reduce unemployment by increasing investment
which of the following policies would be most appropriate?
(A) Equal increases in government expenditure and taxes.
(B) An increase in government expenditures only.
(C) An increase in transfer payments.
(D) An increase in the reserve requirements.
(E) Purchase of government securities by the Fed.
64. An inflationary gap can be eliminated by all of the following except:
(A) An increase in personal income taxes
(B) A decrease in net exports
(C) An increase in the money supply
(D) A decrease in government spending
(E) An increase in interest rates

65. If the government increases its spending during recession in order to assist the economy in recovery,
the funds for such expenditures must come from some source. Which of the following sources would
tend to be the most expansionary?
(A) Additional taxes upon personal incomes.
(B) Creating new money.
(C) Borrowing from the public.
(D) Additional taxes upon corporate profits.
(E) None of the above.

66. If the government simultaneously engages in expansionary monetary and fiscal policy, which of the
following is the likely effect on interest rates and unemployment
Interest rates Unemployment
(A) Increase Might either increase or decrease
(B) Increase Decrease
(C) Decrease Decrease
(D) Might either increase or decrease Decrease
(E) Might either increase or decrease Increase

67. In order to reduce or eliminate crowding out, expansionary fiscal policy can be accompanied by
(A) An increase in government spending
(B) A decrease in investment
(C) Expansionary monetary policy
(D) Contractionary monetary policy
(E) An increase in the interest rate

68. An increase in government spending will be most inflationary when it is financed by

(A) Selling bonds to households
(B) Selling bonds to nonbank business firms
(C) Selling bonds to commercial banks
(D) Selling bonds to the central bank
(E) Collecting higher taxes

69. Which of the following monetary and fiscal policy combinations would most likely result in a
decrease in aggregate demand?
Discount Rate Open-Market Operations Government Spending
(A) Lower Buy bonds Increase
(B) Lower Buy bonds Decrease
(C) Raise Sell bonds Increase
(D) Raise Buy bonds Increase
(E) Raise Sell bonds Decrease

70. If the Federal Reserve wishes to use monetary policy to reinforce government's fiscal policy it should
(A) Increase the money supply when government spending is increased
(B) Increase the money supply when government spending is decreased
(C) Decrease the money supply when government spending is increased
(D) Increase interest rates when government spending is increased
 (E) Decrease interest rates when government spending is decreased

71. A combination of expansionary fiscal policy and tight monetary policy

(A) Raises real output, lowers interest rate
(B) Raises interest rate, lowers real output
(C) Raises real output, can't predict effect on interest rate
(D) Raises interest rate, can't predict effect on real output
(E) Raises interest rate, has no effect on real output

72. An inflationary gap could be reduced by

(A) An increase in government spending
(B) An increase in the supply of money
(C) An increase in the income tax rate
(D) A decrease in the discount rate
(E) A decrease in the reserve requirement

73. Which statement is false?

(A) Increased government spending affects aggregate spending more quickly than does an increase in
the money supply.
(B) Increased government spending affects aggregate supply less quickly than does an increase in the
money supply.
(C) It takes Congress longer to authorize an increase in government spending that it takes for the
Federal Reserve to increase the money supply.
(D) Monetary policy can be changed quickly by the Federal Reserve.
(E) No true answer.

74. Which of the following statements about stabilization policy is true?

(A) In the short run, a decision by the Fed to increase the targeted money supply is essentially the same
as a decision to increase the targeted interest rate.
(B) Congress has veto power over the monetary policy decisions of the Fed.
(C) Long lags enhance the ability of policymakers to "fine tune" the economy.
(D) Many economists prefer automatic stabilizers because they affect the economy with a shorter lag
than activist stabilization policy.
(E) All of the above are true.

75. Suppose a wave of investor and consumer pessimism causes a reduction in spending. If the Federal
Reserve chooses to engage in activist stabilization policy, it should
(A) Increase government spending and decrease taxes
(B) Decrease government spending and increase taxes
(C) Increase the money supply and decrease interest rates
(D) Decrease the money supply and increase interest rates
(E) Increase the money supply and decrease taxes

76. According to Keynesians, when the economy is in a recession, which of the following is the
governmental policy most effective for stimulating production?
(A) Government spending increases.
(B) Government spending decreases.
(C) Personal income taxes are increased.
(D) The Federal Reserve sells bonds on the open market.
(E) The Federal Reserve buys bonds on the open market.

77. According to Monetarists, when the economy is in a recession, which of the following is the
governmental policy most effective for stimulating production?
(A) Government spending increases.
 (B) Government spending decreases.
(C) Personal income taxes are increased.
(D) The Federal Reserve sells bonds on the open market.
(E) The Federal Reserve buys bonds on the open market.

78. Which of the following type of policy is most likely to increase output in the long run?
(A) Supply side.
(B) Demand side.
(C) Neither.
(D) Both.
(E) Neither for closed economy, both for open economy.