Mishkin 6ce TB Ch26

Economics of Money, Banking, and Financial Markets 6e (Mishkin)
Chapter 26 Transmission Mechanisms of Monetary Policy
26.1 Transmission Mechanisms of Monetary Policy
1) Economic theory suggests that ________ interest rates are ________ important than
________ interest rates in explaining investment behavior.
A) nominal; more; real
B) real; less; nominal
C) real; more; nominal
D) market; more; real
Answer: C
Diff: 2 Type: MC
Skill: Recall
Objective: 26.1 List and summarize the transmission mechanisms through which monetary
policy can effect the real economy
2) According to the traditional interest-rate channel, expansionary monetary policy lowers the
real interest rate, thereby raising expenditure on ________.
A) business investment decisions
B) government expenditure
C) consumer nondurables
D) net exports
Answer: A
Diff: 2 Type: MC
Skill: Recall
3) The monetary transmission mechanism that links monetary policy to GDP through real
interest rates and investment spending is called the ________.
A) traditional interest-rate channel
B) Tobins' q theory
C) wealth effects
D) cash flow channel
Answer: A
Diff: 2 Type: MC
Skill: Recall
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Copyright 2017 Pearson Canada, Inc.
4) If the aggregate price level adjusts slowly over time, then an expansionary monetary policy
lowers ________.
A) only the short-term nominal interest rate
B) only the short-term real interest rate
C) both the short-term nominal and real interest rates
D) the short-term nominal, the short-term real, and the long-term real interest rates
Answer: D
Diff: 2 Type: MC
Skill: Recall
5) If monetary policy can influence ________ prices and conditions in ________ markets, then
it can affect spending through channels other than the traditional interest-rate channel.
A) asset; labor
B) asset; credit
C) commodity; labor
D) commodity; credit
Answer: B
Diff: 2 Type: MC
Skill: Recall
6) An expansionary monetary policy lowers the real interest rate, causing the domestic currency
to ________, thereby ________ net exports.
A) appreciate; raising
B) appreciate; lowering
C) depreciate; raising
D) depreciate; lowering
Answer: C
Diff: 2 Type: MC
Skill: Recall
7) An expansionary monetary policy increases net exports by ________ interest rates and
________ the value of the dollar.
A) lowering nominal; decreasing
B) lowering real; decreasing
C) raising nominal; increasing
D) raising real; increasing
Answer: B
Diff: 2 Type: MC
Skill: Recall
2
8) A contractionary monetary policy raises the real interest rate, causing the domestic currency
to ________, thereby ________ net exports.
A) appreciate; raising
B) appreciate; lowering
C) depreciate; raising
D) depreciate; lowering
Answer: B
Diff: 2 Type: MC
Skill: Recall
9) A contractionary monetary policy decreases net exports by ________ interest rates and
________ the value of the dollar.
A) lowering real; decreasing
B) lowering real; increasing
C) raising nominal; increasing
D) raising real; increasing
Answer: D
Diff: 2 Type: MC
Skill: Recall
10) Tobin's q is defined as the market value of firms ________ the replacement cost of capital.
A) times
B) minus
C) plus
D) divided by
Answer: D
Diff: 2 Type: MC
Skill: Recall
11) Tobin's q theory suggests that monetary policy may affect investment spending through its
impact on ________.
A) stock prices
B) interest rates
C) bond prices
D) cash flow
Answer: A
Diff: 2 Type: MC
Skill: Recall
3
12) During the Great Depression, Tobin's q ________.
A) rose dramatically, as did real interest rates
B) fell to unprecedentedly low levels
C) stayed fairly constant, in contrast to most other economic measures
D) rose only slightly, in spite of Hoover's attempts to prop it up
Answer: B
Diff: 2 Type: MC
Skill: Applied
13) According to Tobin's q theory, ________ policy can affect ________ spending through its
effect on the prices of common stock.
A) fiscal; consumption
B) fiscal; investment
C) monetary; consumption
D) monetary; investment
Answer: D
Diff: 2 Type: MC
Skill: Recall
14) According to Tobin's q theory, if q is ________, new plant and equipment capital is
________ relative to the market value of business firms, so companies can buy a lot of new
investment goods with only a ________ issue of stock.
A) high; expensive; large
B) high; cheap; large
C) high; cheap; small
D) low; cheap; large
E) low; cheap; small
Answer: C
Diff: 2 Type: MC
Skill: Recall
4
15) According to Tobin's q theory, when equity prices are low the market price of existing
capital is ________ relative to new capital, so expenditure on fixed investment is ________.
A) cheap; low
B) expensive ; low
C) cheap; high
D) expensive; high
Answer: A
Diff: 2 Type: MC
Skill: Recall
16) According to Tobin's q theory, when equity prices are high the market price of existing
capital is ________ relative to new capital, so expenditure on fixed investment is ________.
A) cheap; low
B) expensive; low
C) cheap; high
D) expensive; high
Answer: D
Diff: 2 Type: MC
Skill: Recall
17) Franco Modigliani has found that an expansionary monetary policy can cause stock market
prices to ________ and consumption to ________.
A) increase; increase
B) increase; decrease
C) decrease; decrease
D) decrease; increase
Answer: A
Diff: 2 Type: MC
Skill: Recall
18) The ________ proposes that two types of monetary transmission channels arise as a result
of problems in credit markets
A) interest rate channel
B) asset price channel
C) credit view
D) Tobin q theory
Answer: A
Diff: 1 Type: MC
Skill: Applied
5
19) A rise in stock prices ________ the net worth of firms and so leads to ________ investment
spending because of the reduction in moral hazard.
A) raises; higher
B) raises; lower
C) reduces; higher
D) reduces; lower
Answer: A
Diff: 2 Type: MC
Skill: Recall
20) Because of the presence of asymmetric information problems in credit markets, an

