Iowa State University Department of Economics Econ353: Section 2 Spring 2003

Sample Test 3: Multiple-Choice Questions

Chapter 9: The Banking Firm and the Management of Financial Institutions

1) All else the same, if a bank has more rate-sensitive liabilities than assets, then a(n) _____ in interest rates will _____ bank profits. A) increase; increase B) increase; reduce C) decline; reduce D) decline; not affect

2) If the First National Bank has a gap equal to a negative $30 million, then a 5 percentage point increase in interest rates will cause profits to A) increase by $15 million. B) increase by $1.5 million. C) decline by $15 million. D) decline by $1.5 million.

3) Which of the following are primary concerns of the bank manager? A) maintaining sufficient reserves to minimize the cost to the bank of deposit outflows B) extending loans to borrowers who will pay high interest rates, but who are also good credit risks C) acquiring funds at a relatively low cost, so that profitable lending opportunities can be realized D) all of the above

4) Banks' attempts to solve adverse selection and moral hazard problems help explain loan management principles such as: A) screening and monitoring of loan applicants. B) collateral and compensating balances. C) credit rationing. D) all of the above. E) only (a) and (b) of the above.

5) Provisions in loan contracts that prohibit borrowers from engaging in specified risky activities are called A) proscription bonds. B) restrictive covenants. C) due-on-sale clauses. D) liens.

1 6) When a bank suspects that a $1 million loan might prove to be bad debt that will have to be written off in the future the bank A) can set aside $1 million of its earnings in its loan loss reserves account. B) adds $1 million to its capital when it adds $1 million to its loan loss reserve account. C) reduces its reported earnings by $1, even though it has not yet actually lost the $1 million. D) does all of the above E) does only (a) and (b) of the above occur.

7) Compensating balances A) are a particular form of collateral commonly required on commercial loans. B) are a required minimum amount of funds that a borrower (i.e., a firm receiving a loan) must keep in a checking account at the bank. C) allow banks to monitor firms' check payment practices which can yield information about their borrowers' financial conditions. D) all of the above.

8) When a lender refuses to make a loan, although borrowers are willing to pay the stated interest rate or even a higher rate, the bank is said to engage in A) coercive bargaining. B) strategic holding out. C) credit rationing. D) collusive behavior.

9) Because larger loans create greater incentives for borrowers to engage in undesirable activities that make it less likely they will repay the loans, banks A) ration credit, granting borrowers smaller loans than they have requested. B) ration credit, charging higher interest rates to borrowers who want large loans than to those who want small loans. C) ration credit, charging higher fees as a percentage of the loan to borrowers who want large loans than to those who want small loans. D) do none of the above.

10) One way for a bank to assure depositors that it is not taking on too much risk, and so obtain their deposits, is for it to A) diversify its loan portfolio. B) increase its equity capital. C) lengthen the maturity of its assets. D) do both (a) and (b) of the above.

2 11) Measuring the sensitivity of bank profits to changes in interest rates by multiplying the gap times the change in the interest rate is called A) basic duration analysis. B) basic gap analysis. C) interest-exposure analysis. D) gap-exposure analysis.

12) Duration analysis involves comparing the average duration of the bank's _____ to the average duration of its _____. A) securities portfolio; non-deposit liabilities B) loan portfolio; non-deposit liabilities C) loan portfolio; deposit liabilities D) assets; deposit liabilities E) assets; liabilities

First National Bank

13) If interest rates rise by 5 percentage points, say from 10 to 15%, bank profits (measured using gap analysis) will A) decline by $0.5 million. B) decline by $1.5 million. C) decline by $2.5 million. D) increase by $1.5 million.

