MonetaryPolicyPracticeQuestions
1. Which of the following will lead to a decrease in a nation’s money supply?
(A) A decrease in income tax rates
(B) A decrease in the discount rate
(C) An open market purchase of government securities by the central bank
(D) An increase in reserve requirements
(E) An increase in government expenditures on goods and services
2. A commercial bank’s ability to create money depends on which of the following?
(A) The existence of a central bank
(B) A fractional reserve banking system
(C) Gold or silver reserves backing up the currency
(D) A large national debt
(E) The existence of both checking accounts and savings accounts
3. To counter a recession, the central bank might pursue which of the following actions?
(A) Increasing reserve requirements and selling securities on the open market
(B) Increasing capital gains tax and selling securities on the open market
(C) Decreasing reserve requirements and increasing the discount rate
(D) Decreasing the discount rate and buying securities on the open market
(E) Decreasing the capital gains tax and selling securities on the open market
4. Which of the following policies, if appropriately sized, would provide expansion during a recession with the
smallest change in interest rates?
(A) An open-market purchase of government securities by the central bank and a decrease in the federal funds rate
(B) An open-market sale of government securities by the central bank and an increase in the federal funds rate
(C) A decrease in taxes and an open-market purchase of government securities by the central bank
(D) An increase in government spending and an open-market sale of government securities by the central bank
(E) An increase in taxes and an increase in the federal funds rate
5. Assume that the Federal Reserve pursues a contractionary monetary policy. Based on the resulting change in the
interest rate, what will happen to the international value of the dollar, United States imports, and United States
exports?
(A)
(B)
(C)
(D)
(E)
International Value
of the Dollar
Increase
Increase
Increase
Decrease
Decrease
United States
Imports
Increase
Increase
Decrease
Increase
Decrease
United States
Exports
Increase
Decrease
Increase
Decrease
Increase
6. In the long run, an increase in aggregate demand due to an expansion in the money supply will increase
(A) price level and real output
(B) nominal output and real output
(C) nominal output but not the price level
(D) nominal output and the price level
(E) real output but not the price level
7. Which of the following is most likely to occur if the Federal Reserve engages in open market operations to reduce
inflation?
(A) A decrease in interest rates
(B) A decrease in reserves in the banking system
(C) A decrease in the government deficit
(D) An increase in the money supply
(E) An increase in exports
8. If the central bank conducts an open-market purchase of bonds, which of the following will occur?
(A) The price of bonds will increase.
(B) The money supply will decrease.
(C) Total bank reserves will decrease.
(D) Consumption will decrease.
(E) The government will balance its budget.
9. Which of the following combinations of economic policies would be most effective to correct a severe recession?
(A)
(B)
(C)
(D)
(E)
Taxes
Increase
Increase
Increase
Decrease
Decrease
Money
Supply
Increase
Decrease
No change
Increase
Decrease
10. An increase in inflationary expectations will most likely affect nominal interest rates and bond prices in which of
the following ways in the short run?
(A)
(B)
(C)
(D)
(E)
Nominal
Interest Rates
Increase
Increase
No change
Decrease
Decrease
Bond Prices
No change
Decrease
Increase
Increase
Decrease
MonetaryPolicyPracticeQuestions(Key)
1. Which of the following will lead to a decrease in a nation’s money supply?
(A) A decrease in income tax rates
(B) A decrease in the discount rate
(C) An open market purchase of government securities by the central bank
(D) An increase in reserve requirements
(E) An increase in government expenditures on goods and services
1. If there is an increase in reserve requirements that means that banks are now required to keep more of
each deposit that consumers make in their total bank reserves. This in turn means that they are not able to
loan out as much money. Since making loans is how banks make new money, this limits their ability to create
new funds. This would be considered a contractionary or tight money policy since restricting the money
supply would help curb inflation.
2. A commercial bank’s ability to create money depends on which of the following?
(A) The existence of a central bank
(B) A fractional reserve banking system
(C) Gold or silver reserves backing up the currency
(D) A large national debt
(E) The existence of both checking accounts and savings accounts
2. The type of banking system used in the United States is a fractional reserve banking system which means
that banks are required to keep a fraction (or small percentage) of all deposits. Since the required reserve
ratio (rr%) is used to figure out the money multiplier (mm = 1/rr%), the lower the amount required to be
kept in reserves means a greater money multiplier. [Ex. rr% = 10% ; 1/.10 = 10 /// rr% = 20% ; 1/.2 = 5]
3. To counter a recession, the central bank might pursue which of the following actions?
(A) Increasing reserve requirements and selling securities on the open market
(B) Increasing capital gains tax and selling securities on the open market
(C) Decreasing reserve requirements and increasing the discount rate
(D) Decreasing the discount rate and buying securities on the open market
(E) Decreasing the capital gains tax and selling securities on the open market
3. The discount rate is the interest rate that the Federal Reserve charges member banks to borrow money from
them for short term loans. If the Federal Reserve lowers the cost of borrowing, banks will be more likely to
increase the amount of loans they give out to customers since their personal cost of borrowing is so low. In
additional, buying securities (or bonds) on the open market means that the Fed is essentially buying “IOUs” from
the government at interest. This means that when the Fed buys these certificates of debt from the government they
are giving the government money. This expansionary measure counters recessions by increasing the amount of
government spending which will increase aggregate demand.