expansionary monetary policy causes a ________ in net worth, which ________ the adverse
selection problem, thereby ________ increased lending to finance investment spending.
A) decline; increases; encouraging
B) rise; increases; discouraging
C) rise; reduces; encouraging
D) decline; reduces; discouraging
Answer: C
Diff: 2 Type: MC
Skill: Recall
21) Due to asymmetric information in credit markets, monetary policy may affect economic
activity through the balance sheet channel, where an increase in the money supply ________.
A) raises stock prices, lowering the cost of new capital relative to firms' market value, thus
increasing investment spending
B) raises firms' net worth, decreasing adverse selection and moral hazard problems, thus
increasing banks' willingness to lend to finance investment spending
C) raises the level of bank reserves, deposits, and bank loans, thereby raising spending by those
individuals who do not have access to credit markets
D) lowers the value of the dollar, increasing net exports and aggregate demand
Answer: B
Diff: 3 Type: MC
Skill: Recall
6
22) An expansionary monetary policy raises firms' cash flows by ________ interest rates.
A) lowering real
B) lowering nominal
C) raising real
D) raising nominal
Answer: B
Diff: 2 Type: MC
Skill: Recall
23) If a contractionary monetary policy lowers the price level by more than expected, it raises
the real value of consumer debt. This reduces consumer expenditure through ________.
A) the bank lending channel
B) Tobin's q
C) the traditional interest-rate channel
D) the household liquidity effect
Answer: D
Diff: 2 Type: MC
Skill: Recall
24) An expansionary monetary policy may cause asset prices to rise, thereby reducing the
likelihood of financial distress and causing consumer durable and housing expenditures to rise.
This monetary transmission mechanism is referred to as ________.
A) the household liquidity effect
B) the wealth effect
C) Tobin's q theory
D) the cash flow effect
Answer: A
Diff: 2 Type: MC
Skill: Recall
7
25) According to the household liquidity effect, an expansionary monetary policy causes a
________ in the value of households' financial assets, causing consumer durable expenditure to
________.
A) decline; rise
B) rise; rise
C) rise; fall
D) decline; fall
Answer: B
Diff: 2 Type: MC
Skill: Recall
26) According to the household liquidity effect, higher stock prices lead to increased
consumption expenditures because consumers ________.
A) feel more secure about their financial position
B) want to sell stocks and spend the proceeds before stock prices fall
C) believe that their wages will increase due to increased profitability of firms
D) can now afford more expensive imports
Answer: A
Diff: 2 Type: MC
Skill: Recall
27) The subprime financial crisis caused a recession because of the ________ in adverse
selection and moral hazard problems and the ________ in housing prices.
A) increase; increase
B) increase; decrease
C) decrease; increase
D) decrease; decrease
Answer: B
Diff: 2 Type: MC
Skill: Recall
28) Explain the traditional interest-rate channel for expansionary monetary policy. Explain how
a tight monetary policy affects the economy through this channel.
Answer: In the traditional channel, a monetary expansion reduces real interest rates, lowering
the cost of capital and increasing investment spending. The increase in investment increases
aggregate demand. A monetary contraction has the opposite effect, raising real interest rates,
lowering investment and aggregate spending.
Diff: 2 Type: ES
Skill: Recall
8
29) Explain how expansionary and contractionary monetary policies affect aggregate demand
through the exchange rate channel.
Answer: An expansionary monetary policy reduces real interest rates, causing depreciation of
the domestic currency. This depreciation increases net exports and aggregate spending. A
monetary contraction increases real interest rates, causing appreciation of the domestic
currency, reducing net exports and aggregate spending.
Diff: 2 Type: ES
Skill: Recall
30) Discuss three channels by which monetary policy affects stock prices and aggregate
spending.
Answer: The answer should include three of the following:
In Tobin's q theory, a monetary expansion increases stock prices, increasing the value of the
firm relative to the cost of new capital. This stimulates investment in new capital goods, which
in turn increases aggregate spending.
A monetary expansion increases stock prices, increasing wealth and stimulating consumption
and aggregate spending.
Expansionary monetary policy increases equity prices. This improves firms' balance sheets,
reducing adverse selection and moral hazard and increasing lending for investment, which
increases aggregate spending.
In the household liquidity effect, the increase in equity prices due to a monetary expansion