14) Assuming that the average duration of its assets is five years, while the average duration of its liabilities is three years, then a 5 percentage point increase in interest rates will cause the net worth of First National to _____ by _____ of the total original asset value. A) decline; 5% B) decline; 10% C) decline; 15% D) decline; 25%

15) Bruce the Bank Manager can reduce interest rate risk by _____ the duration of the bank's assets to increase their rate sensitivity or, alternatively, _____ the duration of the bank's liabilities. A) shortening; lengthening B) shortening; shortening C) lengthening; lengthening D) lengthening; shortening

3 16) Bruce the Bank Manager can reduce interest rate risk by shortening the duration of the bank's _____, to increase their rate sensitivity or, alternatively, lengthening the duration of the bank's _____. A) rate-sensitive liabilities; rate-sensitive assets B) rate-sensitive deposits; rate-sensitive loans C) liabilities; assets D) assets; liabilities

17) Examples of off-balance-sheet activities include A) loan sales. B) foreign exchange market transactions. C) trading in financial futures. D) all of the above. E) only (a) and (b) of the above.

18) For a given return on assets, A) the lower is bank capital, the higher is the return for the owners of the bank. B) the lower is bank capital, the higher is the credit risk for the owners of the bank. C) the lower is bank capital, the higher is the return for the owners of the bank. D) both (a) and (b) of the above.

19) A bank's commitment to provide a firm with loans up to pre-specified limit at an interest rate that is tied to a market interest rate is called A) an adjustable gap loan. B) an adjustable portfolio loan. C) a line of credit. D) pre-credit loan line.

20) Credit risk management tools include: A) compensating balances. B) collateral. C) restrictive covenants. D) all of the above. E) only (a) and (b) of the above.

21) Credit risk management tools include: A) credit rationing. B) collateral. C) interest rate swaps. D) all of the above. E) only (a) and (b) of the above.

4 22) Loophole mining refers to A) financial innovation designed to hide transactions from the IRS. B) financial innovation designed to conceal transactions from the SEC. C) financial innovation designed to get around regulations. D) none of the above.

23) Which of the following are examples of loophole mining. A) The introduction of NOW accounts in Massachusetts in 1970 B) The creation of ATS accounts C) The creation of overnight repurchase agreements D) All of the above E) Only (a) and (c) of the above

24) Large fluctuations in interest rates lead to A) substantial capital gains and losses to owners of securities. B) greater uncertainty about returns on investments. C) greater interest-rate risk. D) all of the above.

25) Adjustable rate mortgages A) protect households against higher mortgage payments when interest rates rise. B) keep financial institutions' earnings high even when interest rates are falling. C) benefit homeowners when interest rates are falling. D) do only (a) and (b) of the above. E) none of the above.

26) According to Edward Kane, because the banking industry is one of the most _____ industries in America, it is an industry in which _____ is especially likely to occur. A) competitive; loophole mining B) competitive; innovation C) regulated; loophole mining D) regulated; innovation

27) Burdensome regulations, and rising interest rates and inflation help to explain A) the rapid pace of financial innovations in banking in the 1960s and 1970s. B) the low rate of bank failures in the 1980s. C) both (a) and (b) of the above. D) neither (a) nor (b) of the above.

5 28) The most significant change in the economic environment that changed the demand for financial products since 1970 has been A) the aging of the baby-boomer generation. B) the dramatic increase in the volatility of interest rates. C) the dramatic increase in competition from foreign banks. D) the deregulation of financial institutions.

29) The most important source of the changes in supply conditions that stimulate financial innovation has been the A) aging of the baby-boomer generation. B) dramatic increase in the volatility of interest rates. C) improvement in computer and telecommunications technology. D) dramatic increase in competition from foreign banks. E) the deregulation of financial institutions.

30) In this type of arrangement, any balances above a certain amount in a corporation's checking account at the end of the business day are "removed" and invested in overnight repos that pay the corporation interest. This innovation is referred to as a A) sweep account. B) share draft account. C) removed-repo account. D) stockman account.

