Chapter 15 Monetary Theory and Policy PDF

Chapter 15 Monetary Theory and Policy
TRUEFALSE
1. The demand for money is a downward sloping line that depicts the relationship between the price
level and the opportunity cost of holding money.
(A) True
(B) False
Answer : (B)
2. The money demand curve shifts to the right whenever there is a decrease in the interest rate.
(A) True
(B) False
Answer : (B)
3. The higher the interest rate, the greater the preference for liquidity.
(A) True
(B) False
Answer : (B)
4. The demand for money was high in the year 2015 when the interest rate on savings deposits and
time deposits was close to zero.
(A) True
(B) False
Answer : (A)
5. The supply of money is depicted as an upward sloping line that depends directly on the interest
rate.
(A) True
(B) False
Answer : (B)
6. If the money supply in an economy is increased, the interest rate will fall, and real GDP will
decrease.
(A) True
(B) False
Answer : (B)
7. A decrease in the money supply in the short run will cause an increase in planned investment
spending.
(A) True
(B) False
Answer : (B)
8. If the value of the spending multiplier is greater than 1, then an increase in investment will shift
the aggregate demand curve to the left.
(A) True
(B) False
Answer : (B)
9. An expansionary monetary policy is always capable of boosting aggregate investment.
(A) True
(B) False
Answer : (B)
10. For a given shift of the aggregate demand curve, the steeper the short-run aggregate supply
curve, the larger the change in real GDP.
(A) True
(B) False
Answer : (B)
11. When calculating how much changes in the money supply will change nominal GDP, we use the
money multiplier instead of the spending multiplier.
(A) True
(B) False
Answer : (B)
12. The quantity theory of money states that increases in the money supply result in proportional
increases in real GDP.
(A) True
(B) False
Answer : (B)
13. In the long run, increases in the money supply increase the economy's potential output level.
(A) True
(B) False
Answer : (B)
14. The quantity theory of money assumes that money supply and price level are the only variables
in the equation of exchange that are free to fluctuate.
(A) True
(B) False
Answer : (B)
15. According to the quantity theory of money, if velocity of money is constant, a 5 percent increase
in money supply will lead to a 0.25 percent increase in nominal GDP.
(A) True
(B) False
Answer : (B)
16. An identity is a relationship expressed in such a way that it is true by definition.
(A) True
(B) False
Answer : (A)
17. A wider use of charge accounts and credit cards have reduced the demand for "walking-around"
money.
(A) True
(B) False
Answer : (A)
18. When the Fed is targeting the money supply, it has complete control over the interest rate.
(A) True
(B) False
Answer : (B)
19. Since the Federal Reserve was established in 1913, the U.S. has experienced three periods of
high inflation and each was preceded and accompanied by a period of sharp decline in the money
supply.
(A) True
(B) False
Answer : (B)
20. The Dodd-Frank Act gave the Fed and the FDIC expanded oversight of large financial
institutions, including those that were not depository institutions.
(A) True
(B) False
Answer : (A)
21. Before 2008, money market mutual funds and hedge funds had been out of Fed's scope and
control because they did not rely on customer deposits.
(A) True
(B) False
Answer : (A)
MULTICHOICE
22. Which of these is a flow variable?
(A) Money
(B) Income
(C) Jewelry
(D) Bank deposit
(E) Foreign currency reserve
Answer : (B)
23. The demand for money in an economy is high when the:
(A) real GDP is low.
(B) personal tax rate is low.
(C) unemployment rate is high.
(D) price level is high.
(E) interest rate is high.
Answer : (D)
24. The demand for money is a relationship between:
(A) the price level and the amount of cyclical unemployment.
(B) the price level and the actual output produced in an economy.
(C) the interest rate and how much money people choose to hold.
(D) the interest rate and how much money people earn during a certain time period.
(E) the interest rate and the rate of inflation.
Answer : (C)
25. The demand for money will be high in an economy experiencing:
(A) a depression.
(B) hyperinflation.
(C) deflation.
(D) a recession.
(E) a sluggish population growth.
Answer : (B)
26. The opportunity cost of holding money is measured by the:
(A) interest rate.
(B) liquidity lost by holding money.
(C) money supply curve.
(D) inflation rate.
(E) cost of cashing in financial assets.
Answer : (A)
27. The opportunity cost of holding money increases when:
(A) the interest rate rises.
(B) the interest rate falls.
(C) the price level falls.
(D) nominal GDP rises.
(E) nominal GDP falls.
Answer : (A)
28. The demand for money is based primarily on money's role as a(n):
(A) measure of wealth.
(B) medium of exchange.
(C) standard of economic well-being.
(D) interest-bearing asset.
(E) non-interest-bearing asset.
Answer : (B)
29. Which of these is an advantage of money as a store of value?
(A) It can generate high interest income.
(B) It can facilitate hassle-free international exchange.
(C) It can be easily liquidated.
(D) It can signal a nation's economic health.

(E) It can increase potential output.
Answer : (C)
30. Which of the following forms of money will earn at least some interest income?
(A) Gold coins
(B) Currency notes
(C) Traveler's checks
(D) Checkable deposits
(E) Gift checks
Answer : (D)
31. Suppose an individual can earn 3 percent interest on an annual term deposit. His opportunity
cost of holding $100,000 in cash instead of investing in the term deposit will be:
(A) $3,300.
(B) $330.
(C) $1,000.
(D) $6,000.
(E) $3,000.
Answer : (E)
32. Other things constant, the quantity of money demanded varies:
(A) directly with the market interest rate.
(B) inversely with the market interest rate.
(C) inversely with the price level.
(D) directly with the price level.
(E) inversely with the unemployment rate.
Answer : (B)
33. Movements along a money demand curve reflect the effects of changes in the:
(A) price level on the quantity of money demanded.