improves consumer balance sheets, reducing the probability of financial distress, and increasing
consumer spending on durable goods and housing.
Diff: 3 Type: ES
Skill: Recall
9
26.2 Lessons for Monetary Policy
1) Analysis of the transmission mechanisms of monetary policy provides four basic lessons for
a central bank's conduct of monetary policy. These lessons include:
A) It is dangerous always to associate the easing or tightening of monetary policy with a fall or
a rise in short-term interest rates.
B) Monetary policy can be highly effective in reviving a weak economy even if short-term
interest rates are already near zero.
C) Avoiding fluctuations in the level of unemployment is an important objective of monetary
policy, thus providing a rationale for interest-rate stability as the primary long-run goal for
monetary policy.
D) A and B only.
Answer: D
Diff: 3 Type: MC
Skill: Recall
Objective: 26.2 Summarize and apply the four lessons outlined in this chapter for the conduct of
monetary policy
A) Rising interest rates indicate a tightening of monetary policy, whereas falling interest rates
indicate an easing of monetary policy.
monetary policy.
D) A and B only.
Answer: B
Diff: 3 Type: MC
Skill: Recall
monetary policy
10
A) Monetary policy can be highly effective in reviving a weak economy so long as short-term
interest rates are not too close to zero.
B) Avoiding fluctuations in the level of unemployment is an important objective of monetary
monetary policy.
C) Other asset prices beside those on short-term debt instruments contain important information
about the stance of monetary policy because they are important elements in various monetary
policy transmission mechanisms.
D) A and B only.
Answer: C
Diff: 3 Type: MC
Skill: Recall
monetary policy
monetary policy.
D) Other asset prices beside those on short-term debt instruments do not contain important
information about the stance of monetary policy because they are not important elements in
various monetary policy transmission mechanisms.
Answer: B
Diff: 3 Type: MC
Skill: Recall
monetary policy
11
a central bank's conduct of monetary policy. Which of the following is not one of these
lessons?
C) Avoiding unanticipated fluctuations in the price level is an important objective of monetary
policy, thus providing a rationale for price stability as the primary long-run goal for monetary
policy.
D) Other asset prices beside those on short-term debt instruments do not contain important
information about the stance of monetary policy because they are important elements in various
monetary policy transmission mechanisms.
Answer: A
Diff: 3 Type: MC
Skill: Recall
monetary policy
6) In the late 1990s and early 2000s, the Japanese economy has experienced ________.
A) easy monetary policy as indicated by falling nominal interest rates
B) easy monetary policy as indicated by short-term interest rates near zero
C) tight monetary policy as indicated by falling asset prices
D) tight monetary policy as indicated by short-term interest rates near zero
Answer: C
Diff: 2 Type: MC
Skill: Applied
monetary policy
7) Recent Japanese experience has been characterized by tight monetary policy, as indicated by
________.
A) falling interest rates
B) short-term interest rates near zero
C) falling asset prices
D) low real interest rates
Answer: C
Diff: 2 Type: MC
Skill: Applied
monetary policy
12
8) In a period of deflation, when there is a declining price level, ________ nominal interest
rates do not necessarily indicate that the cost of borrowing is ________ or that monetary policy
is easy.
A) low; low
B) low; high
C) high; low
D) high; high
Answer: A
Diff: 2 Type: MC
Skill: Recall
monetary policy
9) In a period of deflation, when there is a declining price level, low nominal interest rates do
not necessarily indicate that the cost of borrowing is ________ or that monetary policy is
________.
A) low; tight
B) low; easy
C) high; tight
D) high; easy
Answer: B
Diff: 2 Type: MC
Skill: Recall
monetary policy
13
26.3 Web Appendix 26.1: Evaluating Empirical Evidence: The Debate over the Importance of
Money in Economic Fluctuations
1) Evidence that examines whether one variable has an effect on another by simply looking
directly at the relationship between the two variables is ________.
A) reduced-form evidence
B) organizational-model evidence
C) direct-model evidence
D) structural-model evidence
Answer: A
Diff: 2 Type: MC
Skill: Recall
Objective: Appendix: Evaluating Empirical Evidence
2) Evidence that is based on a variable having its effect on another variable through channels
rather than a direct effect is known as ________.
A) indirect-model evidence
B) organizational-model evidence
C) reduced-form evidence
D) structural-model evidence
Answer: D
Diff: 2 Type: MC
Skill: Recall
3) A ________ model is one that describes how ________.