Chapter 14: Structure of Central Banks and the Federal Reserve System

1) The unusual structure of the Federal Reserve System is perhaps best explained by A) Americans' fear of centralized power. B) the traditional American distrust of moneyed interests. C) Americans' desire to remove control of the money supply from the U.S. Treasury. D) all of the above. E) only (a) and (b) of the above.

2) The _____ Fed bank, with over 30 percent of the system's assets, is the most important of the Federal Reserve Banks. A) Chicago B) Los Angeles C) Miami D) New York E) Washington, DC

6 3) Which of the following are entities of the Federal Reserve System? A) Federal Reserve Banks B) The FOMC C) The Board of Governors D) All of the above are Federal Reserve entities E) Only (a) and (b) of the above are Federal Reserve entities

4) Member commercial banks have purchased stock in their district Fed banks; the dividend paid by that stock is limited to A) four percent annually. B) five percent annually. C) six percent annually. D) eight percent annually.

5) All _____ are required to be members of the Fed. A) state chartered banks B) nationally chartered banks C) banks with assets less than $100 million D) banks with assets less than $500 million

6) Which of the following are duties of the Board of Governors of the Federal Reserve System? A) Setting margin requirements, the fraction of the purchase price of the securities that has to be paid for with cash. B) Setting the maximum interest rates payable on certain types of time deposits under Regulation Q. C) Regulating credit with the approval of the President under the Credit Control Act of 1969. D) None of the above have been duties of the Board since the mid-1980s.

7) Banks subject to reserve requirements set by the Federal Reserve System include A) only state chartered banks. B) only nationally chartered banks. C) only banks with assets less than $100 million. D) only banks with assets less than $500 million . E) all banks whether or not they are members of the Federal Reserve System.

8) Which of the following are true statements? A) The FOMC usually meets every six weeks to set monetary policy. B) The FOMC issues a directive to the trading desk at the New York Fed. C) Designers of the Federal Reserve Act did not envision the use of discount lending as a monetary policy tool. D) All of the above are true statements. E) Only (a) and (b) of the above are true statements.

7 9) The designers of the Federal Reserve Act meant to create a central bank characterized by its A) system of checks and balances and decentralization of power. B) strong concentration of power in the hands of a few men. C) inability to function as a lender-of-last-resort. D) responsiveness to the electorate.

10) Factors that provide the Federal Reserve with a high degree of autonomy include A) 14-year terms for members of the Board of Governors. B) a source of revenue free from the appropriations process. C) a four-year term for the chairman of the Board of Governors that does not coincide with the president's four-year term. D) all of the above. E) only (a) and (b) of the above.

11) The Fed may feel implicit pressure to support the president's policies since the President A) can abolish the Fed by presidential announcement. B) can veto legislation that might limit the Fed's discretionary authority and power. C) both (a) and (b) of the above. D) neither (a) nor (b) of the above.

12) The theory of bureaucratic behavior suggests that the objective of a bureaucracy is to maximize A) the public's welfare. B) profits. C) its own welfare. D) conflict with the executive and legislative branches of government.

13) The theory of bureaucratic behavior suggests that the Federal Reserve will A) try to avoid a conflict with the President and Congress over increases in interest rates. B) try to gain regulatory power over more banks. C) devise clever strategies in an effort to avoid blame for poor economic performance. D) do each of the above.

14) Supporters of the current system of Fed independence believe that a less autonomous Fed would A) adopt a short-run bias toward policymaking. B) pursue overly expansionary monetary policies. C) be more likely to create a political business cycle. D) do each of the above. E) do only (b) and (c) of the above.

8 15) Critics of the current system of Fed independence contend that A) the current system is undemocratic. B) voters have too much say about monetary policy. C) the President has too much control over monetary policy on a day-today basis. D) all of the above are true.

16) Which of the following actions are consistent with the theory of bureaucratic behavior? A) The Fed reports its target paths for more than one monetary aggregate. B) The Fed delays the release of Federal Open Market Committee directives. C) The Fed blames high interest rates on budget deficits rather than on inflationary money growth. D) All of the above are consistent with the theory of bureaucratic behavior. E) Only (b) and (c) are consistent with the theory of bureaucratic behavior.

