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ECON 10020/20020
Principles of Macroeconomics
Problem Set 5
Dennis C. Plott∗
University of Notre Dame
Department of Economics
March 25, 2015
∗Email: [email protected]
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Name:
General Instructions
1. Due: Thursday 2nd April 2015 by 4:30 p.m.
2. Read and follow all instructions/directions carefully. An inability to follow instructions/directions willresult in points being deducted.
3. All problems sets submitted must be stapled, handwritten, and include the cover page.
4. Only problem sets submitted in person and/or in class will be accepted.
5. Answer all questions in blue or black ink only; i.e., no pencils or colored inks. The only exception: graphsmay be drawn in pencil. Note: use a guide of some sort (e.g., a ruler) for all graphs. Do not use white outor similar products, but neatly cross/scratch out any mistakes.
6. Write, mark, and draw your answers neatly and clearly. If your answer is illegible (i.e., difficult to read inthe least), then it will not be graded. It is your job to clearly communicate.
7. Label all graphs fully and completely; i.e., axes, intersections, curves, etc.
8. Support your answers as thoroughly as possible; i.e., graphically, conceptually, and mathematically. Note:this may not be feasible or necessary for all questions asked. State and define any concept utilized and listand name any equation used. In other words, show all of your work.
9. Do not copy from another student.
10. Note: only use materials from this class, listed textbooks, and suggested resources to answer questions.The Google can be quite useful and tempting, but very often a question has been constructed in a veryspecific manner; i.e., using a certain set of assumptions. Another source may have a very similar problem,but with slightly different underlying assumptions that change the answer completely. This is typicallynot obvious and will likely leave you very confused.
11. For the True/False/Uncertain questions clearly indicate your choice by writing either “True”, “False”, or“Uncertain” underneath the respective question. Unless explicitly instructed otherwise, a justification isrequired to receive credit.
12. For the multiple choice questions, choose the “best” answer and mark the letter in the spaces provided atthe bottom of the page. Only clearly written letters in the allocated space will be graded.
13. Assume the nominal wage is fixed in the short-run, all markets begin in long-run equilibrium, and capitalstock is fixed in both the short-run and long-run except for negative shocks. For changes in the variablesof interest, reference the initial level, unless instructed otherwise, in both the short-run and long-run.
14. Questions pertaining to the problem set will not be answered on the due date. Further, it is stronglyrecommended that any questions be asked in person.
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1. Your roommate argues that he can think of no better situation than living in a deflationary economy,as prices of goods and services would continuously fall. You disagree and argue that during a deflation,people can be made worse off because
(A) the purchasing power of people’s incomes would increase.
(B) the purchasing power of the currency would decrease.
(C) the value of the real interest rate will drop below the nominal interest rate.
(D) borrowers will have to pay increasing amounts in real terms over time.
2. Which of the following is one of the most important benefits of money in an economy?
(A) Money allows for the exchange of goods and services.
(B) Money allows for the accumulation of wealth.
(C) Money makes exchange easier, leading to more specialization and higher productivity.
(D) Money encourages people to produce all of their own goods (self-sufficiency) and therefore increaseseconomic stability.
3. Which of the following functions of money would be violated if inflation were high?
(A) unit of account
(B) store of value
(C) certificate of gold
(D) medium of exchange
4. Dollar bills in the modern economy serve as money because
(A) they are backed by the gold stored in Fort Knox.
(B) they can be redeemed for gold by the central bank.
(C) they have value as a commodity independent of their use as money.
(D) people have confidence that others will accept them as money.
5. When a grocery store accepts your $5 bill in exchange for bread and milk, the $5 bill serves as a
(A) medium of exchange.
(B) unit of account.
(C) store of value.
(D) standard of deferred payment.
1. 2. 3. 4. 5.
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6. If the Federal Reserve decided to include virtual money like Bitcoins in its measure of the money supply,what would be the effect on M1 or M2?
(A) M1 would rise.
(B) M1 would fall.
(C) M1 would rise and M2 would remain constant.
(D) M2 would rise but M1 would remain constant.
7. If a person withdraws $500 from his/her savings account and puts it in his/her checking account, then M1will and M2 will .
(A) increase; decrease
(B) increase; not change
(C) not change; increase
(D) not change; decrease
8. If credit card balances rise in the economy, then M1 will and M2 will .
(A) increase; increase
(B) not change; increase
(C) decrease; increase
(D) not change; not change
9. The largest liability on the balance sheet of most banks is its
(A) loans.
(B) holdings of securities.
(C) deposits with the Federal Reserve.
(D) checking account and savings account deposits of its customers.
10. A bank will consider a car loan to a customer and a customer’s checking account to be .
(A) a liability; an asset
(B) an asset; a liability
(C) a liability; a liability
(D) an asset; an asset
6. 7. 8. 9. 10.