Statement: G inc .: AD inc .: GDPr inc & PL inc .: u% dec & π% inc
4. Which of the following policies, if appropriately sized, would provide expansion during a recession with the
smallest change in interest rates?
(A) An open-market purchase of government securities by the central bank and a decrease in the federal funds rate
(B) An open-market sale of government securities by the central bank and an increase in the federal funds rate
(C) A decrease in taxes and an open-market purchase of government securities by the central bank
(D) An increase in government spending and an open-market sale of government securities by the central bank
(E) An increase in taxes and an increase in the federal funds rate
4. By combining fiscal and monetary policies here, the decrease in taxes coupled with buying securities would
help offset each other. Lowering taxes would increase the cost of borrowing as it increases consumers demand
for monetary transactions (they need money to buy goods) while the action of buying securities from the
government would increase the money supply which lowers interest rates.
5. Assume that the Federal Reserve pursues a contractionary monetary policy. Based on the resulting change in the
interest rate, what will happen to the international value of the dollar, United States imports, and United States
exports?
(A)
(B)
(C)
(D)
(E)
International Value
of the Dollar
Increase
Increase
Increase
Decrease
Decrease
United States
Imports
Increase
Increase
Decrease
Increase
Decrease
United States
Exports
Increase
Decrease
Increase
Decrease
Increase
5. Contractionary policies raise interest rates which dissuade domestic investment but encourage
international investment as foreign investors are attracted to higher interest rates. This would increase
demand for the U.S. dollar which would make the dollar appreciate in value. A stronger dollar would make
our goods relatively more expensive for foreign investors which would decrease U.S. exports and increase
U.S. imports. [Look at Page 5 of your Monetary Policy Notes Packet]
6. In the long run, an increase in aggregate demand due to an expansion in the money supply will increase
(A) price level and real output
(B) nominal output and real output
(C) nominal output but not the price level
(D) nominal output and the price level
(E) real output but not the price level
6. If the Federal Reserve either [buys bonds, lowers FFR, lowers DR, or decreases rr%] .: MS inc .: i% dec .:
I inc .: Ig inc .: AD inc .: GDPr inc & PL inc .: u% dec & π% inc
7. Which of the following is most likely to occur if the Federal Reserve engages in open market operations to reduce
inflation?
(A) A decrease in interest rates
(B) A decrease in reserves in the banking system
(C) A decrease in the government deficit
(D) An increase in the money supply
(E) An increase in exports
7. Reserves (also known as ‘Total Reserves’ in AP Macroeconomics) are the combination of all required
reserves (RR) and excess reserves (ER). So in formula format, TR = RR + ER. If the Federal Reserve engages
in contractionary monetary policy to combat inflation, this would raise the cost of borrowing for everyone.
The interest rates banks charge each other (The Federal Funds Rate), what the Fed charges member banks
(The Discount Rate), and the required reserve ratio (fraction of deposits banks have to keep) would increase
which would hinder the ability of banks to issue out loans. Less new loans would decrease total reserves.
8. If the central bank conducts an open-market purchase of bonds, which of the following will occur?
(A) The price of bonds will increase.
(B) The money supply will decrease.
(C) Total bank reserves will decrease.
(D) Consumption will decrease.
(E) The government will balance its budget.
8. Buying bonds would increase the money supply, decrease interest rates, and increase investments which
would ultimately expand the economy. However, a greater demand for Bonds would cause the price of bonds
to rise, meaning that new bonds issued after this transaction would be more expensive.
[Apply the same concepts of basic supply and demand to the market for bonds and securities]
9. Which of the following combinations of economic policies would be most effective to correct a severe recession?
(A)
(B)
(C)
(D)
(E)
Taxes
Increase
Increase
Increase
Decrease
Decrease
Money
Supply
Increase
Decrease
No change
Increase
Decrease
9. By combining expansionary Fiscal Policy (either increasing government spending or decreasing taxes) with
expansionary monetary policy (increasing the amount of money in circulation by either buying bonds,
lowering the Federal Funds Rate, lowering the Discount Rate, and/or lowering the required reserve ratio) the
U.S. would be able to correct a severe recession.
10. An increase in inflationary expectations will most likely affect nominal interest rates and bond prices in which of
the following ways in the short run?
(A)
(B)
(C)
(D)
(E)
Nominal
Interest Rates
Increase
Increase
No change
Decrease
Decrease
Bond Prices
No change
Decrease
Increase
Increase
Decrease
10.Ifthereisexpectedinflation,bankswillincreasenominalinterestrates.Rememberthatnominal
interestistheinterestratethatbankschargeyouwhenyoutakeoutaloan.Therealinterestrate,or
whatbanksactuallyearnontheloan,iswhenthebanktakesintoaccounttheeffectsofinflationwith
theloan(r%=i%-π%).Thebankwillraiseinterestratestoensurethattheinflationdoesnotcause
themtolosemoneyontheirloans.Additionally,welearnedthatinflationcausesthedollartolose
value(theideaofadollartodayisworthmorethanadollartomorrow).Therefore,bondsissued
wouldnothaveasmuchvalueastheinflationaffectstherealvalueofthebond.