Monetary Economics
Practice Questions
Course Introduction
Monetary Economics explores the role of money and financial institutions in shaping economic activity. The course covers the functions and evolution of money, the structure and operation of banking systems, and the conduct and effects of monetary policy. Students examine theories concerning the demand and supply of money, the mechanisms of money creation, and the influence of central banks on interest rates and inflation. Emphasis is placed on real-world applications, including how monetary policy interacts with fiscal policy, affects macroeconomic stability, and responds to financial crises both domestically and internationally.
Recommended Textbook
The Economics of Money Banking and Financial Markets 9th Edition by Frederic S. Mishkin
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Page 2
Chapter 1: Why Study Money, Banking, and Financial Markets
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Sample Questions
Q1) There is a ________ association between inflation and the growth rate of money
A)positive; demand
B)positive; supply
C)negative; demand
D)negative; supply
Answer: B
Q2) Between 1950 and 1980 in the U.S.,interest rates trended upward.During this same time period,
A)the rate of money growth declined.
B)the rate of money growth increased.
C)the government budget deficit (expressed as a percentage of GNP)trended downward.
D)the aggregate price level declined quite dramatically.
Answer: B
Q3) Why is it important to understand the bond market?
Answer: The bond market supports economic activity by enabling the government and corporations to borrow to undertake their projects and it is the market where interest rates are determined.
Page 3
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Chapter 2: An Overview of the Financial System
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Q1) Well-functioning financial markets
A)cause inflation.
B)eliminate the need for indirect finance.
C)cause financial crises.
D)produce an efficient allocation of capital.
Answer: D
Q2) ________ are short-term loans in which Treasury bills serve as collateral.
A)Repurchase agreements
B)Negotiable certificates of deposit
C)Federal funds
D)U.S.government agency securities
Answer: A
Q3) You can borrow $5000 to finance a new business venture.This new venture will generate annual earnings of $251.The maximum interest rate that you would pay on the borrowed funds and still increase your income is
A)25%.
B)12.5%.
C)10%.
D)5%.
Answer: D
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Chapter 3: What Is Money
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Q1) If an individual moves money from a money market deposit account to currency,
A)M1 increases and M2 stays the same.
B)M1 stays the same and M2 increases.
C)M1 stays the same and M2 stays the same.
D)M1 increases and M2 decreases.
Answer: A
Q2) If an individual moves money from a small-denomination time deposit to a demand deposit account,
A)M1 increases and M2 stays the same.
B)M1 stays the same and M2 increases.
C)M1 stays the same and M2 stays the same.
D)M1 increases and M2 decreases.
Answer: A
Q3) The M1 measure of money includes
A)small denomination time deposits.
B)traveler's checks.
C)money market deposit accounts.
D)money market mutual fund shares.
Answer: B
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Chapter 4: Understanding Interest Rates
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Sample Questions
Q1) The concept of ________ is based on the common-sense notion that a dollar paid to you in the future is less valuable to you than a dollar today.
A)present value
B)future value
C)interest
D)deflation
Q2) An $8,000 coupon bond with a $400 coupon payment every year has a coupon rate of
A)5 percent.
B)8 percent.
C)10 percent.
D)40 percent.
Q3) The nominal interest rate minus the expected rate of inflation
A)defines the real interest rate.
B)is a less accurate measure of the incentives to borrow and lend than is the nominal interest rate.
C)is a less accurate indicator of the tightness of credit market conditions than is the nominal interest rate.
D)defines the discount rate.
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Chapter 5: The Behavior of Interest Rates
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Q1) Factors that decrease the demand for bonds include
A)an increase in the volatility of stock prices.
B)a decrease in the expected returns on stocks.
C)a decrease in the inflation rate.
D)a decrease in the riskiness of stocks.
Q2) Everything else held constant,when households save less,wealth and the demand for bonds ________ and the bond demand curve shifts ________.
A)increase; right
B)increase; left
C)decrease; right
D)decrease; left
Q3) Everything else held constant,if interest rates are expected to fall in the future,the demand for long-term bonds today ________ and the demand curve shifts to the ________.
