Eco Exam

 1) The Fed uses three policy tools to manipulate the money supply: ________, which
affect reserves and the monetary base; changes in ________, which affect the monetary base;
and changes in_____, which affect the money multiplier.
B) open market operations; borrowed reserves; reserve requirements
 2) The Fed uses three policy tools to manipulate the money supply: open market
operations, which affect the ________; changes in borrowed reserves, which affect the
________; and changes in reserve requirements, which affect the ________.
C) monetary base; monetary base; money multiplier
 3) The interest rate charged on overnight loans of reserves between banks is the
C) federal funds rate.
 4) The primary indicator of the Fedʹs stance on monetary policy is
B) the federal funds rate.
 5) The quantity of reserves demanded equals
C) required reserves plus excess reserves.
 6) Everything else held constant, when the federal funds rate is ________ the interest rate
paid on reserves, the quantity of reserves demanded rises when the federal funds rate ________.
B) above, falls
 7) The opportunity cost of holding excess reserves is the federal funds rate ________.
D) minus the interest rate paid on excess reserves
 8) In the market for reserves, when the federal funds rate is above the interest rate paid on
excess reserves, the demand curve for reserves is ________.
D) negatively sloped
 9) When the federal funds rate equals the interest rate paid on excess reserves ________.
D) the demand curve for reserves is horizontal
 10) Which of the following is NOT an argument for the Federal Reserve paying interest
on excess reserve holdings?
C) Paying interest will help the Federal Reserve have more control of the amount of discount loans.
 11) The quantity of reserves supplied equals
B) nonborrowed reserves plus borrowed reserves.
 12) In the market for reserves, when the federal funds interest rate is below the discount
rate, the supply curve of reserves is
A) vertical.
 13) When the federal funds rate equals the discount rate
B) the supply curve of reserves is horizontal.

 14) In the market for reserves, if the federal funds rate is above the interest rate paid on
excess reserves, then an open market ________ the supply of reserves, raising the federal funds
interest rate, everything else held constant.
A) sale decreases
excess reserves, an open market purchase ________ the ________ of reserves which causes the
federal funds rate to fall, everything else held constant.
A) increases; supply
 16) Suppose on any given day there is an excess demand of reserves in the federal funds
market. If the Federal Reserve wishes to keep the federal funds rate at its current level, then the
appropriate action for the Federal Reserve to take is a ________ open market ________,
everything else held constant.
B) defensive; purchase
excess reserves, an open market purchase ________ the supply of reserves and causes the federal
funds interest rate to ________, everything else held constant.
B) increases; fall
 18) Suppose on any given day the prevailing equilibrium federal funds rate is above the
Federal Reserveʹs federal funds target rate. If the Federal Reserve wishes for the federal funds
rate to be at their target level, then the appropriate action for the Federal Reserve to take is a
________ open market ________, everything else held constant.
D) dynamic; purchase
excess reserves, an open market sale ________ the supply of reserves causing the federal funds
rate to________, everything else held constant.
D) decreases; increase
 20) Suppose on any given day there is an excess supply of reserves in the federal funds
market. If the Federal Reserve wishes to keep the federal funds rate at its current level, then the
appropriate action for the Federal Reserve to take is a ________ open market ________,
everything else held constant.
A) defensive; sale
 21) Suppose on any given day the prevailing equilibrium federal funds rate is below the
Federal Reserveʹs federal funds target rate. If the Federal Reserve wishes for the federal funds
rate to be at their target level, then the appropriate action for the Federal Reserve to take is a
________ open market ________, everything else held constant.
C) dynamic; sale
excess reserves, an open market sale ________ the ________ of reserves, causing the federal
funds rate to increase, everything else held constant.
C) decreases; supply
 23) In the market for reserves, a lower discount rate
D) shortens the vertical section of the supply curve of reserves.
 24) In the market for reserves, a lower interest rate paid on excess reserves
C) decreases the effective floor for the federal funds rate.
 25) Everything else held constant, in the market for reserves, when the federal funds rate
is 3%, lowering the discount rate from 5% to 4%
C) has no effect on the federal funds rate.
is 3%, increasing the interest rate paid on excess reserves from 1% to 2%
 27) Everything else held constant, in the market for lowering the discount rate from 5%
to 4%reserves, when the federal funds rate is 5%,
A) lowers the federal funds rate.
is 1%, increasing the interest rate paid on excess reserves from 1% to 2%
B) raises the federal funds rate.
is 3%, raising the discount rate from 5% to 6%
is 3%, lowering the interest rate paid on excess reserves rate from 2% to 1%
equals the discount rate, lowering the discount rate
B) lowers the federal funds rate.
equals the interest rate paid on excess reserves, raising the interest rate paid on excess reserves
A) increases the federal funds rate.
 33) Everything else held constant, in the market for reserves, when the demand for
federal funds intersects the reserve supply curve along the horizontal section, increasing the
discount rate
 34) Everything else held constant, in the market for reserves, when the supply for federal
funds intersects the reserve demand curve along the horizontal section, lowering the interest rate
paid on excess reserves
 35) Everything else held constant, in the market for reserves, when the demand for
federal funds intersects the reserve supply curve on the vertical section, increasing the discount
rate

 36) 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
C) has no effect on the federal funds rate
 37) Everything else held constant, in the market for reserves, increases in the discount
rate affect the federal funds rate
B) when the funds rate equals the discount rate.
 38) Everything else held constant, in the market for reserves, decreases in the interest rate
paid on excess reserves affect the federal funds rate
B) when the funds rate equals the interest rate paid on excess reserves.
 39) The Federal Reserve usually keeps the discount rate
A) above the target federal funds rate.
 40) Everything else held constant, the vertical section of the supply curve of reserves is
shortened when the
B) discount rate decreases.
 41) Everything else held constant, the vertical section of the supply curve of reserves is
lengthened when the
A) discount rate increases.

 42) In the market for reserves, if the federal funds rate is between the discount rate and
the interest rate paid on excess reserves, an increase in the reserve requirement ________ the
demand for reserves, ________ the federal funds rate, everything else held constant.
C) increases; raising
the interest rate paid on excess reserves, a ________ in the reserve requirement ________ the
demand for reserves, raising the federal funds interest rate, everything else held constant.
B) rise; increases
the interest rate paid on excess reserves, a ________ in the reserve requirement increases the
demand for reserves, ________ the federal funds interest rate, everything else held constant.
D) rise; raising
demand of reserves and causes the federal funds interest rate to ________, everything else held
constant.
C) increases; rise
________ for reserves and causes the federal funds interest rate to rise, everything else held
constant.
B) increases; demand
the interest rate paid on excess reserves, a ________ in the reserve requirement ________ the
demand for reserves, lowering the federal funds interest rate, everything else held constant.
D) decline; decreases
the interest rate paid on excess reserves, a ________ in the reserve requirement decreases the
demand for reserves, ________ the federal funds interest rate, everything else held constant.
C) decline; lowering
the interest rate paid on excess reserves, a decline in the reserve requirement ________ the
________ curve of reserves and causes the federal funds interest rate to fall, everything else held
constant.
A) decreases; demand
the interest rate paid on excess reserves, a decline in the reserve requirement ________ the
demand of reserves, ________ the federal funds rate, everything else held constant.
A) decreases; lowering
 51) Suppose, at a given federal funds rate, there is an excess demand for reserves in the
federal funds market. If the Fed wants the federal funds rate to stay at that level, then it should
undertake an open market ________ of bonds, everything else held constant. If the Fed does
nothing, however, the federal funds rate will ________.
B) purchase; increase
 52) Suppose, at a given federal funds rate, there is an excess supply of reserves in the
federal funds market. If the Fed wants the federal funds rate to stay at that level, then it should
undertake an open market ________ of bonds, everything else held constant. If the Fed does
nothing, however, the federal funds rate will ________.
C) sale; decrease
 1) ________ are the most important monetary policy tool because they are the primary
determinant of changes in the ________, the main source of fluctuations in the money supply.
A) Open market operations; monetary base
 2) Open market purchases raise the ________ thereby raising the ________.
C) monetary base; money supply
 3) Open market purchases ________ reserves and the monetary base thereby ________
the money supply.
B) raise; raising
 4) Open market sales shrink ________ thereby lowering ________.
C) reserves and the monetary base; the money supply
 5) Open market sales ________ reserves and the monetary base thereby ________ the
money supply.
C) lower; lowering
 6) The two types of open market operations are
D) dynamic and defensive.
 7) There are two types of open market operations: ________ open market operations are
intended to change the level of reserves and the monetary base, and ________ open market
operations are intended to offset movements in other factors that affect the monetary base.
C) dynamic; defensive
 8) Open market operations intended to offset movements in noncontrollable factors (such

as float) that affect reserves and the monetary base are called
A) defensive open market operations.
 9) When the Federal Reserve engages in a repurchase agreement to offset a withdrawal of

Treasury funds from the Federal Reserve, the open market operation is said to be
A) defensive.
 10) The Federal Open Market Committee makes the Fedʹs decisions on the purchase or
sale of government securities, but these purchases or sales are executed by the Federal Reserve
Bank of
C) New York.
 11) The actual execution of open market operations is done at
B) the Federal Reserve Bank of New York.

 12) If float is predicted to decrease because of unseasonably good weather, the manager
of the trading desk at the Federal Reserve Bank of New York will likely conduct a ________
open market ________ of securities.
B) defensive; purchase
 13) When bad storms slow the check-clearing process, float tends to ________ causing
the Fed to initiate defensive open market ________.
C) increase; sales
 14) When good weather speeds the check-clearing process, float tends to ________
causing the Fed to initiate defensive open market ________.
B) decrease; purchases
 15) When bad storms slow the check-clearing process, float tends to ________ causing
the Fed to initiate ________ open market ________.
C) increase; defensive; sales
 16) When good weather speeds the check-clearing process, float tends to ________
causing the Fed to initiate ________ open market ________.
C) decrease; defensive; purchases
 17) If float is predicted to increase because of bad weather, the manager of the trading
desk at the New York Fed bank will likely conduct ________ open market operations to
________ reserves.
B) defensive; drain
 18) If float is predicted to decrease because of good weather, the manager of the trading
________ reserves.
A) defensive; inject
 19) If Treasury deposits at the Fed are predicted to increase, the manager of the trading
________ reserves.
A) defensive; inject
 20) If Treasury deposits at the Fed are predicted to ________, the manager of the trading
________ reserves.
A) increase; defensive; inject
 21) If Treasury deposits at the Fed are predicted to fall, the manager of the trading desk at
the New York Fed bank will likely conduct ________ open market operations to ________
reserves.
B) defensive; drain
 22) If Treasury deposits at the Fed are predicted to ________, the manager of the trading
________ reserves.
B) fall; defensive; drain
 23) If the Fed expects currency holdings to rise, it conducts open market ________ to
offset the expected ________ in reserves.
B) purchases; decrease
 24) If the Fed expects currency holdings to fall, it conducts open market ________ to
offset the expected ________ in reserves.
C) sales; increase
 25) If the banking system has a large amount of reserves, many banks will have excess
reserves to lend and the federal funds rate will probably ________; if the level of reserves is low,
few banks will have excess reserves to lend and the federal funds rate will probably ________.
B) fall; rise
 26) The Federal Reserve will engage in a repurchase agreement when it wants to
________ reserves________ in the banking system.
B) increase; temporarily
 27) If the Fed wants to temporarily inject reserves into the banking system, it will engage
in
A) a repurchase agreement.
 28) The Fed can offset the effects of an increase in float by engaging in
B) a matched sale-purchase transaction.
 29) The Federal Reserve will engage in a matched sale-purchase transaction when it
wants to________ reserves ________ in the banking system.
A) increase; permanently
 1) Discount policy affects the money supply by affecting the volume of ________ and the
________.
B) borrowed reserves; monetary base
 2) The discount rate is
A) the interest rate the Fed charges on loans to banks.
 3) The most common type of discount lending that the Fed extends to banks is called
C) primary credit.
 4) The most common type of discount lending, ________ credit loans, are intended to
help healthy banks with short-term liquidity problems that often result from temporary deposit
outflows.
B) primary
 5) When the Fed acts as a lender of last resort, the type of lending it provides is
C) secondary credit.
 6) The Fedʹs discount lending is of three types: ________ is the most common category;
________ is given to a limited number of banks in vacation and agricultural areas; ________ is
given to banks that have experienced severe liquidity problems.
C) primary credit; seasonal credit; secondary credit

 7) The discount rate is ________ kept ________ the federal funds rate.
D) typically; above
 8) The discount rate refers to the interest rate on
A) primary credit.
 9) The interest rate on secondary credit is set ________ basis points ________ the
primary credit rate.
C) 50; above
 10) The interest rate for primary credit is usually set ________ basis points ________ the
federal funds rate. In March 2008, this gap was changed to ________ basis points.
B) 100; above; 25
 11) The interest rate on seasonal credit equals
D) an average of the federal funds rate and rates on certificates of deposits.
 12) The Fed is considering eliminating
C) seasonal credit lending.
 13) At its inception, the Federal Reserve was intended to be
C) a lender-of-last-resort.
 14) Much of the credit for prevention of a financial market meltdown after ʺBlack
Mondayʺ (October 19, 1987) must be given to the Federal Reserve System and its chairman
D) Alan Greenspan.
 15) A financial panic was averted in October 1987 following ʺBlack Mondayʺ when the
Fed announced that
B) it would provide discount loans to any bank that would make loans to the security industry.
 16) The facility that was created in December of 2007 that banks can use to borrow from
the Fed that has less of a stigma for banks compared to borrowing from the discount window is
the ________.
B) Term Auction Facility
 17) Which of the following special lending facilities set up by the Federal Reserve is
reserve neutral?
C) Term Securities Lending Facility
 18) The Fedʹs lender-of-last-resort function
D) creates a moral hazard problem.
 19) The most important advantage of discount policy is that the Fed can use it to
B) perform its role as lender of last resort.

