Macroeconomics, 7e (Blanchard)

Chapter 23: Monetary Policy: A Summing Up

23.1 What We Have Learned

1) Monetary policy affects which of the following variables in the long run?
A) the level of output
B) the rate of unemployment
C) the rate of inflation
D) the real interest rate
E) all of the above
Answer: C
Diff: 1

2) Which of the following is a function of money?

A) medium of exchange
B) provides protection from inflation
C) it is a flow variable
D) all of the above
E) none of the above
Answer: A
Diff: 1

23.2 From Money Targeting to Inflation Targeting

1) Suppose the annual inflation rate is 10%, and an asset bought at the beginning of the year for
$100,000 is sold for $115,000. If the capital-gains tax rate is 30%, what is the (approximate)
effective tax rate on the sale of this asset?
A) 10%
B) 20%
C) 25%
D) 30%
E) 4%
Answer: E
Diff: 1

2) Which of the following would serve to reduce the costs caused by the variability of inflation?
A) seignorage
B) bracket creep
C) a higher capital gains tax
D) indexed wages
E) none of the above
Answer: D
Diff: 1

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3) The nominal interest
A) will never be negative.
B) can be negative if inflation is unexpected.
C) can be negative if the inflation rate is greater than the nominal interest rate.
D) can be negative if deflation occurs.
E) can be negative when the real interest rate is negative.
Answer: A
Diff: 1

4) Which of the following is part of "M2" but not "M1"?

A) money market mutual fund shares
B) saving deposits
C) time deposits (under $100,000)
D) all of the above
E) none of the above
Answer: D
Diff: 1

5) M1 consists of
A) currency only.
B) currency plus travelers checks only.
C) currency plus checkable deposits only.
D) checkable deposits only.
E) none of the above
Answer: E
Diff: 1

6) Which of the following is part of M1 and part of M2?

A) currency
B) travelers checks
C) checkable deposits
D) all of the above
E) none of the above
Answer: D
Diff: 1

7) An asset is considered liquid if it

A) can be used as a store of value.
B) has a guaranteed rate of return.
C) is indexed to the rate of inflation.
D) acts as a medium of exchange.
E) none of the above
Answer: E
Diff: 1

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8) M2 is also referred to as which of the following?
A) currency
B) narrow money
C) near money
D) high powered money
E) none of the above
Answer: E
Diff: 1

9) Since the 1980s, "NOW" accounts have been included in

A) M1, but not M2.
B) M2, but not M1.
C) both M1 and M2.
D) the monetary base and M1, but not M2.
E) neither M1 nor M2.
Answer: C
Diff: 1

10) Suppose individuals decide to reduce their holdings of money market funds. Further assume
that these decisions put funds into checkable deposits. Given this information, we know that
A) the demand for M1 would increase and the demand for M2 would decrease.
B) the demand for M1 would decrease and the demand for M2 would decrease.
C) the demand for M1 would increase and the demand for M2 would increase.
D) the demand for M1 would decrease and the demand for M2 would increase.
E) none of the above
Answer: A
Diff: 1

11) The maximum number of individuals a U.S. president can appoint to the Board of governors
is
A) 15.
B) 12.
C) 7.
D) 4 .
E) none of the above
Answer: C
Diff: 1

12) There are how many members of the Board of Governors in the Federal Reserve system?
A) 15
B) 12
C) 7
D) 4
E) none of the above
Answer: C
Diff: 1

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13) There are how many members of the Federal Open Market Committee?
A) 15
B) 14
C) 12
D) 7
E) 5
Answer: C
Diff: 1

14) The Humphrey-Hawkins Act requires the Fed to promote

A) stable prices.
B) maximum employment.
C) moderate long-term interest rates.
D) all of the above
E) none of the above
Answer: D
Diff: 1

15) Each governor of the Federal Reserve is

A) appointed by the President to a 4-year term.
B) appointed by the President to a 14-year term.
C) appointed by the President for life.
D) elected by the Presidents of banks and savings institutions.
Answer: B
Diff: 1

