Ch28 Monetary Policy and Bank Regulation

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Ch28 Monetary Policy and Bank Regulation
Multiple Choice Questions
1. Which of the following institutions determines the quantity of money in the economy as its most important task?
A. U.S. Department of the Treasury
B. Federal Open Market Committee
C. Central Bank
D. Federal Reserve Board of Governors
Answer: C  Reference:
Explanation:
Type: Multiple Choice                   
2. The ___________________ is the institution designed to control the quantity of money in the economy and also to oversee the: 
A. FOMC; passing of tax and spending bills.
B. Central Bank; safety and stability of the banking system.
C. FFIEC; day-to-day democratic control of policy.
D. FDIC; responsibility for deposit insurance.
Answer: B  Reference:
Explanation:
Type: Multiple Choice                   
3. Which of the following institutions oversees the safety and stability of the U.S. banking system?
A. Office of the Comptroller of the Currency
B. Federal Financial Institutions Examination Council
C. Federal Open Market Committee
D. The Federal Reserve
Answer: D  Reference:
Explanation:
Type: Multiple Choice                   
4. Which of the following is a traditional tool used by the Fed during recessions?
A. quantitative easing
B. higher interest rates
C. open market operations
D. coins and paper currency
Answer: C  Reference:
Explanation:
Type: Multiple Choice                   
5. Which of the following terms is used to describe the proportion of deposits that banks are legally required to deposit with the central bank?
A. discount requirements
B. deposit requirements
C. reserve requirements
D. monetary requirements
Answer: C  Reference:
Explanation:
Type: Multiple Choice                   
6. What term is used to describe the interest rate charged by the central bank when it makes loans to commercial banks?
A. discount rate
B. reserve requirement
C. Fed rate
D. open market rate
Answer: A  Reference:
Explanation:
Type: Multiple Choice                   
7. Which of the following is considered to be a relatively weak tool of monetary policy?
A. quantitative easing
B. altering the discount rate
C. reserve requirements
D. reducing the money supply
Answer: B  Reference:
Explanation:
Type: Multiple Choice                    
8. A central bank that wants to increase the quantity of money in the economy will:
A. raise the discount rate.
B. sell bonds in open market operations.
C. reverse quantitative easing.
D. buy bonds in open market operations.
Answer: D  Reference:
Explanation:
Type: Multiple Choice                   
9. A central bank that desires to reduce the quantity of money in the economy can:
A. raise the reserve requirement.
B. buy bonds in open market operations.
C. lower the discount rate.
D. engage in quantitative easing.
Answer: A  Reference:
Explanation:
Type: Multiple Choice                   
10. The quantitative easing policies adopted by the Federal Reserve are usually thought of as:
A. short term loans to fill out reserves.
B. temporary emergency measures.
C. traditional monetary policies.
D. a relatively weak tool.
Answer: B  Reference:
Explanation:
Type: Multiple Choice                   
11. Which of the following is described as an innovative and nontraditional method used by the Federal Reserve to expand the quantity of money and credit during the recent U.S. recession?
A. increased discount rate
B. increased reserves requirements
C. open market operations
D. quantitative easing
Answer: D  Reference:
Explanation:
Type: Multiple Choice                   
12. Central Bank policy requires Northern Bank to hold 10% of its deposits as reserves. Northern Bank policy prevents it from holding excess reserves. If the central bank purchases $30 million in bonds from Northern Bank what will be the result?
A. Northern’s loan assets increase by $30 million
B. Northern’s bond assets increase by $30 million
C. Northern’s net worth changes by $30 million
D. the money supply in the economy decreases
Answer: A  Reference:
Explanation:
Type: Multiple Choice                   
13. The central bank requires Southern to hold 10% of deposits as reserves. Southern Bank’s policy prohibits it from holding excess reserves. If the central bank sells $25 million in bonds to Southern Bank which of the following will result?