(B) interest rate on the demand for money.
(C) real exchange rate on the demand for money.
(D) interest rate on the quantity of money demanded.
(E) potential GDP on the quantity of money demanded.
Answer : (D)
34. The money demand curve will shift when there is a change in the:
(A) unemployment rate.
(B) inflation rate.
(C) money supply.
(D) nominal interest rate.
(E) price level.
Answer : (E)
35. A decrease in the market interest rate, other things constant, will result in:
(A) a rightward shift of the money demand curve.
(B) a leftward shift of the money demand curve.
(C) an increase in the slope of the money demand curve.
(D) a movement up along the money demand curve.
(E) a movement down along the money demand curve.
Answer : (E)
36. Other things constant, an increase in the real GDP of a country will:
(A) increase the price level.
(B) shift the demand for money curve rightward.
(C) shift the demand for money curve leftward.
(D) decrease the nominal interest rate.
(E) decrease the quantity of money demanded.
Answer : (B)
37. Which of the following changes will shift the money demand curve leftward?
(A) An increase in the price level
(B) An increase in real GDP
(C) A decrease in the nominal interest rate
(D) An increase in the nominal interest rate
(E) A decrease in real GDP
Answer : (E)
38. Which of the following changes will shift the money demand rightward?
(A) An increase in the price level
(B) A decrease in real GDP
(C) A decrease in the nominal interest rate
(D) An increase in the nominal interest rate
(E) A decrease in the price level
Answer : (A)
39. The money demand curve slopes:
(A) downward because the cost of holding money decreases as the interest rate decreases.
(B) downward because the cost of holding money increases as the interest rate decreases.
(C) upward because people demand more money as real GDP increases.
(D) upward because people demand more money as real GDP decreases.
(E) downward because people demand more money as the price level decreases.
Answer : (A)
40. Other things constant, an increase in the price level will:
(A) shift the money demand curve to the right.
(B) shift the money demand curve to the left.
(C) increase the quantity of money people want to hold.
(D) decrease the quantity of money people want to hold.

(E) have no impact on the money demand curve.
Answer : (A)
41. Other things constant, if the interest rate rises, people prefer to hold:
(A) less money because the opportunity cost of holding money has increased.
(B) more money because the opportunity cost of holding money has increased.
(C) less money because the opportunity cost of holding money has declined.
(D) more money because the opportunity cost of holding money has declined.
(E) the same amount of money because the opportunity cost of holding money is zero.
Answer : (A)
42. An increase in the nominal interest rate, other things constant, will:
(A) shift the money demand curve to the right.
(B) shift the money demand curve to the left.
(C) increase the quantity of money people choose to hold.
(D) decrease the quantity of money people choose to hold.
(E) have no impact on the money demand curve.
Answer : (D)
43. Which of the following is not assumed to be constant along a money demand curve?
(A) The price level
(B) The interest rate
(C) Real GDP
(D) Nominal GDP
(E) Individual's tastes and preferences
Answer : (B)
44. Which of the following changes will cause a downward movement along the money demand
curve?
(A) An increase in the interest rate

(B) A decrease in the interest rate
(C) A decrease in real GDP
(D) An increase in real GDP
(E) An increase in the price level
Answer : (B)
45. A movement upward and to the left along the money demand curve is caused by:
(A) an increase in the interest rate.
(B) a decrease in the interest rate.
(C) a decrease in real GDP.
(D) an increase in real GDP.
(E) an increase in the average price level.
Answer : (A)
46. At a given point in time, if the demand for money increases:
(A) the interest rate will fall.
(B) there will be a movement downward along the money demand curve.
(C) there will be a movement upward along the money demand curve.
(D) there will be a rightward shift of the money demand curve.
(E) there will be a leftward shift of the money demand curve.
Answer : (D)
47. Which of the following changes is most likely to be observed in the money market of a country
experiencing a recession?
(A) The demand curve for money will shift to the right.
(B) The demand curve for money will shift to the left.
(C) The quantity of money demanded will increase.
(D) The quantity of money demanded will decrease.
(E) The supply of money will fall.
Answer : (A)
48. The figure given below shows the interest rate on the vertical axis and the quantity of money on
the horizontal axis. In this figure, an increase in the interest rate will cause a movement from:
Figure 15.1
(A) point B to point A.
(B) point A to point B.
(C) DM to DM'.
(D) DM to DM*.
(E) point E to point D.
Answer : (A)
the horizontal axis. In this figure, an increase in the price level will cause a movement from:
Figure 5.1

(C) DM to DM'.
(D) DM to DM*.
(E) point E to point F.
Answer : (C)
the horizontal axis. In this figure, an increase in the level of real GDP will cause a movement from:
Figure 15.1
(C) DM to DM'.

(D) DM to DM*.
Answer : (C)
the horizontal axis. In this figure, a decrease in nominal GDP with no change in the price level will
cause a movement from:
Figure 15.1
(C) DM to DM'.
(D) DM to DM*.
Answer : (D)
52. When people exchange money for financial assets, the _____ rises.
(A) real GDP
(B) price level
(C) unemployment rate
(D) nominal GDP
(E) interest rate

Answer : (E)
53. People prefer to hold less of their wealth in the form of financial assets like bonds and term
deposits when:
(A) real GDP is at an all-time low
(B) the real interest rate is above 10 percent.
(C) the price level is very low.
(D) the nominal interest rate is close to zero.
(E) the nominal interest rate is very high.
Answer : (D)
54. Which of the following will result in the money market when the price level in an economy rises,
while the supply of money remains unchanged?
(A) The demand for money will decrease.
(B) The supply of money will increase.
(C) The rate of interest will decrease.
(D) The total investment spending in the economy will increase.
(E) The rate of interest will increase.
Answer : (C)
55. In the money market, if the money supply decreases, the opportunity cost of holding money:
(A) decreases and the quantity of money demanded increases.
(B) decreases and the quantity of money demanded falls.
(C) increases and the quantity of money demanded falls.
(D) increases but the quantity of money demanded remains unchanged.
(E) increases and the quantity of money demanded also increases.
Answer : (C)
56. For a given money demand curve, an increase in money supply:
(A) drives up the real interest rate.
(B) lowers the opportunity cost of holding money.