16) In the United States, day-to-day decisions about monetary policy are carried out by
A) the Board of Governors.
B) the Chairman of the Board of Governors.
C) the Federal Open Market Committee.
D) the Open Market desk in New York.
E) none of the above
Answer: D
Diff: 1

17) When the Fed wants to signal the public about the direction of monetary policy, it will likely
use
A) a change in the discount rate.
B) open market operations.
C) a change in the reserve requirement.
D) a public announcement about a change in the targeted federal funds rate.
E) all of the above
Answer: D
Diff: 1

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18) Chairmen of the Federal Reserve Board
A) serve 14-year terms as chairmen.
B) serve 4-year renewable terms as chairmen.
C) also serve as members of the administration.
D) serve 4-year non-renewable terms as chairmen.
E) none of the above
Answer: B
Diff: 1

19) A change in the reserve requirement changes

A) the monetary base.
B) the money multiplier.
C) the discount rate.
D) all of the above
E) none of the above
Answer: B
Diff: 2

20) Which of the following statements about Fed management of the money supply is correct?
A) Over the past thirty years, the Fed has always stayed within its pre-announced target rates for
growth in M2.
B) The most common tool used by the Fed is a change in the required ratio of reserves to
deposits.
C) The rate at which the Fed lends money to banks is called the "Federal Funds rate."
D) The Fed must report each week to Congress on the conduct of monetary policy.
E) none of the above
Answer: E
Diff: 1

21) Which of the following would cause a reduction in M1?

A) an increase in the required ratio of reserves to deposits
B) a reduction in the discount rate
C) an open market operation where the Fed sells bonds
D) all of the above
E) none of the above
Answer: C
Diff: 1

22) Monetary policy has short-run effects on which of the following?

A) the level of output but not its composition
B) both the level and composition of output
C) only the price level
D) only the nominal interest rate, not the real interest rate
E) none of the above
Answer: B
Diff: 1

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23) Monetary policy has medium-run effects on which of the following?
A) the level of output but not its composition
B) both the level and composition of output
C) the nominal interest rate
D) the real interest rate
E) none of the above
Answer: C
Diff: 1

24) Monetary policy has medium-run effects on which of the following?

A) the level of output but not its composition
B) both the level and composition of output
C) only the price level
D) the level of output AND the price level
E) none of the above
Answer: C
Diff: 1

25) In the medium run, an increase in the rate of growth of nominal money will cause
A) lower nominal and lower real interest rates.
B) lower nominal interest rates and no change in the real interest rate.
C) an increase in inflation and an increase in output growth.
D) a proportionate increase in inflation.
Answer: D
Diff: 1

26) In the medium run, an increase in inflation causes

A) an increase in the opportunity cost of holding money.
B) a reduction in the opportunity cost of holding money.
C) no change in the opportunity cost of holding money.
D) individuals to switch from holding bonds to money and increase their real money balances.
Answer: A
Diff: 1

27) Bracket creep would less likely occur in which of the following?
A) a progressive income tax system
B) a regressive income tax system
C) a flat income tax system
D) none of the above
Answer: B
Diff: 1

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28) Broad money is represented by
A) H.
B) M1.
C) M2.
D) higher powered money.
E) the monetary base.
Answer: C
Diff: 1

29) Which of the following has the tightest relation with inflation?
A) H, the monetary base
B) M1
C) M2
D) M3
Answer: C
Diff: 1

30) The Taylor rule (where a and b are positive parameters) is represented by
A) i = i* + a(π* - π) - b(un - u).
B) i = i* + a(π - π *) + b(u - un).
C) i = i* + a(π* - π) - b(u - un).
D) none of the above
Answer: D
Diff: 1

31) Which of the following is not a tool of the Fed?