17) Members of Congress are able to influence monetary policy, albeit indirectly, through their ability to A) withhold appropriations from the Board of Governors. B) withhold appropriations from the Federal Open Market Committee. C) propose legislation that would force the Fed to submit budget requests to Congress, as must other government agencies. D) do all of the above.

18) Although it enjoys a high degree of autonomy, the Fed is still subject to the influence of the President because A) the President can veto legislation that would limit Fed appropriations. B) the President can veto legislation that would restrict Fed independence. C) the President can remove members of the Board of Governors on a whim. D) of only (a) and (b) of the above.

19) The theory of bureaucratic behavior when applied to the Fed helps to explain why the Fed A) is supportive of congressional attempts to limit the central bank's autonomy. B) is so secretive about the conduct of future monetary policy. C) sought less control over banks in the 1980s. D) is willing to take on powerful groups that may threaten its autonomy.

20) The Federal Reserve entity that determines monetary policy strategy is the A) Board of Governors. B) chairman of the Board of Governors. C) Federal Open Market Committee. D) Shadow Open Market Committee.

9 21) The case for Federal Reserve independence includes the idea that A) political pressure would impart an inflationary bias to monetary policy. B) a politically insulated Fed would be more concerned with long-run objectives and thus be a defender of a sound dollar and a stable price level. C) a Federal Reserve under the control of Congress or the President might make the so-called political business cycle more pronounced. D) all of the above.

22) The strongest argument for an independent Federal Reserve rests on the view that subjecting the Fed to more political pressures would impart A) an inflationary bias to monetary policy. B) a deflationary bias to monetary policy. C) a disinflationary bias to monetary policy. D) a countercyclical bias to monetary policy.

23) Politicians in a democratic society may be shortsighted because of their desire to win reelection; thus, the political process can A) impart an inflationary bias to monetary policy. B) generate a political business cycle, in which just before an election expansionary policies are pursued to lower unemployment and interest rates. C) place too much pressure on the Fed to finance federal budget deficits. D) cause all of the above. E) cause only (a) and (b) of the above.

24) Putting the Fed under control of the President, as a part of the U.S. Treasury, A) may place too much pressure on the Fed to finance federal budget deficits. B) impart an inflationary bias to monetary policy. C) generate a political business cycle, in which just before an election contractionary policies are pursued to raise unemployment and interest rates. D) may cause all of the above. E) may cause only (a) and (b) of the above.

25) The central bank which is generally regarded as the most independent in the world because its charter cannot be changed by legislation is the A) Bank of England. B) Bank of Canada. C) European Central Bank D) Bank of Japan.

10 Chapter 15: Multiple Deposit Creation and the Money Supply Process

1) The monetary liabilities of the Federal Reserve include A) government securities and discount loans. B) currency in circulation and reserves. C) government securities and reserves. D) currency in circulation and discount loans.

2) The sum of vault cash and bank deposits at Federal Reserve banks is called A) the monetary base. B) the money supply. C) reserves. D) discount loans.

3) When the Federal Reserve purchases a government bond in the open market, A) reserves in the banking system increase. B) reserves in the banking system decline. C) Federal Reserve liabilities remain unchanged. D) Federal Reserve liabilities decline. E) both (b) and (d) of the above occur.

4) When the Fed wants to increase the level of reserves of the banking system, it can A) buy government bonds from the general public. B) buy government bonds from banks. C) increase discount loans to banks. D) do any of the above. E) do only (a) and (b) of the above.

5) Excess reserves are equal to A) total reserves minus discount loans. B) vault cash plus deposits with Federal Reserve banks minus required reserves. C) vault cash minus required reserves. D) deposits with the Fed minus vault cash plus required reserves.