A) structural; the economy works
B) structural; prices change
C) simple; the economy works
D) analytical; prices change
Answer: A
Diff: 1 Type: MC
Skill: Recall
4) Using ________ we can predict how ________ changes may affect the link between M and
Y.
A) a structural model; institutional
B) a structural model; political
C) reduced form evidence; institutional
D) reduced form evidence; political
Answer: A
Diff: 3 Type: MC
Skill: Recall
14
5) On the evening news you hear of a scientific study that directly links premature births to
cigarette smoking. This is an example of ________.
A) direct-model evidence
B) informed voter-model evidence
C) structural-model evidence
D) reduced-form evidence
Answer: D
Diff: 2 Type: MC
Skill: Applied
6) The monetarist-Keynesian debate on the importance of monetary policy is unresolved

because monetarists and Keynesians focus on two different types of evidence that generate
conflicting conclusions. Monetarists tend to focus on ________.
A) structural-model evidence, while Keynesians focus on reduced-form evidence
B) reduced-form evidence, while Keynesians focus on structural-model evidence
C) reduced-form evidence, while Keynesians focus on direct-model evidence
D) structural-model evidence, while Keynesians focus on direct-model evidence
Answer: B
Diff: 3 Type: MC
Skill: Recall
7) The channels through which monetary policy affects economic activity are called the
________ of monetary policy.
A) transmission mechanisms
B) flow mechanisms
C) distribution mechanisms
D) allocational mechanisms
Answer: A
Diff: 2 Type: MC
Skill: Recall
8) A model that is composed of many equations that show the channels through which
monetary and fiscal policy affect aggregate output and spending is called a ________.
A) reduced-form model
B) median-voter model
C) informed median-voter model
D) structural model
Answer: D
Diff: 2 Type: MC
Skill: Recall
15
9) Monetarists directly study the link between money and economic activity using ________.
A) structural models
B) reduced-form models
C) scientific models
D) experimental models
Answer: B
Diff: 2 Type: MC
Skill: Recall
10) The monetarist reduced-form evidence does not specify the working of the economy and
thus is considered to be a ________.
A) scientific model
B) open model
C) black box
D) black hole
Answer: C
Diff: 2 Type: MC
Skill: Recall
11) Which of the following is not an advantage of a correctly specified structural model?
A) Structural models may help us to more accurately predict the effect that monetary policy has
on economic activity.
B) A structural model provides more pieces of evidence about monetary policy's effect on
economic activity.
C) Structural models may allow economists to more accurately predict the impact institutional
changes have on the link between monetary policy and income.
D) A structural model imposes no restrictions on the way monetary policy affects the economy.
Answer: D
Diff: 3 Type: MC
Skill: Recall
12) Predicting the impact of institutional change on the effectiveness of monetary policy is best
done with a ________.
A) structural model
B) reduced-form model
C) black-box model
D) scientific model
Answer: A
Diff: 2 Type: MC
Skill: Recall
16
13) The monetarists complained that early Keynesian structural models tended to ignore the
impact of monetary policy changes on ________.
A) interest rates
B) investment spending
C) consumption spending
D) capital goods spending
Answer: C
Diff: 2 Type: MC
Skill: Applied
14) Monetarists contend that the channels of monetary influence in Keynesian structural
models are too ________ defined, ________ the importance of monetary policy.
A) broadly; exaggerating
B) broadly; understating
C) narrowly; understating
D) narrowly; exaggerating
Answer: C
Diff: 2 Type: MC
Skill: Recall
15) Monetarists claim that ________ models ignore important transmission mechanisms and
therefore ________ the importance of the effects of monetary policy on the economy.
A) structural; overstate
B) reduced-form; overstate
C) reduced-form; understate
D) structural; understate
Answer: D
Diff: 2 Type: MC
Skill: Recall
16) Monetarists assert that monetary policy may affect aggregate demand through ________.
A) only an interest rate channel
B) only an exchange rate channel
C) only two channels: interest rates and exchange rates
D) many channels
Answer: D
Diff: 2 Type: MC
Skill: Recall
17
17) If the particular channels through which changes in the money supply affect aggregate
income are diverse and continually changing, the best evidence of monetary policy's effect is
likely to come from ________.
A) reduced-form models
B) structural models
C) median-voter models
D) indirect models
Answer: A
Diff: 2 Type: MC
Skill: Recall
18) Monetarists' preference for reduced-form models is based on their belief that ________.
A) reverse causation is a problem
B) structural models may understate money's effect on economic activity
C) money supply changes are always endogenous
D) monetary policy affects only investment spending
Answer: B
Diff: 2 Type: MC
Skill: Recall
19) When Keynesians argue that "correlation does not necessarily imply causation," they are
probably criticizing ________.
A) structural-model evidence
B) reduced-form evidence
C) indirect-model evidence
D) black-box evidence
Answer: B
Diff: 2 Type: MC
Skill: Recall
20) A basic principle in economics is that correlation ________ imply ________.