 1) An increase in ________ reduces the money supply since it causes the ________ to
fall.
B) reserve requirements; money multiplier
 2) A decrease in ________ increases the money supply since it causes the ________ to
rise.
B) reserve requirements; money multiplier
 3) The Federal Reserve has had the authority to vary reserve requirements since the
B) 1930s.
 4) Since 1980, ________ are subject to reserve requirements.
D) all depository institutions
 5) Funds held in ________ are subject to reserve requirements.
A) all checkable deposits
 6) The policy tool of changing reserve requirements is
C) no longer used.
CH16 (6 of 10): Tools of Monetary Policy: P. 409

In Ch15, we saw how MB=MBn + BR is constructed.
Reserves of banks are very important.
16.1 The Market for Reserves and the Federal Funds Rate:
FED can lend funds to banks at Discount rate (i d ).
Banks keeps reserve balances (called Federal Fund) @ the FED to earn little interest rate (i er ) or (i ¿).
Banks actively trade reserve balances with each other (usually overnight).
Banks charges each other a favorable interest rate (called federal funds rate (i ff ) or inter-bank rate).
Banks negotiate federal funds rate between themselves.
FED keeps close eye on the federal funds rate (i ff ) & actually targets the federal funds rate.
Note: Discount rate (i d ) > federal funds rate (i¿¿ ff ) ¿ > little interest rate (i er ) that is paid on these ER @
FED.
Demand for Reserves ( Rd ): that’s means how much banks are willing to keep ER:
Reserves (R): R=RR+ ER :

RR=( rrr x D )
ER = is additional reserves banks choose to hold.
Excess reserves (ER) are extra insurance against deposit outflows.
The cost of holding these ER is their opportunity cost (OC).
Opportunity Cost (OC) of ER = i. r . that could have been earned −i er
Opportunity Cost (OC) of ER = i. r . doing traditional business−ier
Opportunity Cost (OC) of ER = i ff −i er = the difference = the Gap
When i ff >i er : ¿ ↓i ff → ↓OC →↑ Q dER → banks are willing ¿ keep more ER

When i ff >i er : ¿ ↑i ff → ↑OC →↓ Q dER → banks are willing ¿ keep less ER
→ a downward sloping demand for reserves ( Rd ) curve (negative relationship between i ff & Q dER).
If i ff =i er : OC is ZERO and banks will keep all ER. Rd curve will become FLAT (perfect Elastic).
Supply for Reserves ( R s): that’s means how the Fed is willing to provide ER:
R s = Reserves supplied by the Fed’s OMO + Reserves borrowed from the FED @ (i d ) cost.
R s = non-borrowed reserves (NBR) + borrowed reserves (BR)

R s = NBR + BR
If i ff <i d : banks will not borrow from the FED → BR=0 → R s = NBR only (by FED OMO)
s s
→ R s Not interest-sensitive → ↑ ↓i ff → Q´ER → R curve will be VERTICAL(perfect Inelastic).
If i ff >i d : It’s too good to be true. Banks will borrow from Fed @ i d then re-lend to others @ i ff .
→ all bank will borrow from FED @ known i d → R s curve will become FLAT (perfect Elastic).
Figure 1: Equilibrium in the Market for Reserves (P410):
Reserves Market Equilibrium:
When Rd curve intersects with R s curve, we have market equilibrium and Q dER = Q sER at point 1.
At i 2ff , we have excess supply of reserves → i ff would go lower toward the red dotted line.
At i 1ff , we have excess demand of reserves → i ff would go higher toward the red dotted line.
¿
At point 1, we have market equilibrium i ff with no excess reserves.
Summary:
Banks are always in a hunt for funds & the dynamic i ff .
FED keeps close eye on the federal funds rate (i ff ) & actually targets the federal funds rate.
How Changes in the Tools of Monetary Policy Affect the Federal Funds Rate (i ff )?
16.2 Open Market Operations:
Figure 2: i ff Response to an Open Market Operation (OMO):

16.3 Discount Policy:
Figure 3: i ff Response to a Change in the Discount Rate (i d ):
16.4 Reserve Requirements
Figure 4: i ff Response to a Change in Required Reserves (rrr):
16.5 Change in the Interest Rate (i er or i ¿) on Reserves
Figure 5: i ff Response to a Change in the Interest Rate (i er or i ¿) on Reserves:

CH17 (7 of 10): The Conduct of Monetary Policy (MP): Strategy, & Tactics:
P434
MB = C + R
Δ MB = ΔC + Δ R
Δ MS = m x Δ MB
17.1 Goals of monetary policy (MP):

 Maintaining a stable price level (controlling inflation rate) by controlling money supply (MS). The most
common goal for policymakers.
Other Goals:
 High employment and output stability.
 Maintain economic growth.
 Stability of financial markets.
 Interest-rate stability.
 Stability in foreign exchange markets.
17.2 Tactics: Choosing the Policy Instrument:

• Tools:
– Open market operation (OMO)
– Reserve requirements (rrr)
– Discount rate (i d )
• Policy instruments (operating instruments):
– Reserve aggregates (R)
– Interest rates (i.r.)
Figure 2: Linkages between Central Bank Tools, Policy Instruments, Intermediate Targets,
and Goals of Monetary Policy
Figure 3: Result of Targeting on Nonborrowed Reserves (NBR).
Figure 4: Result of Targeting on the Federal Funds Rate (i ff ).

CH15 (5 of 10): The Money Supply (MS) Process: P. 379
We need to know how the banking system creates deposits as a big part of the money supply (MS).
15.1 Three Players in the Money Supply Process:
Player1: The Central Bank (Federal Reserve System_FED): to conduct the monetary policy.
Player2: Banks (depository institutions): financial intermediaries.
Player3: Depositors: Individuals & Institutions.
15.2 The Central Bank (Fed’s) Balance Sheet:
15.3 Control of the Monetary Base (MB):

MB Definition: The SUM of the Fed’s monetary liabilities (banknotes “the green” in circulation &
reserves) PLUS U.S. Treasury’s monetary liabilities (primarily coins “the gray”)
MB also called “high-powered money”
MB=C+ R
Where C is Fed’s banknotes (more than %90 of C) + Treasury’s coins (less than
%10 of C) & R is total reserves in banking system +
15.3.1 Federal Reserve Open Market Operations (OMO):

Fed causes Δ in MB through its Open Market Operations, sell/buy securities (e.g., T-bills, Bonds).
Example 1: Open Market Purchase from a Bank by a check (deposited @ Fed or cashed in Vault):
Example 2: Open Market Purchase from the Nonbank Public by a check (deposited @ bank):
Example 3: Open Market Purchase from the Nonbank Public by a check (get cash @ FED):
OMO Purchase: Summary:
1- The effect of an OMO purchase on “R” depends on whether the seller of the bonds keeps the
proceeds from the sale in currency or in deposits.
2- The effect of an OMO purchase on the MB always increases the MB by the amount of the purchase.
Example 4: Open Market Sale to the Nonbank Public (pay cash):
Example 5: Open Market Sale to a Bank (pay from deposit @ Fed= from Reserves):
OMO Sale: Summary: The effect of OMO sale on the MB is much more certain than the effect on
reserves (R).
15.3.2 Shifts from Deposits into Currency (No effect on MB & Fed does not conduct OMO):
If the public decided to hold more $100M currency in hand.
Deposits into Currency Summary:
1- R is changed by random fluctuations.
2- MB is a more stable variable.
3- That’s why Fed has more control over the MB than over R.
15.3.3 Loans to Financial Institutions (Fed does not conduct OMO but there is effect on MB):
Fed makes $100M loan to a bank (Discounted loan @ discount rate).
Loans to Financial Institutions Summary: Monetary liabilities of the Fed have increased by $100M & MB
also increases by this amount.
15.3.4 Overview of the Fed’s Ability to Control the Monetary Base (MB):
1- Open market operations (OMO) are completely controlled by the Fed. Called “nonborrowed MB (
MB n ¿”.
2- The Fed cannot determine the amount of borrowing (loans) by banks from the Fed & depends on how
eager the banks are & what is the discount rate. Fed has lightly control & Called “borrowed reserves
from the fed (BR)”.
Now:
MB=MBn + BR
Rearranging, MB n=MB−BR
Where, MB n = non-borrowed MB, MB = Monetary Base, BR = borrowed reserves from the fed.
Note: The MS is positively related to both the MBn and to the level of BR, from the Fed.
15.4 Multiple Deposit Creation: A Simple Model
15.4.1 Deposit Creation: The Single Bank:
Note: The Money Supply (MS) has increased by $100M.

15.4.2 Deposit Creation: The Banking System:
We assume the borrower from 1st National bank bought goods for $100M & wrote a check for a
merchant. The merchant will deposit the check in his Bank A account.
Note: The Money Supply (MS) has increased by another $90M & another $81M. And so forth.
Creation of Deposits (assuming 10% reserve requirement and an initial $100 increase in reserves:
Note: The Money Supply (MS) has
increased by a total of $1000M in the banking system.
15.4.3 Deriving the Formula for Multiple Deposit Creation:

We know R=RR+ ER
If banks decided to use all ER from checkable Deposits (D) in order to maximize profits, they will loan
out any ER & hold only RR.
Then, R=RR+ ER → R=RR+0 → R=RR Or
rewrite as RR=R (1)
The total amount of RR=rrr x D (e,g., 10 = 0.10 x 100, 9 = 0.10 x 90, 8.1 = 0.10 x 81, etc)
recal , RR=R
now rrr x D=R
rrr x D R
=
rrr rrr
1
D= xR
rrr
1
∆ D= x ∆ R(1)
rrr
1
1000= x 100
0.10
1000=10 x 100
∴ ∆ MS=∆ D=$ 1000 M
15.4.4 Critique of the Simple Model:
1- Holding cash stops the process. Since currency has no multiple deposit expansion.
2- Banks may not use all of their ER to make loans.
3- Depositors’ decisions (how much currency to hold) cause the MS to change.
15.5 Factors that Determine the Money Supply (MS):
1- Changes in the non-borrowed monetary base MBn created by OMO. ↑ MBn → ↑ MS
2- Changes in borrowed reserves BR from the Fed at discount rate. ↑ BR → ↑ MS
3- Changes in the required reserves ratio (rrr). ↑ rrr → ↓ MS
4- Changes in currency (C) holdings. ↑ Currency holdings → ↓ MS

5- Changes in excess reserves (ER). ↑ ER → ↓ MS
15.6 The Money Multiplier (m):

15.6.1 Deriving the Money Multiplier (m):
How much the MS (M=M1=currency (C) + checkable deposits (D)) changes for a given change
in monetary base MB ( MB=currency ∈circulation ( C )+ Reserves(R))
M =m x MB (2.1)
similarly , ∆ M =m x ∆ MB (2.2)
Any change in Fed’s intention to control MS by controlling MB (via OMO) will be affected by
the value of a multiplier (m).
Assume ↑ holdings of currency (C) & ↑ excess reserves (ER) are proportionally related to ↑ checkable
deposits (D)
Then define:
C ER
 Currency Ratio (c): c ¿ , and Excess Reserves Ratio (e): e=
D D
 Recall, Reserves (R): R=RR+ ER=( rrr x D )+ ER (3)
 Recall, MB=currency ∈circulation ( C )+ Reserves ( R ) =C+ R(4)
Substituting equation (3) into equation (4):
 Now, MB=C+ R=C+ RR+ ER=C+ ( rrr x D ) + ER(5)
Equation (5) reveals the amount of the MB needed to support the existing amounts of checkable
deposits (D), currency (C) & excess reserves (ER).
C
 From the Currency Ratio (c): c ¿ we can drive C as : C=c x D
D
ER
 From Excess Reserves Ratio (e): e= we can drive ER as : ER=e x D
D
Substituting C & ER into equation (5):
MB=C+ ( rrr x D ) + ER= ( c x D )+ ( rrr x D ) +( e x D)(6)
MB=(c+ rrr+e) x D(7)
Or,
1
D= x MB (8)
c +rrr+ e
Recall, MS or simple M1, M = Currency (C) + Checkable Deposits (D), Or M = D+C (9)
Rewrite (9) by substituting C = c x D into (9), we get: M =D+ ( c x D ) =( 1+ c ) D(10)
Substitute equation (8) into (10):
1 1+c
M =( 1+c ) D=( 1+c ) x MB= x MB=m x MB (11)
c+rrr +e c +rrr+ e
1+c
Hence, the money multiplier (m) can be expressed as: m= >1 if u recall eq. (2.1)
c +rrr+ e
15.6.2 Intuition behind the Money Multiplier:
Required Reserves Ratio (rrr) = 0.10 (set by FED)
Currency in Circulation (C) = $400B (reflects depositor’s behavior)
Checkable Deposits (D) = $800B (available bank’s funds to do business)
Excess Reserves (ER) = $0.8B (reflects banks behavior)
Money supply (MS) = M = M1 = C + D = $400B + $800B = $1200B
C $ 400 B 1
Currency Ratio (c): c ¿ = = =0.50
D $ 800 B 2
ER $ 0.8 B
Excess Reserves Ratio (e): e= = =¿ 0.001
D $ 800 B
1+c 1+ 0.50 1.50
Money multiplier m= = = =2.5
c +rrr+ e 0.50+0.10+ 0.001 0.601
1 1
Comparing to the simple deposit multiplier = =10, this is smaller although there was
rrr 0.10
multiple expansion of deposits but clearly not to full capacity.
∆ M =m x ∆ MB=2.5 x ∆ MB
Conclusion: A $1 increase in the MB (MB=C+R or MB= MB n+ BR ) leads to a $2.50 increase
in the money supply (M1).
15.6.3 MS Response to Changes in the Factors:

