karoliukas

Silvano Jimenez, an analyst at Banco del Rey, is reviewing recent actions taken by the U.S. Federal Reserve (the Fed) in setting monetary policy. Recently, the Fed decided to increase the money supply, which has resulted in a decrease in real interest rates. At a staff meeting, Jimenez brings this matter to the attention of his colleagues and makes the following statements:
Statement 1: Although the money supply increase has led to a decrease in real interest rates, we should begin to see U.S. investors decrease their investments abroad and the U.S. dollar will appreciate in the foreign exchange market.
Statement 2: The Fed’s increase in the money supply will increase the amount of imports into the U.S.
Are Statement 1 and Statement 2 as made by Jimenez CORRECT?

Statement 1

Statement 2

A) Correct Incorrect

B) Incorrect Incorrect

C) Incorrect Correct

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If the Fed increases the money supply and real interest rates decline, U.S. investors will seek higher real rates of return abroad and the U.S. dollar will depreciate as the dollar will be exchanged for foreign currencies in order to buy the foreign investments. Likewise, the decrease in real interest rates will reduce the inflow of funds from abroad as foreign investors seek higher rates of return outside the U.S. With a dollar that has depreciated, U.S. exports should increase, as U.S. products will become cheaper for foreign buyers. As such, both statements are incorrect.

karoliukas

If a country’s economy is growing at an unsustainably rapid rate and the central bank decreases its target overnight interest rate, the country’s:

A) long-term rate of economic growth will increase.

B) expected rate of inflation is likely to decline.

C) inflation rate is likely to increase.

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The central bank should increase target interest rates when the economy is growing at an unsustainable (above-full-employment) level. Decreasing the target overnight rate is likely to further increase aggregate demand and cause inflation to accelerate, which will be detrimental to the long-term growth rate of the economy.

karoliukas

If the U.S. Federal Reserve decides to decrease the money supply, which of the following is most likely to occur in the short run?

A) An increase in the velocity of money similar to decrease in the money supply.

B) An increase in the real rate of interest.

C) A decrease in the unemployment rate.

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If the U.S. Federal Reserve decreases the money supply, an increase in nominal and real interest rates will occur. Higher real rates will cause businesses to invest less, which will cause the unemployment rate to increase. Furthermore, households will decrease purchases of durable goods, automobiles, and other items that are typically financed at short-term rates. This will decrease aggregate demand. The decrease in aggregate demand and expenditures will cause incomes to go down, which further decreases consumption and investment. Moreover, this decrease in aggregate demand will decrease real GDP and the price level in the short run and the long run.

karoliukas

An economy’s long-term trend rate of real GDP growth is 3% and the central bank’s target inflation rate is 2%. If the policy rate is 6%, monetary policy is:

A) expansionary.

B) contractionary.

C) neutral.

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Monetary policy is contractionary when the policy rate is greater than the neutral rate, which is the sum of the real trend rate of economic growth and the target rate of inflation. Here, the neutral rate is 3% + 2% = 5% and the policy rate of 6% is greater than the neutral rate. Monetary policy is expansionary when the policy rate is less than the neutral interest rate.

karoliukas

Which of the following statements regarding the monetary policy transmission mechanism is most accurate?

A) Central banks can control long-term interest rates directly because decisions by consumers and businesses are based on these rates.

B) Central banks can control short-term interest rates directly, but long-term interest rates are beyond their control.

C) Central banks can control short-term interest rates by increasing the money supply to increase interest rates or by decreasing the money supply to decrease interest rates.

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Central banks can control short-term interest rates directly. However, the decisions of consumers and businesses are based on long-term interest rates, which are beyond the control of central banks. Increasing the money supply will decrease interest rates and decreasing the money supply will increase interest rates.

karoliukas

Which of the following statements best explains how automatic stabilizers work? Even without a change in fiscal policy, automatic stabilizers tend to promote:

A) a budget surplus during a recession and a budget deficit during an inflationary expansion.

B) a budget deficit during a recession but do not promote a budget surplus during an inflationary expansion.

C) a budget deficit during a recession and a budget surplus during an inflationary expansion.

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Automatic stabilizers such as unemployment compensation, corporate profits tax, and the progressive income tax run a deficit during a business slowdown but run a surplus during an economic expansion. Therefore, they automatically implement countercyclical fiscal policy without the delays associated with policy changes that require legislative action.

karoliukas

When an economy dips into a recession, automatic stabilizers will tend to alter government spending and taxation so as to:

A) reduce interest rates, thus stimulating aggregate demand.

B) reduce the budget deficit (or increase the surplus).

C) enlarge the budget deficit (or reduce the surplus).

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During a recession unemployment is high, so the government will pay out more in unemployment compensation at the exact time that tax receipts from corporations and individuals are low. This will increase the size of the deficit and also maintain aggregate demand during recessionary periods.

karoliukas

The term "automatic stabilizers" refers to the fact that:

A) legislators automatically change the tax structure and expenditure programs to correct upswings and downswings in business activity.

B) government expenditures and tax receipts automatically balance over the course of the business cycle, although they may be out of balance in any single year.

C) with given tax rates and expenditure policies, a rise in national income tends to produce a surplus, while a decline tends to result in a deficit.

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Automatic stabilizers are built-in fiscal devices that ensure deficits in a recession and surpluses during booms. Automatic stabilizers minimize the problem of proper timing.

karoliukas

Unemployment compensation is an example of:

A) an automatic monetary policy stabilizer.

B) an automatic fiscal policy stabilizer.

C) a discretionary fiscal policy stabilizer.

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Unemployment compensation automatically rises and falls with the business cycle, therefore it is an example of an automatic fiscal policy stabilizer.

karoliukas

Assuming the federal government maintains a balanced budget, the most likely effects of a tax increase on government expenditures and real GDP are:

Government Expenditures

Real GDP

A) Decrease Decrease

B) Increase Increase

C) Increase Decrease

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The amount of the spending program exactly offsets the amount of the tax increase, leaving the budget unaffected (balanced budget). The multiplier effect is stronger for government spending versus the tax increase. Therefore, the balanced budget multiplier will be positive. All of the government spending enters the economy as increased expenditure, whereas only a portion of the tax increase results in lessened expenditure (determined by the marginal propensity to consume), because part of the tax increase will come from the savings of the taxpayer (determined by the marginal propensity to save).