A) does not necessarily; causation
B) does; causation
C) does not necessarily; independence
D) A and C only
Answer: D
Diff: 3 Type: MC
Skill: Recall
18
21) A basic principle in economics is that ________ does not necessarily imply ________.
A) correlation; causation
B) correlation; significance
C) causation; correlation
D) A and C only
Answer: A
Diff: 3 Type: MC
Skill: Recall
22) Reverse causation between money and aggregate output is likely to be a problem when a
central bank targets ________.
A) a monetary aggregate
B) an interest rate
C) the exchange rate
D) the inflation rate
Answer: B
Diff: 2 Type: MC
Skill: Recall
23) The reduced form approach ________ the way monetary policy affects the economy and
may be ________ likely to spot the full effect of changes in M on Y.
A) does not restrict; more
B) restricts; more
C) does not restrict; less
D) restricts; less
Answer: A
Diff: 3 Type: MC
Skill: Recall
24) A disadvantage of ________ evidence is that it cannot rule out ________.

A) reduced-form; reverse causation
B) reduced-form; adverse selection
C) structural model; reverse causation
D) structural model; adverse selection
Answer: A
Diff: 3 Type: MC
Skill: Recall
19
25) A(n) ________ of reduced-form evidence is that it cannot rule out ________.
A) disadvantage; reverse causation
B) disadvantage; adverse selection
C) advantage; reverse causation
D) advantage; adverse selection
Answer: A
Diff: 3 Type: MC
Skill: Recall
26) When using reduced-form evidence to evaluate monetary policy and find that M affects Y,
________.
A) it is possible that we may suffer from reverse causation
B) we are sure that there is no reverse causation
C) there is never adverse selection
D) there is never moral hazard
Answer: A
Diff: 2 Type: MC
Skill: Recall
27) When the ________ has an interest rate target, ________ output might lead to a ________
money supply.
A) Bank of Canada; higher; higher
B) Bank of Canada; higher; lower
C) Ministry of Finance; higher; higher
D) Ministry of Finance; lower; lower
Answer: A
Diff: 3 Type: MC
Skill: Recall
28) When the Bank of Canada has an interest rate target, ________ output might lead to a
________ money supply.
A) higher; higher
B) higher; lower
C) higher; stable
D) lower; lower
Answer: A
Diff: 3 Type: MC
Skill: Recall
20
29) Most Keynesians currently believe that ________.
A) monetary policy does matter
B) monetary policy is irrelevant
C) fiscal policy does matter
D) A and C only
Answer: D
Diff: 1 Type: MC
Skill: Recall
30) The early Keynesians of the 1950s and early 1960s believed that ________.
A) monetary policy does not matter at all
B) fiscal policy matters
C) monetary policy does matter
D) A and B only
Answer: D
Diff: 1 Type: MC
Skill: Recall
31) Early Keynesians believed that monetary policy ________.