(C) decreases the quantity of money demanded.
(D) drives down the price level in an economy.
(E) contracts the total output produced in an economy.
Answer : (B)
57. In the money market, an increase in money supply will:
(A) increase the demand for money at each interest rate.
(B) decrease the demand for money at each interest rate.
(C) encourage people to exchange money for interest-bearing assets.
(D) encourage people to exchange interest-bearing assets for money.
(E) increase the interest rate.
Answer : (C)
58. Which one of these statements is correct?
(A) The lower the interest rate, the higher the opportunity cost of holding assets in the form of
money.
(B) The quantity of money supplied is independent of the interest rate.
(C) The larger the supply of money, the higher the interest rate, all things equal.
(D) Travelers checks and government bonds are equally liquid assets.
(E) The demand for money increases whenever the price level decreases.
Answer : (B)
59. The equilibrium interest rate in a money market is determined by:
(A) the rate of inflation.
(B) aggregate demand and aggregate supply.
(C) money demand and money supply.
(D) the Congress.
(E) the Fed.
Answer : (C)
60. If the quantity of money supplied exceeds the quantity of money demanded, at a point in time:
(A) the price level in the economy will fall.
(B) the equilibrium interest rate will fall.
(C) the equilibrium interest rate will fall.
(D) the money demand curve will shift to the right.
(E) the money demand curve will shift to the left.
Answer : (C)
61. Which of the following changes is most likely to happen when there is a decrease in the supply
of money in a market that was initially in equilibrium?
(A) The demand for money increases
(B) Planned investment spending increases
(C) Interest rate increases
(D) Aggregate expenditure increases
(E) The demand for money decreases
Answer : (C)
62. The figure given below shows equilibrium in a money market. If S is the supply curve, the
equilibrium interest rate and quantity of money will be:
Figure 15.2
(A) r and m, respectively.

(B) r* and m*, respectively.
(C) r' and m', respectively.
(D) r and m', respectively.
(E) r' and m*, respectively.
Answer : (A)
63. The figure given below shows equilibrium in a money market. If S is the initial supply curve, the
movement from S to S* can be attributed to:
Figure 152
(A) a decrease in the required reserve ratio.
(B) the purchase of U.S. Treasury securities by the Fed.
(C) the sale of U.S. Treasury securities by the Fed.
(D) a decrease in the discount rate.
(E) a decrease in excess reserves in the banking system.
Answer : (C)
64. The figure given below shows equilibrium in a money market. When the money supply curve
shifts from S to S', the equilibrium interest rate and quantity of money changes to:
Figure 15.2
(A) r and m, respectively.
(B) r* and m*, respectively.
(C) r' and m', respectively.
(D) r and m', respectively.
(E) r' and m*, respectively.
Answer : (C)
65. The figure given below shows equilibrium in a money market. Which of the following will be
observed if the money supply curve shifts from S to S' while the rate of interest remains at "r"?
Figure 15.2
(A) There will be an excess demand for money.
(B) There will be an excess supply of money.
(C) The Fed will buy U.S. Treasury securities.

(D) The quantity of money demanded will fall.
(E) The quantity of money supplied will fall.
Answer : (B)
66. The figure given below shows equilibrium in a money market. Which of the following will be
observed if the money supply curve shifts from S to S* while the rate of interest remains at "r?
Figure 15.2
(A) There will be an excess demand for money.
(B) There will be an excess supply of money.
(C) The Fed will sell U.S. Treasury securities.
(D) The money market equilibrium will move from point B to point C.
(E) The money market equilibrium will move from point C to point A.
Answer : (A)
67. Which of these changes is likely to follow when the Fed purchases U.S. government securities?
(A) Aggregate demand will decrease.
(B) The demand for financial securities will increase.
(C) Rate of interest will increase.
(D) Planned investment spending will increase.
(E) Real GDP will decrease.
Answer : (D)
68. In the short run, a decrease in the money supply will lead to a(n):
(A) decrease in Gross Domestic Product.
(B) increase in the price level.
(C) increase in aggregate demand.
(D) increase in the demand for money.
(E) decrease in the market interest rate.
Answer : (A)
69. In the aggregate demand-aggregate supply model in the short run, an increase in the money
supply will lead to a(n):
(A) increase in both the price level and real GDP.
(B) decrease in both the price level and real GDP.
(C) increase in real GDP and a decrease in the price level.
(D) decrease in real GDP and an increase in the price level.
(E) increase in the price level only.
Answer : (A)
70. In the aggregate demand-aggregate supply model in the short run, a decrease in the money
supply is likely to cause a(n):
(A) increase in both the price level and real GDP.
(B) decrease in both the price level and real GDP.
(C) increase in real GDP and a decrease in the price level.
(D) decrease in real GDP and an increase in the price level.
(E) increase in the price level only.
Answer : (B)
71. Which of the following policies can be adopted by the Fed in order to stimulate an economy in
the short run?
(A) Increase the market interest rate
(B) Purchase U.S. government securities
(C) Increase the discount rate

(D) Increase the price of consumer goods
(E) Increase the required reserve ratio
Answer : (B)
72. If the Fed increases the money supply, then:
(A) the interest rate declines and the quantity of money demanded increases.
(B) the interest rate declines and the quantity of money demanded declines.
(C) the interest rate increases and the quantity of money demanded increases.
(D) the interest rate increases and the quantity of money demanded declines.
(E) the interest rate increases but the quantity of money demanded remains unaffected.
Answer : (A)
73. When the Fed purchases U.S. government securities through the open market, the money
supply:
(A) increases, the interest rate falls, and the quantity of money demanded increases.
(B) falls, the interest rate falls, and the quantity of money demanded increases.
(C) increases, the interest rate increases, and the quantity of money demanded increases.
(D) falls, the interest rate increases, and the quantity of money demanded falls.
(E) falls, the interest rate falls, and the quantity of money demanded falls.
Answer : (A)
74. The demand curve for investment depicts:
(A) an inverse relationship between interest rate and aggregate demand.
(B) an inverse relationship between interest rate and investment.
(C) an inverse relationship between price level and real GDP.
(D) a direct relationship between interest rate and quantity of money.
(E) a direct relationship between aggregate demand and real GDP
Answer : (B)
75. All other things constant, when the interest rate increases:
(A) the demand for investment curve shifts to the right
(B) the demand for investment curve shifts to the left.
(C) there is a movement downward along the demand for investment curve.
(D) there is a movement upward along the demand for investment curve.
(E) GDP increases.
Answer : (D)
76. All other things constant, if the interest rate decreases on account of a monetary policy:
(A) the demand for investment curve shifts to the right.
(B) the demand for investment curve shifts to the left.
(C) there is a downward movement along the demand for investment curve.
(D) there is an upward movement along the demand for investment curve.
(E) real GDP decreases.
Answer : (C)
77. Planned investment expenditures will eventually decrease after:
(A) the money supply decreases.
(B) the demand for money decreases.
(C) the interest rate falls.
(D) the Fed buys government securities.
(E) business managers become more optimistic about future market conditions for their products.
Answer : (A)
78. When the Fed adopts an expansionary monetary policy:
(A) the demand for investment curve shifts to the left.
(B) the demand for investment curve shifts to the right.
(C) there is a downward movement along the demand for investment curve.
(D) there is an upward movement along the demand for investment curve.
(E) there is no impact on the demand for investment curve.