Only change Required Reserves Ratio (rrr) = 0.10 (set by FED) to 0.15:
1+c 1+ 0.50 1.50
Money multiplier m= = = =2.3
c +rrr+ e 0.50+0.15+ 0.001 0.651
See book page 399 for other numerical examples.
Answer: A
2
Individuals that lend funds to a bank by opening a checking account are called
1. A) policyholders.
2. B) partners.
3. C) depositors.
4. D) debt holders.
Answer: C
3
The three players in the money supply process include
1. A) banks, depositors, and the U.S. Treasury.
2. B) banks, depositors, and borrowers.
3. C) banks, depositors, and the central bank.
4. D) banks, borrowers, and the central bank.
Answer: C
4
Of the three players in the money supply process, most observers agree that the most
important player is
1. A) the United States Treasury.
2. B) the Federal Reserve System.
3. C) the FDIC.
4. D) the Office of Thrift Supervision.
Answer: B
5
Both ________ and ________ are Federal Reserve assets.
1. A) currency in circulation; reserves
2. B) currency in circulation; securities
3. C) securities; loans to financial institutions
4. D) securities; reserves
Answer: C
6
The monetary liabilities of the Federal Reserve include
1. A) securities and loans to financial institutions.
2. B) currency in circulation and reserves.
3. C) securities and reserves.
4. D) currency in circulation and loans to financial institutions.
Answer: B
7
Both ________ and ________ are monetary liabilities of the Fed.
1. A) securities; loans to financial institutions
2. B) currency in circulation; reserves
3. C) securities; reserves
4. D) currency in circulation; loans to financial institutions
Answer: B
8
The sum of the Fed's monetary liabilities and the U.S. Treasury's monetary liabilities is
called
1. A) the money supply.
2. B) currency in circulation.
3. C) bank reserves.
4. D) the monetary base.
Answer: D
9
The monetary base consists of
1. A) currency in circulation and Federal Reserve notes.
2. B) currency in circulation and the U.S. Treasury's monetary liabilities.
3. C) currency in circulation and reserves.
4. D) reserves and Federal Reserve Notes.
Answer: C
10
Total reserves minus bank deposits with the Fed equals
1. A) vault cash.
2. B) excess reserves.
3. C) required reserves.
4. D) currency in circulation.
Answer: A
11
Reserves are equal to the sum of
1. A) required reserves and excess reserves.
2. B) required reserves and vault cash reserves.
3. C) excess reserves and vault cash reserves.
4. D) vault cash reserves and total reserves.
Answer: A
12
Total reserves are the sum of ________ and ________.
1. A) excess reserves; borrowed reserves
2. B) required reserves; currency in circulation
3. C) vault cash; excess reserves
4. D) excess reserves; required reserves
Answer: D
13
Excess reserves are equal to
1. A) total reserves minus discount loans.
2. B) vault cash plus deposits with Federal Reserve banks minus required
reserves.
3. C) vault cash minus required reserves.
4. D) deposits with the Fed minus vault cash plus required reserves.
Answer: B
14
Total Reserves minus vault cash equals
1. A) bank deposits with the Fed.
2. B) excess reserves.
3. C) required reserves.
4. D) currency in circulation.
Answer: A
15
The amount of deposits that banks must hold in reserve is
1. A) excess reserves.
2. B) required reserves.
3. C) total reserves.
4. D) vault cash.
Answer: B
16
The percentage of deposits that banks must hold in reserve is the
1. A) excess reserve ratio.
2. B) required reserve ratio.
3. C) total reserve ratio.
4. D) currency ratio.
Answer: B
17
Suppose that from a new checkable deposit, First National Bank holds two million
dollars in vault cash, eight million dollars on deposit with the Federal Reserve, and one
million dollars in required reserves. Given this information, we can say First National
Bank has ________ million dollars in excess reserves.
1. A) three
2. B) nine
3. C) ten
4. D) eleven
Answer: B
18
dollars in vault cash, eight million dollars on deposit with the Federal Reserve, and one
million dollars in required reserves. Given this information, we can say First National
Bank faces a required reserve ratio of ________ percent.
1. A) ten
2. B) twenty
3. C) eighty
4. D) ninety
Answer: A
19
dollars in vault cash, eight million dollars on deposit with the Federal Reserve, and nine
million dollars in excess reserves. Given this information, we can say First National Bank
has ________ million dollars in required reserves.
1. A) one
2. B) two
3. C) eight
4. D) ten
Answer: A
20
dollars in vault cash, eight million dollars on deposit with the Federal Reserve, and nine
million dollars in excess reserves. Given this information, we can say First National Bank
faces a required reserve ratio of ________ percent.
1. A) ten
2. B) twenty
3. C) eighty
4. D) ninety
Answer: A
21
Suppose that from a new checkable deposit, First National Bank holds eight million
dollars on deposit with the Federal Reserve, one million dollars in required reserves, and
faces a required reserve ratio of ten percent. Given this information, we can say First
National Bank has ________ million dollars in excess reserves.
1. A) two
2. B) eight
3. C) nine
4. D) ten
Answer: C
22
dollars on deposit with the Federal Reserve, one million dollars in required reserves, and
National Bank has ________ million dollars in vault cash.
1. A) two
2. B) eight
3. C) nine
4. D) ten
Answer: A
23
dollars in vault cash, nine million dollars in excess reserves, and faces a required reserve
ratio of ten percent. Given this information, we can say First National Bank has ________
million dollars in required reserves.
1. A) one
2. B) two
3. C) eight
4. D) ten
Answer: A
24
dollars in vault cash, nine million dollars in excess reserves, and faces a required reserve
ratio of ten percent. Given this information, we can say First National Bank has ________
million dollars on deposit with the Federal Reserve.
1. A) one
2. B) two
3. C) eight
4. D) ten
Answer: C
25
dollars in vault cash, one million dollars in required reserves, and faces a required
reserve ratio of ten percent. Given this information, we can say First National Bank has
________ million dollars in excess reserves.
1. A) one
2. B) two
3. C) nine
4. D) ten
Answer: C
26
dollars in vault cash, one million dollars in required reserves, and faces a required
reserve ratio of ten percent. Given this information, we can say First National Bank has
________ million dollars on deposit with the Federal Reserve.
1. A) one
2. B) two
3. C) eight
4. D) ten
Answer: C
27
dollars on deposit with the Federal Reserve, nine million dollars in excess reserves, and
National Bank has ________ million dollars in required reserves.
1. A) one
2. B) two
3. C) nine
4. D) ten
Answer: A
28
dollars on deposit with the Federal Reserve, nine million dollars in excess reserves, and
National Bank has ________ million dollars in vault cash.
1. A) one
2. B) two
3. C) nine
4. D) ten
Answer: B
29
The interest rate the Fed charges banks borrowing from the Fed is the
1. A) federal funds rate.
2. B) Treasury bill rate.
3. C) discount rate.
4. D) prime rate.
Answer: C
30
When banks borrow money from the Federal Reserve, these funds are called
1. A) federal funds.
2. B) discount loans.
3. C) federal loans.
4. D) Treasury funds.
Answer: B
Answer: B
31
The monetary base minus currency in circulation equals
1. A) reserves.
2. B) the borrowed base.
3. C) the nonborrowed base.
4. D) discount loans.
Answer: A
32
The monetary base minus reserves equals
1. A) currency in circulation.
Answer: A
33
High-powered money minus reserves equals
1. A) reserves.
2. B) currency in circulation.
3. C) the monetary base.
4. D) the nonborrowed base.
Answer: B
34
High-powered money minus currency in circulation equals
1. A) reserves.
Answer: A
35
Purchases and sales of government securities by the Federal Reserve are called
1. A) discount loans.
2. B) federal fund transfers.
3. C) open market operations.
4. D) swap transactions.
Answer: C
36
When the Federal Reserve purchases a government bond from a primary dealer,
reserves in the banking system ________ and the monetary base ________, everything else
held constant.
1. A) increase; increases
2. B) increase; decreases
3. C) decrease; increases
4. D) decrease; decreases
Answer: A
37
When the Federal Reserve sells a government bond to a primary dealer, reserves in the
banking system ________ and the monetary base ________, everything else held constant.
Answer: D
38
When a primary dealer sells a government bond to the Federal Reserve, reserves in the
banking system ________ and the monetary base ________, everything else held constant.
Answer: A
39
When a primary dealer buys a government bond from the Federal Reserve, reserves in
the banking system ________ and the monetary base ________, everything else held
constant.
Answer: D
40
When the Fed buys $100 worth of bonds from a primary dealer, reserves in the banking
system
1. A) increase by $100.
2. B) increase by more than $100.
3. C) decrease by $100.
4. D) decrease by more than $100.
Answer: A
41
When the Fed sells $100 worth of bonds to a primary dealer, reserves in the banking
system
Answer: C
42
When the Fed extends a $100 discount loan to the First National Bank, reserves in the
banking system
Answer: A
43
All else the same, when the Fed calls in a $100 discount loan previously extended to the
First National Bank, reserves in the banking system
Answer: C
44
When the Federal Reserve extends a discount loan to a bank, the monetary base ________
and reserves ________.
1. A) remains unchanged; decrease
2. B) remains unchanged; increase
3. C) increases; increase
4. D) increases; remain unchanged
Answer: C
45
When the Federal Reserve calls in a discount loan from a bank, the monetary base
________ and reserves ________.
1. A) remains unchanged; decrease
2. B) remains unchanged; increase
3. C) decreases; decrease
4. D) decreases; remains unchanged
Answer: C
46
If the Fed decides to reduce bank reserves, it can
1. A) purchase government bonds.
2. B) extend discount loans to banks.
3. C) sell government bonds.
4. D) print more currency.
Answer: C
47
There are two ways in which the Fed can provide additional reserves to the banking
system: it can ________ government bonds or it can ________ discount loans to commercial
banks.
1. A) sell; extend
2. B) sell; call in
3. C) purchase; extend
4. D) purchase; call in
Answer: C
48
A decrease in ________ leads to an equal ________ in the monetary base in the short run.
1. A) float; increase
2. B) float; decrease
3. C) Treasury deposits at the Fed; decrease
4. D) discount loans; increase
Answer: B
49
The monetary base declines when
1. A) the Fed extends discount loans.
2. B) Treasury deposits at the Fed decrease.
3. C) float increases.
4. D) the Fed sells securities.
Answer: D
50
An increase in ________ leads to an equal ________ in the monetary base in the short run.
1. A) float; decrease
2. B) float; increase
3. C) discount loans; decrease
4. D) Treasury deposits at the Fed; increase
Answer: B
51
Suppose a person cashes his payroll check and holds all the funds in the form of
currency. Everything else held constant, total reserves in the banking system ________ and
the monetary base ________.
1. A) remain unchanged; increases
2. B) decrease; increases
3. C) decrease; remains unchanged
Answer: C
52
Suppose your payroll check is directly deposited to your checking account. Everything
else held constant, total reserves in the banking system ________ and the monetary base
________.
1. A) remain unchanged; remains unchanged
2. B) remain unchanged; increases
Answer: A
53
The Fed does not tightly control the monetary base because it does NOT completely
control
1. A) open market purchases.
2. B) open market sales.
3. C) borrowed reserves.
4. D) the discount rate.
Answer: C
54
Subtracting borrowed reserves from the monetary base obtains
1. A) reserves.
2. B) high-powered money.
3. C) the nonborrowed monetary base.
4. D) the borrowed monetary base.
Answer: C
55
The relationship between borrowed reserves (BR), the nonborrowed monetary base
(MBn), and the monetary base (MB) is
1. A) MB = MBn- BR.
2. B) BR = MBn- MB.
3. C) BR = MB - MBn.
4. D) MB = BR - MBn.
Answer: C
56
Explain two ways by which the Federal Reserve System can increase the monetary base.
Why is the effect of Federal Reserve actions on bank reserves less exact than the effect
on the monetary base?
Answer: The Fed can increase the monetary base by purchasing government bonds and
by extending discount loans. Because the Fed cannot control the distribution of the
monetary base between reserves and currency, it has less control over reserves than the
base.
57
When the Fed supplies the banking system with an extra dollar of reserves, deposits
increase by more than one dollar—a process called
1. A) extra deposit creation.
2. B) multiple deposit creation.
3. C) expansionary deposit creation.
4. D) stimulative deposit creation.
Answer: B
58
When the Fed supplies the banking system with an extra dollar of reserves, deposits
________ by ________ than one dollar—a process called multiple deposit creation.
1. A) increase; less
2. B) increase; more
3. C) decrease; less
4. D) decrease; more
Answer: B
59
If the required reserve ratio is equal to 10 percent, a single bank can increase its loans
up to a maximum amount equal to
1. A) its excess reserves.
2. B) 10 times its excess reserves.
3. C) 10 percent of its excess reserves.
4. D) its total reserves.
Answer: A
60
In the simple deposit expansion model, if the Fed purchases $100 worth of bonds from a
bank that previously had no excess reserves, the bank can now increase its loans by
1. A) $10.
2. B) $100.
3. C) $100 times the reciprocal of the required reserve ratio.
4. D) $100 times the required reserve ratio.
Answer: B
61
In the simple deposit expansion model, if the Fed purchases $100 worth of bonds from a
bank that previously had no excess reserves, deposits in the banking system can
potentially increase by
1. A) $10.
2. B) $100.
Answer: C
62
In the simple deposit expansion model, if the Fed extends a $100 discount loan to a
bank that previously had no excess reserves, the bank can now increase its loans by
1. A) $10.
2. B) $100.
Answer: B
63
In the simple deposit expansion model, if the Fed extends a $100 discount loan to a
bank that previously had no excess reserves, deposits in the banking system can
potentially increase by
1. A) $10.
2. B) $100.
Answer: C
64
In the simple model of multiple deposit creation in which banks do not hold excess
reserves, the increase in checkable deposits equals the product of the change in reserves
and the
1. A) reciprocal of the excess reserve ratio.
2. B) simple deposit expansion multiplier.
3. C) reciprocal of the simple deposit multiplier.
4. D) discount rate.
Answer: B
65
The simple deposit multiplier can be expressed as the ratio of the
1. A) change in reserves in the banking system divided by the change in
deposits.
2. B) change in deposits divided by the change in reserves in the banking
system.
3. C) required reserve ratio divided by the change in reserves in the banking
system.
4. D) change in deposits divided by the required reserve ratio.
Answer: B
66
If reserves in the banking system increase by $100, then checkable deposits will increase
by $1000 in the simple model of deposit creation when the required reserve ratio is
1. A) 0.01.
2. B) 0.10.
3. C) 0.05.