A)rises; right
B)rises; left
C)falls; right
D)falls; left
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Chapter 6: The Risk and Term Structure of Interest Rates
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Q1) A bond with default risk will always have a ________ risk premium and an increase in its default risk will ________ the risk premium.
A)positive; raise
B)positive; lower
C)negative; raise
D)negative; lower
Q2) A key assumption in the segmented markets theory is that bonds of different maturities
A)are not substitutes at all.
B)are perfect substitutes.
C)are substitutes only if the investor is given a premium incentive.
D)are substitutes but not perfect substitutes.
Q3) Everything else held constant,abolishing all taxes will
A)increase the interest rate on corporate bonds.
B)reduce the interest rate on municipal bonds.
C)increase the interest rate on municipal bonds.
D)increase the interest rate on Treasury bonds.
Q4) If a higher inflation is expected,what would you expect to happen to the shape of the yield curve? Why?
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Chapter 7: The Stock Market, the Theory of Rational
Expectations, and the Efficient Market Hypothesis
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Q1) If expectations are formed adaptively,then people
A)use more information than just past data on a single variable to form their expectations of that variable.
B)often change their expectations quickly when faced with new information.
C)use only the information from past data on a single variable to form their expectations of that variable.
D)never change their expectations once they have been made.
Q2) ________ means people are more unhappy when they suffer losses than they are happy when they achieve gains.
A)Loss fundamentals
B)Loss aversion
C)Loss leader
D)Loss cycle
Q3) In the generalized dividend model,if the expected sales price is in the distant future
A)it does not affect the current stock price.
B)it is more important than dividends in determining the current stock price.
C)it is equally important with dividends in determining the current stock price.
D)it is less important than dividends but still affects the current stock price.
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Chapter 8: An Economic Analysis of Financial Structure
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Q1) Of the sources of external funds for nonfinancial businesses in the United States,stocks account for approximately ________ of the total.
A)2%
B)11%
C)20%
D)40%
Q2) One way of describing the solution that high net worth provides to the moral hazard problem is to say that it
A)collateralizes the debt contract.
B)makes the debt contract incentive compatible.
C)state verifies the debt contract.
D)removes all of the risk in the debt contract.
Q3) The recent Enron and Tyco scandals are an example of
A)the free-rider problem.
B)the adverse selection problem.
C)the principal-agent problem.
D)the "lemons problem."
Q4) How does collateral help to reduce the adverse selection problem in credit market?
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Chapter 9: Financial Crises and the Subprime Meltdown
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Q1) Although the subprime mortgage market problem began in the United States,the first indication of the seriousness of the crisis began in A)Europe.
B)Australia.
C)China.
D)South America.
Q2) In emerging market countries,many firms have debt denominated in foreign currency like the dollar or yen.A depreciation of the domestic currency
A)results in increases in the firm's indebtedness in domestic currency terms,even though the value of their assets remains unchanged.
B)results in an increase in the value of the firm's assets.
C)means that the firm does not owe as much on their foreign debt.
D)strengthens their balance sheet in terms of the domestic currency.
Q3) How can asymmetric information lead to a bank panic?
Q4) Typically,the economy recovers fairly quickly from a recession.Why did this not happen in the United States during the Great Depression?
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Chapter 10: Banking and the Management of Financial Institutions
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Q1) A bank is insolvent when
A)its liabilities exceed its assets.
B)its assets exceed its liabilities.
C)its capital exceeds its liabilities.
D)its assets increase in value.
Q2) When a lender refuses to make a loan,although borrowers are willing to pay the stated interest rate or even a higher rate,the bank is said to engage in
A)coercive bargaining.
B)strategic holding out.
C)credit rationing.
D)collusive behavior.
Q3) When $1 million is deposited at a bank,the required reserve ratio is 20 percent,and the bank chooses not to make any loans but to hold excess reserves instead,then,in the bank's final balance sheet,
A)the assets at the bank increase by $1 million.