6) A bank cannot increase its loans by an amount greater than A) the total reserves it has before it makes the loan. B) 10 percent of its net worth. C) 5 percent of its net worth. D) the excess reserves it has before it makes the loan.

11 7) If the required reserve ratio is equal to 10 percent, a single bank can increase its loans up to a maximum amount equal to A) 10 percent of its excess reserves. B) its excess reserves. C) 10 times its excess reserves. D) its total reserves.

8) If the required reserve ratio is 15 percent, the simple deposit multiplier is approximately A) 15.0. B) 1.5. C) 6.67 D) 3.33.

9) If the required reserve ratio is 10 percent and the Fed increases reserves by $100, checkable deposits can potentially expand by A) $100. B) $250. C) $500. D) $1,000.

10) 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 A) sold $200 in government bonds. B) sold $500 in government bonds. C) purchased $200 in government bonds. D) purchased $500 in government bonds.

11) The sum of vault cash, deposits at Federal Reserve banks, and currency in circulation is called A) the money supply. B) the monetary base. C) Federal Reserve liabilities. D) near-cash.

12) When the Fed supplies the banking system with an extra dollar of reserves, deposits ______by _____ than one dollar--a process called multiple deposit creation. A) increase; less B) increase; more C) decrease; less D) decrease; more

13) An increase in discount loans by the Fed leads to A) a decline in the monetary base. B) a decline in the money supply. C) an increase in the money supply. D) all of the above. E) only (a) and (b) of the above.

14) A decrease in government securities held by the Fed leads to A) a decline in the monetary base. B) a decline in the money supply. C) an increase in the money supply. D) only (a) and (b) of the above.

12 15) When the Fed sells $100 worth of bonds to the First National Bank, reserves in the banking system A) increase by $100. B) increase by more than $100. C) decrease by $100. D) decrease by more than $100.

16) 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 A) $10. B) $100. C) $100 times the reciprocal of the required reserve ratio. D) $100 times the required reserve ratio.

17) If a bank chooses to purchase securities rather than extend loans with its excess reserves, A) the expansion of deposits in the banking system will be dampened. B) the effect on deposits will be the same as if the bank had held its excess reserves in vault cash. C) the effect on deposits will be the same as if the bank had extended loans. D) all of the above. E) only (a) and (b) of the above.

18) Which of the following liabilities are found on the Fed's balance sheet? A) Bank deposits B) U.S. Treasury deposits C) Coin D) Both (a) and (b) of the above E) Both (a) and (c) of the above

19) Which of the following are found on the asset side of the Federal Reserve's balance sheet? A) Treasury deposits with the Fed B) Foreign deposits with the Fed C) Discount loans D) Only (a) and (b) of the above E) Only (a) and (c) of the above

20) Which is the most important category of Fed assets? A) securities B) discount loans C) gold and SDR certificates D) cash items in the process of collection

13 21) When the Fed purchases $100 of bonds from a bank, the bank may either deposit the check it receives in its account with the Fed or cash it for currency, which will be counted as vault cash. Either action means that the bank will find itself with A) additional reserves. B) more assets. C) both (a) and (b). D) none of the above.

22) If a person selling bonds to the Fed cashes the Fed's check, A) reserves remain unchanged, but currency in circulation declines. B) reserves remain unchanged, but currency in circulation increases. C) currency in circulation remains unchanged, but reserves increase. D) currency in circulation remains unchanged, but reserves decline.

23) The effect of an open market purchase on reserves differs depending on how the seller of the bonds keeps the proceeds. If the proceeds are kept in currency, the open market purchase _____ reserves; if the proceeds are kept as deposits, the open market purchase _____ reserves. A) has no effect on; has no effect on B) has no effect on; increases C) increases; has no effect on D) increases; increases

24) If a member of the nonbank public sells a government bond to the Federal Reserve in exchange for currency, A) the monetary base will rise. B) reserves will remain unchanged. C) reserves will rise. D) both (a) and (b) of the above will occur.