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Imagine that Kristy deposits $10,000 of currency into her checking account deposit at Bank A and thatthe required reserve ratio is 20%.
11. Refer to the Scenario. As a result of Kristy’s deposit, Bank A’s reserves immediately increase by
(A) $2,000.
(B) $8,000.
(C) $10,000.
(D) $50,000.
12. Refer to the Scenario. As a result of Kristy’s deposit, Bank A’s required reserves increase by
(A) $2,000.
(B) $8,000.
(C) $10,000.
(D) $50,000.
13. Refer to the Scenario. As a result of Kristy’s deposit, Bank A’s excess reserves increase by
(A) $2,000.
(B) $8,000.
(C) $10,000.
(D) $50,000.
14. Refer to the Scenario. As a result of Kristy’s deposit, Bank A can make a maximum loan of
(A) $2,000.
(B) $8,000.
(C) $10,000.
(D) $50,000.
15. Refer to the Scenario. As a result of Kristy’s deposit, checking account deposits in the banking system asa whole (including the original deposit) could eventually increase up to a maximum of
(A) $2,000.
(B) $8,000.
(C) $10,000.
(D) $50,000.
11. 12. 13. 14. 15.
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16. The more excess reserves banks choose to keep,
(A) the larger the deposit multiplier.
(B) the smaller the deposit multiplier.
(C) the higher the required reserve ratio.
(D) the lower the required reserve ratio.
17. Which of the following best describes how banks create money?
(A) Banks charge higher interest rates on loans than they pay on deposits.
(B) Banks charge fees for providing financial advice.
(C) Banks create checking account deposits when making loans from excess reserves.
(D) Banks make loans from reserves.
18. A commercial bank like Comerica creates money by
(A) printing paper money.
(B) earning profits.
(C) selling corporate bonds.
(D) making loans.
19. Suppose there is a bank panic. Which of the following would not be a consequence of this bank panic?
(A) Bank total reserves would decrease.
(B) Required reserves would increase.
(C) Bank checking account balances would decrease.
(D) Individual banks would have to shrink the value of loans they made.
20. Banks keep of checking deposits as reserves because on a typical day withdrawals deposits.
(A) more than 100%; are much greater than
(B) exactly 100%; are about the same as
(C) less than 100%; are about the same as
(D) exactly 100%; are much greater than
16. 17. 18. 19. 20.
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21. In response to the destructive bank panics of the Great Depression, future bank panics are designed to beprevented by
(A) the Federal Reserve System acting as a lender of last resort.
(B) the Federal Reserve System conducting open market operations.
(C) the establishment of the Federal Deposit Insurance Corporation.
(D) establishing a fractional reserve system of banking.
22. The Federal Open Market Committee consists of the seven members of the , the president of theFederal Reserve Bank of New York, and .
(A) Federal Reserve’s Board of Governors; four members of the Council of Economic Advisors
(B) Federal Reserve’s Board of Governors; four presidents from the other 11 Federal Reserve banks
(C) Council of Economic Advisors; four presidents from the 11 Federal Reserve banks
(D) Council of Economic Advisors; four members of the U.S. Banking Committee
23. The purchase of Treasury securities by the Federal Reserve will, in general,
(A) not change the money supply.
(B) not change the quantity of reserves held by banks.
(C) increase the quantity of reserves held by banks.
(D) decrease the quantity of reserves held by banks.
24. To decrease the money supply, the Federal Reserve could
(A) lower the discount rate.
(B) raise income taxes.
(C) lower the required reserve ratio.
(D) conduct an open market sale of Treasury securities.
25. In 1913, Congress established the Federal Reserve system with the intention of putting an end to
(A) high interest rates.
(B) high unemployment rates.
(C) inflation.
(D) bank panics.
21. 22. 23. 24. 25.
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26. Which of the following tools of monetary policy is used least often?
(A) open market operations
(B) setting the required reserve ratio
(C) setting the discount rate
(D) acting as a lender of last resort
27. Using the quantity equation, if the velocity of money grows at 5 percent, the money supply grows at 10percent, and real GDP grows at 4 percent, then the inflation rate will be
(A) 19 percent.
(B) 15 percent.
(C) 11 percent.
(D) 6 percent.
28. If money demand is extremely sensitive to changes in the interest rate, the money demand curve becomesalmost horizontal. If the Fed expands the money supply under these circumstances, then the interest ratewill
(A) fall substantially and investment and consumer spending will fall substantially.
(B) rise substantially and investment and consumer spending will rise substantially.
(C) fall substantially and investment and consumer spending will change very little.
(D) change very little and investment and consumer spending will change very little.
29. According to the quantity theory of money, deflation will occur if the
(A) money supply is less than real GDP.