B)the liabilities of the bank decrease by $1 million.
C)reserves increase by $200,000.
D)liabilities increase by $200,000.
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Chapter 11: Economic Analysis of Financial Regulation
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Q1) That several hundred S&Ls were not even examined once in the period January 1984 through June 1986 can be explained by
A)Congress's unwillingness to allocate the necessary funds to thrift regulators.
B)regulators' reluctance to find the specific problem thrifts that they knew existed.
C)slower growth in lending meant that less regulation was needed.
D)Congress's unwillingness to listen to campaign contributors.
Q2) Off-balance-sheet activities
A)generate fee income with no increase in risk.
B)increase bank risk but do not increase income.
C)generate fee income but increase a bank's risk.
D)generate fee income and reduce risk.
Q3) If the FDIC decides that a bank is too big to fail,it will use the ________ method,effectively ensuring that ________ depositors will suffer losses.
A)payoff; large
B)payoff; no
C)purchase and assumption; large
D)purchase and assumption; no
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Chapter 12: Banking Industry: Structure and Competition
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Q1) One factor contributing to the rapid growth of the commercial paper market since 1970 is
A)the fact that commercial paper has no default risk.
B)improved information technology making it easier to screen credit risks.
C)government regulation.
D)FDIC insurance for commercial paper.
Q2) Experts predict that the future structure of the U.S.banking industry will have
A)an increased number of banks.
B)as few as ten banks.
C)several thousand banks.
D)a few hundred banks.
Q3) A ________ is a subsidiary of a U.S.bank that is engaged primarily in international banking.
A)Edge Act corporation
B)Eurodollar agency
C)universal bank
D)McFadden corporation
Q4) What financial innovations helped banks to get around the bank branching restrictions of the McFadden Act?
Q5) Why did the interest rate volatibility of the 1970s spur financial innovation?
Page 14
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Chapter 13: Central Banks and the Federal Reserve System
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Q1) Goal independence is the ability of ________ to set monetary policy ________.
A)the central bank; goals
B)Congress; goals
C)Congress; instruments
D)the central bank; instruments
Q2) Members of the Board of Governors are
A)chosen by the Federal Reserve Bank presidents.
B)appointed by the newly elected president of the United States,as are cabinet positions.
C)appointed by the president of the United States and confirmed by the Senate as members resign.
D)never allowed to serve more than 7-year terms.
Q3) Members of the Executive Board of the European System of Central Banks are appointed to ________ year,nonrenewable terms.
A)four
B)eight
C)ten
D)fourteen
Q4) Make the case for and against an independent Federal Reserve.
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Chapter 14: The Money Supply Process
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Sample Questions
Q1) An increase in which of the following leads to a decline in the monetary base?
A)Float
B)Discount loans
C)Foreign deposits at the Fed
D)SDRs
Q2) The effect of an open market purchase on reserves differs depending on how the seller of the bonds keeps the proceeds.If the proceeds are kept in ________,the open market purchase has no effect on reserves; if the proceeds are kept as ________,reserves increase by the amount of the open market purchase.
A)deposits; deposits
B)deposits; currency
C)currency; deposits
D)currency; currency
Q3) The steepest increase in the currency ratio since 1892 occurred during A)World War II.
B)the Great Depression.
C)the interwar years.
D)the past twenty years.
Q4) Explain why the simple deposit multiplier overstates the true deposit multiplier.
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Chapter 15: Tools for Monetary Policy
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Q1) In the market for reserves,a lower interest rate paid on excess reserves
A)decreases the supply of reserves.
B)increases the supply of reserves.
C)decreases the effective floor for the federal funds rate.
D)increases the effective floor for the federal funds rate.
Q2) Open market sales ________ reserves and the monetary base thereby ________ the money supply.
A)raise; lowering
B)raise; raising
C)lower; lowering D)lower; raising
Q3) Everything else held constant,in the market for reserves,when the supply for federal funds intersects the reserve demand curve on the downward sloping section,decreasing the interest rate paid on excess reserves
A)increases the federal funds rate.