A. the money supply in the economy decreases
B. Southern’s net worth increases by $25 million
C. decrease in Southern’s bond assets by $25 million
D. increase in Southern’s loan assets of $25 million
Answer: A  Reference:
Explanation:
Type: Multiple Choice                    
14. Central bank policy requires all banks to hold 10% of deposits as reserves. Pacific Bank policy prevents it from holding excess reserves. Suppose banks cannot trade any of the bonds they already have. If the central bank decides to lower the reserve requirement to 9%, which of the following will result?
A. the money supply in the economy decreases
B. decrease of $1 million in Pacific’s net worth
C. increase of $1 million in Pacific’s loan assets
D. increase of Pacific’s bond assets by $1million
Answer: C  Reference:
Explanation:
Type: Multiple Choice                   
15. Atlantic Bank is required to hold 10% of deposits as reserves. If the central bank increases the discount rate, how would Atlantic Bank respond?
A. by noting a decrease in net worth
B. by increasing its reserves
C. its balance sheet will be unchanged
D. it can make more loans with increased loan assets
Answer: B  Reference:
Explanation:
Type: Multiple Choice                   
16. The Central Bank has raised its reserve requirements from 10% to 12%. If Southern Bank finds that it is not holding enough in reserves to meet the higher requirements, then it will likely:
A. keep track of whether money is flowing in or out of the bank.
B. buy bonds to increase the size of its reserve assets.
C. reduce the quantity of money and loans on the balance sheet.
D. borrow for the short term from the central bank.
Answer: D  Reference:
Explanation:
Type: Multiple Choice                   
17. When the central bank decides to increase the discount rate, the:
A. money supply increases.
B. interest rates decrease.
C. interest rates are unaffected.
D. interest rates increase.
Answer: D  Reference:
Explanation:
Type: Multiple Choice                   
18. When the central bank decides it will sell bonds using open market operations:
A. interest rates decrease.
B. the money supply increases.
C. the money supply decreases.
D. the money supply is unaffected.
Answer: C  Reference:
Explanation:
Type: Multiple Choice                   
19. When the central bank lowers the reserve requirement on deposits:
           
A. the money supply increases and interest rates decrease.
B. the money supply and interest rates decrease.
C. the money supply and interest rates increase.
D. the money supply decreases and interest rates increase.
Answer: A  Reference:
Explanation:
Type: Multiple Choice                   
20. Which of the following events would cause interest rates to increase?
A. lower tax rates
B. a higher discount rate
C. lower reserve requirements
D. an open market operation to buy bonds
Answer: B  Reference:
Explanation:
Type: Multiple Choice                    Category: Analyze
21. When the Federal Reserve announces that it is implementing a new interest rate policy, the ____________________ will be affected?
A. real interest rate
B. consumer lending rate
C. nominal interest rate
D. federal funds rate
Answer: D  Reference:
Explanation:
Type: Multiple Choice                   
22. How are the specific interest rates for the lending and borrowing markets determined?
A. U.S. Treasury Department Board policy
B. by the forces of supply and demand
C. through open market operations
D. by altering the discount rate
Answer: B  Reference:
Explanation:
Type: Multiple Choice                   
23. When the Central Bank acts in a way that causes the money supply to increase while aggregate demand remains unchanged, it is:
A. following a contractionary monetary policy.
B. following quantitative easing policy.
C. following a tight monetary policy.
D. following an expansionary monetary policy.
Answer: D  Reference:
Explanation:
Type: Multiple Choice                   
24. If a Central Bank decides it needs to decrease both the aggregate demand and the money supply, then it will:
A. follow expansionary monetary policy.
B. follow loose monetary policy.
C. follow tight monetary policy.
D. follow quantitative easing policy.
Answer: C  Reference:
Explanation:
Type: Multiple Choice                   
25. When a Central Bank takes action to decrease the money supply and increase the interest rate, it is following:
A. a loose monetary policy.
B. a contractionary monetary policy.
C. a expansionary monetary policy.
D. a quantitative easing policy.
Answer: B  Reference:
Explanation:
Type: Multiple Choice                    Category: Analyze
26. When a Central Bank makes a decision that will cause an increase in both the money supply and aggregate demand, it is:
A. following a loose monetary policy.
B. following a tight monetary policy.
C. following a contractionary monetary policy.
D. reversing quantitative easing.
Answer: A  Reference:
Explanation:
Type: Multiple Choice                    Category: Analyze
27. ____________________________ will often cause monetary policy to be considered counterproductive because it makes it hard for the central bank to know when the policy will take effect?