A) affected aggregate demand solely through its effect on nominal interest rates
B) did not affect aggregate demand through nominal interest rates
C) affected aggregate demand through many channels
D) affected real output directly
Answer: A
Diff: 1 Type: MC
Skill: Recall
32) ________ nominal interest rates do ________ indicate that the cost of borrowing is
________.
A) Low; not necessarily; low
B) High; necessarily; high
C) Low; necessarily; low
D) B and C only
Answer: A
Diff: 1 Type: MC
Skill: Recall
21
33) With regard to aggregate demand, early Keynesians tended to believe that ________.
A) monetary policy mattered most
B) monetary policy was all that mattered
C) monetary policy mattered
D) monetary policy did not matter
Answer: D
Diff: 2 Type: MC
Skill: Recall
34) The ________ held the view that monetary policy does not matter at all for movements in
aggregate output.
A) new Keynesian economists
B) early Keynesians
C) early monetarists
D) early classical economists
Answer: B
Diff: 2 Type: MC
Skill: Recall
35) Early Keynesians felt that ________ policy was ________, so they stressed the importance
of ________ policy.
A) fiscal; ineffective; monetary
B) monetary; ineffective; fiscal
C) monetary; potent; monetary
D) fiscal; too potent; monetary
Answer: B
Diff: 2 Type: MC
Skill: Recall
36) Early Keynesians believed that ________ interest rates during the Great Depression
indicated that monetary policy had been ________.
A) high; contractionary
B) high; expansionary
C) low; contractionary
D) low; expansionary
Answer: D
Diff: 2 Type: MC
Skill: Recall
22
37) Early Keynesians viewed monetary policy as influencing aggregate demand solely through
its impact on ________ interest rates, which, in turn, affect ________ spending.
A) nominal; consumer
B) nominal; investment
C) real; consumer
D) real; investment
Answer: B
Diff: 2 Type: MC
Skill: Recall
38) Early Keynesians believed that ________ interest rates during the Great Depression
indicated that monetary policy was ________.
A) high; easy
B) high; tight
C) low; easy
D) low; tight
Answer: C
Diff: 2 Type: MC
Skill: Recall
39) Early Keynesians believed that low ________ during the Great Depression indicated that
________ policy was easy.
A) money growth; fiscal
B) money growth; monetary
C) interest rates; fiscal
D) interest rates; monetary
Answer: D
Diff: 2 Type: MC
Skill: Recall
40) Early Keynesians concluded that changes in monetary policy had no impact on aggregate
output because early empirical studies found no linkage between movements in ________ and
________.
A) nominal interest rates; investment spending
B) real interest rates; investment spending
C) money supply; aggregate output
D) investment spending; aggregate output
Answer: A
Diff: 2 Type: MC
Skill: Recall
23
41) In response to the early Keynesians, monetarists contended that ________.
A) monetary policy during the Great Depression was not easy
B) bank failures during the Great Depression were not the cause of the decline in the money
supply
C) evidence from the Great Depression demonstrated the ineffectiveness of monetary policy
D) there is a weak link between interest rates and investment spending
Answer: A
Diff: 2 Type: MC
Skill: Recall
42) Milton Friedman and Anna Schwartz showed that monetary policy during the Great
Depression had ________.
A) been quite inflationary
B) never been more contractionary
C) been more expansionary than in the 1920s
D) been essentially neutral
Answer: B
Diff: 2 Type: MC
Skill: Applied
43) By the standard of low-grade bonds, interest rates were ________ and monetary policy was
________ during the Great Depression.
A) low; tight
B) low; easy
C) high; tight
D) high; easy
Answer: C
Diff: 2 Type: MC
Skill: Recall
44) During the Great Depression, real interest rates ________.

A) rose to unprecedentedly high levels
B) rose only slightly above the long-run trend
C) fell to unprecedentedly low levels
D) fell only slightly below the long-run trend
Answer: A
Diff: 2 Type: MC
Skill: Applied
24
45) Movements of ________ interest rates indicate that, contrary to the early Keynesians'
beliefs, monetary policy was ________ during the Great Depression.
A) nominal; tight
B) nominal; easy
C) real; tight
D) real; easy
Answer: C
Diff: 2 Type: MC
Skill: Recall
46) Movements of real interest rates indicate that, contrary to the early Keynesians' beliefs,
________ policy was ________ during the Great Depression.
A) fiscal; tight
B) fiscal; easy
C) monetary; tight
D) monetary; easy
Answer: C
Diff: 2 Type: MC
Skill: Recall
47) Periods of price deflation, such as the Great Depression, are characterized by ________.
A) low nominal rates but high real rates of interest
B) low nominal and real interest rates
C) real rates of interest lower than the nominal rate of interest
D) high nominal and real rates of interest
Answer: A
Diff: 2 Type: MC
Skill: Applied
48) Monetarists contend that ________.

