Mishkin 6ce TB Ch24

Economics of Money, Banking, and Financial Markets 6e (Mishkin)
Chapter 24 Monetary Policy Theory
24.1 Response of Monetary Policy to Shocks
1) Non-activists believe that that expectations are ________ formed and that wages and prices
are ________ with respect to the expected price level.
A) adaptively; completely flexible
B) adaptively; sticky
C) rationally; completely flexible
D) rationally; sticky
Answer: C
Diff: 1 Type: MC
Skill: Recall
Objective: 24.1 Illustrate and explain the policy choices that monetary policymakers face under
the conditions of aggregate demand shocks, temporary supply shocks, and permanent supply
shocks
2) An expansionary monetary policy will cause aggregate output to expand in the non-activist
macroeconomic model ________.
A) if the policy is unanticipated
B) if the policy is anticipated
C) only after a long and variable lag, provided the policy is anticipated
D) never; output will never expand in the non-activist model when monetary policy is changed
Answer: A
Diff: 1 Type: MC
Skill: Recall
shocks
3) According to the new classical model, ________.

A) unanticipated policy has no effect
B) only anticipated policy can influence the business cycle
C) anticipated policy has no effect on the business cycle
D) A and B only
Answer: C
Diff: 1 Type: MC
Skill: Recall
shocks
1
Copyright 2017 Pearson Canada, Inc.
4) Steve the economist tells his students that one anticipated policy is just like any othernone
has any effect on aggregate output. You can probably infer that he is a ________.
A) Keynesian economist
B) monetarist
C) proponent of activist policies
D) new classical economist
Answer: D
Diff: 1 Type: MC
Skill: Applied
shocks
5) In the view of the new classical economists, an increase in the money supply will affect
aggregate output and employment ________.
A) only if the increase in money supply is anticipated
B) only if the increase in money supply is expected
C) only if the increase in money supply is unanticipated
D) only if the increase in money supply is the result of an announced open market operation
Answer: C
Diff: 1 Type: MC
Skill: Recall
shocks
6) In the new classical model, an anticipated increase in the money stock will cause ________.
A) the price level and aggregate output to increase
B) aggregate output to increase
C) the price level to increase
D) no effect on either the price level or aggregate output
Answer: C
Diff: 1 Type: MC
Skill: Recall
shocks
2
7) In the new classical model, ________.
A) all wages and prices are perfectly flexible with respect to expected changes in the price level
B) a fall in the expected price level results in an immediate and equal rise in wages and prices
C) only unanticipated policy can affect aggregate output and unemployment
D) A and C only
Answer: D
Diff: 3 Type: MC
Skill: Recall
shocks

A) wages and prices are sticky with respect to expected changes in the price level
B) unanticipated policy has no effect on aggregate output and unemployment
C) an anticipated increase in the money supply will increase aggregate output temporarily
D) only unanticipated policy can affect aggregate output and unemployment
Answer: D
Diff: 1 Type: MC
Skill: Recall
shocks

A) wages and prices are sticky with respect to expected changes in the price level
B) a rise in the expected price level results in an immediate and equal rise in wages and prices
C) an anticipated increase in the money supply will increase aggregate output temporarily
D) unanticipated policy has no effect on aggregate output and unemployment
Answer: B
Diff: 1 Type: MC
Skill: Recall
shocks

