Question

1. Drawing on her account at Comerica Bank, Jack writes a check to Jill, who deposits the check in her checking account at Chase Bank. Once the check has cleared, which of the following would have occurred to bank reserves and the M1 money supply? (More than one answer is correct)
a. Bank reserves at Chase would have decreased, and bank reserves at Comerica would have increased.
b. Total bank reserves would have increased; there would have been no change in M1.
c. There would have been no change in bank reserves; but M1 would have increased.
d. There would have been no changes in total bank reserves and no changes in total M1.
e. Bank reserves at Comerica Bank would have decreased, and bank reserves at Chase would have increased.

2. If policy makers wanted to consistently use both monetary and fiscal policy to help reduce a high rate of inflation, which of the following would be most appropriate?

a. a larger budget deficit, the purchase of securities in the open market, and a higher discount rate.

b. a government budget surplus, the sale of securities in the open market, and a higher discount rate.

c. a larger government budget deficit, the sale of securities in the open market, and a lower discount rate.

d. a government budget surplus, the purchase of securities in the open market, and a lower discount rate.

e. none of the above.

3. When the Fed unexpectedly increases the money supply, it will cause an increase in aggregate demand because:

a. real interest rates will fall, stimulating business investment and consumer purchases.

b. the dollar will depreciate on the foreign exchange market, leading to an increase in net exports.

c. lower nominal interest rates will tend to increase asset prices (such as the prices of homes), which decreases wealth and thereby decreases current consumption.

d. all of the above are true.

e. both a and b are true.

4. If the Federal Reserve Bank raises both the discount rate and the target federal funds rate, and as a result decision makers anticipate a lower future rate of inflation, the most likely result is:

a. a reduction in both short-term and long-term nominal interest rates.

b. lower short-term nominal interest rates but higher long-term nominal interest rates.

c. an increase in both short-term and long-term nominal interest rates.

d. higher short-term nominal interest rates but lower long-term nominal interest rates.

e. none of the above

5. An economic analysis of the Great Depression indicates that (more than one answer is correct):

a. monetary and fiscal policies were highly contractionary during the 1930s.

b. even though monetary policy was expansionary, restrictive fiscal policy dominated during the 1930s.

c. a reduction in tax rates could not prevent the economic downturn from spiraling into a depression.

d. the severity of the economic decline, if not its onset, was the result of perverse monetary and fiscal policies.

Answer 1

The calculation money supply M1 includes coins and currency in circulation, checkable or demand deposit and traveler’s cheque.

Here total reserve is the reserves at Comerica Bank and Chase Bank. While clearing the change the bank reserves at Comerica Bank would have decreased, and bank reserves at Chase would have increased. But no change in total reserves. The M1 also do not change since what amount is withdrawn from the checking account of the Comerica Bank is deposited at Chase bank.

Answers: d. there would have been no changes in total bank reserves and no changes in total M1.

e. Bank reserves at Comerica Bank would have decrease, and bank reserves at Chase would have increased.

2. The appropriate monetary and fiscal policy combination to reduce inflation is a government budget surplus, sale of government securities in the open market and higher discount rate. A budget surplus increases the tax rate and reduces the public expenditure. This will reduce aggregate demand and thereby curb inflation. The sale of securities in the open market transfers money from the public to the central banks and reduces AD and reduces the inflation. The increase in bank rate reduces borrowing from the commercial banks and causes a fall in AD and inflation.

Answer: b. a government budget surplus, the sale of securities in the open market and a higher discount rate.

3. Aggregate demand consist of C+ I+ G+ Xn.

When the Fed unexpectedly increase the money supply, real interest rates will fall, this will stimulate business investment (I) and consumer purchase(C). The increased money supply lowers the interest rate in the domestic economy. Thus capital will flow from domestic economy to the rest of the world in search of higher returns. Thus dollar depreciate and the depreciation in dollar stimulate net export (Xn).

Answer: e. both ‘a’ and ‘b’ are true.

4. The discount rate is the interest that each bank has to pay when they borrow money from Fed. The Federal fund rate is the rate that banks have to pay when they borrow from one another. The borrowing from Fed and mutual borrowing between banks are only shorter term loans. So an increase in discount rate and Federal fund rate increase the short term interest. This increase in the shorter interest rate also increases the long term interest through the process of transmission mechanism.

Answer: c. an increase in both short term and long term nominal interest rate.

5. Answer ‘a’ and ‘ c’.

On the basis of classical notions the monetary and fiscal policies were highly contractionary. A tax cut adopted by the economy could not revive the world economies from depression.