Answer : (C)
79. If the Fed decreases the money supply, gross domestic product:
(A) increases by the same amount as the increase in the interest rate.
(B) decreases by a greater amount than the increase in the interest rate because of the multiplier.
(C) decreases by the same amount as the decrease in investment.
(D) decreases by a greater amount than the decrease in investment because of the multiplier.
(E) decreases by a lesser amount than the decrease in investment because of the multiplier.
Answer : (D)
80. If the Fed purchases U.S. government securities, gross domestic product:
(A) increases because the resulting increase in the interest rate leads to a decrease in investment.
(B) increases because the resulting decrease in the interest rate leads to an increase in investment.
(C) decreases because the resulting increase in the interest rate leads to a decrease in investment.
(D) decreases because the resulting increase in the interest rate leads to an increase in investment.
(E) decreases because the resulting decrease in the interest rate leads to an increase in investment.
Answer : (B)
81. If the Fed sells U.S. government securities in the open market, gross domestic product:
(A) increases because the resulting increase in the interest rate leads to a decrease in investment.
(B) increases because the resulting decrease in the interest rate leads to an increase in investment.
(C) decreases because the resulting increase in the interest rate leads to a decrease in investment.
(D) decreases because the resulting increase in the interest rate leads to an increase in investment.
(E) decreases because the resulting decrease in the interest rate leads to an increase in investment.
Answer : (C)
82. As a result of an expansionary monetary policy:
(A) both aggregate expenditure and aggregate demand increase.
(B) both aggregate expenditure and aggregate demand decrease.
(C) aggregate expenditure increases and aggregate demand decreases.

(D) aggregate expenditure decreases and aggregate demand increases.
(E) aggregate expenditure remains unchanged; aggregate demand increases.
Answer : (A)
83. If the Fed sells U.S. government securities to drain reserves from banks, which of the following
is most likely to occur?
(A) The demand for money will increase and the interest rate will rise.
(B) The money supply will increase and the interest rate will fall.
(C) The interest rate will rise and the quantity of money demanded will fall.
(D) The money supply will decrease and the interest rate will fall.
(E) The interest rate will fall and the quantity of money demanded will increase.
Answer : (C)
84. If the Fed adopts a contractionary monetary policy, eventually we can expect:
(A) aggregate demand to increase.
(B) short-run aggregate supply to decrease.
(C) interest rates to decrease.
(D) planned investment expenditures to decrease.
(E) real Gross Domestic Product to increase.
Answer : (D)
85. An increase in the money supply leads to a(n)
(A) decline in interest rates, an increase in investment, and an increase in aggregate demand.
(B) decline in interest rates, a decrease in investment, and an increase in aggregate demand.
(C) decline in interest rates, an increase in investment, and a decline in aggregate demand.
(D) increase in interest rates, an increase in investment, and an increase in aggregate demand.
(E) decline in interest rates, a decline in investment, and a decline in aggregate demand.
Answer : (A)
86. If investment is not sensitive to changes in the interest rate, then changes in the money supply:
(A) will have no effect on interest rates.
(B) will have no impact on the quantity of money demanded.
(C) will have no effect on the aggregate demand of an economy.
(D) will have a major impact on the aggregate demand of an economy.
(E) will have a major impact on the price level in an economy.
Answer : (C)
87. For monetary policy to be effective in changing planned investment spending:
(A) interest rates must not be responsive to changes in the money supply.
(B) interest rates must be sensitive to changes in Gross Domestic Product.
(C) investment must be sensitive to changes in interest rates.
(D) investment must be sensitive to changes in the price level.
(E) interest rates must be sensitive to changes in the price level.
Answer : (C)
88. Identify the correct statement about changes in money supply.
(A) A decrease in money supply causes interest rates to fall.
(B) A decrease in money supply causes investment spending to increase.
(C) A decrease in money supply causes gross domestic product to increase.
(D) A decrease in money supply causes investment spending to decrease.
(E) A decrease in money supply causes aggregate expenditure to increase.
Answer : (D)
89. Monetary policy will be effective in changing the gross domestic product of a nation only if:
(A) planned investment expenditures are autonomous.
(B) planned investment expenditures are sensitive to interest rates.
(C) interest rates are unresponsive to changes in money supply.
(D) interest rates are sensitive to changes in the price level.
(E) planned investment expenditures are sensitive to interest rates.

Answer : (B)
90. The ultimate effect of a reduction in the money supply is:
(A) a leftward shift of the aggregate demand curve.
(B) a rightward shift of the short-run aggregate supply curve.
(C) a movement upward along the aggregate demand curve.
(D) a movement downward along the aggregate demand curve.
(E) a movement upward along the short-run aggregate supply curve.
Answer : (A)
91. To eliminate a recessionary gap, the Fed can:
(A) increase the money supply as it will increase the interest rate and investment.
(B) increase the money supply as it will decrease the interest rate and increase investment.
(C) decrease the money supply as it will increase the interest rate and investment.
(D) decrease the money supply as it will decrease the interest rate and investment.
(E) decrease the money supply as it will increase the interest rate and decrease investment.
Answer : (B)
92. Which of the following monetary policies would be appropriate to close a recessionary gap?
(A) A tax cut
(B) A decrease in government purchases
(C) An increase in reserve requirements
(D) The Fed's purchase of U.S. government securities
(E) The Fed's raising the discount rate
Answer : (D)
93. An increase in investment can lead to a greater increase in aggregate demand if the value of the
spending multiplier is:
(A) greater than 1.
(B) less than 1 but more than zero.

