Economic Policy Analysis
Textbook Exam Questions
Course Introduction
Economic Policy Analysis explores the principles, methods, and tools used to evaluate and design public policies affecting economic outcomes. The course examines the roles of government intervention, market failures, and policy instruments, equipping students with analytical frameworks to assess the efficiency, equity, and effectiveness of various economic policies. Topics include cost-benefit analysis, taxation, regulation, welfare programs, and monetary and fiscal policy, all grounded in contemporary case studies and real-world applications. Students develop the ability to critically analyze policy proposals and understand their broader social and economic impacts.
Recommended Textbook Money Banking and Financial Markets 4th Edition by Stephen G. Cecchetti
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Chapter 1: An Introduction to Money and the Financial System
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Q1) Investing in financial instruments in today's economy:
A)is an activity practiced only by the wealthy.
B)involves costly transactions.
C)requires a relatively large sum of money to invest (more than $100,000).
D)is made easier by the use of mutual funds.
Answer: D
Q2) Stock prices are:
A)set by the company issuing the stock.
B)set by the central bank.
C)determined by market transactions.
D)unrelated to the value of the company issuing the stock.
Answer: C
Q3) The central bank of the United States is:
A)the Bank of America
B)the Federal Reserve System
C)the U.S.Treasury
D)Citibank
Answer: B
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Chapter 2: Money and the Payments System
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Q1) Compare two economies: a barter economy versus an economy that uses money.In order to exchange goods and services:
A)a double coincidence of wants is necessary in the barter economy.
B)a double coincidence of wants is more likely to occur in the barter economy.
C)transactions are likely to be smoother in the barter economy because goods and services are exchanged directly.
D)the money economy requires that sellers have more information about buyers' wants.
Answer: A
Q2) Have the growth rates of the two measures of money moved together over time? Explain.
Answer: From 1960 to 1980 the growth rates of the two money measures did move together.After 1980 M1 behaved very differently than M2.The main reason for this seems to be the high rates of inflation that began in the late 1970s and fostered innovation into other types of accounts that people could hold to earn a higher return and yet were relatively liquid, such as money market accounts.
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Chapter 3: Financial Instruments, Financial Markets, and Financial Institutions
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Q1) Financial institutions:
A)raise the level of transaction costs relating to borrowing/lending.
B)can lower the information asymmetry involved with borrowing/lending.
C)decrease the liquidity to savers.
D)are required for all financial transactions.
Answer: B
Q2) A financial instrument would include:
A)only a written obligation and a transfer of value.
B)only a written obligation and a specified date.
C)a written obligation, a transfer of value, a future date, and certain conditions.
D)a written obligation, a transfer of value, a specific date for payment, uncertain conditions.
Answer: C
Q3) Well-run financial markets:
A)keep transactions costs high to benefit brokers
B)prevent the widespread pooling of information
C)ensure that resources are allocated efficiently
D)are usually the result of little or no government regulation
Answer: C
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Chapter 4: Future Value, Present Value, and Interest Rates
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Q1) Which of the following best expresses the payment a lender receives for lending money for three years?
A)3PV
B)PV(1 + i)3
C)PV/(1 + i)3
D)FV/(1 + i)3
Q2) The future value of $200 that is left in account earning 6.5% interest for three years is best expressed by which of the following?
A)$200(1.065) × 3
B)$200(1.065)/3
C)$200(1.065)n
D)$200(1.065)3
Q3) Interest rates that are adjusted for expected inflation are known as:
A)coupon rates.
B)ex ante real interest rates.
C)ex post real interest rates.
D)nominal interest rates.
Q4) Explain why, if real interest rates are so important, we see most interest rates quoted in nominal terms.
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Chapter 5: Understanding Risk
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Q1) Consider an individual who plans to buy a new home.He has two options: (i) pay for mortgage insurance (that insures the lender in case the borrower defaults), or (ii) pay the lender a higher interest rate for the mortgage.Describe how these two options are related to the concept of risk premium and the lender's aversion to risk.Why does the interest rate on the mortgage differ in these two options?