A) the discount rate
B) reserve requirements
C) open market operations
D) the proportion of money held as currency
Answer: D
Diff: 1

32) The discount rate represents the interest rate on

A) overnight loans between banks.
B) three-month U.S. securities.
C) municipal bonds.
D) one-year discount bonds.
E) none of the above
Answer: D
Diff: 1

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33) For this question, assume that the Fed sets monetary policy according to the Taylor rule.
Suppose current U.S. macroeconomic conditions are represented by the following: π > π?* and u
= un. Given this information, we would expect that the Fed will
A) implement a monetary contraction.
B) implement a monetary expansion.
C) maintain its current stance of monetary policy.
D) more information is need to answer this question.
Answer: A
Diff: 1

34) For this question, assume that the Fed sets monetary policy according to the Taylor rule.
Suppose current U.S. macroeconomic conditions are represented by the following: π < π?* and u
= un. Given this information, we would expect that the Fed will
A) implement a monetary contraction.
B) implement a monetary expansion.
C) maintain its current stance of monetary policy.
D) more information is need to answer this question.
Answer: B
Diff: 1

35) For this question, assume that the Fed sets monetary policy according to the Taylor rule.
Suppose current U.S. macroeconomic conditions are represented by the following: π = π?* and u
> un. Given this information, we would expect that the Fed will
A) implement a monetary contraction.
B) implement a monetary expansion.
C) maintain its current stance of monetary policy.
D) more information is need to answer this question.
Answer: B
Diff: 1

36) For this question, assume that the Fed sets monetary policy according to the Taylor rule.
Suppose current U.S. macroeconomic conditions are represented by the following: π = π?* and u
< un. Given this information, we would expect that the Fed will
A) implement a monetary contraction.
B) implement a monetary expansion.
C) maintain its current stance of monetary policy.
D) more information is need to answer this question.
Answer: A
Diff: 1

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37) For this question, assume that the Fed sets monetary policy according to the Taylor rule.
Suppose current U.S. macroeconomic conditions are represented by the following: π > π?* and u
< un. Given this information, we would expect that the Fed will
A) implement a monetary contraction.
B) implement a monetary expansion.
C) maintain its current stance of monetary policy.
D) more information is need to answer this question.
Answer: A
Diff: 1

38) For this question, assume that the Fed sets monetary policy according to the Taylor rule.
Suppose current U.S. macroeconomic conditions are represented by the following: π < π?* and u
> un. Given this information, we would expect that the Fed will
A) implement a monetary contraction.
B) implement a monetary expansion.
C) maintain its current stance of monetary policy.
D) more information is need to answer this question.
Answer: B
Diff: 1

39) Which of the following would cause an increase in M1?

A) a reduction in the required ratio of reserves to deposits
B) an increase in the discount rate
C) an open market operation where the Fed buys bonds
D) all of the above
E) none of the above
Answer: C
Diff: 1

40) Explain the macroeconomic effects of changes in monetary policy in: (1) the short run; and
(2) the medium run.
Answer: The answers can vary (not to mention be very long!). In the short run, we learned that
changes in the money supply can affect financial market variables and economic activity (in
addition to the composition of GDP). Monetary policy can also be used to affect the price
level/inflation rate in the short run. In the medium run, monetary policy only affects nominal
variables and, therefore, is said to be neutral.
Diff: 2

41) First, write out the equation that represents the Taylor rule. Second, discuss how the Taylor
rule is used to explain the implementation of monetary policy.
Answer: The Taylor rule is represented as the following: i = i* + a(π - π*) - b(u - un). i* is the
target interest rate and π* is the desired inflation rate. Two quick cases can be examined. If
actual inflation is greater than π*, the central bank should raise the interest rate above the target
rate. This will reduce economic activity and reduce the actual inflation rate over time. If the
unemployment rate is above the natural rate, the central bank should set the interest rate below
the target rate in order to stimulate economic activity.
Diff: 2
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42) Briefly discuss the organization of the Federal Reserve. Include in your answer a discussion
of the individuals/groups who make decisions about monetary policy.
Answer: In terms of the structure of the Fed, answers should mention the 12 district banks (and
their presidents), the Board of Governors, the FOMC, and, possibly, the open market desk in
New York. In terms of the individuals, answers should include a discussion of the 7 governors
(with 14-year terms) and the chair with a renewable 4-year term. The role that district presidents
play on the FOMC should also be noted.
Diff: 2

43) Discuss and explain each of the instruments of monetary policy.