B)lowers the federal funds rate.
C)has no effect on the federal funds rate.
D)has an indeterminate effect on the federal funds rate.
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Chapter 16: The Conduct of Monetary Policy: Strategy and Tactics
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Q1) Which of the following criteria need not be satisfied for choosing an intermediate target?
A)The variable must be measurable.
B)The variable must be controllable.
C)The variable must be predictable.
D)The variable must be transportable.
Q2) The monetary policy strategy that provides an immediate signal on target achievement is
A)exchange-rate targeting.
B)monetary targeting.
C)inflation targeting.
D)the implicit nominal anchor.
Q3) Which of the following is a disadvantage to monetary targeting?
A)It relies on a stable money-inflation relationship.
B)There is a delayed signal about the achievement of a target.
C)It implies larger output fluctuations.
D)It implies a lack of transparency.
Q4) Explain and demonstrate graphically how targeting the federal funds rate can result in fluctuations in nonborrowed reserves.
18
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Chapter 17: The Foreign Exchange Market
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Q1) A decrease in the expected future domestic exchange rate causes the demand for domestic assets to ________ and the domestic currency to ________,everything else held constant.
A)increase; appreciate B)increase; depreciate
C)decrease; appreciate D)decrease; depreciate
Q2) Evidence from the United States during the period 1973-2002 indicates that the value of the dollar and the measure of the ________ interest rate rose and fell together.
A)real
B)nominal
C)expected
D)actual
Q3) The theory of purchasing power parity states that exchange rates between any two currencies will adjust to reflect changes in A)the trade balances of the two countries.
B)the current account balances of the two countries.
C)fiscal policies of the two countries.
D)the price levels of the two countries.
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Chapter 18: The International Financial System
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Q1) Under the Exchange Rate Mechanism of the European Monetary System,when the German mark depreciated below its lower limit against the British pound,the Bank of England was required to buy ________ and sell ________,thereby ________ international reserves.
A)pounds; marks; losing B)pounds; marks; gaining C)marks; pounds; gaining D)marks; pounds; losing
Q2) Which of the following is not a disadvantage of controls on capital outflows?
A)The controls may lead to excessive risk taking by the domestic banks.
B)They are seldom effective during a crisis.
C)Capital flight may increase after they are put in place.
D)Controls often lead to an increase in government corruption.
Q3) Under the Bretton Woods system,the United States was designated as the A)reserve-currency country.
B)fixed-rate country.
C)par-standard country.
D)dollar-standard country.
Q4) Explain an additional disadvantage for a country undergoing dollarization compared to a currency board or other exchange-rate targeting regimes.
Page 20
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Chapter 19: The Demand for Money
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Sample Questions
Q1) If nominal GDP is $10 trillion,and velocity is 10,the money supply is
A)$1 trillion.
B)$5 trillion.
C)$10 trillion.
D)$100 trillion.
Q2) Velocity,over the business cycle,tends to
A)rise during economic contractions.
B)fall during economic expansions.
C)stay constant.
D)fall during economic contractions.
Q3) If nominal GDP is $10 trillion,and the money supply is $2 trillion,velocity is A)0.2.
B)5.
C)10.
D)20.
Q4) Because Treasury bills pay a higher return than money and have no risk
A)the transactions demand for money may be zero.
B)the precautionary demand for money may be zero.
C)the speculative demand for money may be zero.
D)all three of the above motives for holding money will be zero.
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Chapter 20: The Islm Model
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Q1) If you know the value of the multiplier and the amount of a change in autonomous investment,you can calculate
A)the change in the interest rate.
B)the change in the money supply.
C)the change in money demand.
D)the change in equilibrium output.
Q2) Everything else held constant,if consumption expenditure increases by 65 for a 100 increase in disposable income,the mpc is A)0.
B)0.5.
C)0.65.
D)1.
Q3) Assume that disposable income equals $1000 and the mpc equals 0.6.If total consumption equal $800,then autonomous consumption is equal to A)$0.
B)$200.
C)$800.