Q2) When the home construction industry does poorly due to a recession, this is an example of:
A)systematic risk.
B)idiosyncratic risk.
C)risk premium.
D)unique risk.
Q3) Another name for the expected value of an investment would be the:
A)mean value.
B)upper-end value.
C)certain value.
D)risk-free value.
Q4) What would be the impact of leverage on the expected return and standard deviation of purchasing an asset with 10% of the owner's funds and 90% borrowed funds?
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Chapter 6: Bonds, Bond Prices, and the Determination of Interest Rates
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Q1) If you were going to issue bonds, would you prefer to be in a country where the average inflation rate is 3% inflation but fluctuates wildly, or in a country with a higher, 4% expected inflation rate that is stable (meaning it's always 4%).Explain.
Q2) If interest rates are expected to rise, the bond prices will:
A)not change until interest rates actually change.
B)fall, due to the demand for bonds decreasing.
C)rise, as people seek capital gains.
D)move in the same direction as the expected change in interest rates.
Q3) In considering the holding period return, the longer the term of the bond the:
A)less important is the capital gain and the more important in the current yield.
B)less important is the coupon rate and the more important is the current yield.
C)less important is the capital gain.
D)more important is the capital gain.
Q4) Interest-rate risk results from:
A)bond prices being fixed over the life of the bond.
B)a mismatch between an individual's investment horizon and a bond's maturity.
C)the fact that most people hold bonds until they mature.
D)inflation being uncertain.
Page 8
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Chapter 7: The Risk and Term Structure of Interest Rates
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Q1) The Expectations Hypothesis assumes:
A)a high level of uncertainty regarding the future of long-term yields.
B)investors know the yields on bonds today and form expectations of the yields on short-term bonds in future time periods.
C)securities of different maturities are not perfect substitutes for each other.
D)the risk premium increases with longer maturities.
Q2) The reason for the increase in inflation risk over time is due to the fact that:
A)the inflation rate always increases over time.
B)we always have inflation.
C)it is more difficult to forecast inflation over longer periods of time.
D)investors are more focused on nominal returns than real returns.
Q3) The yield curve for U.S.Treasury securities allows us to draw the following conclusions, except that:
A)long-term yields tend to higher than short term yields.
B)interest rates of different maturities tend to move.
C)long-term rates tend to equal short-term rates.
D)yields on short-term securities are more volatile than yields on long-term bonds.
Q4) Why do economists pay particular attention to inverted yield curves?
Q5) Explain why an inverted yield curve is a valuable forecasting tool.
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Chapter 8: Stocks, Stock Markets, and Market Efficiency
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Q1) The investment you made in a mutual fund one year ago lost 50% of its value over the past year.What percentage increase is needed in the fund to restore your portfolio to the level it was one year ago?
Q2) Compare/contrast the Nasdaq Composite Index with the Dow Jones Industrial Average.
Q3) What price would an individual be willing to pay today for a stock he/she expects can be sold for $200 one year from now, if the individual has a discount rate of 6% (.06) and the stock pays an annual dividend of $7.50?
Q4) Which of the following statements is most correct?
A)Managers, directors, and stockholders almost always share the same interest.
B)Managers' and directors' interests often conflict with stockholders' interest.
C)Managers and stockholders have the same interests, but this usually conflicts with the interests of directors.
D)Directors and stockholders have the same interests, but this usually conflicts with the interests of managers.
Q5) Does the concept of limited liability make owning stocks more or less attractive? Explain.
Q6) Explain why being a residual claimant can increase the risk from owning stocks.
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Chapter 9: Derivatives: Futures, Options, and Swaps
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Q1) If we have a stock selling for $95.00 and a call option for this stock has a strike price of $82.00 and an option price of $13.60:
A)the intrinsic value of the option is $0.60 and the time value of the option is $13.00.
B)the intrinsic value is $82.00 and the time value of the option is $13.60.
C)the intrinsic value of the option is $13.00 and the time value of the option is $0.60.
D)the intrinsic value is $0 since the option is out of the money.
Q2) Standardization of derivative contracts:
A)results in increased risk for the parties involved.