A) monetary policy affects aggregate demand solely through investment
B) monetary policy may affect aggregate demand through many channels
C) a weak link between nominal interest rates and investment spending implies monetary
policy ineffectiveness
D) monetary policy affects aggregate demand solely through consumption
Answer: B
Diff: 2 Type: MC
Skill: Recall
25
49) In the early 1960s, monetarists used reduced-form timing, statistical, and historical
evidence to show that ________.
A) fiscal policy had a strong impact on economic activity
B) monetary policy had a strong impact on economic activity
C) monetary policy had a weak impact on economic activity
D) neither monetary nor fiscal policy had a strong impact on economic activity
Answer: B
Diff: 2 Type: MC
Skill: Applied
50) In a study published in 1963, Milton Friedman and Anna Schwartz found that in every
business cycle they studied over nearly a hundred-year period, the growth rate of the ________
decreased before ________ decreased.
A) money supply; interest rates
B) money supply; output
C) budget deficit; interest rates
D) budget deficit; output
Answer: B
Diff: 2 Type: MC
Skill: Applied
51) Friedman and Schwartz found that the rate of money growth fell prior to business cycle
downturns in ________.
A) about three out of every four instances
B) four out of every five instances
C) about two out of every three instances
D) every instance studied
Answer: D
Diff: 2 Type: MC
Skill: Applied
52) In a study published in 1963, Milton Friedman and Anna Schwartz found that in every
business cycle they studied over nearly a hundred-year period, ________.
A) the growth rate of the money supply decreased before output decreased
B) interest rates decreased before output decreased
C) the growth rate of federal government spending decreased before output decreased
D) the growth rate of state and local government spending decreased before output decreased
Answer: A
Diff: 2 Type: MC
Skill: Applied
26
53) Timing evidence is valid only if it is known that the first event is ________.
A) endogenous
B) exogenous
C) a leading indicator of the second event
D) a lagging indicator of the second event
Answer: B
Diff: 2 Type: MC
Skill: Recall
54) Because ________ evidence is of a ________ nature, there is always the possibility of
reverse causation, in which output growth causes money growth.
A) historical; structural
B) statistical; structural
C) timing; structural
D) timing; reduced-form
Answer: D
Diff: 2 Type: MC
Skill: Recall
55) The monetarist statistical evidence examines the correlations between both ________ and
________ with ________.
A) money; aggregate spending; the unemployment rate
B) money; autonomous expenditures; the unemployment rate
C) money; consumption spending; aggregate spending
D) money; autonomous expenditures; aggregate spending
Answer: D
Diff: 3 Type: MC
Skill: Recall
56) A criticism of the monetarist autonomous expenditure variable is that ________.

A) some types of autonomous expenditure do not affect aggregate demand
B) some types of autonomous expenditure affect aggregate demand before the expenditure
occurs
C) some types of autonomous expenditure affect aggregate demand only long after they occur
D) Keynesians do not think that autonomous expenditure affects aggregate demand
Answer: B
Diff: 3 Type: MC
Skill: Recall
27
57) One of the best examples of an episode in which a change in monetary policy appears to
have been an exogenous event is the ________ in reserve requirements in ________.
A) increase; 1936-1937
B) decrease; 1936-1937
C) decrease; 1818-1819
D) increase; 1818-1819
Answer: A
Diff: 2 Type: MC
Skill: Applied
58) The monetarist position on the importance of monetary policy is probably best supported
by ________ evidence.
A) timing
B) statistical
C) historical
D) structural
Answer: C
Diff: 2 Type: MC
Skill: Recall
59) The monetarist ________ evidence in which declines in money growth are followed by
recessions provides the strongest support for their position that monetary policy matters.
A) statistical
B) historical
C) timing
D) structural
Answer: B
Diff: 2 Type: MC
Skill: Recall
60) As a result of recent empirical research, there has been a convergence of Keynesian and
monetarist opinion to the view that ________.
A) money is all that matters
B) money does matter
C) money does not matter
D) fiscal policy is all that matters
Answer: B
Diff: 2 Type: MC
Skill: Recall
28
61) Real business cycle theorists are critical of monetarist reduced-form evidence because they
believe ________.
A) money is the most important cause of changes in aggregate demand
B) there is reverse causation from the business cycle to money
C) there is reverse causation from money to the business cycle
D) business cycles do not exist
Answer: B
Diff: 2 Type: MC
Skill: Recall
62) Real business cycle theory states that the most important cause of business cycles is
________.
A) shocks to the money supply
B) interest rate shocks
C) Bank of Canada policy decisions
D) shocks to tastes and technology
Answer: D
Diff: 2 Type: MC
Skill: Recall
63) Explain what we call structural model evidence in describing the transmission mechanism
of monetary policy.
Answer: When we build a structural model to examine the evidence on the effect of changes in
the money supply on economic activity, we are using a collection of equations that describe the
behaviour of firms and consumers in many sectors of the economy. These equations then show
the channels through which monetary and fiscal policy affect aggregate output and spending. A
structural model might have behavioural equations that describe the working of monetary
policy through many variables. Structural model evidence on the relationship between M and Y
looks at empirical evidence on the specific channels of monetary influence, such as the link
between interest rates and investment spending.
Diff: 3 Type: ES
Skill: Recall
64) What do you know about the reduced-form evidence in describing the transmission
mechanism of monetary policy? provide a brief description.
Answer: The quantity theory approach to aggregate demand does not describe specific ways in
which the money supply affects aggregate spending, Instead, it suggests that the effect of
money on economic activity should be examined by looking at whether movements in Y are
tightly linked to movements in M. Reduced-form evidence analyzes the effect of changes in M
on Y as if the economy were a black box whose workings cannot be seen.
Diff: 1 Type: ES
Skill: Recall
29
65) What are the advantages of structural model evidence if the structure is correct?
Answer:
a. Because we can evaluate each transmission mechanism separately to see whether it is
plausible, we can gather more evidence on whether monetary policy has an important effect on
economic activity.
b. Knowing how changes in monetary policy affect economic activity may help us predict the
effect of changes in M on Y more accurately.
c. By knowing how the economy operates, we may be able to predict how institutional changes
in the economy might affect the link between changes in M and Y.
Diff: 3 Type: ES
Skill: Recall
66) What are the advantages of reduced-form evidence?