A. Altering the discount rate
B. Reserve requirements
C. Long and variable time lags
D. Quantitative easing
Answer: C  Reference:
Explanation:
Type: Multiple Choice                   
28. When banks hold excess reserves because they don’t see good lending opportunities:
A. it negatively affects contractionary monetary policy.
B. it negatively affects expansionary monetary policy.
C. expansionary monetary policy is unaffected.
D. contractionary monetary policy is unaffected.
Answer: B  Reference:
Explanation:
Type: Multiple Choice                   
29. If the economy is in recession with high unemployment and output below potential GDP, then __________________ would cause the economy to return to its potential GDP?
A. a tight monetary policy
B. fewer loanable funds
C. a loose monetary policy
D. higher interest rates
Answer: C  Reference:
Explanation:
Type: Multiple Choice                   
30. The central bank uses a ____________________ monetary policy to offset business related economic contractions and expansions?
A. laissez faire
B. loose
C. contractionary
D. countercyclical
Answer: D  Reference:
Explanation:
Type: Multiple Choice                   
31. Regardless of the outcome in the long run, ______________________ always has the effect of stimulating the economy in the short run.
A. expansionary monetary policy
B. contractionary monetary policy
C. reverse quantitative easing policy
D. tight monetary policy
Answer: A  Reference:
Explanation:
Type: Multiple Choice                   
32. What is the name given to the macroeconomic equation MV = PQ?
A. basic velocity of money equation
B. basic quantity equation of output
C. basic quantity equation of money
D. basic velocity of price equation
Answer: C  Reference:
Explanation:
Type: Multiple Choice                   
33. According to the quantity theory, if constant growth in the money supply is combined with fluctuating velocity, which of the following is most likely to result?
A. unpredictable rises and falls in nominal GDP
B. monetary policy will become inevitably imprecise
C. quantity of credit rises above where it otherwise be
D. innovations relating to banking and finance
Answer: A  Reference:
Explanation:
Type: Multiple Choice                    Category: Analyze
34. According to the basic quantity equation of money, if price and output fall while velocity increases, then:
A. the quantity of money will rise.
B. the quantity of money will fall.
C. the quantity of money will rise before it falls.
D. the quantity of money will rise slowly.
Answer: B  Reference:
Explanation:
Type: Multiple Choice                   
35. If nominal GDP is 1800 and the money supply is 450, then what is velocity?
A. 25
B. 4.5
C. 4
D. 22
Answer: C  Reference:
Explanation:
Type: Multiple Choice                   
36. If GDP is 3600 and the money supply is 300, what is the velocity?
A. 18
B. 8
C. 4.57
D. 12
Answer: D  Reference:
Explanation:
Type: Multiple Choice                   
37. In good economic times, a surge in lending exaggerates the episode of economic growth. Which of the following adaptations of monetary policy can moderate these exaggerated effects?
A. price stability to reinforce effect of deposit insurance
B. monitoring asset prices and leverage
C. quantitative easing when banks are under stress
D. inflation-targeting lender of last resort policies
Answer: B  Reference:
Explanation:
Type: Multiple Choice                    Category: Analyze
38. If you were to survey central bankers from around the world and ask them what they believe the primary task of monetary policy should be, what would the most popular answer likely be?