(C) negative.
(D) exactly equal to zero.
(E) exactly equal to one.
Answer : (A)
94. Given an upward sloping aggregate supply curve, which of the following changes in the
aggregate demand curve is observed when the Fed reduces the money supply?
(A) The aggregate demand curve shifts leftward, lowering real GDP and the price level.
(B) The aggregate demand curve shifts leftward, raising real GDP and the price level.
(C) The aggregate demand curve shifts leftward, lowering real GDP but raising the price level.
(D) The aggregate demand curve shifts rightward, raising real GDP and the price level.
(E) The aggregate demand curve shifts rightward, lowering real GDP but raising the price level.
Answer : (A)
95. When the Fed decreases the money supply:
(A) aggregate demand and aggregate supply both increase.
(B) aggregate demand increases, which leads to movement along the short-run aggregate supply
curve.
(C) aggregate demand decreases, which leads to movement along the short-run aggregate supply
curve.
(D) aggregate supply increases, which leads to movement along the aggregate demand curve.
(E) aggregate supply decreases, which leads to movement along the aggregate demand curve.
Answer : (C)
96. The Fed can close a recessionary gap by:
(A) increasing fiscal expenditure.
(B) increasing taxes.
(C) decreasing taxes.
(D) selling U.S. government bonds.
(E) lowering the discount rate.
Answer : (E)
97. The figure given below depicts short-run equilibrium in an aggregate demand-aggregate supply
model. If the economy is at point "e" in the short run, which of these policies adopted by the Fed is
likely to return it to long-run equilibrium?
Figure 15.3
(A) A decrease in government spending
(B) An increase in the tax rate
(C) A decrease in the tax rate
(D) A decrease in the money supply
(E) An increase in the money supply
Answer : (D)
model. The Fed can return the economy to potential output in the long run by:
Figure 15.3

(A) purchasing U.S. government securities.
(B) decreasing taxes.

(C) selling U.S. government securities.
(D) lowering the discount rate.
(E) lowering the required reserve ratio.
Answer : (C)
model. Which of the following policies will allow the Fed to close the GDP gap in the long run?
Figure 15.3
(A) A decrease in government spending
(B) A decrease in taxes
(C) A sale of U.S. government bonds
(D) An increase the discount rate
(E) An increase in the required reserve ratio
Answer : (E)
100. Which of the following is an example of an expansionary monetary policy?
(A) A reduction in government purchases of goods and services
(B) An increase in the discount rate
(C) An open market sale of U.S. government securities
(D) A reduction in the required reserve ratio
(E) A tax cut
Answer : (D)
101. Which of the following is an example of a contractionary monetary policy?
(A) Reduction in the amount of transfer payments made to poor families
(B) Purchase of U.S. government securities in the open market
(C) Increase in the discount rate
(D) Decrease in the required reserve ratio
(E) Increase in the tax rate
Answer : (C)
102. For a given increase in aggregate demand, the steeper the short-run aggregate supply curve:
(A) the larger the increase in investment expenditure.
(B) the smaller the increase in the price level.
(C) the smaller the increase in real GDP.
(D) the larger the increase in real GDP.
(E) the smaller the increase in real interest rate.
Answer : (C)
103. When the short-run aggregate supply curve is steep, then for a given increase in aggregate
demand:
(A) the increase in real GDP will be relatively small and the increase in the price level will be
relatively large.
(B) the increase in real GDP will be relatively large and the increase in the price level will be
relatively small.
(C) the increase in both real GDP and the price level will be large.
(D) the increase in both real GDP and the price level will be small.
(E) the decrease in real GDP will be larger than the decrease in the price level.
Answer : (A)
104. If the short-run aggregate supply curve is positively sloped and the Fed increases the money
supply, aggregate demand:
(A) falls, which increases real GDP and the price level.
(B) increases, which decreases real GDP and the price level.
(C) falls, which decreases real GDP and increases the price level.
(D) increases, which decreases real GDP and increases the price level.
(E) increases, which increases real GDP and the price level.
Answer : (E)
105. The figure given below shows the aggregate demand curve and the short-run aggregate supply
curve of an economy. In this figure, short-run equilibrium occurs at:
Figure 15.4

(A) point b, where actual output exceeds potential output.
(B) point a, where actual output exceeds potential output.
(C) point c, where actual price level exceeds the expected price level.
(D) point c, where the actual price level is less than the expected price level.
(E) point b, where the actual price level exceeds the expected price level.
Answer : (C)
106. The figure given below shows the aggregate demand curve and the short-run aggregate supply
curve of an economy. The Fed can return the economy depicted by this figure to its potential output
in the long run by:
Figure 15.4
(A) selling US Treasury securities in the open market.
(B) lowering the discount rate.
(C) by lowering the reserve requirement.
(D) buying US Treasury securities in the open market.
(E) printing money.
Answer : (A)
107. The figure given below shows short run and long run equilibrium in an aggregate demand-
aggregate supply model. The economy shown in this figure is:
Figure 15.5