(B) money supply is more than real GDP.
(C) money supply grows at a slower rate than real GDP.
(D) money supply grows at a faster rate than real GDP.
30. During the turmoil in the market for subprime mortgages in 2007 and 2008, the Fed increased the volumeof discount loans. The goal of the Fed was to
(A) reduce the rate of inflation.
(B) stimulate economic growth.
(C) reduce unemployment.
(D) reassure financial markets and promote financial stability.
26. 27. 28. 29. 30.
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31. Monetary policy refers to the actions the Federal Reserve takes to manage
(A) the money supply and income tax rates to pursue its economic objectives.
(B) the money supply and interest rates to pursue its economic objectives.
(C) income tax rates and interest rates to pursue its economic objectives.
(D) government spending and income tax rates to pursue its economic objectives.
32. Which of the following are goals of monetary policy?
(A) maximizing the value of the dollar relative to other currencies, economic growth, and high employment
(B) price stability, maximizing the value of the dollar relative to other currencies, and high employment
(C) price stability, economic growth, and high employment
(D) price stability, economic growth, and maximizing the value of the dollar relative to other currencies
33. Rising prices erode the value of money as a and as a .
(A) unit of barter; unit of account
(B) store of value; unit of liquidity
(C) medium of exchange; store of value
(D) store of value; unit of barter
34. The money demand curve has a
(A) negative slope because an increase in the interest rate decreases the quantity of money demanded.
(B) positive slope because an increase in the interest rate increases the quantity of money demanded.
(C) negative slope because an increase in the price level decreases the quantity of money demanded.
(D) positive slope because an increase in the price level increases the quantity of money demanded.
35. An increase in the interest rate
(A) decreases the opportunity cost of holding money.
(B) increases the opportunity cost of holding money.
(C) decreases the percentage yield of holding money.
(D) increases the percentage yield of holding money.
31. 32. 33. 34. 35.
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36. Changes in the federal funds rate usually result in
(A) changes in both short-term and long-term interest rates with more of an effect on short-term interestrates.
(B) changes in both short-term and long-term interest rates with more of an effect on long-term interestrates.
(C) changes in both short-term and long-term interest rates with equal effect on both.
(D) no change in both short-term and long-term interest rates.
37. The federal funds rate
(A) is determined administratively by the Fed.
(B) is determined by the supply of and demand for bank reserves.
(C) is determined directly by household demand for funds.
(D) is determined directly by firm demand for funds.
38. The situation in which short-term interest rates are pushed to zero, leaving the central bank unable tolower them further is known as
(A) the Taylor rule.
(B) a liquidity trap.
(C) a zero-sum game.
(D) an interest rate panic.
39. In response to already low interest rates doing little to stimulate the economy, the Fed began buying10-year Treasury notes and certain mortgage-backed securities to keep interest rates low. This policy isknown as
(A) inflation targeting.
(B) contractionary monetary policy.
(C) securities-bubble deflating.
(D) quantitative easing.
40. Monetary policy could be procyclical if the Federal Reserve
(A) is late recognizing that a recession has begun and conducts expansionary monetary policy.
(B) is quick to recognize that a recession has begun and conducts expansionary monetary policy.
(C) is late recognizing that a recession has begun and does not conduct expansionary monetary policy.
(D) is quick to recognize that a recession has begun and does not conduct expansionary monetary policy.
36. 37. 38. 39. 40.
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41. The Wall Street Journal1 recently reported Japan is experiencing “. . . anemic household spending andbusiness investment . . . ”.
(a) Demonstrate the change in consumption and investment using the closed AD − SRAS − LRASgraph, ceteris paribus, in both the short-run and long-run. Clearly explain the economic rationale forwhy the curve(s) shift, if at all. State explicitly what occurs to the (i) price level, (ii) natural rate ofoutput, (iii) output, (iv) nominal wage, and (v) money supply; i.e., increase, decrease, unchanged, orambiguous.
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1The Wall Street Journal “Japan Growth Revised Down” 8 March 2015 by Mitsuru Obe
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(b) Assume the Bank of Japan (i.e., the Japanese central bank) wants to target output. Suggest amonetary policy (i.e., expansionary and/or contractionary) and demonstrate the change in monetarypolicy using the closed AD − SRAS − LRAS graph, ceteris paribus, after the initial short-run shock(i.e., short-run from part (a) above), but before the nominal wages and prices are fully flexible. Clearlyexplain the economic rationale for why the curve(s) shift, if at all. State explicitly what occurs to the(i) price level, (ii) natural rate of output, (iii) output, (iv) nominal wage, and (v) money supply; i.e.,increase, decrease, unchanged, or ambiguous.
How does the monetary policy situation differ, comparing the variables of interest, from the self-correcting version [part (a)]?
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