A. leverage cycle
B. bank runs
C. fighting inflation
D. bank supervision
Answer: C  Reference:
Explanation:
Type: Multiple Choice                   
39. If the original level of aggregate demand is AD0, then an expansionary monetary policy that shifts aggregate demand to AD1 will only:
A. create an inflationary increase in price level.
B. create an increase in GDP.
C. create an increase in unemployment.
D. create a deflationary loss in price level.
Answer: A  Reference:
Explanation:
Type: Multiple Choice                   
40. If nominal GDP is 2700 and the money supply is 900, what is velocity?
A. 25
B. 13.5
C. 3
D. .33
Answer: C  Reference:
Explanation:
Type: Multiple Choice                   
41. If GDP is 2400 and the money supply is 600, then what is the velocity?
A. 18.3
B. 4
C. 4.57
D. 12
Answer: B  Reference:
Explanation:
Type: Multiple Choice                   
42. If GDP is 1800 and the money supply is 300, then what is the velocity?
A. 18.3
B. 8
C. 4.57
D. 6
Answer:   Reference:
Explanation:
Type: Multiple Choice                   
           
43. If the economy is at equilibrium as shown in the diagram above, then a contractionary monetary policy will
A. increase unemployment, but have little effect on inflation.
B. increase unemployment and decrease inflation.
C. increase output and increase inflation.
D. have no effect on output, but increase inflation.
Answer: A  Reference:
Explanation:
Type: Multiple Choice                   
 
           
44. If the economy is at equilibrium as shown in the diagram above, then an expansionary monetary policy will:
A. have no effect on both unemployment and inflation.
B. reduce unemployment, but increase inflation.
C. reduce both unemployment and inflation.
D. reduce unemployment, but have little effect on inflation.
Answer: D  Reference:
Explanation:
Type: Multiple Choice                   
           
45. The diagram above refers to a private closed economy.  In this instance, the equilibrium GDP is:
A. $60 billion.
B. $180 billion.
C. between $60 and $180 billion.
D. $60 billion at all levels of GDP.
Answer: B  Reference:
Explanation:
Type: Multiple Choice                   


Essay Questions
1. Contrast the actions a central bank would take to increase the quantity of money in the economy with the actions it would take to produce the opposite affect.
A central bank that wants to increase the quantity of money in the economy can buy bonds in an open market operation, reduce the reserve requirement, lower the discount rate, or engage in quantitative easing. Conversely, a central bank that wants to reduce the quantity of money in the economy can sell bonds in an open market operation, raise the reserve requirement, raise the discount rate, or reverse its past practices of quantitative easing.
Reference:
Explanation:
Type: Essay                   
2. Contrast the actions a central bank should take when an economy is in recession with production substantially below potential GDP and those needed when an economy is producing in overdrive above potential GDP.
If the economy is in a recession, with production substantially below potential GDP, then the central bank should raise the supply of money and credit, first by reducing interest rates, and then by considering the use of “quantitative easing” and direct loans. 
If the economy is producing in overdrive above potential GDP, experiencing high inflation, then the central bank should raise interest rates by holding down growth of the money supply.
Reference:
Explanation:
Type: Essay                   
3. Briefly explain what a central bank is and what its most important task is. Discuss the U.S. central bank, including a brief explanation of what is involved in its decision making about the money supply and its ability to affect some goals of macroeconomic policy; including examples of some macroeconomic policy goals that would be affected. Conclude by explaining what is involved in its policies relating to the money and banking system.
The central bank is the institution designed to control the quantity of money in the economy and also to oversee the safety and stability of the banking system. The most important task of a central bank is to determine the quantity of money in the economy. 
In the United States, the central bank is called the Federal Reserve. In making decisions about the money supply, a central bank decides to raise or lower interest rates, and in this way, to affect some goals of macroeconomic policy like low unemployment and inflation.
Another set of policies related to the money and banking system involves reinforcing the stability of a nation’s banking system with a combination of protections for bank depositors and regular government inspections of the balance sheets of banks.
Reference:
Explanation:
Type: Essay                   
4. Briefly explain the affects of time lags on monetary policy.
Monetary policy affects the economy only after a time lag that is typically long and of variable length. Because monetary policy involves a chain of events: the central bank must perceive a situation in the economy, hold a meeting, and make a decision to react by tightening or loosening monetary policy. The change in monetary policy must percolate through the banking system, changing the quantity of loans and affecting interest rates. As a result of this chain of events, monetary policy has little effect in the immediate future; instead, its primary effects are felt perhaps 1–3 years in the future.