(A) in a long-run equilibrium at the price level P and income level Y.
(B) in a short-run equilibrium at the price level P and income level Y.
(C) experiencing a contractionary gap at price level P and income level Y.
(D) experiencing an expansionary gap at price level P" and income level Y'.
(E) in a short-run equilibrium at the price level P' and income level Y.
Answer : (B)
108. Over the past 40 years, the most frequent target for the Fed's monetary policy has been the:
(A) prime interest rate.
(B) federal funds rate.
(C) M1 money supply.
(D) M2 money supply.
(E) required reserve ratio.
Answer : (B)
109. Which of the following changes is observed when the Fed increases the federal funds rate?
(A) Inflation is brought to an immediate halt.
(B) The inflation rate increases for several months, but then begins to decrease.
(C) Major banks try to offset this change by lowering the interest rates they charge on loans.
(D) Major banks try to offset this change by lowering the interest rates they pay on savings deposits.
(E) Major banks raise the prime interest rate that they charge to their best customers.
Answer : (E)
110. The Fed uses the federal funds rate to pursue its twin goals of:
(A) exchange rate stability and maximum GDP.
(B) interest rate stability and maximum GDP.
(C) deflation and maximum GDP.
(D) price stability and maximum employment.
(E) interest rate stability and maximum employment.
Answer : (D)
111. equation of exchange states that the quantity of money multiplied by the velocity of money
equals:
(A) real Gross Domestic Product.
(B) the price level.
(C) nominal Gross Domestic Product.
(D) the turnover rate.
(E) the demand for money.
Answer : (C)
112. Which of the following is true of the equation of exchange?
(A) It states that the product of the price level and velocity of money is equal to real GDP.
(B) It states that aggregate demand in an economy is equal to total investment spending.
(C) It states that money supply times velocity of money equals real GDP.
(D) It states that velocity of money is equal to the ratio of nominal GDP and money supply.
(E) It changes to the quantity theory of money if the price level is assumed to be constant.
Answer : (D)
113. Which of the following identities describe the equation of exchange?
(A) Money in circulation × prices = velocity × income
(B) Money in circulation × income = velocity × prices
(C) Real GDP = money in circulation × velocity
(D) Nominal GDP = money in circulation × velocity
(E) Real GDP = prices × money in circulation × velocity
Answer : (D)
114. The velocity of money in circulation measures:
(A) the average length of time that people hold wealth.
(B) how fast aggregate spending will increase for a given decline in money demand.
(C) how fast inflation will rise for a given increase in the money supply.
(D) how quickly money changes hands
(E) how quickly banks can create money.
Answer : (D)
115. If the money supply in an economy equals $1,000 and nominal GDP equals $3,000, then
according to the equation of exchange, velocity of money:
(A) equals 1/3.
(B) equals 3.
(C) equals 3 million.
(D) cannot be determined since we do not know anything about prices.
(E) cannot be determined since we do not know anything about real GDP.
Answer : (B)
116. If the money supply is $1,000, the price level is 3, and real income (or output) is $5,000, then
the velocity of money is _____.
(A) 0.2
(B) 0.6
(C) 1.67
(D) 5
(E) 15
Answer : (E)
117. According to the equation of exchange, if nominal GDP equals $6 trillion and the money supply
equals $1 trillion, the velocity of money:
(A) must be 6.
(B) must be 1/6.
(C) must be 6 trillion.
(D) must be 1/6 trillion.
(E) cannot be determined unless we know the price level.
Answer : (A)
118. According to the equation of exchange, if real GDP is $2 trillion and the money supply is $0.5
trillion, the velocity of money:
(A) must be 4.
(B) must be 1/4.
(C) must be 4 trillion.
(D) must be 1/4 trillion.
(E) cannot be determined unless we know the price level.
Answer : (E)
119. If the money supply in an economy is $300, the price level is $4, and real GDP is $1,500, what
is the nominal value of output?
(A) $1,200
(B) $4,500
(C) $6,000
(D) $180,000
(E) $500
Answer : (C)
120. If the money supply is $600, the price level is $2, and real GDP is $300, the velocity of money is
_____.
(A) 1
(B) 150
(C) 300
(D) 600
(E) 1,200
Answer : (A)
121. According to the equation of exchange, if the amount of money in an economy multiplied by the
velocity of money equals 800 million dollars, then this economy's:
(A) real GDP equals $800 million.
(B) nominal GDP equals $800 million.
(C) real GDP equals $800 million times the price level.
(D) nominal GDP equals $800 million times the price level.
(E) price level equals $800.
Answer : (B)
122. In the long run, an expansionary monetary policy will lead to:
(A) a decrease in aggregate expenditure.
(B) an increase in unemployment.
(C) an increase in the price level.
(D) an increase in potential output.
(E) a decrease in the price level.
Answer : (C)
123. Which of the following variables are assumed to be more or less constant in the quantity theory
of money equation?
(A) The price level

(B) The real GDP
(C) The money supply
(D) The nominal GDP
(E) The velocity of money
Answer : (E)
124. In the long run, if the money supply increases:
(A) most of the resulting rise in nominal GDP will be a result of increases in the exchange rate.
(B) most of the resulting rise in nominal GDP will be a result of increases in the price level.
(C) most of the resulting rise in real GDP will be a result of increases in the price level.
(D) most of the resulting rise in real GDP will be a result of increases in the interest rate.
(E) most of the resulting rise in real GDP will be a result of increases in aggregate expenditure.
Answer : (B)
125. An increase in aggregate demand will have a smaller long-run effect on real GDP if the:
(A) aggregate demand curve is flat.
(B) short-run aggregate supply curve is horizontal.
(C) economy is well below potential output.
(D) economy is already at potential output.
(E) aggregate demand curve is fairly steep.
Answer : (D)
126. In the long run, an increase in aggregate demand:
(A) increases the price level and real output, but the effect on the price level is larger.
(B) increases the price level and real output, but the effect on output is larger.
(C) affects only real output.
(D) affects only the price level.
(E) affects neither the price level nor real output.
Answer : (D)
127. In an economy in which velocity is constant and the same level of real output is produced year
after year, a slow increase in the money supply would result in a:
(A) constant price level.
(B) slowly increasing price level.
(C) rapidly increasing price level.
(D) slowly increasing real GDP.
(E) rapidly increasing real GDP.
Answer : (B)
128. In an economy in which velocity is constant and real output grows at an average rate of 4
percent per year, a 4 percent average rate of growth in the money supply would result in:
(A) a constant price level.
(B) a slowly increasing price level.
(C) a rapidly increasing price level.
(D) constant real GDP.
(E) constant nominal GDP.
Answer : (A)
129. In an economy in which velocity of money in circulation is constant and real output grows at an
average rate of 3 percent per year, a 5 percent average rate of growth in the money supply would
result in a:
(A) constant price level.
(B) slowly increasing price level.
(C) slowly decreasing price level.
(D) stable 4 percent growth in real GDP.
(E) stable 4 percent growth in nominal GDP.
Answer : (B)
130. In an economy in which real output grows at an average rate of 3 percent per year, a 7 percent
average rate of growth in the money supply would result in a(n):
(A) inflation rate of 4 percent, if velocity of money in circulation is constant.