4. D) 0.20.
Answer: B
67
1. A) 0.01.
2. B) 0.10.
3. C) 0.05.
4. D) 0.20
Answer: D
68
If the required reserve ratio is 10 percent, the simple deposit multiplier is
1. A) 5.0.
2. B) 2.5.
3. C) 100.0.
4. D) 10.0
Answer: D
69
1. A) 15.0.
2. B) 1.5.
3. C) 6.67.
4. D) 3.33.
Answer: C
70
1. A) 5.0.
2. B) 2.5.
3. C) 4.0.
4. D) 10.0.
Answer: A
71
1. A) 5.0.
2. B) 2.5.
3. C) 4.0.
4. D) 10.0.
Answer: C
72
A simple deposit multiplier equal to one implies a required reserve ratio equal to
1. A) 100 percent.
2. B) 50 percent.
3. C) 25 percent.
4. D) 0 percent.
Answer: A
73
A simple deposit multiplier equal to two implies a required reserve ratio equal to
1. A) 100 percent.
2. B) 50 percent.
3. C) 25 percent.
4. D) 0 percent.
Answer: B
74
A simple deposit multiplier equal to four implies a required reserve ratio equal to
1. A) 100 percent.
2. B) 50 percent.
3. C) 25 percent.
4. D) 0 percent.
Answer: C
75
In the simple deposit expansion model, if the banking system has excess reserves of $75,
and the required reserve ratio is 20%, the potential expansion of checkable deposits is
1. A) $75.
2. B) $750.
3. C) $37.50.
4. D) $375.
Answer: D
76
In the simple deposit expansion model, if the required reserve ratio is 20 percent and
the Fed increases reserves by $100, checkable deposits can potentially expand by
1. A) $100.
2. B) $250.
3. C) $500.
4. D) $1,000.
Answer: C
77
In the simple deposit expansion model, if the required reserve ratio is 10 percent and
the Fed increases reserves by $100, checkable deposits can potentially expand by
1. A) $100.
2. B) $250.
3. C) $500.
4. D) $1,000.
Answer: D
78
In the simple deposit expansion model, an expansion in checkable deposits of $1,000
when the required reserve ratio is equal to 20 percent implies that the Fed
1. A) sold $200 in government bonds.
2. B) sold $500 in government bonds.
3. C) purchased $200 in government bonds.
4. D) purchased $500 in government bonds.
Answer: C
79
In the simple deposit expansion model, an expansion in checkable deposits of $1,000
when the required reserve ratio is equal to 10 percent implies that the Fed
1. A) sold $1,000 in government bonds.
Answer: D
80
In the simple deposit expansion model, a decline in checkable deposits of $1,000 when
the required reserve ratio is equal to 20 percent implies that the Fed
Answer: A
81
In the simple deposit expansion model, a decline in checkable deposits of $1,000 when
1. A) sold $1,000 in government bonds.
3. C) purchased $1,000 in government bonds.
Answer: B
82
In the simple deposit expansion model, a decline in checkable deposits of $500 when
Answer: B
83
In the simple deposit expansion model, a decline in checkable deposits of $500 when
3. C) sold $50 in government bonds.
Answer: B
84
1. A) 0.01.
2. B) 0.10.
3. C) 0.20.
4. D) 0.25.
Answer: D
85
1. A) 0.01.
2. B) 0.05.
3. C) 0.15.
4. D) 0.20.
Answer: C
86
1. A) 0.01.
2. B) 0.10.
3. C) 0.20.
4. D) 1.00.
Answer: D
87
by $2,000 in the simple model of deposit creation when the required reserve ratio is
1. A) 0.01.
2. B) 0.05.
3. C) 0.10.
4. D) 0.20.
Answer: B
88
1. A) 0.04.
2. B) 0.25.
3. C) 0.40.
4. D) 0.50.
Answer: C
89
If a bank has excess reserves of $10,000 and demand deposit liabilities of $80,000, and if
the reserve requirement is 20 percent, then the bank has actual reserves of
1. A) $16,000.
2. B) $20,000.
3. C) $26,000.
4. D) $36,000.
Answer: C
90
the reserve requirement is 20 percent, then the bank has total reserves of
1. A) $16,000.
2. B) $20,000.
3. C) $26,000.
4. D) $36,000.
Answer: D
91
1. A) $11,000.
2. B) $20,000.
3. C) $21,000.
4. D) $26,000.
Answer: C
92
the reserve requirement is 20 percent, then the bank has total reserves of
1. A) $11,000.
2. B) $21,000.
3. C) $31,000.
4. D) $41,000.
Answer: C
93
1. A) $17,000.
2. B) $19,000.
3. C) $24,000.
4. D) $29,000.
Answer: B
94
1. A) $14,000.
2. B) $19,000.
3. C) $24,000.
4. D) $29,000.
Answer: A
95
1. A) $17,000.
2. B) $22,000.
3. C) $27,000.
4. D) $29,000.
Answer: B
96
1. A) $14,000.
2. B) $17,000.
3. C) $22,000.
4. D) $27,000.
Answer: B
97
A bank has excess reserves of $6,000 and demand deposit liabilities of $100,000 when
the required reserve ratio is 20 percent. If the reserve ratio is raised to 25 percent, the
bank's excess reserves will be
1. A) -$5,000.
2. B) -$1,000.
3. C) $1,000.
4. D) $5,000.
Answer: C
98
1. A) -$5,000.
2. B) -$1,000.
3. C) $1,000.
4. D) $5,000.
Answer: B
99
1. A) -$5,000.
2. B) -$1,000.
3. C) $1,000.
4. D) $5,000.
Answer: D
100
A bank has no excess reserves and demand deposit liabilities of $100,000 when the
required reserve ratio is 20 percent. If the reserve ratio is raised to 25 percent, the bank's
excess reserves will now be
1. A) -$5,000.
2. B) -$1,000.
3. C) $1,000.
4. D) $5,000.
Answer: A
101
A bank has excess reserves of $1,000 and demand deposit liabilities of $80,000 when the
reserve requirement is 20 percent. If the reserve requirement is lowered to 10 percent,
the bank's excess reserves will be
1. A) $1,000.
2. B) $8,000.
3. C) $9,000.
4. D) $17,000.
Answer: C
102
A bank has excess reserves of $1,000 and demand deposit liabilities of $80,000 when the
reserve requirement is 25 percent. If the reserve requirement is lowered to 20 percent,
the bank's excess reserves will be
1. A) $1,000.
2. B) $5,000.
3. C) $8,000.
4. D) $9,000.
Answer: B
103
Decisions by depositors to increase their holdings of ________, or of banks to hold
________ will result in a smaller expansion of deposits than the simple model predicts.
1. A) deposits; required reserves
2. B) deposits; excess reserves
3. C) currency; required reserves
4. D) currency; excess reserves
Answer: D
104
Decisions by depositors to increase their holdings of ________, or of banks to hold excess
reserves will result in a ________ expansion of deposits than the simple model predicts.
1. A) deposits; smaller
2. B) deposits; larger
3. C) currency; smaller
4. D) currency; larger
Answer: C
105
Decisions by ________ about their holdings of currency and by ________ about their
holdings of excess reserves affect the money supply.
1. A) borrowers; depositors
2. B) banks; depositors
3. C) depositors; borrowers
4. D) depositors; banks
Answer: D
106
Assume that no banks hold excess reserves, and the public holds no currency. If a bank
sells a $100 security to the Fed, explain what happens to this bank and two additional
steps in the deposit expansion process, assuming a 10% reserve requirement. How
much do deposits and loans increase for the banking system when the process is
completed?
Answer: Bank A first changes a security for reserves, and then lends the reserves,
creating loans. It receives $100 in reserves from the sale of securities. Since all of these
reserve will be excess reserves (there was no change in checkable deposits), the bank
will loan out all $100. The $100 will then be deposited into Bank B. This bank now has a
change in reserves of $100, of which $90 is excess reserves. Bank B will loan out this $90,
which will be deposited into Bank C. Bank C now has an increase in reserves of $90, $81
of which is excess reserves. Bank C will loan out this $81 dollars and the process will
continue until there are no more excess reserves in the banking system.
For the banking system, both loans and deposits increase by $1000.
107
Explain two reasons why the Fed does not have complete control over the level of bank
deposits and loans. Explain how a change in either factor affects the deposit expansion
process.
Answer: The Fed does not completely control the level of bank deposits and loans
because banks can hold excess reserves and the public can change its currency holdings.
A change in either factor changes the deposit expansion process. An increase in either
excess reserves or currency reduces the amount by which deposits and loans are
increased.
108
Explain why the simple deposit multiplier overstates the true deposit multiplier.
Answer: The simple model ignores the role banks and their customers play in the
creation process. The bank's customers can decide to hold currency and the bank can
decide to hold excess reserves. Both of these will restrict the banking system's ability to
create deposits. Thus, the true multiplier is less than the prediction of the simple deposit
multiplier.
109
An increase in the nonborrowed monetary base, everything else held constant, will
cause
1. A) the money supply to fall.
2. B) the money supply to rise.
3. C) no change in the money supply.
4. D) demand deposits to fall.
Answer: B
110
The money supply is ________ related to the nonborrowed monetary base, and ________
related to the level of borrowed reserves.
1. A) positively; negatively
2. B) negatively; not
3. C) positively; positively
4. D) negatively; negatively
Answer: C
111
The amount of borrowed reserves is ________ related to the discount rate, and is ________
related to the market interest rate.
1. A) negatively; negatively
2. B) negatively; positively
3. C) positively; negatively
4. D) positively; positively
Answer: B
112
A ________ in market interest rates relative to the discount rate will cause discount
borrowing to_______.
1. A) fall; increase
2. B) rise; decrease
3. C) rise; increase
4. D) fall; remain unchanged
Answer: C
113
Everything else held constant, an increase in currency holdings will cause
1. A) the money supply to rise.
2. B) the money supply to remain constant.
3. C) the money supply to fall.
4. D) checkable deposits to rise.
Answer: C
114
Everything else held constant, a decrease in holdings of excess reserves will mean
1. A) a decrease in the money supply.
2. B) an increase in the money supply.
3. C) a decrease in checkable deposits.
4. D) an increase in discount loans.
Answer: B
115
In the model of the money supply process, the Federal Reserve's role in influencing the
money supply is represented by
1. A) both the required reserve ratio and the market interest rate.
2. B) the required reserve ratio, nonborrowed reserves, and borrowed reserves.
3. C) only borrowed reserves.
4. D) only nonborrowed reserves.
Answer: B
116
In the model of the money supply process, the depositor's role in influencing the money
supply is represented by
1. A) the currency holdings.
2. B) the currency holdings and excess reserve.
3. C) the currency holdings and borrowed reserve.
4. D) the market interest rate.
Answer: A
117
In the model of the money supply process, the bank's role in influencing the money
supply process is represented by
1. A) the excess reserve.
2. B) both the excess reserve and the market interest rate.
3. C) the currency ratio.
4. D) only borrowed reserves.
Answer: A
118
Models describing the determination of the money supply and the Fed's role in this
process normally focus on ________ rather than ________, since Fed actions have a more
predictable effect on the former.
1. A) reserves; the monetary base
2. B) reserves; high-powered money
3. C) the monetary base; high-powered money
4. D) the monetary base; reserves
Answer: D
119
The Fed can exert more precise control over ________ than it can over ________.
1. A) high-powered money; reserves
2. B) high-powered money; the monetary base
3. C) the monetary base; high-powered money
4. D) reserves; high-powered money
Answer: A
120
The ratio that relates the change in the money supply to a given change in the monetary
base is called the
1. A) money multiplier.
2. B) required reserve ratio.
3. C) deposit ratio.
4. D) discount rate.
Answer: A
121
An assumption in the model of the money supply process is that the desired levels of
currency and excess reserves
1. A) are given as constants.
2. B) grow proportionally with checkable deposits.
3. C) grow proportionally with high-powered money.
4. D) grow proportionally over time.
Answer: B
122
The total amount of reserves in the banking system is equal to the ________ required
reserves and excess reserves.
1. A) sum of
2. B) difference between
3. C) product of
4. D) ratio between
Answer: A
123
The total amount of required reserves in the banking system is equal to the ________ the
required reserve ratio and checkable deposits.
1. A) sum of
2. B) difference between
3. C) product of
4. D) ratio between
Answer: C
124
Since the Federal Reserve sets the required reserve ratio to less than one, one dollar of
reserves can support ________ of checkable deposits.
1. A) exactly one dollar
2. B) less than one dollar
3. C) more than one dollar
4. D) exactly twice the amount
Answer: C
125
An increase in the monetary base that goes into ________ is not multiplied, while an
increase that goes into ________ is multiplied.
1. A) deposits; currency
2. B) excess reserves; currency
3. C) currency; excess reserves
4. D) currency; deposits
Answer: D
126
An increase in the monetary base that goes into currency is ________, while an increase
that goes into deposits is ________.
1. A) multiplied; multiplied
2. B) not multiplied; multiplied
3. C) multiplied; not multiplied
4. D) not multiplied; not multiplied
Answer: B
127
If the Fed injects reserves into the banking system and they are held as excess reserves,
then the money supply
1. A) increases by only the initial increase in reserves.
2. B) increases by only one-half the initial increase in reserves.
3. C) increases by a multiple of the initial increase in reserves.
4. D) does not change.
Answer: D
128
If the Fed injects reserves into the banking system and they are held as excess reserves,
then the monetary base ________ and the money supply ________.
1. A) remains unchanged; remains unchanged
2. B) remains unchanged; increases
3. C) increases; increases
4. D) increases; remains unchanged
Answer: D
129
If the required reserve ratio is 10 percent, currency in circulation is $400 billion,
checkable deposits are $800 billion, and excess reserves total $0.8 billion, then the
money supply is ________ billion.
1. A) $8000
2. B) $1200
3. C) $1200.8
4. D) $8400
Answer: B
130
checkable deposits are $800 billion, and excess reserves total $0.8 billion, then the M1
money multiplier is
1. A) 2.5.
2. B) 1.67.
3. C) 2.0.
4. D) 0.601.
Answer: A
131
If the required reserve ratio is 10 percent, currency in circulation is $1,200 billion,
checkable deposits are $1,600 billion, and excess reserves total $2,500 billion, then the
M1 money multiplier is
1. A) 2.5.
2. B) 1.7.
3. C) 7.3.
4. D) 0.73.
Answer: D
132
currency-deposit ratio is
1. A) 0.25.
2. B) 0.50.
3. C) 0.40.
4. D) 0.05.
Answer: B
133
excess reserves-checkable deposit ratio is
1. A) 0.001.
2. B) 0.10.
3. C) 0.01.
4. D) 0.05.
Answer: A
134
If the required reserve ratio is 10 percent, currency in circulation is $1,200 billion,
checkable deposits are $1,600 billion, and excess reserves total $2,500 billion, then the
excess reserves-checkable deposit ratio is
1. A) 1.56.
2. B) 0.48.
3. C) 0.72.
4. D) 0.56.
Answer: A
135
monetary base is
1. A) $480 billion.
2. B) $480.8 billion.
3. C) $80 billion.
4. D) $80.8 billion.
Answer: B
136
checkable deposits are $800 billion, and excess reserves total $0.8 billion, then the M1
money multiplier is
1. A) 2.5.
2. B) 1.67.
3. C) 2.3.
4. D) 0.651.
Answer: C
137
If the required reserve ratio is 5 percent, currency in circulation is $400 billion, checkable
deposits are $800 billion, and excess reserves total $0.8 billion, then the M1 money
multiplier is
1. A) 2.5.
2. B) 2.72.
3. C) 2.3.
4. D) 0.551.
Answer: B
138
checkable deposits are $1000 billion, and excess reserves total $1 billion, then the