Reference:
Explanation:
Type: Essay                   
5. Identify the three government policies for assuring safe and stable banking systems.
The three government policies for assuring safe and stable banking systems are: (1) the provision of deposit insurance to reassure households that their bank deposits are safe; (2) examining the financial records of banks to ensure that they have positive net worth; and (3) making emergency short-term loans to banks in times of financial chaos.
Reference:
Explanation:
Type: Essay                   
6. Briefly describe the tools used by a central bank to affect the money supply and identify which is the most powerful and commonly used method and which is the weakest method.
A central bank has three traditional tools to affect the quantity of money in the economy: open market operations, reserve requirements, and the discount rate. The most powerful and commonly used of the three traditional tools of monetary policy is open market operations, while altering the discount rate is a relatively weak tool of monetary policy.
Reference:
Explanation:
Type: Essay                   
7. Discuss the reserve requirements method of conducting monetary policy, including a description of this method, the types of adjustments banks are likely to be required to make and the affects on the economy that are likely to result.
A second method of conducting monetary policy is for the central bank to raise or lower the reserve requirement, which is the proportion of its deposits that a bank is legally required to deposit with the central bank. 
If a bank finds that it is not holding enough in reserves to meet the reserve requirements, it needs to borrow at least for the short term from the central bank. If the central bank raises the discount rate, then banks will hold a higher level of reserves to reduce the chance of needing to borrow at that higher interest rate.
When banks hold these higher reserves, it reduces the money supply in the economy as a whole. If the central bank lowers the discount rate it charges to banks, then banks will be less concerned about the prospect of needing a short-term loan to fill out their reserves. In turn, the bank will be more willing to lend aggressively, which will increase the money supply.
Reference:
Explanation:
Type: Essay                   
8. Discuss the method of quantitative easing used by the Federal Reserve during the most recent U.S. recession, including any criticisms of this action.
One method of quantitative easing was that the Federal Reserve began to make discount rate loans broadly available to many financial firms like those who buy and sell financial securities or even insurance companies, not just to banks.
The quantitative easing policies adopted by the Federal Reserve (and by other central banks around the world) are usually thought of as temporary emergency measures. But if these steps are indeed to be temporary, then the Federal Reserve will need to stop making these additional loans and sell off the financial securities it has accumulated—and the process of quantitative easing may prove more difficult to reverse than it was to enact.
Reference:
Explanation:
Type: Essay                   
9. Define and contrast contractionary monetary policy and expansionary monetary policy and their respective economic outcomes. Explain what happens if the affects of either of these policies goes too far.
A monetary policy which reduces the amount of money and loans in the economy is a contractionary monetary policy or a “tight” monetary policy. A monetary policy that expands the quantity of money and loans is known as an expansionary monetary policy or a “loose” monetary policy. Tight or contractionary monetary policy that leads to higher interest rates and a reduced quantity of loanable funds will reduce two components of aggregate demand. Conversely, loose or expansionary monetary policy that leads to lower interest rates and a higher quantity of loanable funds will tend to increase business investment and consumer borrowing for big-ticket items. If loose monetary policy seeking to end a recession goes too far, it may push aggregate demand so far to the right that it triggers inflation. If tight monetary policy seeking to reduce inflation goes too far, it may push aggregate demand so far to the left that a recession begins.
Reference:
Explanation:
Type: Essay                    
10. Talona’s latest economic data indicates that GDP is -0.08 and unemployment is 8.1%, while Genovia’s economic data indicates shows continuing pressure for rising price levels. Diagnose the current health for each of these economies and provide your prescription of the appropriate remedy needed in each instance.
Talona’s economy is suffering a recession and high unemployment, with output below potential GDP.  A loose monetary policy can help the economy return to potential GDP.
Genovia’s economy is producing at a quantity of output above its potential GDP. A tight or contractionary monetary policy can reduce the inflationary pressures for a rising price level.
Reference:
Explanation:
Type: Essay