(B) inflation rate of -4 percent, if velocity of money in circulation is constant.
(C) $7 increase in the price level each year.
(D) $7 decrease in the price level each year.
(E) increase in the velocity of money in circulation.
Answer : (A)
131. If real output and velocity are stable and predictable, then the equation of exchange can be
used to derive a simple relationship between:
(A) the money supply and the price level.
(B) the money supply and the interest rate.
(C) the money supply and the foreign exchange rate.
(D) unemployment and aggregate demand.
(E) unemployment and nominal GDP.
Answer : (A)
132. The quantity theory of money states that if the velocity of money is stable or at least
predictable, then:
(A) the quantity of money in circulation determines real GDP in the short run.
(B) the quantity of money in circulation determines aggregate spending.
(C) the quantity of money in circulation determines both real GDP and the price level in the long run.
(D) the quantity of money in circulation determines only the price level in the long run.
(E) the quantity of money in circulation determines the potential output in the long run.
Answer : (D)
133. In the long run, a change in the money supply does not affect the natural rate of unemployment
because:
(A) the aggregate demand curve is vertical.
(B) the aggregate demand curve is downward sloping.
(C) the long-run aggregate supply curve is vertical.
(D) the long-run aggregate supply curve is upward sloping.
(E) the long-run aggregate supply curve is horizontal.

Answer : (C)
134. The velocity of money is defined as:
(A) the time it takes the average worker to get to the bank with his/her paycheck.
(B) the time it takes banks to clear checks.
(C) the average number of times per year each dollar is used to purchase final goods and services.
(D) the ratio of money supply to the average price level in an economy.
(E) the average number of times per year each dollar is spent for goods, payrolls, Social Security
payments, etc.
Answer : (C)
135. The velocity of money increases with a _____, other things constant.
(A) fall in the inflation rate
(B) rise in the inflation rate
(C) rise in the employment rate
(D) fall in the exchange rate
(E) rise in the real interest rate
Answer : (B)
136. An increase in the expected inflation rate causes:
(A) the velocity of money to increase.
(B) the velocity of money to decrease.
(C) the actual inflation rate to fall.
(D) the actual price level to decrease.
(E) the money supply to increase.
Answer : (A)
137. Which of the following would cause an increase in the velocity of money?
(A) An increase in the use of credit cards
(B) An increase in the money supply

(C) An increase in the demand for money
(D) A decrease in the rate of interest
(E) A decrease in nominal GDP and a constant money supply
Answer : (A)
138. Which of these is most likely to lower the velocity of money?
(A) A commercial innovation that facilitates exchange
(B) A low inflation rate
(C) A decline in the effectiveness of money as a store of wealth
(D) A high inflation rate
(E) A weekly pay for workers instead of a monthly pay
Answer : (B)
139. A rising rate of inflation:
(A) makes people more willing to hold money as an asset.
(B) reduces the usefulness of money as a store of value and thus increases the velocity of money.
(C) increases the usefulness of money as a medium of exchange and thus reduces the velocity of
money.
(D) is usually preceded by a reduction in the money supply.
(E) does not have any effect on the velocity of money.
Answer : (B)
140. The behavior of the M1 velocity of money in recent years can be explained by:
(A) stability of interest rates.
(B) a low and stable rate of inflation.
(C) monetary policy that has been successful in stabilizing the economy.
(D) financial innovation creating new substitutes for M1 money.
(E) a large number of banks and savings and loan associations going bankrupt.
Answer : (D)
141. Which of the following statements about the velocity of money in the U.S. is correct?
(A) From 1915 to 1947, the velocity of M1 increased.
(B) From 1947 to 1973, the velocity of M1 decreased.
(C) The growth in the velocity of money was steady in the 1970s.
(D) The velocity of money has remained more or less stable post 1980s.
(E) ATM machines and credit cards have increased the velocity of money.
Answer : (C)
142. Suppose the money demand curve shifts rightward. Which of the following is true about the
alternative policy options available with the Fed?
(A) The Fed can keep the interest rate from rising only if it increases the money supply.
(B) The Fed cannot prevent the interest rate from rising.
(C) The Fed can prevent the interest rate from rising without changing the money supply.
(D) If the Fed expands the money supply, the interest rate will rise even further.
(E) The Fed should reduce the money supply if it plans to prevent the interest rate from rising.
Answer : (A)
143. Suppose that the demand and supply of money are initially in equilibrium, and that the demand
for money increases. A monetary authority interested in keeping the money supply constant and the
interest rate low must:
(A) adopt an expansionary monetary policy.
(B) adopt a contractionary monetary policy.
(C) increase the demand for money.
(D) decrease the demand for money.
(E) give up pursuing both goals at the same time.
Answer : (E)
144. If interest rates are to remain constant, the money supply should change:
(A) in the opposite direction to a change in aggregate demand.
(B) in the same direction as a change in money demand.
(C) only when investment changes.

(D) only when the demand for money decreases.
(E) only when the inflation rate changes.
Answer : (B)
145. For interest rates to remain stable during economic expansions, the money supply should:
(A) decrease at a faster rate than the demand for money.
(B) grow at the same rate as money demand.
(C) grow at a faster rate than money demand.
(D) grow at a slower rate than money demand.
(E) decrease at a slower rate than the demand for money.
Answer : (B)
146. If the Fed targets the interest rate, then:
(A) the money supply will grow at a more controlled rate.
(B) monetary policy will reinforce fluctuations in economic activity.
(C) the price level will be more stable in the long run.
(D) money demand will be more stable.
(E) velocity will be less stable.
Answer : (B)
147. During the 2007-2009 financial crisis, the Federal Reserve took some unusual steps in its
conduct of monetary policy. Which of the following was not one of them?
(A) It invested in AIG.
(B) It invested more than $1 trillion in mortgage-backed securities.
(C) It worked with the U.S. Treasury and with other regulators to stabilize banks and thaw frozen
credit lines
(D) It worked with the U.S. Treasury and other regulators to help conduct a stress test of the 19
largest banks.
(E) It bailed out General Motors.
Answer : (E)
148. Most policy makers agree that in the long run, changes in the money supply influence:
(A) the price level and inflation.
(B) the real interest rate and aggregate demand.
(C) the planned investment expenditure.
(D) the exchange rate.
(E) the potential GDP and unemployment.
Answer : (A)
149. The Fed seeks a target rate of inflation of around _____.
(A) 1 percent
(B) 2 percent
(C) 3 percent
(D) 4 percent
(E) 5 percent
Answer : (B)
150. The Fed purchases of long-term assets to stabilize financial markets, reduce long-term interest
rates, and improve the investment environment are called:
(A) structural adjustments.
(B) financial strengthening.
(C) quantitative easing.
(D) inflation targeting.
(E) stress testing
Answer : (C)