25) When a member of the nonbank public withdraws currency from her bank account, A) both the monetary base and bank reserves fall. B) both the monetary base and bank reserves rise. C) the monetary base falls, but bank reserves remain unchanged. D) bank reserves fall, but the monetary base remains unchanged.

Chapter 17: Tools of Monetary Policy

1) If the Federal Reserve wants to drain reserves from the banking system, it will A) purchase government securities. B) lower the discount rate. C) sell government securities. D) raise reserve requirements.

14 2) Open market purchases _____ reserves and the monetary base thereby _____ the _____. A) raise; lowering; money supply B) raise; raising; money supply C) lower; lowering; money multiplier D) raise; raising; money multiplier E) lower; raising; money multiplier

3) The Fed conducts most of its open market operations in Treasury securities because the market for these securities A) is the most liquid. B) has the largest trading volume. C) is monopolized by the Fed. D) involves all of the above. E) only (a) and (b) of the above.

4) The Fed uses three policy tools to manipulate the money supply: _____ , which affect reserves and the monetary base; changes in _____, which affect reserves and the monetary base by influencing the quantity of discount loans; and changes in _____, which affect the money multiplier. A) open market operations; the discount rate; margin requirements. B) open market operations; the discount rate; reserve requirements. C) the discount rate; open market operations; margin requirements. D) the discount rate; open market operations; reserve requirements.

5) The discount rate is A) the interest rate the Fed charges on loans to banks. B) the price the Fed pays for government securities. C) the interest rate that banks charge their most preferred customers. D) the price banks pay the Fed for government securities.

6) If the Fed wants to temporarily inject reserves from the banking system, it will engage in A) a repurchase agreement. B) a matched sale-purchase transaction. C) reverse repurchase agreement. D) none of the above.

7) If the Fed wants to temporarily drain reserves from the banking system, it will engage in A) a repurchase agreement. B) a matched sale-purchase transaction. C) a "pump" agreement. D) none of the above.

15 8) If either Treasury deposits or foreign deposits at the Fed are predicted to temporarily fall, then a _____ open market _____ would be needed to offset the expected increase in reserves and the monetary base. A) defensive; sale B) defensive; purchase C) dynamic; sale D) dynamic; purchase

9) The most common type of discount loan, _____ credit loans, are intended to help banks with _____- term liquidity problems that often result from _____ deposit outflows. A) extended; short; temporary B) adjustment; short; temporary C) extended; long; permanent D) seasonal; long; permanent

10) The Fed's ability to discourage banks from making too many trips to the discount window is frequently referred to as A) "arm twisting." B) the "red dog" rule. C) "discount blitzing!" D) "moral suasion."

11) Discount policy affects the money supply by affecting the volume of _____ and the _____. A) excess reserves; monetary base B) discount loans; monetary base C) excess reserves; money multiplier D) discount loans; money multiplier

12) The Fed's discount loans are 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. A) seasonal credit; extended credit; adjustment credit B) extended credit; seasonal credit; adjustment credit C) adjustment credit; seasonal credit; extended credit D) seasonal credit; adjustment credit; extended credit

13) An increase in reserve requirements reduces the money supply since it causes A) reserves to fall. B) reserves and the monetary base to fall. C) the money multiplier to fall. D) both (a) and (b) of the above.

16 14) Of the three policy tools that the Fed can use to change the money supply, the one that does not affect the monetary base is A) open market operations. B) changes in the discount rate. C) changes in the federal funds rate. D) reserve requirements.

15) 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. A) defensive; dynamic B) defensive; static C) dynamic; defensive D) dynamic; static

16) 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 _____. A) fall; fall B) fall; rise C) rise; fall D) rise; rise

17) Open market operations as a monetary policy tool have the advantages that A) they are flexible and precise. B) they are easily reversed if mistakes are made. C) they can be implemented quickly without administrative delays. D) all of the above. E) only (a) and (b) of the above.