money supply is ________ billion.
1. A) $10,000
2. B) $4000
3. C) $1400
4. D) $10,400
Answer: C
139
checkable deposits are $1000 billion, and excess reserves total $1 billion, then the M1
money multiplier is
1. A) 2.5.
2. B) 2.8.
3. C) 2.0.
4. D) 0.7.
Answer: B
140
checkable deposits are $1000 billion, and excess reserves total $1 billion, then the excess
reserves-checkable deposit ratio is
1. A) 0.01.
2. B) 0.10.
3. C) 0.001.
4. D) 0.05.
Answer: C
141
checkable deposits are $1000 billion, and excess reserves total $1 billion, then the
monetary base is
1. A) $400 billion.
2. B) $401 billion.
3. C) $500 billion.
4. D) $501 billion.
Answer: D
142
checkable deposits are $1000 billion, and excess reserves total $1 billion, then the M1
money multiplier is
1. A) 2.54.
2. B) 2.67.
3. C) 2.35.
4. D) 0.551.
Answer: A
143
If the required reserve ratio is one-third, currency in circulation is $300 billion, and
checkable deposits are $900 billion, then the money supply is ________ billion.
1. A) $2700
2. B) $3000
3. C) $1200
4. D) $1800
Answer: C
144
If the required reserve ratio is one-third, currency in circulation is $300 billion, checkable
deposits are $900 billion, and there is no excess reserve, then the M1 money multiplier
is
1. A) 2.5.
2. B) 2.8.
3. C) 2.0.
4. D) 0.67.
Answer: C
145
If the required reserve ratio is one-third, currency in circulation is $300 billion, and
checkable deposits are $900 billion, then the currency-deposit ratio is
1. A) 0.25.
2. B) 0.33.
3. C) 0.67.
4. D) 0.375.
Answer: B
146
If the required reserve ratio is one-third, currency in circulation is $300 billion, checkable
deposits are $900 billion, and there is no excess reserve, then the monetary base is
1. A) $300 billion.
2. B) $600 billion.
3. C) $333 billion.
4. D) $667 billion.
Answer: B
147
Everything else held constant, an increase in the required reserve ratio on checkable
deposits will cause
1. A) the money supply to rise.
2. B) the money supply to remain constant.
3. C) the money supply to fall.
4. D) checkable deposits to rise.
Answer: C
148
Everything else held constant, a decrease in the required reserve ratio on checkable
deposits will mean
1. A) a decrease in the money supply.
2. B) an increase in the money supply.
3. C) a decrease in checkable deposits.
4. D) an increase in discount loans.
Answer: B
149
Everything else held constant, an increase in the required reserve ratio on checkable
deposits causes the M1 money multiplier to ________ and the money supply to ________.
1. A) decrease; increase
2. B) increase; increase
3. C) decrease; decrease
4. D) increase; decrease
Answer: C
150
Everything else held constant, a decrease in the required reserve ratio on checkable
deposits causes the M1 money multiplier to ________ and the money supply to ________.
Answer: B
151
Assuming initially that the required reserve ratio = 10%, the currency-deposit ratio =
40%, and the excess reserve ratio = 0, an increase in the required reserve ratio to 15%
causes the M1 money multiplier to ________, everything else held constant.
1. A) increase from 2.55 to 2.8
2. B) decrease from 2.8 to 2.55
3. C) increase from 1.82 to 2
4. D) decrease from 2 to 1.82
Answer: B
152
40%, and the excess reserve ratio = 0, a decrease in the required reserve ratio to 5%
3. C) increase from 2 to 2.22
4. D) decrease from 2.22 to 2
Answer: A
153
Everything else held constant, if the sum of the required reserve ratio and the excess
reserve ratio is less than one, an increase in the currency-checkable deposit ratio will
mean
1. A) an increase in currency in circulation and an increase in the money
supply.
2. B) an increase in money supply but no change in reserves.
3. C) a decrease in the money supply.
4. D) an increase in currency in circulation but no change in the money supply.
Answer: C
154
reserve ratio is less than one, a decrease in the currency-checkable deposit ratio will
mean
1. A) an increase in currency in circulation and an increase in the money
supply.
2. B) an increase in money supply.
3. C) a decrease in the money supply.
4. D) an increase in currency in circulation but no change in the money supply.
Answer: B
155
reserve ratio is less than one, an increase in the currency-deposit ratio causes the M1
money multiplier to ________ and the money supply to ________.
2. B) increase; decrease
4. D) increase; increase
Answer: C
156
reserve ratio is less than one, a decrease in the currency-deposit ratio causes the M1
Answer: B
157
reserve ratio is greater than one, an increase in the currency-deposit ratio causes the M1
Answer: B
158
40%, and the excess reserve ratio = 0, an increase in the currency-deposit ratio to 50%
3. C) increase from 2.33 to 2.8
4. D) decrease from 2.8 to 2.33
Answer: B
159
40%, and the excess reserve ratio = 0, an decrease in the currency-deposit ratio to 30%
Answer: A
160
Everything else held constant, a decrease in the excess reserves ratio causes the M1
Answer: B
161
Everything else held constant, an increase in the excess reserves ratio causes the M1
Answer: C
162
40%, and the excess reserve ratio = 5%, a decrease in the excess reserve ratio to 0%
Answer: A
163
40%, and the excess reserve ratio = 5%, an increase in the excess reserve ratio to 10%
Answer: B
164
75%, and the excess reserve ratio = 156%, an increase in the excess reserve ratio to
200% causes the M1 money multiplier to ________, everything else held constant.
Answer: B
165
75%, and the excess reserve ratio = 156%, an increase in the required reserve ratio to
2. B) increase from 0.54 to 0.67
3. C) decrease from 0.73 to 0.71
Answer: C
166
75%, and the excess reserve ratio = 156%, an increase in the currency-deposit ratio to
Answer: A
167
The excess reserves ratio is ________ related to expected deposit outflows, and is ________
Answer: C
168
The money supply is ________ related to expected deposit outflows, and is ________
Answer: B
169
The money multiplier is
1. A) negatively related to high-powered money.
2. B) positively related to the excess reserves ratio.
3. C) negatively related to the required reserve ratio.
4. D) positively related to holdings of excess reserves.
Answer: C
170
During the 2007-2009 financial crisis the currency ratio
1. A) increased sharply.
2. B) decreased sharply.
3. C) increased slightly.
4. D) decreased slightly.
Answer: D
171
During the 2007-2009 financial crisis the excess reserve ratio
Answer: A
172
Explain the complete formula for the M1 money supply, and explain how changes in
required reserves, excess reserves, the currency ratio, the nonborrowed base, and
borrowed reserves affect the money supply.
Answer: The formula is M = × (MBn + BR). The formula indicates that the money supply
is the product of the multiplier times the base. Increases in any of the multiplier
components, required reserves, r; excess reserves, e; or the currency ratio, c; reduce the
multiplier and the money supply. Increases in the nonborrowed base and borrowed
reserves both increase the base and the money supply.
173
Which is the most important category of Fed assets?
1. A) securities
2. B) discount loans
3. C) gold and SDR certificates
4. D) cash items in the process of collection
Answer: A
174
The two most important categories of assets on the Fed's balance sheet are ________ and
________ because they earn interest.
1. A) discount loans; coins
2. B) securities; discount loans
3. C) gold; coins
4. D) cash items in the process of collection; SDR certificate accounts
Answer: B
175
The Fed's holdings of securities consist primarily of ________, but also in the past have
included ________.
1. A) Treasury securities; bankers' acceptances
2. B) municipal securities; bankers' acceptances
3. C) bankers' acceptances; Treasury securities
4. D) Treasury securities; municipal securities
Answer: A
176
The volume of loans that the Fed makes to banks is affected by the Fed's setting of the
interest rate on these loans, called the
1. A) federal funds rate.
2. B) prime rate.
3. C) discount rate.
4. D) interbank rate.
Answer: C
177
Special Drawing Rights (SDRs) are issued to governments by the ________ to settle
international debts and have replaced ________ in international transactions.
1. A) Federal Reserve System; gold
2. B) Federal Reserve System; dollars
3. C) International Monetary Fund; gold
4. D) International Monetary Fund; dollars
Answer: C
178
When the Treasury acquires gold or SDRs, it issues certificates to the ________, which are
a claim on the gold or SDRs, and in turn is credited with deposit balances at the ________.
1. A) Federal Reserve System; Fed
2. B) Federal Reserve System; IMF
3. C) International Monetary Fund; Fed
4. D) International Monetary Fund; IMF
Answer: A
179
Which of the following are NOT assets on the Fed's balance sheet?
1. A) discount loans
2. B) U.S. Treasury deposits
3. C) cash items in the process of collection
4. D) U.S. Treasury bills
Answer: B
180
Which of the following are NOT assets on the Fed's balance sheet?
1. A) securities
3. C) cash items in the process of collection
4. D) deferred availability cash items
Answer: D
181
Which of the following are NOT liabilities on the Fed's balance sheet?
1. A) discount loans
2. B) bank deposits
3. C) deferred availability cash items
4. D) U.S. Treasury deposits
Answer: A
182
When the Fed purchases artwork to decorate the conference room at the Federal
Reserve Bank of Kansas City
1. A) reserves rise, but the monetary base falls.
2. B) reserves fall.
3. C) currency in circulation falls.
4. D) the monetary base rises.
Answer: D
183
A Fed purchase of gold, SDRs, a deposit denominated in a foreign currency or any other
asset is just an open market ________ of these assets, ________ the monetary base.
1. A) purchase; raising
2. B) sale; raising
3. C) purchase; lowering
4. D) sale; lowering
Answer: A
184
An increase in Treasury deposits at the Fed causes
1. A) the monetary base to increase.
2. B) the monetary base to decrease.
3. C) Fed assets to increase but has no effect on the monetary base.
4. D) Fed assets to decrease but has no effect on the monetary base.
Answer: B
185
An increase in U.S. Treasury deposits at the Fed reduces both ________ and the ________.
1. A) reserves; monetary base
2. B) Fed liabilities; money multiplier
3. C) Fed assets; monetary base
4. D) Fed assets; money multiplier
Answer: A
186
U.S. Treasury deposits at the Fed are ________ for the Fed but ________ for the Treasury.
Thus an increase in U.S. Treasury deposits ________ the monetary base.
1. A) a liability; an asset; increases
2. B) a liability; an asset; decreases
3. C) an asset; a liability; increases
4. D) an asset; a liability; decreases
Answer: B
187
An increase in which of the following leads to a decline in the monetary base?
1. A) float
3. C) foreign deposits at the Fed
4. D) SDRs
Answer: C
188
Suppose, while cleaning out its closets, a worker at the Federal Reserve bank branch in
Memphis discovers a painting of Elvis (medium: acrylic on velvet) that used to grace the
walls of the conference room. Suppose further that, at a public auction, the bank sells
the painting for $19.95. This sale will cause ________ in the monetary base, everything
else held constant.
1. A) an increase of $19.95
2. B) an increase of more than $19.95
3. C) a decrease of $19.95
4. D) a decrease of more than $19.95
Answer: C
189
Suppose the Bank of China permanently decreases its purchases of U.S. government
bonds and, instead, holds more dollars on deposit at the Federal Reserve. Everything
else held constant, a open market ________ would be the appropriate monetary policy
action for the Fed to take to offset the expected ________ in the monetary base in the
United States.
1. A) purchase; decrease
2. B) purchase; increase
3. C) sale; decrease
4. D) sale; increase
Answer: A
190
The equation that represents M2 in the model of the money supply process is
1. A) M2 = C + D.
2. B) M2 = C + D + T - MMF.
3. C) M2 = C + D - T + MMF.
4. D) M2 = C + D + T + MMF.
Answer: D
191
In the model of the money supply process for M2, the relationship between checkable
deposits and the M2 money supply is represented by
1. A) D = × M2.
2. B) D = (1 + c + t + mm) × M2.
3. C) M2 = × D.
4. D) M2 = .
Answer: A
192
The M2 money supply is represented by
1. A) M2 = × MB.
2. B) M2 = × .
3. C) MB = × M2.
4. D) MB = × .
Answer: A
193
The M2 money multiplier is
1. A) negatively related to high-powered money.
2. B) positively related to the time deposit ratio.
3. C) positively related to the required reserve ratio.
4. D) positively related to the excess reserves ratio.
Answer: B
194
Everything else held constant, an increase in the currency ratio will mean ________ in the
M2 money multiplier and ________ in the M2 money supply.
1. A) an increase; an increase
2. B) an increase; a decrease
3. C) a decrease; an increase
4. D) a decrease; a decrease
Answer: D
195
Everything else held constant, a decrease in the currency ratio will mean ________ in the
M1 money multiplier and ________ in the M2 money multiplier.
Answer: A
196
Everything else held constant, an increase in the required reserve ratio will mean ________
in the M2 money multiplier and ________ in the M2 money supply.
Answer: D
197
Everything else held constant, an increase in the required reserve ratio will result in
________ in M1 and ________ in M2.
Answer: D
198
Everything else held constant, an increase in the time deposit ratio will mean ________ in
the M2 money multiplier and ________ in the M2 money supply.
Answer: A
199
Everything else held constant, an increase in the time deposit ratio will result in ________
in the M1 money multiplier and ________ in the M2 money multiplier.
2. B) no change; an increase
3. C) a decrease; a decrease
4. D) no change; a decrease
Answer: B
200
Everything else held constant, an increase in the money market fund ratio will mean
________ in the M2 money multiplier and ________ in the M2 money supply.
Answer: A
201
Everything else held constant, an increase in the money market fund ratio will result in
________ in the M1 money multiplier and ________ in the M2 money multiplier.
Answer: B
202
Everything else held constant, an increase in the excess reserve ratio will mean ________
in the M2 money multiplier and ________ in the M2 money supply.
Answer: D
203
Everything else held constant, an increase in the excess reserve ratio will mean ________
in the M1 money multiplier and ________ in the M2 money multiplier.
Answer: C
204
Factors causing an increase in currency holdings include
1. A) an increase in the interest rates paid on checkable deposits.
2. B) an increase in the cost of acquiring currency.
3. C) a decrease in bank panics.
4. D) an increase in illegal activity.
Answer: D
205
Part of the increase in currency holdings in the 1960s and 1970s can be attributed to
1. A) increases in income tax rates.
2. B) the switch from progressive to proportional income taxes.
3. C) the adoption of regressive taxes.
4. D) bracket creep due to inflation and progressive income taxes.
Answer: D
206
Everything else held constant, an increase in wealth will cause the holdings of checkable
deposits to the holdings of currency to ________ and the currency ratio will ________.
1. A) increase; increase
3. C) decrease; increase
4. D) decrease; decrease
Answer: B
207
Everything else held constant, an increase in the interest rate paid on checkable deposits