Answer: The instruments are: the discount rate, open market operations, and reserve
requirements.
Diff: 2

44) Discuss the relationships among the various monetary aggregates.

Answer: Answers will include a discussion of the monetary base (H), M1, M2, and M3.
Diff: 2

45) Discuss the current debate on the optimal inflation target.

Answer: At this stage, most central banks in richer countries have an inflation target of about
2%. They are being challenged on two fronts. Some economists want to achieve price stability
— that is, 0% inflation. Others want, instead, a higher target rate of inflation, say 4%, to help
prevent from falling in the liquidity trap in the future.
Diff: 2

23.3 The Optimal Inflation Rate

1) Which of the following is considered a benefit of inflation?

A) the option of a negative real interest rate
B) money illusion
C) seignorage
D) all of the above
E) none of the above
Answer: D
Diff: 1

2) Which of the following is an example of the "shoe-leather costs" of inflation?

A) a rise in the cost of primary raw materials, like leather for shoes
B) an artificial rise in the capital gains tax
C) the need to take more trips to the bank
D) miscalculations due to money illusion
E) All of the above
Answer: C
Diff: 1

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3) The existence of inflation does which of the following?
A) reduces tax distortions
B) allows governments to benefit from seignorage
C) reduces shoe-leather costs
D) reduces the costs associated with money illusion
Answer: B
Diff: 1

4) The existence of inflation does which of the following?

A) reduces tax distortions
B) reduces shoe-leather costs
C) allows for the possibility of negative real interest rates
D) reduces the costs associated with money illusion
Answer: C
Diff: 1

5) The existence of inflation does which of the following?

A) facilitates the downward adjustment of real wages
B) reduces shoe-leather costs
C) reduces tax distortions
D) reduces the costs associated with money illusion
Answer: A
Diff: 1

6) In 2014, the average inflation rate in the OECD countries was

A) 1.7%.
B) 2.3%.
C) 5.2%.
D) 3.8%.
E) 10.5%.
Answer: A
Diff: 1

7) Explain the costs imposed by an increase in inflation.

Answer: The answers to this question should include a discussion of: shoe-leather costs, tax
distortions, money illusion, and inflation variability.
Diff: 1

8) Suppose an economy experiences an increase in inflation. Explain the possible

macroeconomic benefits of this increase in inflation.
Answer: Answers should include discussions of: seignorage, the option of a negative real
interest rate, and money illusion.
Diff: 1

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9) Explain what role money illusion plays in determining the Fed's ability to affect output in the
short run.
Answer: Money illusion refers to a situation where individuals make mistakes about the
distinction between nominal and real magnitudes. For example, individuals might be reluctant to
accept a reduction in the nominal wage (that would cause a reduction in the real wage) while at
the same time would "accept" a reduction in the real wage when inflation exists and the nominal
wage does not change. Money illusion, therefore, might allow a central bank to inflate an
economy and, therefore, cause output to rise temporarily.
Diff: 1

10) Explain what is meant by shoe-leather costs.

Answer: In the medium run, an increase in inflation will cause an increase in nominal interest
rates. When the nominal interest rate rises, the opportunity cost of holding money increases
causing individuals to reduce their money balances. Individuals, therefore, make more trips to
the bank. The costs associated with this are called shoe-leather costs.
Diff: 2

11) What are the factors that will determine the optimal inflation rate?
Answer: In short, the factors that will determine the optimal inflation rate are the relative
magnitudes of the costs and benefits of inflation. Therefore, on the cost side, individuals would
consider: shoe-leather costs, tax distortions, money illusion, and inflation variability. On the
benefit side, one would consider: seignorage, the option of a negative real interest rate, and
money illusion. So, an individual would compare the costs and benefits of inflation and choose
some optimal inflation rate.
Diff: 2

23.4 Unconventional Monetary Policy

1) Which of the following is not correct about quantitative easing?