18) A bank faces three costs when it borrows from the discount window A) the interest cost; the cost of complying with Fed investigations of the soundness of the bank; the cost of being turned down for a discount loan in the future. B) the interest cost; the administrative cost to the bank; the cost of being turned down for a discount loan in the future. C) the interest cost; the origination fee charged by the Fed; the administrative cost to the bank. D) only (a) and (b) of the above.

19) Disadvantages of discount policy include A) the confusion concerning the Fed's intentions about future monetary policy because of the uncertainty about what a change in the discount rate is intended to signal. B) large fluctuations in the money multiplier from even small changes in the discount rate. C) its powerful effect, when compared to open market operations, on reserves and the monetary base. D) only (a) and (b) of the above.

17 20) The main advantage of using reserve requirements to control the money supply and interest rates is A) that they affect all banks equally and have a powerful effect on the money supply. B) that they eliminate the need for the Fed to use dynamic open market operations. C) that raising them can reduce liquidity problems for banks with low excess reserves. D) none of the above.

21) The Fed is reluctant to use reserve requirements to control the money supply and interest rates because A) frequent changes in reserve requirements complicate liquidity management for banks. B) they have the potential to create liquidity problems for banks with low excess reserves. C) of their weak impact on the money supply. D) of all of the above. E) of only (a) and (b) of the above.

22) In the market for reserves, an open market _____ shifts the supply curve to the _____, lowering the federal funds interest rate. A) sale; left B) sale; right C) purchase; right D) purchase; left

23) In the market for reserves, a _____ discount rate shifts shifts the supply curve to the _____, lowering the federal funds interest rate. A) lower; left B) lower; right C) higher; right D) higher; left

24) In the market for reserves, an increase in the reserve requirement shifts the demand curve to the A) left, lowering the federal funds interest rate. B) right, lowering the federal funds interest rate. C) right, raising the federal funds interest rate. D) left, raising the federal funds interest rate.

25) In the market for reserves, a _____ in the reserve requirement shifts the demand curve to the _____, lowering the federal funds interest rate. A) rise; left B) rise; right C) decline; right D) decline; left

18 Chapter 18: Conduct of Monetary Policy: Goals and Targets

1) The objectives of the Federal Reserve in its conduct of monetary policy include A) economic growth. B) price stability. C) high employment. D) all of the above.

2) Price stability is desirable because A) inflation creates uncertainty, making it difficult to plan for the future. B) everyone is better off when prices are stable. C) price stability increases the profitability of the Fed. D) it guarantees full employment.

3) The Federal Reserve desires interest rate stability because A) it allows for less uncertainty about future planning. B) interest-rate volatility often leads to demands to curtail the Fed's power. C) it guarantees full employment. D) of both (a) and (b) of the above.

4) When workers voluntarily leave work while they look for better jobs, the resulting unemployment is called A) structural unemployment. B) frictional unemployment. C) cyclical unemployment. D) underemployment.

5) The goal for high employment should be to seek a level of unemployment at which the demand for labor equals the supply of labor. Economists call this level of unemployment the A) frictional level of unemployment. B) structural level of unemployment. C) natural rate level of unemployment. D) Keynesian rate level of unemployment.

6) Although the goals of high employment and economic growth are closely related, policies can be specifically aimed at encouraging economic growth by A) encouraging firms to invest and people to save. B) encouraging firms to limit their price increases. C) doing both (a) and (b) of the above. D) doing neither (a) nor (b) of the above.

19 7) Which of the following is not an operating target? A) Nonborrowed reserves B) Monetary base C) Federal funds interest rate D) Discount rate E) All are operating targets

8) An advantage of an intermediate targeting strategy is that it provides the central bank with A) more timely information regarding the effect of monetary policy. B) a slow adjustment process. C) a target that is precisely correlated with economic activity. D) each of the above. E) only (a) and (b) of the above.

