Chapter 11 Monetary Policy
1) In the AS/AD model, an increase in the money supply causes an increase in the interest rate and an increase in investment spending.
Answer: FALSE
Explanation: An increase in the money supply increases the credit available to banks, which depresses interest rates and increases business investment.
Difficulty: 2 Medium
Topic: How Monetary Policy Works in the Models
Learning Objective: 11-01 Explain how monetary policy works in the AS/AD model.
Bloom’s: Understand
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
2) A contractionary monetary policy decreases the money supply and the interest rate, which decreases investment and output.
Answer: FALSE
Explanation: A contractionary monetary policy decreases the money supply and increases the interest rate, which decreases investment and output.
Difficulty: 1 Easy
Topic: How Monetary Policy Works in the Models
Learning Objective: 11-01 Explain how monetary policy works in the AS/AD model.
Bloom’s: Remember
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
3) The Fed’s duties include acting as a lender of last resort and supervising or regulating a variety of financial institutions.
Answer: TRUE
Explanation: The Fed lends to banks that have no other alternative. It also oversees the operations of many financial institutions.
Difficulty: 1 Easy
Topic: How Monetary Policy Works in Practice
Learning Objective: 11-02 Discuss how monetary policy works in practice.
Bloom’s: Remember
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
4) The three tools of monetary policy are open market operations, setting prices, and setting the velocity of money.
Answer: FALSE
Explanation: The Fed does conduct open market operations, but it does not set the price level or the velocity of money. The last two variables are determined by the aggregate behavior of firms and households.
Difficulty: 1 Easy
Topic: The Tools of Conventional Monetary Policy
Learning Objective: 11-03 Discuss the tools of conventional monetary policy.
Bloom’s: Remember
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
5) An increase in the federal funds rate is a signal that the Fed wants a tighter monetary policy.
Answer: TRUE
Explanation: A higher federal funds rate is a signal to banks that the Fed wants to increase interest rates and pursue a tighter monetary policy.
Difficulty: 2 Medium
Topic: The Tools of Conventional Monetary Policy
Learning Objective: 11-03 Discuss the tools of conventional monetary policy.
Bloom’s: Understand
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
6) A decrease in the federal funds rate is an indication that monetary policy is expansionary.
Answer: TRUE
Explanation: The federal funds rate falls when excess reserves within the banking system increase. The increase in excess reserves is an indication that monetary policy is expansionary.
Difficulty: 2 Medium
Topic: The Tools of Conventional Monetary Policy
Learning Objective: 11-03 Discuss the tools of conventional monetary policy.
Bloom’s: Understand
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
7) The federal funds rate is the rate banks charge one another for overnight loans.
Answer: TRUE
Explanation: The federal funds rate is the rate banks pay when they borrow from one another.
Difficulty: 1 Easy
Topic: The Tools of Conventional Monetary Policy
Learning Objective: 11-03 Discuss the tools of conventional monetary policy.
Bloom’s: Remember
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
8) The Taylor Rule relates changes in the money supply to changes in interest rates.
Answer: FALSE
Explanation: The Taylor Rule examines the relationship between inflation, output, and the federal funds rate.
Difficulty: 1 Easy
Topic: The Complex Nature of Monetary Policy
Learning Objective: 11-04 Discuss the complex nature of monetary policy and the importance of central bank credibility.
Bloom’s: Remember
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
9) The art of monetary policy requires acting in accordance with the Taylor Rule.
Answer: FALSE
Explanation: The art of monetary policy takes judgments into account rather than following a prescribed rule.
Difficulty: 2 Medium
Topic: The Complex Nature of Monetary Policy
Learning Objective: 11-04 Discuss the complex nature of monetary policy and the importance of central bank credibility.
Bloom’s: Understand
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
10) According to the Taylor Rule, if current inflation is 2.5 percent, the target inflation rate is 2 percent, and output is 1 percent above potential, the Fed should target the federal funds rate at 5.25 percent.
Answer: TRUE
Explanation: Target rate = 2 + 2.5 + (0.5)(2.5 − 2) + 0.5 (1).
Difficulty: 3 Hard
Topic: The Complex Nature of Monetary Policy
Learning Objective: 11-04 Discuss the complex nature of monetary policy and the importance of central bank credibility.
Bloom’s: Apply
AACSB: Knowledge Application
Accessibility: Keyboard Navigation
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