will cause ________ in the amount of checkable deposits held relative to currency
holdings and ________ in the currency ratio.
Answer: B
208
The increase in the availability of ATMs has caused the cost of acquiring currency to
________ which will cause the currency ratio to ________, everything else held constant.
1. A) increase; increase
3. C) decrease; increase
4. D) decrease; decrease
Answer: C
209
The steepest increase in the currency ratio since 1892 occurred during
1. A) World War II.
2. B) the Great Depression.
3. C) the interwar years.
4. D) the past twenty years.
Answer: B
210
The factor accounting for the steepest rise in the currency ratio since 1892 is
1. A) taxes.
2. B) bank panics.
3. C) illegal activity.
4. D) an increase in wealth.
Answer: B
211
The increase in the currency ratio during World War II was due to
1. A) bank panics.
2. B) a drop in the rate of interest paid on checking deposits.
3. C) the spread of ATMs.
4. D) high taxes and illegal activities.
Answer: D
212
The upward trend in the currency-deposit ratio during 1994-2007 can be explained by
1. A) the increased holdings of U.S. currency by foreigners.
2. B) bank panics.
3. C) a drop in the rate of interest paid on checking deposits.
4. D) high taxes and illegal activities.
Answer: A
213
The declining trend in the currency-deposit ratio during 2007-2014 can be explained by
1. A) the increased holdings of U.S. currency by foreigners.
2. B) bank panics.
3. C) a drop in the rate of interest paid on checking deposits.
4. D) the increasing use of debit cards.
Answer: D
214
During the bank panics of the Great Depression the currency ratio
Answer: A
215
During the bank panics of the Great Depression the excess reserve ratio
Answer: A
216
In the early 1930s, the currency-deposit ratio rose, as did the level of excess reserves.
Money supply analysis predicts that, everything else held constant, the money supply
should have
1. A) risen.
2. B) fallen.
3. C) remain unchanged.
4. D) either risen, fallen, or remain unchanged.
Answer: B
217
The monetary base increased by 20% during the contraction of 1929-1933, but the
money supply fell by 25%. Explain why this occurred. How can the money supply fall
when the base increases?
Answer: The banking crisis caused the public to fear for the safety of their deposits,
increasing both the currency ratio and bank holdings of excess reserves in anticipation
of deposit outflows. Both of these changes reduce the money multiplier and the money
supply. In this case, the fall in the multiplier due to increases of currency and excess
reserves more than offset the increase in the base, causing the money supply to fall.
Answer: D
2
Inflation results in
1. A) ease of planning for the future.
2. B) ease of comparing prices over time.
3. C) lower nominal interest rates.
4. D) difficulty interpreting relative price movements.
Answer: D
3
Economists believe that countries recently suffering hyperinflation have experienced
1. A) reduced growth.
2. B) increased growth.
3. C) reduced prices.
4. D) lower interest rates.
Answer: A
4
A nominal variable, such as the inflation rate or the money supply, which ties down the
price level to achieve price stability is called ________ anchor.
1. A) a nominal
2. B) a real
3. C) an operating
4. D) an intermediate
Answer: A
5
A central feature of monetary policy strategies in all countries is the use of a nominal
variable that monetary policymakers use as an intermediate target to achieve an
ultimate goal such as price stability. Such a variable is called a nominal
1. A) anchor.
2. B) benchmark.
3. C) tether.
4. D) guideline.
Answer: A
6
A nominal anchor promotes price stability by
1. A) outlawing inflation.
2. B) stabilizing interest rates.
3. C) keeping inflation expectations low.
4. D) keeping economic growth low.
Answer: C
7
Monetary policy is considered time-inconsistent because
1. A) of the lag times associated with the implementation of monetary policy
and its effect on the economy.
2. B) policymakers are tempted to pursue discretionary policy that is more
contractionary in the short run.
3. C) policymakers are tempted to pursue discretionary policy that is more
expansionary in the short run.
4. D) of the lag times associated with the recognition of a potential economic
problem and the implementation of monetary policy.
Answer: C
8
The time-inconsistency problem with monetary policy tells us that, if policymakers use
discretionary policy, there is a higher probability that the ________ will be higher,
compared to policy makers following a behavior rule.
1. A) inflation rate
2. B) unemployment rate
3. C) interest rate
4. D) foreign exchange rate
Answer: A
9
The theory that monetary policy conducted on a discretionary, day-by-day basis leads to
poor long-run outcomes is referred to as the
1. A) adverse selection problem.
2. B) moral hazard problem.
3. C) time-inconsistency problem.
4. D) nominal-anchor problem.
Answer: C
10
The ________ problem of discretionary policy arises because economic behavior is
influenced by what firms and people expect the monetary authorities to do in the future.
1. A) moral hazard
2. B) time-inconsistency
3. C) nominal-anchor
4. D) rational-expectation
Answer: B
11
If the central bank pursues a monetary policy that is more expansionary than what firms
and people expect, then the central bank must be trying to
1. A) boost output in the short run.
2. B) constrain output in the short run.
3. C) constrain prices.
4. D) boost prices in the short run.
Answer: A
12
The time-inconsistency problem in monetary policy can occur when the central bank
conducts policy
1. A) using a nominal anchor.
2. B) using a strict and inflexible rule.
3. C) on a discretionary, day-by-day basis.
4. D) using a flexible, discretionary rule.
Answer: C
13
Explain the time-inconsistency problem. What is the likely outcome of discretionary
policy? What are the solutions to the time-inconsistency problem?
Answer: With policy discretion, policymakers have an incentive to attempt to increase
output by pursuing expansionary policies once expectations are set. The problem is that
this policy results not in higher output, but in higher actual and expected inflation. The
solution is to adopt a rule to constrain discretion. Nominal anchors can provide the
necessary constraint on discretionary behavior.
14
Even if the Fed could completely control the money supply, monetary policy would have
critics because
1. A) the Fed is asked to achieve many goals, some of which are incompatible
with others.
2. B) the Fed's goals do not include high employment, making labor unions a
critic of the Fed.
3. C) the Fed's primary goal is exchange rate stability, causing it to ignore
domestic economic conditions.
4. D) it is required to keep Treasury security prices high.
Answer: A
15
High unemployment is undesirable because it
1. A) results in a loss of output.
2. B) always increases inflation.
3. C) always increases interest rates.
4. D) reduces idle resources.
Answer: A
16
When workers voluntarily leave work while they look for better jobs, the resulting
unemployment is called
1. A) structural unemployment.
2. B) frictional unemployment.
3. C) cyclical unemployment.
4. D) underemployment.
Answer: B
17
Unemployment resulting from a mismatch of workers' skills and job requirements is
called
1. A) frictional unemployment.
2. B) structural unemployment.
3. C) seasonal unemployment.
4. D) cyclical unemployment.
Answer: B
18
The goal for high employment should be a level of unemployment at which the demand
for labor equals the supply of labor. Economists call this level of unemployment the
1. A) frictional level of unemployment.
2. B) structural level of unemployment.
3. C) natural rate level of unemployment.
4. D) Keynesian rate level of unemployment.
Answer: C
19
Supply-side economic policies seek to
1. A) raise interest rates through contractionary monetary policy.
2. B) increase federal government expenditures.
3. C) increase consumption expenditures by increasing taxes.
4. D) increase saving and investment using tax incentives.
Answer: D
20
The Federal Reserve System was created to
1. A) make it easier to finance budget deficits.
2. B) promote financial market stability.
3. C) lower the unemployment rate.
4. D) promote rapid economic growth.
Answer: B
21
Having interest rate stability
1. A) allows for less uncertainty about future planning.
2. B) leads to demands to curtail the Fed's power.
3. C) guarantees full employment.
4. D) leads to problems in financial markets.
Answer: A
22
Foreign exchange rate stability is important because a decline in the value of the
domestic currency will ________ the inflation rate, and an increase in the value of the
domestic currency makes domestic industries ________ competitive with competing
foreign industries.
1. A) increase; more
2. B) increase; less
3. C) decrease; more
4. D) decrease; less
Answer: B
23
Which set of goals can, at times, conflict in the short run?
1. A) high employment and economic growth
2. B) interest rate stability and financial market stability
3. C) high employment and price level stability
4. D) exchange rate stability and financial market stability
Answer: C
24
The primary goal of the European Central Bank is
1. A) price stability.
2. B) exchange rate stability.
3. C) interest rate stability.
4. D) high employment.
Answer: A
25
The mandate for the monetary policy goals that has been given to the European Central
Bank is an example of a ________ mandate.
1. A) primary
2. B) dual
3. C) secondary
4. D) hierarchical
Answer: D
26
The mandate for the monetary policy goals that has been given to the Federal Reserve
System is an example of a ________ mandate.
1. A) primary
2. B) dual
3. C) secondary
4. D) hierarchical
Answer: B
27
Either a dual or hierarchial mandate is acceptable as long as ________ is the primary goal
in the ________.
1. A) price stability; short run
2. B) price stability; long run
3. C) reducing business-cycle fluctuations; short run
4. D) reducing business-cycle fluctuations; long run
Answer: B
28
The type of monetary policy that is used in Canada, New Zealand, and the United
Kingdom is
1. A) monetary targeting.
2. B) inflation targeting.
3. C) targeting with an implicit nominal anchor.
4. D) interest-rate targeting.
Answer: B
29
Which of the following is not an element of inflation targeting?
1. A) a public announcement of medium-term numerical targets for inflation
2. B) an institutional commitment to price stability as the primary long-run
goal
3. C) an information-inclusive approach in which only monetary aggregates are
used in making decisions about monetary policy
4. D) increased accountability of the central bank for attaining its inflation
objectives
Answer: C
30
The first country to adopt inflation targeting was
1. A) the United Kingdom.
2. B) Canada.
3. C) New Zealand.
4. D) Australia.
Answer: C
31
In both New Zealand and Canada, what has happened to the unemployment rate since
the countries adopted inflation targeting?
1. A) The unemployment rate increased sharply.
2. B) The unemployment rate remained constant.
3. C) The unemployment rate has declined substantially after a sharp increase.
4. D) The unemployment rate declined sharply immediately after the inflation
targets were adopted.
Answer: C
32
Which of the following is not an advantage of inflation targeting?
1. A) reduction of the time-inconsistency problem
2. B) increased monetary policy transparency
3. C) There is an immediate signal on the achievement of the target.
4. D) consistency with democratic principles
Answer: C
33
Which of the following is not a disadvantage to inflation targeting?
1. A) There is a delayed signal about achievement of the target.
2. B) Inflation targets could impose a rigid rule on policymakers.
3. C) There is potential for larger output fluctuations.
4. D) There is a lack of transparency.
Answer: D
34
The decision by inflation targeters to choose inflation targets ________ zero reflects the
concern of monetary policymakers that particularly ________ inflation can have
substantial negative effects on real economic activity.
1. A) below; high
2. B) below; low
3. C) above; high
4. D) above; low
Answer: D
35
Inflation targets can increase the central bank's flexibility in responding to declines in
aggregate spending. Declines in aggregate ________ that cause the inflation rate to fall
below the floor of the target range will automatically stimulate the central bank to
________ monetary policy without fearing that this action will trigger a rise in inflation
expectations.
1. A) demand: tighten
2. B) demand; loosen
3. C) supply; tighten
4. D) supply; loosen
Answer: B
36
Explain what inflation targeting is. What are the advantages and disadvantages of this
type of monetary policy strategy?
Answer: There are five main elements to inflation targeting: 1. a public announcement of
a medium-term target for the inflation rate; 2. a commitment to price stability as the
primary long-term goal of policy; 3. many variables are used in making decisions about
policy moves; 4. increased transparency about policy strategy with the public; 5. the
central bank has increased accountability for attaining policy goals.
The advantages of inflation targeting include: 1. the simplicity and clarity of a numerical
target for the inflation rate; 2. there is increased accountability of the central bank; 3.
reduces the effects of inflationary shocks.
The disadvantages of inflation targeting include: 1. there is a delayed signal about the
achievement of the target; 2. it could lead to a rigid rule where the only focus is the
inflation rate (has not happened in practice); 3. if sole focus is the inflation rate, larger
output fluctuations can occur (has not happened in practice).
37
The type of monetary policy regime that the Federal Reserve has followed From the
1980s up until the time Ben Bernanke became chair of the Federal Reserve in 2006 can
best be described as
1. A) monetary targeting.
2. B) inflation targeting.
3. C) policy with an implicit nominal anchor.
4. D) exchange-rate targeting.
Answer: C
38
Estimates from large macroeconometric models of the U.S. economy suggests that it
takes over ________ for monetary policy to affect output and over ________ for monetary
policy to affect the inflation rate.
1. A) 1 year; 2 years
2. B) 2 years; 1 year
3. C) 1 year; 6 months
4. D) 6 months; 1 year
Answer: A
39
Which of the following is not a disadvantage of of the Fed's "just do it" approach to
monetary policy?
1. A) There is low transparency of policy.
2. B) There is low accountability for central bankers.
3. C) This type of policy make the Fed more susceptible to the time-
inconsistency problem.
4. D) It relies on a stable money-inflation relationship.
Answer: D
40
Suppose it takes roughly two years for monetary policy to have a significant impact on
inflation. If inflation is currently low but policymakers believe inflation will rise over the
next two years with an unchanged stance of monetary policy, when should they tighten
monetary policy to prevent the inflationary surge?
1. A) now
2. B) wait until overt signs of inflation appear
3. C) next year
4. D) two years later
Answer: A
41
Under Alan Greenspan and Ben Bernanke, the Federal Reserve was successful in
pursuing a ________ policy.