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Chapter 15 Monetary Theory and Policy

9. An expansionary monetary policy is always capable of boosting aggregate investment.

16. An identity is a relationship expressed in such a way that it is true by definition.

22. ​Which of these is a flow variable?

(D) ​Bank deposit

(E) ​Foreign currency reserve

23. ​The demand for money in an economy is high when the:

(A) ​real GDP is low.

(B) ​personal tax rate is low.

(C) ​unemployment rate is high.

(D) ​price level is high.

(E) ​interest rate is high.

24. ​The demand for money is a relationship between:

(A) ​the price level and the amount of cyclical unemployment.

(E) ​the interest rate and the rate of inflation.

25. ​The demand for money will be high in an economy experiencing:

(E) ​a sluggish population growth.

(A) ​interest rate.

(B) ​liquidity lost by holding money.

(C) ​money supply curve.

(D) ​inflation rate.

(E) ​cost of cashing in financial assets.

27. ​The opportunity cost of holding money increases when:

(A) ​the interest rate rises.

(B) ​the interest rate falls.

(C) ​the price level falls.

(D) ​nominal GDP rises.

(E) ​nominal GDP falls.

(A) ​measure of wealth.

(B) ​medium of exchange.

(C) ​standard of economic well-being.

(D) ​interest-bearing asset.

(E) ​non-interest-bearing asset.

29. ​Which of these is an advantage of money as a store of value?

(A) ​It can generate high interest income.

(B) ​It can facilitate hassle-free international exchange.

(C) ​It can be easily liquidated.

(D) ​It can signal a nation's economic health.

(A) ​Gold coins

(B) ​Currency notes

(C) ​Traveler's checks

(D) ​Checkable deposits

(E) ​Gift checks

32. ​Other things constant, the quantity of money demanded varies:

(A) ​directly with the market interest rate.

(B) ​inversely with the market interest rate.

(C) ​inversely with the price level.

(D) ​directly with the price level.

(E) ​inversely with the unemployment rate.

(A) ​price level on the quantity of money demanded.

(C) ​real exchange rate on the demand for money.

(D) ​interest rate on the quantity of money demanded.

(E) ​potential GDP on the quantity of money demanded.

(A) ​unemployment rate.

(B) ​inflation rate.

(C) ​money supply.

(D) nominal interest rate.

(E) ​price level.

(A) ​a rightward shift of the money demand curve.

(B) ​a leftward shift of the money demand curve.

(C) ​an increase in the slope of the money demand curve.

(D) ​a movement up along the money demand curve.

(E) a movement down along the money demand curve.

22. Which of these is a flow variable?

(D) Bank deposit

(E) Foreign currency reserve

23. The demand for money in an economy is high when the:

(A) real GDP is low.

(B) personal tax rate is low.

(C) unemployment rate is high.

(D) price level is high.

(E) interest rate is high.

24. The demand for money is a relationship between:

(A) the price level and the amount of cyclical unemployment.

(E) the interest rate and the rate of inflation.

25. The demand for money will be high in an economy experiencing:

(E) a sluggish population growth.

(A) interest rate.

(B) liquidity lost by holding money.

(C) money supply curve.

(D) inflation rate.

(E) cost of cashing in financial assets.

27. The opportunity cost of holding money increases when:

(A) the interest rate rises.

(B) the interest rate falls.

(C) the price level falls.

(D) nominal GDP rises.

(E) nominal GDP falls.

(A) measure of wealth.

(B) medium of exchange.

(C) standard of economic well-being.

(D) interest-bearing asset.

(E) non-interest-bearing asset.

29. Which of these is an advantage of money as a store of value?

(A) It can generate high interest income.

(B) It can facilitate hassle-free international exchange.

(C) It can be easily liquidated.

(D) It can signal a nation's economic health.

(A) Gold coins

(B) Currency notes

(C) Traveler's checks

(D) Checkable deposits

(E) Gift checks

32. Other things constant, the quantity of money demanded varies:

(A) directly with the market interest rate.

(B) inversely with the market interest rate.

(C) inversely with the price level.

(D) directly with the price level.

(E) inversely with the unemployment rate.

(A) price level on the quantity of money demanded.

(C) real exchange rate on the demand for money.

(D) interest rate on the quantity of money demanded.

(E) potential GDP on the quantity of money demanded.

(A) unemployment rate.

(B) inflation rate.

(C) money supply.

(E) price level.

(A) a rightward shift of the money demand curve.

(B) a leftward shift of the money demand curve.

(C) an increase in the slope of the money demand curve.

(D) a movement up along the money demand curve.

(A) increase the price level.

(B) shift the demand for money curve rightward.

(C) shift the demand for money curve leftward.

(D) decrease the nominal interest rate.

(E) decrease the quantity of money demanded.

(A) An increase in the price level

(B) An increase in real GDP

(C) A decrease in the nominal interest rate

(D) An increase in the nominal interest rate

(E) A decrease in real GDP

(A) An increase in the price level

(B) A decrease in real GDP

(C) A decrease in the nominal interest rate

(D) An increase in the nominal interest rate

(E) A decrease in the price level

39. The money demand curve slopes:

40. Other things constant, an increase in the price level will:

(A) shift the money demand curve to the right.

(B) shift the money demand curve to the left.

(C) increase the quantity of money people want to hold.

(D) decrease the quantity of money people want to hold.

(A) shift the money demand curve to the right.