D)$1000.
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Chapter 21: Monetary and Fiscal Policy in the ISLM Model
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Q1) If the economy is characterized by a certain and stable LM curve,then ________ target produces ________ fluctuations in aggregate output.
A)an interest rate; smaller
B)a money supply; smaller
C)a money supply; larger
D)an exchange rate; larger
Q2) In the Keynesian cross diagram,a decline in autonomous consumer expenditure causes the aggregate demand function to shift ________ and the equilibrium level of aggregate output to ________,everything else held constant.
A)up; rise
B)up; fall
C)down; rise
D)down; fall
Q3) If the ________ curve is relatively more unstable than the ________ curve,an interest rate target is preferred.
A)IS; IS
B)IS; LM
C)LM; IS
D)LM; LM
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Page 23
Chapter 22: Aggregate Demand and Supply Analysis
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Q1) Everything else held constant,aggregate demand increases when A)net exports decrease.
B)taxes increase.
C)planned investment spending increases.
D)the money supply decreases.
Q2) Everything else held constant,if workers expect an increase in the price level,________ aggregate supply ________.
A)long-run; increases
B)long-run; decreases
C)short-run; decreases
D)short-run; increases
Q3) A theory of aggregate economic fluctuations called real business cycle theory holds that
A)changes in the real money supply are the only demand shocks that affect the natural rate of output.
B)aggregate demand shocks do affect the natural rate of output.
C)aggregate supply shocks do affect the natural rate of output.
D)changes in net exports are the only demand shocks that affect the natural rate of output.
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Chapter 23: Transmission Mechanisms of Monetary Policy:
The Evidence
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Q1) Timing evidence is valid only if it is known that the first event is
A)endogenous.
B)exogenous.
C)a leading indicator of the second event.
D)a lagging indicator of the second event.
Q2) The channels through which monetary policy affects economic activity are called the ________ of monetary policy.
A)transmission mechanisms
B)flow mechanisms
C)distribution mechanisms
D)allocational mechanisms
Q3) The subprime financial crisis caused a recession because of the ________ in adverse selection and moral hazard problems and the ________ in housing prices.
A)increase; increase
B)increase; decrease
C)decrease; increase
D)decrease; decrease
Q4) Explain how expansionary and contractionary monetary policies affect aggregate demand through the exchange rate channel.
and
Chapter 24: Money and Inflation
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Q1) The ________ lag is the time it takes for policymakers to change policy instruments once they have decided on the new policy,while the ________ lag is the time it takes for the policy to actually have an impact on the economy.
A)recognition; implementation
B)legislative; effectiveness
C)implementation; recognition
D)implementation; effectiveness
Q2) Some economists contend that a policy of shifting the aggregate demand curve will be costly because it produces more volatility in both the price level and output.These economists likely are advocates of ________ policy.
A)supply-side
B)discretionary
C)demand-management
D)nondiscretionary
Q3) Proponents of Ricardian Equivalence reject the view that deficits
A)cause the monetary base to decrease.
B)cause the monetary base to increase.
C)have no effect on the monetary base.
D)cannot be inflationary,even when financed by tax hikes.
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Chapter 25: Rational Expectations: Implications for Policy
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Q1) Mariann the economist argues that expectations are formed rationally,yet a pre-announced monetary expansion will lower unemployment.Mariann is probably a A)Keynesian economist.
B)monetarist.
C)new classical economist.
D)new Keynesian economist.
Q2) In the new Keynesian model,an unanticipated increase in the money supply causes
A)aggregate demand to increase along a stationary aggregate supply curve.
B)both aggregate demand and supply to increase.
C)aggregate demand to increase as aggregate supply decreases.
D)both aggregate demand and supply to decrease.
Q3) Kristin the economist argues that an anticipated monetary expansion will cause aggregate output to increase but believes that aggregate output would increase by an even greater amount if the monetary expansion came as a surprise to everyone.Kristin is probably a
A)new Keynesian.
B)new classical economist.
C)monetarist.
D)Keynesian economist.
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