A) It is one of the conventional monetary policy tools.
B) It refers to the Fed's asset purchasing program.
C) It helped reduce term premium on long-term government bonds.
D) As a result, the balance sheet of the Fed is much larger than it was before the crisis.
Answer: A
Diff: 1

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23.5 Monetary Policy and Financial Stability

1) In the medium run, a reduction in inflation causes

A) a reduction in the opportunity cost of holding money.
B) an increase in the opportunity cost of holding money.
C) no change in the opportunity cost of holding money.
D) individuals to switch from holding money to bonds and reduce their real money balances.
Answer: A
Diff: 1

2) Bracket creep would be more likely occur in which of the following?

A) a progressive income tax system
B) a regressive income tax system
C) a flat income tax system
D) none of the above
Answer: A
Diff: 1

3) LTV ratio appears to be positively related to

A) bond price.
B) stock price.
C) housing price.
D) none of the above
E) all of the above
Answer: C
Diff: 1

4) An economy is said to be in the liquidity trap when the short-term ________ is down to zero.
A) real interest rate on corporate bonds
B) nominal interest rate on government bonds
C) nominal interest rate on corporate bonds
D) real interest rate on government bonds
Answer: B
Diff: 1

5) To deal with dangerous behavior in the financial system, macro prudential tools can be used to
aim directly at
A) borrowers.
B) lenders.
C) banks and other financial institutions.
D) none of the above
E) all of the above
Answer: E
Diff: 1

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6) Reducing the maximum LTV is likely to ________ demand and thus ________ the housing
price increase.
A) decrease; slow down
B) increase; slow down
C) decrease; speed up
D) increase; speed up
Answer: A
Diff: 1

7) From 2000 to 2007, which country had the highest nominal house price increase?
A) Spain
B) Portugal
C) Greece
D) Italy
Answer: A
Diff: 1

8) From 2000 to 2007, which country had the maximum LTV allowed?
A) United Kingdom
B) Australia
C) Netherlands
D) Canada
E) United States
Answer: C
Diff: 1

9) What are the lessons from the crisis for monetary policy?
Answer: Liquidity trap has led a number of countries to explore unconventional monetary policy
tools, such as QE. The crisis has shown that stable inflation is not a sufficient condition for
macroeconomic stability. This is leading central banks to explore the use of macro prudential
tools.
Diff: 1

10) What are some of the questions about the macro prudential tools?
Answer: 1) In many cases we do not know how well these tools work; 2) there are likely to be
complex interaction between the traditional monetary policy tools and these macro prudential
tools. 3) Whether macro prudential tools should be under the control of the central bank or under
the control of a separate authority.
Diff: 2

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11) Until the 1990s, how was monetary policy typically conducted in advanced countries?
Answer: 1) The central bank chose a target rate for nominal money growth corresponding to the
inflation rate it wanted to achieve in the medium run. 2) In the short run, the central bank
allowed for deviations of nominal money growth from the target. 3) To communicate to the
public both what it wanted to achieve in the medium run and what it intended to do in the short
run, the central bank announced a range for the rate of nominal money growth it intended to
achieve.
Diff: 2

12) Discuss the change of the design of monetary policy over time.
Answer: Traditionally, the design of monetary policy was focused on nominal money growth.
But, because of the poor relation between inflation and nominal money growth, this approach
was abandoned by most central banks. Central banks now typically focus on an inflation rate
target rather than a nominal money growth rate target. And they think about monetary policy in
terms of determining the nominal interest rate rather than determining the rate of nominal money
growth. The Taylor rule gives a useful way of thinking about the choice of the nominal interest
rate. The rule states that the central bank should move its interest rate in response to two main
factors: the deviation of the inflation rate from the target rate of inflation, and the deviation of the
unemployment rate from the natural rate of unemployment. A central bank that follows this rule
will stabilize activity and achieve its target inflation rate in the medium run.
Diff: 2

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