9) If the central bank targets a monetary aggregate, it is likely to lose control over the interest rate because A) of fluctuations in the money demand function. B) of fluctuations in the consumption function. C) bond values will tend to remain stable. D) of fluctuations in the business cycle.

10) If the central bank's strategy for conducting monetary policy is thought of as a game plan that proceeds in stages, then the game plan can be summarized as follows: A) The central bank selects its policy goals, then the intermediate targets consistent with achieving its policy goals, then the operating targets consistent with its intermediate targets, finally, it adjusts its policy tools to affect the desired targets and goals. B) The central bank selects its policy goals, then the operating targets consistent with achieving its policy goals, then the intermediate targets consistent with its operating targets, finally, it adjusts its policy tools to affect the desired targets and goals. C) The central bank selects its policy goals, then the operating targets consistent with achieving its policy goals, then the intermediate targets consistent with its operating targets, finally, it adjusts its policy tools to affect the desired targets and goals. D) The central bank selects its policy tools, then the operating targets consistent with achieving its policy tools, then the intermediate targets consistent with its operating targets, finally, it adjusts its policy goals to affect the desired targets and tools. E) none of the above.

11) Which of the following is not a requirement in selecting an intermediate target? A) measurability. B) controllability. C) flexibility. D) predictability.

20 12) If the desired intermediate target is an interest rate, then the preferred operating target will be a(n) _____ variable like the _____. A) interest rate; three-month T-bill rate B) interest rate; federal funds rate C) monetary aggregate; monetary base D) monetary aggregate; nonborrowed base

13) If the desired intermediate target is a monetary aggregate, then the preferred operating target will be a(n) _____ variable like the _____. A) interest rate; three-month T-bill rate B) interest rate; federal funds rate C) reserve aggregate; monetary base D) reserve aggregate; narrow money supply M1

14) Which of the following best explains why the Federal Reserve does not use nominal GDP as an intermediate target? A) Nominal GDP has little connection with Fed policy goals. B) Nominal GDP is unaffected by open market operations. C) The Fed has little direct control over nominal GDP. D) None of the above.

15) If the desired intermediate target is a monetary aggregate, which of the following would be the most preferred operating target? A) The federal funds interest rate B) The 90-day T-bill rate C) The 180-day T-bill rate D) The monetary base

16) Interest rates are difficult to measure because A) data on them are not timely available. B) real interest rates depend on the hard-to-determine expected inflation rate. C) they fluctuate too often to be accurate. D) they cannot be controlled by the Fed.

17) If the Fed pursues a strategy of targeting an interest rate when fluctuations in money demand are prevalent, A) fluctuations in the money supply will be small. B) fluctuations in the money supply will be large. C) the Fed will probably quickly abandon this policy, as it did in the 1960s. D) the Fed will probably quickly abandon this policy, as it did in the 1950s.

21 18) In practice, the Fed's policy of targeting money market conditions in the 1960s proved to be A) countercyclical, helping to stabilize the economy. B) procyclical, destabilizing the economy. C) procyclical, helping to stabilize the economy. D) countercyclical, destabilizing the economy.

19) A policy of targeting free reserves is likely to prove to be A) procyclical. B) stabilizing. C) too difficult to implement practically. D) none of the above.

20) Fed policy since the early 1990s indicates that it is pursuing a policy of targeting the A) monetary base. B) money supply. C) federal funds interest rate. D) exchange rate.

21) The Fed's use of the federal funds rate as an operating target in the 1970s A) resulted in countercyclical monetary policy. B) resulted in too slow growth in M1 throughout the decade. C) resulted in procyclical monetary policy. D) resulted in too rapid growth in M1 throughout the decade. E) resulted in none of the above.

22) 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. A) raising; lowering B) raising; raising C) lowering; lowering D) lowering; raising

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