B)makes them more difficult to understand and therefore leads to increased misuse.
C)makes the premiums involved with these contracts increase.
D)leads to greater liquidity and lower risk.
Q3) Identify four factors that will cause the value of put options to decrease.
Q4) With a futures contract:
A)payment is made when the contract is created.
B)no payment is made until the settlement date.
C)the short position agrees to purchase the underlying asset.
D)the risk is eliminated for both parties.
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Chapter 10: Foreign Exchange
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Q1) A country's capital account:
A)is synonymous with the current account.
B)will be in a deficit position when the current account is in a deficit.
C)will be in a surplus position if the current account is in a deficit position.
D)reflects the sum of exports minus imports.
Q2) If a Japanese Toyota sells for 2,500,000 yen and the nominal exchange rate is 110 yen/$U.S., then the dollar price of the Japanese automobile is:
A)22,727 yen.
B)$20,000.
C)$25,000.
D)$22,727.
Q3) In the spring of 2002, the Japanese Ministry of Finance intervened in the foreign exchange market by selling yen and purchasing dollars.Why? And why did the intervention fail?
Q4) In theory, the law of one price makes a lot of sense.So why do we see it fail so often?
Q5) Explain why a real exchange rate that does not equal one implies purchasing power parity does not hold.
Q6) Explain why the law of one price may best be applied to financial assets.
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Chapter 11: The Economics of Financial Intermediation
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Q1) Providing stock options to corporate managers was an idea designed to:
A)hide increases in pay of corporate executives from stockholders.
B)align managers' interest with the stockholders' interest.
C)treat adverse selection.
D)treat the free-rider problem.
Q2) Emerging market economies, compared to industrialized economies, have financial markets that:
A)differ in composition and size.
B)differ in composition but not in size.
C)are the same in composition but differ in size.
D)are similar in composition and size.
Q3) Examples of economies of scale are:
A)the additional fees financial intermediaries charge on small accounts.
B)the decrease in overall transaction costs that occur as volume increases.
C)the reduction in the cost per transaction that occurs as the number of transactions increase.
D)the decrease in overall information costs that occurs as more transactions are handled.
Q4) Explain how the threat of a leveraged buyout or a takeover can actually address the problem of moral hazard.
Page 13
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Chapter 12: Depository Institutions: Banks and Bank Management
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Q1) Suppose a particular depository institution that specializes in residential mortgages is owned by its depositors.The institution is probably a:
A)regional or super-regional bank.
B)money center bank.
C)community bank.
D)savings bank.
Q2) Which of the following is a bank asset?
A)Demand deposits
B)Borrowings from other banks
C)Mortgage loans
D)CDs
Q3) Secondary reserves for banks are:
A)the same as the bank's net worth.
B)mainly the bank's liquid securities.
C)vault cash.
D)deposits the bank has at the Federal Reserve.
Q4) Identify the four broad categories that make up the asset side of the balance sheet for banks and which category is usually the largest.
Q5) Why are U.S.banks prohibited from owning stocks?
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Chapter 13: Financial Industry Structure
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Q1) Whole life insurance differs from term life in which of the following ways?
A)Whole life has a rising premium as the policyholder ages, but term life has a fixed premium.
B)Term life has a savings component while whole life is pure insurance.
C)Term life is usually more expensive than whole life.
D)Whole life is a combination of term life insurance and a savings account.
Q2) Which of the following is an accurate statement about universal banks?
A)In Germany universal banks do everything under one roof, including direct investment in the shares of nonfinancial firms.
B)In Germany the provision of insurance, banking, and securities must be done by separate corporations.
C)As in Germany, universal banks in the United States do everything under one roof, including direct investment in the shares of nonfinancial firms.
D)Universal banks in the United States account for the largest share of financial intermediary assets.
Q3) In what way(s) can a pension plan be seen as the opposite of life insurance?
Q4) What does it mean to say the United States has a dual banking system?
Q5) Why do insurance companies often find it necessary to purchase re-insurance?
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Chapter 14: Regulating the Financial System
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Q1) Explain why depository institutions receive a disproportionate amount of attention from government regulators (compared to most other industries).