1. A) preemptive
2. B) inflation targeting
3. C) exchange rate targeting
4. D) monetary targeting
Answer: A
42
After Ben Bernanke became chair of the Fed in 2006, he
1. A) increased Fed transparency.
2. B) abandoned inflation targeting.
3. C) used "just do it" policy.
4. D) increased the opacity of the policymaking.
Answer: A
43
The FOMC finally moved to ________ on January 25, 2012, when it issued its "Statement
on Long-Run
Goals and Monetary Policy Strategy."

1. A) inflation targeting
2. B) zero inflation policy
3. C) "just do it" policy
4. D) monetary targeting
Answer: A
44
In the FOMC's "Statement on Long-Run Goals and Monetary Policy Strategy,"the FOMC
agreed to a single numerical value of the inflation objective, 2% on the ________.
1. A) PCE deflator
2. B) GDP deflator
3. C) CPI
4. D) PPI
Answer: A
45
The FOMC "Statement on Long-Run Goals and Monetary Policy Strategy"made it clear
that the Federal Reserve would be pursuing ________, consistent with its dual mandate.
1. A) a flexible form of inflation targeting
2. B) a strict form of inflation targeting
3. C) a zero inflation targeting
4. D) an implicit inflation targeting
Answer: A
46
Lessons that economists and policy makers have learned from the recent global financial
crisis include
1. A) Developments in the financial sector have a far greater impact on
economic activity than was earlier realized.
2. B) The zero lower bound on interest rates can be a serious problem.
3. C) The cost of cleaning up after a financial crisis is very high.
4. D) Price and output stability do not ensure financial stability.
5. E) All of the above.
Answer: E
47
The problems of raising the level of the inflation target include
1. A) if the zero-lower-bound problem is rare, then the benefits of a higher
inflation target are not very large.
2. B) the costs of higher inflation in terms of the distortions it produces in the
economy are high.
3. C) it is more difficult to stabilize the inflation rate at a higher targeting level.
4. D) all of the above.
Answer: D
48
The "Greenspan doctrine"—central banks should not try to prick bubbles—was based
on which of the following arguments?
1. A) Asset-price bubbles are nearly impossible to identify.
2. B) Monetary actions would be likely to affect asset prices in general, rather
than the specific assets that are experiencing a bubble.
3. C) Raising interest rates has often been found to cause a bubble to burst
more severely.
4. D) Monetary policy actions to prick bubbles can have harmful effects on the
aggregate economy.
5. E) All of the above.
Answer: E
49
When asset prices increase above their fundamental values it is called an
1. A) asset-price bubble.
2. B) irrational bubble.
3. C) asset-price spike.
4. D) irrational spike.
Answer: A
50
Suppose interest rates are kept very low for a long time such that there is a spike in the
amount of lending. Everything else held constant, this could cause ________ bubble.
1. A) an irrational exuberance
2. B) a credit-driven
3. C) a stock
4. D) a debt-driven
Answer: B
51
A credit-driven bubble arises when ________ in lending causes ________ in asset prices
which can cause ________ in lending.
1. A) a decrease; a decrease; an increase
2. B) a decrease; an increase; an increase
3. C) an increase; an increase; a further increase
4. D) a decrease; a decrease; a further decrease
Answer: C
52
________ bubble is driven entirely by unrealistic optimistic expectations.
1. A) An irrational exuberance
2. B) A credit-driven
3. C) A stock
4. D) A debt-driven
Answer: A
53
Everything else held constant, a credit-drive bubble is generally considered to have the
potential to cause ________ damage to an economy compared to an irrational
exuberance bubble.
1. A) less
2. B) about the same amount of
3. C) more
4. D) either more, less, or the same amount of
Answer: C
54
A central bank has ________ chance to identify a credit-driven bubble compared to an
irrational exuberance bubble.
1. A) a greater
2. B) less of a
3. C) about the same level of a
4. D) a greater, less or about the same level of a
Answer: A
55
Which of the following is NOT an argument against using monetary policy to prick
asset-price bubbles?
1. A) The effect of increasing interest rates on asset prices is uncertain.
2. B) A bubble may only exist in some asset-prices and monetary policy will
affect all asset prices.
3. C) Using monetary policy to prick an asset-price bubble may have adverse
effect on the aggregate economy.
4. D) Even though credit-drive bubbles are easier to identify, they are still
relatively hard to identify.
Answer: D
56
Which of the following is NOT an operating instrument?
1. A) nonborrowed reserves
2. B) monetary base
3. C) federal funds interest rate
4. D) discount rate
Answer: D
57
Which of the following is a potential operating instrument for the central bank?
1. A) the monetary base
2. B) the M1 money supply
3. C) nominal GDP
4. D) the discount rate
Answer: A
58
Due to the lack of timely data for the price level and economic growth, the Fed's
strategy
1. A) targets the exchange rate, since the Fed can control this variable.
2. B) targets the price of gold, since it is closely related to economic activity.
3. C) uses an intermediate target, such as an interest rate.
4. D) stabilizes the consumer price index, since the Fed can control the CPI.
Answer: C
59
If the central bank targets a monetary aggregate, it is likely to lose control over the
interest rate because
1. A) of fluctuations in the demand for reserves.
2. B) of fluctuations in the consumption function.
3. C) bond values will tend to remain stable.
4. D) of fluctuations in the business cycle.
Answer: A
60
If the Fed pursues a strategy of targeting an interest rate when fluctuations in money
demand are prevalent
1. A) fluctuations of nonborrowed reserves will be small.
2. B) fluctuations of nonborrowed reserves will be large.
3. C) the Fed will probably quickly abandon this policy, as it did in the 1960s.
4. D) the Fed will probably quickly abandon this policy, as it did in the 1950s.
Answer: B
61
Fluctuations in the demand for reserves cause the Fed to lose control over a monetary
aggregate if the Fed targets
1. A) a monetary aggregate.
2. B) the monetary base.
3. C) an interest rate.
4. D) nominal GDP.
Answer: C
62
Real interest rates are difficult to measure because
1. A) data on them are not available in a timely manner.
2. B) real interest rates depend on the hard-to-determine expected inflation
rate.
3. C) they fluctuate too often to be accurate.
4. D) they cannot be controlled by the Fed.
Answer: B
63
Which of the following criteria need NOT be satisfied for choosing a policy instrument?
1. A) The variable must be measurable.
2. B) The variable must be controllable.
3. C) The variable must be predictable.
4. D) The variable must be transportable.
Answer: D
64
Which of the following is NOT a requirement in selecting a policy instrument?
1. A) measurability
2. B) controllability
3. C) flexibility
4. D) predictability
Answer: C
65
When it comes to choosing an policy instrument, both the ________ rate and ________
aggregates are measured accurately and are available daily with almost no delay.
1. A) three-month T-bill; monetary
2. B) three-month T-bill; reserve
3. C) federal funds; monetary
4. D) federal funds; reserve
Answer: D
66
Explain and demonstrate graphically how targeting nonborrowed reserves can result in
federal funds rate instability.
Answer: See figure - Chapter 16 Number 66
When nonborrowed reserves are held constant, increases in the demand for reserves
result in the federal funds rate increasing and decreases in the demand for
nonborrowed reserves result in the federal funds rate declining. Since fluctuations in
demand do not cause monetary policy actions, the result is the federal funds rate will
fluctuate (assuming the equilibrium federal funds rate is below the discount rate).
67
Explain and demonstrate graphically how targeting the federal funds rate can result in
fluctuations in nonborrowed reserves.
Answer: See figure - Chapter 16 Number 67
With a federal funds rate target, fluctuations in demand for reserves require similar
changes in the nonborrowed reserves to keep the federal funds rate constant.
68
According to the Taylor rule, the Fed should raise the federal funds interest rate when
inflation ________ the Fed's inflation target or when real GDP ________ the Fed's output
target.
1. A) rises above; drops below
2. B) drops below; drops below
3. C) rises above; rises above
4. D) drops below; rises above
Answer: C
69
Using Taylor's rule, when the equilibrium real federal funds rate is 3 percent, the positive
output gap is 2 percent, the target inflation rate is 1 percent, and the actual inflation
rate is 2 percent, the nominal federal funds rate target should be
1. A) 5 percent.
2. B) 5.5 percent.
3. C) 6 percent.
4. D) 6.5 percent.
Answer: D
70
Using Taylor's rule, when the equilibrium real federal funds rate is 2 percent, there is no
output gap, the actual inflation rate is zero, and the target inflation rate is 2 percent, the
nominal federal funds rate should be
1. A) 0 percent.
2. B) 1 percent.
3. C) 2 percent.
4. D) 3 percent.
Answer: B
71
According to the Taylor Principle, when the inflation rate rises, the nominal interest rate
should be ________ by ________ than the inflation rate increase.
1. A) increased; more
2. B) increased; less
3. C) decreased; more
4. D) decreased; less
Answer: A
72
If the Taylor Principle is not followed and nominal interest rates are increased by less
than the increase in the inflation rate, then real interest rates will ________ and monetary
policy will be too ________.
1. A) rise; tight
2. B) rise; loose
3. C) fall; tight
4. D) fall; loose
Answer: D
73
The rate of inflation tends to remain constant when
1. A) the unemployment rate is above the NAIRU.
2. B) the unemployment rate equals the NAIRU.
3. C) the unemployment rate is below the NAIRU.
4. D) the unemployment rate increases faster than the NAIRU increases.
Answer: B
74
The rate of inflation increases when
1. A) the unemployment rate equals the NAIRU.
2. B) the unemployment rate exceeds the NAIRU.
3. C) the unemployment rate is less than the NAIRU.
4. D) the unemployment rate increases faster than the NAIRU increases.
Answer: C
75
Explain the Taylor rule, including the formula for setting the federal funds rate target,
and the components of the formula. If the Fed were to use this rule, how many goals
would it use to set monetary policy?
Answer: The Taylor rule specifies that the target federal fund rates should be set to
equal the equilibrium real federal funds rate, plus the rate of inflation (for the Fisher
effect), plus one-half times the output gap, plus one-half times the inflation gap. The
formula is
Federal funds rate target = equilibrium real federal funds rate + inflation rate + (output
gap) + (inflation gap)
The output gap is the percentage deviation of real GDP from potential full-employment
real GDP. The inflation gap is the difference between actual inflation and the central
bank's target rate of inflation. The equilibrium real federal funds rate is the real rate
consistent with full employment in the long run. The inflation rate is the actual rate of
inflation. The Taylor rule sets the federal funds rate recognizing the goals of low
inflation and full employment (or equilibrium long-run economic growth).
76
In pursuing a strategy of monetary targeting, the central bank announces that it will
achieve a certain value (the target) of the annual growth rate of a ________.
1. A) a monetary aggregate
2. B) a reserve aggregate
3. C) the monetary base
4. D) GDP
Answer: A
77
During the years 1979 to 1982, the Federal Reserve's announced policy was monetary
targeting. During this time period the Federal Reserve
1. A) hit all of their monetary targets.
2. B) did not hit any of their monetary targets because it is believed that
controlling the money supply was not the intent of the Federal Reserve.
3. C) did not hit any of their monetary targets because they were unrealistic.
4. D) hit about half of their monetary targets.
Answer: B
78
Compared to the United States, Japan's experience with monetary targeting during the
1978––1987 period performed
1. A) better with regard to the inflation rate and output fluctuations.
2. B) worse with regard to the inflation rate and output fluctuations.
3. C) better with regard to the inflation rate, but worse with regard to output
fluctuations.
4. D) worse with regard to the inflation rate, but better with regard to output
fluctuations.
Answer: A
79
One of the factors that contributed to the success German policymakers had using a
monetary targeting type policy starting in the mid-1970s and continuing through the
next two decades was that
1. A) they used a rigid target for the money growth rate.
2. B) they implemented policy so their inflation rate goal was met in the short
run.
3. C) the money target was flexible to allow the Bundesbank to concentrate on
other goals as needed.
4. D) they rarely communicated the intentions of policy to the public in order
to keep the public from panicking.
Answer: C
80
The European Central Bank (ECB) pursues a hybrid monetary policy strategy that has
elements in common with the -targeting strategy previously used by the Bundesbank
but also includes some elements oftargeting.
1. A) monetary; inflation
2. B) inflation; monetary
3. C) monetary; exchange rate
4. D) monetary; nominal GDP
Answer: A
81
Which of the following is an advantage to money targeting?
1. A) There is an immediate signal on the achievement of the target.
2. B) It does not rely on a stable money-inflation relationship.
3. C) It implies lack of transparency.
4. D) It implies smaller output fluctuations.
Answer: A
82
Which of the following is a disadvantage to monetary targeting?
1. A) It relies on a stable money-inflation relationship.
2. B) There is a delayed signal about the achievement of a target.
3. C) It implies larger output fluctuations.
4. D) It implies a lack of transparency.
Answer: A
83
If the relationship between the monetary aggregate and the goal variable is weak, then
1. A) monetary aggregate targeting is superior to exchange-rate targeting.
2. B) monetary aggregate targeting is superior to inflation targeting.
3. C) inflation targeting is superior to exchange-rate targeting.
4. D) monetary aggregate targeting will not work.
Answer: D
84
The monetary policy strategy that relies on a stable money-income relationship is
1. A) exchange-rate targeting.
2. B) monetary targeting.
3. C) inflation targeting.
4. D) the implicit nominal anchor.
Answer: B
85
In its earliest years, the Federal Reserve's guiding principle for the conduct of monetary
policy was known as the
1. A) real bills doctrine.
2. B) liberal liquidity doctrine.
3. C) free reserves doctrine.
4. D) quantity theory of money.
Answer: A
86
The guiding principle for the conduct of monetary policy that held that as long as loans
were being made for "productive" purposes, then providing reserves to the banking
system to make these loans would not be inflationary became known as the
1. A) free reserves doctrine.
2. B) Benjamin Strong doctrine.
3. C) efficient liquidity doctrine.
4. D) real bills doctrine.
Answer: D
87
The real bills doctrine was the guiding principle for the conduct of monetary policy
during the
1. A) 1910s.
2. B) 1940s.
3. C) 1950s.
4. D) 1960s.
Answer: A
88
The Fed accidentally discovered open market operations in the early
1. A) 1920s.
2. B) 1910s.
3. C) 1900s.
4. D) 1890s.
Answer: A
89
The Fed accidentally discovered open market operations when
1. A) it came to the rescue of failing banks in the early 1930s, and found that
its purchases of bank loans injected reserves into the banking system.
2. B) it purchased securities for income following the 1920-1921 recession.
3. C) it attempted to slow inflation in 1919 by selling securities and found that
its sales drained reserves from the banking system.
4. D) it reinterpreted a key provision of the Federal Reserve Act.
Answer: B
90
The Fed's mistakes of the early 1930s were compounded by its decision to
1. A) raise reserve requirements in 1936-1937.
2. B) lower reserve requirements in 1936-1937.
3. C) raise the monetary base in 1936-1937.
4. D) lower the monetary base in 1936-1937.
Answer: A
91
During World War II, whenever interest rates would ________ and the price of bonds
would begin to ________, the Fed would make open market purchases.
1. A) rise; rise
2. B) rise; fall
3. C) fall; rise
4. D) fall; fall
Answer: B
92
During World War II, whenever interest rates would rise and the price of bonds would
begin to fall, the Fed would
1. A) lower reserve requirements.
2. B) raise reserve requirements.
3. C) make open market purchases of government securities.
4. D) make open market sales of government securities.
Answer: C
93
During World War II, the Fed in effect relinquished its control of monetary policy
through its policy of
1. A) continually lowering reserve requirements.
2. B) continually raising reserve requirements.
3. C) pegging interest rates.
4. D) targeting free reserves.
Answer: C
94
The Fed was committed to keeping interest rates low to assist Treasury financing of
budget deficits
1. A) only during World War I.
2. B) during the Great Depression.
3. C) during World War I and World War II.
4. D) throughout the entire existence of the Fed.
Answer: C
95
The Fed-Treasury Accord of March 1951 provided the Fed greater freedom to
1. A) let interest rates increase.
2. B) let unemployment increase.
3. C) let inflation accelerate.
4. D) let exchange rates increase.
Answer: A
96
During the 1950s, the Fed targeted
1. A) M1.
2. B) M2.
3. C) the monetary base.
4. D) money market conditions.
Answer: D
97
During the 1950s, Fed monetary policy targeted
1. A) the monetary base.
2. B) the exchange rate.
3. C) discount loans.
4. D) interest rates.
Answer: D
98
Targeting interest rates can be procyclical because
1. A) an increase in income increases interest rates, causing the Fed to buy
bonds, increasing the monetary base and money supply, leading to further
increases in income.
2. B) an increase in interest rates increases income, causing the Fed to buy
bonds, increasing the monetary base and money supply, leading to further
increases in income.
3. C) an increase in the monetary base increases the money supply, causing the
Fed to buy bonds, increasing the monetary base and money supply, leading
to further increases in income.
4. D) an increase in income increases the monetary base and money supply,
causing the Fed to buy bonds to increase interest rates and income.
Answer: A
99
High inflation can spiral out of control when
1. A) expected inflation increases nominal interest rates, causing the Fed to buy
bonds, increasing the money supply and further increasing inflation.
2. B) expected inflation decreases nominal interest rates, causing the Fed to
buy bonds, increasing the money supply and further increasing inflation.
3. C) expected inflation increases nominal interest rates, causing the Fed to sell
bonds, increasing the money supply and further increasing inflation.
4. D) expected inflation decreases nominal interest rates, causing the Fed to
sell bonds, increasing the money supply and further increasing inflation.
Answer: A
100
In practice, the Fed's policy of targeting money market conditions in the 1960s proved
to be
1. A) countercyclical, helping to stabilize the economy.
2. B) procyclical, destabilizing the economy.
3. C) procyclical, helping to stabilize the economy.
4. D) countercyclical, destabilizing the economy.
Answer: B
101
In practice, the Fed's policy of targeting ________ in the 1960s proved to be ________,
destabilizing the economy.
1. A) money market conditions; countercyclical
2. B) money market conditions; procyclical
3. C) monetary aggregates; countercyclical
4. D) monetary aggregates; procyclical
Answer: B
102
Although the Fed professed employment of a monetary aggregate targeting strategy
during the 1970s, its behavior suggests that it emphasized
1. A) free-reserve targeting.
2. B) interest-rate targeting.
3. C) a real-bills doctrine.
4. D) price-index targeting.
Answer: B
103
Although the Fed professed employment of ________ targeting during the 1970s, its
behavior suggests that it emphasized ________ targeting.
1. A) free-reserve; interest-rate
2. B) interest-rate; monetary aggregate
3. C) monetary aggregate; interest-rate
4. D) free reserve; monetary aggregate
Answer: C
104
The Fed's use of the federal funds rate as an operating target in the 1970s resulted in
1. A) countercyclical monetary policy.
2. B) too slow growth in M1 throughout the decade.
3. C) procyclical monetary policy.
4. D) too rapid growth in M1 throughout the decade.
Answer: C
105
The Fed's use of the ________ as an operating target in the 1970s resulted in ________
monetary policy.
1. A) federal funds rate; countercyclical
2. B) federal funds rate; procyclical
3. C) M1 money supply; countercyclical
4. D) M1 money supply; procyclical
Answer: B
106
In the 1970s, the Fed selected an interest rate as an operating target rather than a
reserve aggregate primarily because it
1. A) had no interest in targeting a monetary aggregate, as evidenced by its
unwillingness to target a reserve aggregate.
2. B) was still very concerned with achieving interest rate stability.
3. C) was committed to targeting free reserves.
4. D) was committed to the real bills doctrine.
Answer: B
107
The Fed operating procedures employed between 1979 and 1982 resulted in ________
swings in the federal funds rate and ________ swings in the M1 growth rate.
1. A) increased; increased
2. B) increased; decreased
3. C) decreased; decreased
4. D) decreased; increased
Answer: A
108
The fluctuations in both money supply growth and the federal funds rate during 1979-
1982 suggest that the Fed
1. A) had shifted to borrowed reserves as an operating target.
2. B) had shifted to total reserves as an operating target.
3. C) had shifted to the monetary base as an operating target.
4. D) never intended to target monetary aggregates.
Answer: D
109
Large fluctuations in money supply growth and smaller fluctuations in the federal funds
rate between October 1982 and the early 1990s indicate that the Fed had shifted to
________ as an operating target.
1. A) borrowed reserves
2. B) nonborrowed reserves
3. C) excess reserves
4. D) required reserves
Answer: A
110
The strengthening of the dollar between 1980 and 1985 contributed to a ________ in
American competitiveness, putting pressure on the Fed to pursue a more ________
monetary policy.
1. A) decrease; contractionary
2. B) increase; expansionary
3. C) increase; contractionary
4. D) decrease; expansionary
Answer: D
111
A borrowed reserves target is ________ because increases in income ________ interest rates
and discount loans, causing the Fed to ________ the monetary base, everything else held
constant.
1. A) procyclical; increase; increase
2. B) countercyclical; increase; increase
3. C) procyclical; reduce; reduce
4. D) countercyclical; reduce; reduce
Answer: A
112
Fed policy since the early 1990s indicates that it is pursuing a policy of targeting the
1. A) monetary base.
2. B) money supply.
3. C) federal funds interest rate.
4. D) exchange rate.
Answer: C
113
Since the early 1990s, the Fed has conducted monetary policy by setting a target for the
1. A) level of borrowed reserves.
2. B) monetary base.
3. C) federal funds rate.
4. D) inflation rate.
Answer: C
114
The Fed can engage in preemptive strikes against a rise in inflation by ________ the
federal funds interest rate; it can act preemptively against negative demand shocks by
________ the federal funds interest rate.
1. A) raising; lowering
2. B) raising; raising
3. C) lowering; lowering
4. D) lowering; raising
Answer: A
115
International policy coordination refers to
1. A) central banks in major nations acting without regard to the global
consequences of their policies.
2. B) central banks in major nations pursuing only domestic objectives.
3. C) central banks adopting policies in pursuit of joint objectives.
4. D) central banks all adopting identical policies.
Answer: C
116
The Federal Reserve has been ________ preemptive because of the changing view that
monetary policy has to be ________ looking.
1. A) more; forward
2. B) more; backward
3. C) less; forward
4. D) less; backward
Answer: A