Answer: The main advantage of reduced-form evidence over structural model evidence is that
no restrictions are imposed on the way monetary policy affects the economy. If we are not sure
that we know what all the monetary transmission mechanisms are, we may be more likely to
spot the full effect of changes in M on Y by looking at whether movements in Y correlate
highly with movements in M.
Diff: 1 Type: ES
Skill: Recall
67) What is reverse causation and how does it relate to reduced-form evidence on monetary
policy transmission?
Answer: A basic principle applicable to all scientific disciplines, including economics, states
that correlation does not necessarily imply causation. The situation where after finding
correlation between two variables say M and Y, we conclude erroneously that one causes the
other is called reverse causation. The fact that the movement of one variable is linked to
another doesn't necessarily mean that one variable causes the other. The reverse causation
problem may be present when examining the link between changes in money and aggregate
output or spending. If most of the correlation between M and Y occurs because of the Bank's
interest-rate target, controlling the money supply will not help control aggregate output because
it is actually changes in Y that are causing changes in M rather than the other way around.
Diff: 3 Type: ES
Skill: Recall
30
68) What structural evidence lead early Keynesians to believe that monetary policy does not
matter?
Answer:
a. Interest rates during the Great Depression fell to extremely low levels. Early Keynesians
believed monetary policy affected aggregate demand solely through its effect on nominal
interest rates, which in turn affected investment spending. They believed that low interest rates
during the Depression indicated that monetary policy was easy since it encouraged investment
spending and so could not have played a contractionary role during this period.
b. Early empirical studies found no linkage between movements in nominal interest rates and
investment spending. Since early Keynesians believed that this is the only channel through
which money supply affects aggregate demand, finding this link weak, led them to believe that
money has no effect on output.
c. Surveys of businesspeople revealed that their decisions on how much to invest in new
physical capital were not influenced by market interest rates.
Diff: 2 Type: ES
Skill: Recall
69) What is the statistical evidence of early monetarists on the importance of money?
Answer: Monetarist statistical evidence conducted in a paper by Friedman and Meiselman in
1963 and examined the correlations between money M and autonomous expenditure A to
aggregate spending Y. They characterized the Keynesian model as saying that A should be
highly correlated with aggregate spending Y, while money supply M should not. In the
monetarist model, the money supply is the source of fluctuations in aggregate spending, and M
should be highly correlated with Y, while A should not. A logical way to find out which model
is better would be to see which is more highly correlated with Y: M or A. When they conducted
this test for many different periods of U.S. data, they discovered that the monetarist model
wins. They concluded that monetarist analysis gives a better description than Keynesian
analysis of how aggregate spending is determined.
Diff: 2 Type: ES
Skill: Recall
31

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Economics of Money, Banking, and Financial Markets 6e (Mishkin)

Chapter 26 Transmission Mechanisms of Monetary Policy

26.1 Transmission Mechanisms of Monetary Policy

20) Because of the presence of asymmetric information problems in credit markets, an

3) A model is one that describes how .

6) The monetarist-Keynesian debate on the importance of monetary policy is unresolved

20) A basic principle in economics is that correlation imply .

24) A disadvantage of evidence is that it cannot rule out .

31) Early Keynesians believed that monetary policy ________.

44) During the Great Depression, real interest rates ________.

48) Monetarists contend that ________.

56) A criticism of the monetarist autonomous expenditure variable is that ________.

66) What are the advantages of reduced-form evidence?

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