Q2) A bank supervisor examines the bank's portfolio of loans to see if the loans are being repaid in a timely manner.In terms of the acronym CAMELS, this would be part of rating the bank's:
A)asset quality.
B)losses.
C)management.
D)earnings.
Q3) Considering the methods available to the FDIC for dealing with a failed bank, the depositors of the failed bank should:
A)be indifferent between the two since it really does not matter to them which method is used.
B)prefer the purchase and assumption method since the deposits over $250,000 will also be protected.
C)prefer the payoff method because they will have access to their funds earlier.
D)prefer the payoff method since a lot less paperwork is involved for the depositor.
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Chapter 15: Central Banks in the World Today
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Q1) Many governments give their central bank control over issuing currency because:
A)printing currency can be profitable for a government so government officials may have a strong incentive to print too much.
B)having large amounts of currency can lead to lower rates of inflation.
C)central banks use the profits from issuing currency to finance their operations.
D)the only way to distribute currency to banks is through the central bank.
Q2) The main problem from inflation as seen by most economists is:
A)inflation raises prices more than wages.
B)inflation harms lenders more than it benefits borrowers.
C)during periods of inflation some prices fall.
D)inflation creates risk.
Q3) One thing that is true about economic policy in the U.S.is:
A)fiscal and monetary policy never conflict.
B)monetary and fiscal policy need not, but may conflict.
C)monetary policy ultimately controls fiscal policy since the Fed controls the money supply.
D)fiscal policy ultimately controls monetary policy since Congress can control the Fed's budget.
Q4) What are the operational components of central bank independence?
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Chapter 16: The Structure of Central Banks: The Federal
Reserve and the European Central Bank
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Q1) France, Germany, and Italy are:
A)all members of the European Union and the Euro system.
B)all members of the Euro system but not the European Union.
C)all members of the European Union but not the Euro system.
D)not members of either the Euro system or the European Union; they have their own economic union.
Q2) Explain why the decision to join the Euro system presents serious domestic monetary policy issues.
Q3) Great Britain is:
A)a member of the European Union but not a member of the Euro system.
B)a member of the Euro system but not a member of the European Union.
C)not a member of the Euro system or the European Union.
D)a member of both the European Union and the Euro system.
Q4) The Federal Reserve District that covers the largest geographic area is serviced by the Bank located in:
A)Chicago.
B)Richmond.
C)Atlanta.
D)San Francisco.
Page 18
Q5) Why are so few state chartered banks members of the Federal Reserve System?
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Chapter 17: The Central Bank Balance Sheet and the Money
Supply Process
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Q1) 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.
Q2) Why do most central banks publish their balance sheets so frequently?
Q3) In the U.S., loans made by Federal Reserve to banks fall in the categories of:
A)discount loans.
B)reserves.
C)discount loans and reserves.
D)discount loans and foreign exchange reserves.
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Chapter 18: Monetary Policy: Stabilizing the Domestic Economy
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Q1) The daily reserve supply curve is:
A)upward sloping.
B)downward sloping.
C)vertical until the federal funds rate equals the discount rate; at that point it becomes horizontal.
D)horizontal until the federal funds rate equals the discount rate; at that point it becomes vertical.
Q2) The main purpose of reserve requirements today is to:
A)decrease the demand for reserves.
B)make sure depositors can withdraw currency on demand.
C)enable the FOMC to keep the market federal funds rate closer to the target reserve rate.
D)keep banks sound.
Q3) Every one percent increase in the rate of inflation will:
A)increase the real federal funds rate by 1.5%.
B)increase the target federal funds rate by 1.5%.
C)increase the real federal funds rate by 0.5%.
D)increase the target federal funds rate by 1.5% and increase the real federal funds rate by 0.5%.
Q4) Explain the three desirable features of a good monetary policy instrument.
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Chapter 19: Exchange-Rate Policy and the Central Bank
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Q1) Purchasing power parity implies:
A)a basket of goods should sell for the same price in all countries, even if trade barriers exist.
B)a basket of goods will sell for the same price in all countries as long as there are no trade barriers is a free flow of capital across borders.