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 1) The Fed uses three policy tools to manipulate the money supply: ________, which

B) open market operations; borrowed reserves; reserve requirements

C) monetary base; monetary base; money multiplier

C) federal funds rate.

 4) The primary indicator of the Fedʹs stance on monetary policy is

B) the federal funds rate.

 5) The quantity of reserves demanded equals

C) required reserves plus excess reserves.

D) the demand curve for reserves is horizontal

 11) The quantity of reserves supplied equals

B) nonborrowed reserves plus borrowed reserves.

B) the supply curve of reserves is horizontal.

 23) In the market for reserves, a lower discount rate

D) shortens the vertical section of the supply curve of reserves.

C) has no effect on the federal funds rate.

C) has no effect on the federal funds rate.

A) lowers the federal funds rate.

B) raises the federal funds rate.

C) has no effect on the federal funds rate.

B) lowers the federal funds rate.

A) increases the federal funds rate.

A) increases the federal funds rate.

A) increases the federal funds rate.

C) has no effect on the federal funds rate.

C) has no effect on the federal funds rate

B) when the funds rate equals the discount rate.

 39) The Federal Reserve usually keeps the discount rate

A) above the target federal funds rate.

B) discount rate decreases.

A) discount rate increases.

A) Open market operations; monetary base

C) monetary base; money supply

 4) Open market sales shrink ________ thereby lowering ________.

C) reserves and the monetary base; the money supply

D) dynamic and defensive.

 8) Open market operations intended to offset movements in noncontrollable factors (such

A) defensive open market operations.

 9) When the Federal Reserve engages in a repurchase agreement to offset a withdrawal of

 11) The actual execution of open market operations is done at

B) the Federal Reserve Bank of New York.

C) increase; defensive; sales

C) decrease; defensive; purchases

A) increase; defensive; inject

B) fall; defensive; drain

B) a matched sale-purchase transaction.

B) borrowed reserves; monetary base

 2) The discount rate is

A) the interest rate the Fed charges on loans to banks.

C) primary credit; seasonal credit; secondary credit

 8) The discount rate refers to the interest rate on

 11) The interest rate on seasonal credit equals

D) an average of the federal funds rate and rates on certificates of deposits.

 12) The Fed is considering eliminating

C) seasonal credit lending.

 13) At its inception, the Federal Reserve was intended to be

B) Term Auction Facility

C) Term Securities Lending Facility

 18) The Fedʹs lender-of-last-resort function

D) creates a moral hazard problem.

B) perform its role as lender of last resort.

B) reserve requirements; money multiplier

B) reserve requirements; money multiplier

 4) Since 1980, ________ are subject to reserve requirements.

 4) Open market sales shrink thereby lowering .