C)a basket of goods cannot sell for the same price in different countries due to the different wage rates.
D)as long as all goods and services are traded freely across international boundaries, one unit of domestic currency should buy the same basket of goods anywhere in the world.
Q2) The benefits to a country from dollarization include each of the following, except:
A)a lower risk premium since inflationary finance is no longer a possibility.
B)greater and faster integration into world markets, increasing trade and investment.
C)no risk of an exchange rate crisis.
D)increased revenue from seignorage.
Q3) What are the general conditions under which a fixed exchange rate makes sense for a country?
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Chapter 20: Money Growth, Money Demand, and Modern Monetary Policy
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Q1) Is variability in velocity more of a problem in high or low inflation countries? Explain.
Q2) A rate of inflation that exceeds the growth rate of money for a country could be explained by:
A)a growing real economy.
B)a constant velocity of money.
C)an increasing velocity of money.
D)a decreasing velocity of money.
Q3) If the equation of exchange is MV = PY the Y represents:
A)nominal GDP.
B)real GDP.
C)potential output.
D)economic growth.
Q4) If we consider the relationship between the opportunity cost of holding money and velocity that existed in the 1980s, if the Fed followed the same policymaking in the 1990s and 2000s, would they have achieved the desired results? Explain.
Q5) If the Fed wanted to keep inflation in check given the growth rate of the economy, how should they have responded to the financial innovations of the mid to late 1970s and early 1980s in terms of money growth?
Page 22
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Chapter 21: Output, Inflation, and Monetary Policy
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Q1) Use the monetary policy reaction curve to link a higher inflation rate to lower aggregate demand.
Q2) It has been argued that the information technology age has greatly increased productivity and potential output.If this is true:
A)the long-run real interest rate is also higher as a result.
B)nominal long-run interest rates should have increased.
C)we should have seen lower short-run interest rates than we have seen.
D)the long-run real interest rate is lower as a result.
Q3) If a point lies on the monetary policy reaction curve, and at this point the inflation rate equals the target rate of inflation, we know that:
A)the real interest rate corresponding to this point is above the long-run real interest rate.
B)the real interest rate corresponding to this point is equal to the long-run real interest rate.
C)the real interest rate corresponding to this point is below the long-run real interest rate.
D)current output is above potential output.
Q4) What are the determinants of the potential output for an economy?
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Chapter 22: Understanding Business Cycle Fluctuations
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Q1) Increases in productivity result in:
A)higher inflation as output increases.
B)lower inflation as output decreases.
C)opportunities for policymakers to reduce their inflation target without inducing a recession.
D)none of the answers provided is correct.
Q2) Which of the following would shift the short-run aggregate supply curve to the right?
A)An increase in oil prices
B)A reduction in the minimum wage
C)A change in the law requiring overtime pay for anyone working more than 30 hours a week
D)An increase in payroll taxes
Q3) A reduction in the central bank's inflation target will result in:
A)an increase in potential output.
B)no change in potential output.
C)a decrease in potential output.
D)the long-run aggregate supply curve having an upward slope.
Q4) Why can monetary policymakers neutralize demand shocks but not supply shocks?
Q5) Explain the view called real business cycle theory.
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Chapter 23: Modern Monetary Policy and the Challenges
Facing Central Bankers
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Q1) All but which of the following could be adjusted as a means of deflating asset price bubbles:
A)Tariffs
B)Capital requirements
C)Capital surcharges
D)Fees for insuring the capital of banks
Q2) Some people who believe monetary policymakers should not address equity and property price bubbles argue their position based on:
A)their belief that government should stay out of private matters.
B)the policymakers lack experience with financial markets.
C)price bubbles are virtually impossible to identify when they are developing.
D)all of the answers given are correct.
Q3) Bonds must have positive yields because:
A)the U.S.treasury guarantees all bonds to have a positive yield.
B)the banking technology does not exist to deal with negative yields.
C)people can always hold cash.
D)all of the answers given are correct.
Q4) If greater stock prices can lead to greater investment spending, should central bankers ever worry about stock prices becoming too high?
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