A) a rise in the expected price level results in an immediate and equal rise in wages and prices
B) anticipated policy has no effect on aggregate output and unemployment
C) unanticipated policy has no effect on aggregate output and unemployment
D) A and B only
Answer: D
Diff: 1 Type: MC
Skill: Recall
shocks
3
11) In the new classical model, an expansionary monetary policy causes ________.
A) the aggregate demand curve to shift to the right, and output to increase only if the policy is
anticipated
B) the aggregate demand curve to shift to the right, and output to increase only if the policy is
unanticipated
C) a decline in the price level
D) B and C only
Answer: B
Diff: 1 Type: MC
Skill: Recall
shocks
12) If all wages and prices are perfectly flexible with respect to expected changes in the price
level, then an expansionary monetary policy will cause ________.
anticipated
unanticipated
C) an increase in the price level
D) B and C only
Answer: D
Diff: 1 Type: MC
Skill: Recall
shocks
13) The new classical model has the word classical associated with it because, when an
increase in the money supply is anticipated, ________.
A) aggregate output drops below the natural rate level
B) aggregate output rises above the natural rate level
C) aggregate output remains at the natural rate level
D) aggregate output increases in the short run, but not in the long run
Answer: C
Diff: 2 Type: MC
Skill: Recall
shocks
4
14) If a rise in the expected price level results in an immediate and equal rise in wages and
prices, then an expansionary monetary policy will cause ________.
anticipated
unanticipated
C) a decline in the price level
D) B and C only
Answer: B
Diff: 2 Type: MC
Skill: Recall
shocks
15) In the new classical model, an unanticipated increase in the money supply will cause
________.
A) output to increase in the short run, but not in the long run
B) an increase in the price level
C) government budget deficits to increase
D) A and B only
Answer: D
Diff: 3 Type: MC
Skill: Recall
shocks
16) In the new classical model, an anticipated policy of a continually increasing money supply
________.
A) causes the aggregate demand curve to shift continually to the right
B) causes the aggregate demand curve to shift continually to the left
C) is shown as a movement along the aggregate demand curve
D) B and C only
Answer: A
Diff: 1 Type: MC
Skill: Applied
shocks
5
17) According to the new classical school of thought, a continually increasing money supply
causes ________.
A) the aggregate demand curve to shift continually to the right, and the price level to increase
continually
B) the aggregate supply curve to shift continually to the right, and the price level to increase
continually
C) the long-run aggregate supply curve to shift continually to the right, and the price level to
increase continually
D) B and C only
Answer: A
Diff: 2 Type: MC
Skill: Applied
shocks
18) In the new classical model, an anticipated policy of a continually increasing money supply
causes ________.
A) the aggregate demand curve to shift right along a stationary aggregate supply curve, leading
to continually increasing aggregate output and prices
B) the aggregate supply curve to shift left along a stationary aggregate demand curve, leading
to continually contracting aggregate output and prices
C) the aggregate demand curve to shift continually to the right while simultaneously the
aggregate supply curve shifts continually inward, leading to higher and higher price levels
D) the aggregate demand curve to shift continually to the left while simultaneously the
aggregate supply curve shifts continually outward, leading to higher and higher price levels
Answer: C
Diff: 3 Type: MC
Skill: Applied
shocks
19) In the new classical model, an unanticipated increase in the money supply causes
________.
A) the aggregate demand curve to shift to the right along a stationary aggregate supply curve
B) both the aggregate demand and supply curves to shift simultaneously to the right
C) the aggregate demand curve to shift to the right as the aggregate supply curve
simultaneously shifts to the left
D) both the aggregate demand and supply curves to shift simultaneously to the left
Answer: A
Diff: 3 Type: MC
Skill: Recall
shocks
6
20) ________ policies do not change aggregate real output or the unemployment in the
________ model.
A) Anticipated; new Keynesian
B) Unanticipated; new Keynesian
C) Anticipated; new classical
D) Unanticipated; new classical
Answer: C
Diff: 2 Type: MC
Skill: Recall
shocks
Figure 27-3
21) In the new classical model in Figure 27-3, an anticipated expansionary monetary policy
________.
A) shifts the economy from point 1 to point 2 to point 3
B) shifts the economy from point 1 to point 4 to point 3
C) shifts the economy from point 1 to point 3
D) shifts the economy from point 3 to point 1
Answer: C
Diff: 2 Type: MC
Skill: Applied
shocks
7
22) In the new classical model in Figure 27-3, an unanticipated expansionary monetary policy
________.
Answer: A
Diff: 2 Type: MC
Skill: Applied
shocks
23) In the new classical model in Figure 27-3, an anticipated contractionary monetary policy
________.
Answer: D
Diff: 2 Type: MC
Skill: Applied
shocks
24) In the new classical model in Figure 27-3, an unanticipated contractionary monetary policy
________.
D) shifts the economy from point 3 to point 4 to point 1
Answer: D
Diff: 2 Type: MC
Skill: Applied
shocks
8
25) In the new classical model in Figure 27-3, the initial impact of an unanticipated monetary
expansion ________.
A) increases output from Yn to Y2, and the inflation rate from P1 to P2
B) decreases output from Yn to Y4, and the inflation rate from P3 to P4
C) does not change output and increases the inflation rate from P1 to P3
D) does not change output and decreases the inflation rate from P3 to P1
Answer: A
Diff: 2 Type: MC
Skill: Applied
shocks
26) In the new classical model in Figure 27-3, the long-run effect of an unanticipated monetary
expansion ________.
Answer: C
Diff: 2 Type: MC
Skill: Applied
shocks
27) In the new classical model in Figure 27-3, an anticipated monetary expansion ________.
Answer: C
Diff: 2 Type: MC
Skill: Applied
shocks
9
28) In the new classical model in Figure 27-3, the initial impact of an unanticipated monetary
contraction ________.
Answer: B
Diff: 3 Type: MC
Skill: Applied
shocks
29) In the new classical model in Figure 27-3, the long-run effect of an unanticipated monetary
contraction ________.
Answer: D
Diff: 3 Type: MC
Skill: Applied
shocks
30) In the new classical model in Figure 27-3, an anticipated monetary contraction ________.
Answer: D
Diff: 3 Type: MC
Skill: Applied
shocks
10
31) The policy ineffectiveness proposition ________.
A) asserts that anticipated changes in monetary policy cannot affect real aggregate output
B) rules out output effects from policy surprises
C) implies that an anticipated contractionary monetary policy cannot reduce the rate of inflation
D) implies that an anticipated expansionary monetary policy will not cause the price level to
rise
Answer: A
Diff: 2 Type: MC
Skill: Recall
shocks
32) The policy ineffectiveness proposition ________.

A) asserts that anticipated changes in monetary policy cannot affect real aggregate output
B) does not rule out output effects from policy surprises
C) implies that an anticipated contractionary monetary policy cannot reduce the rate of inflation
D) A and B only
Answer: D
Diff: 3 Type: MC
Skill: Recall
shocks
33) The notion that anticipated monetary policy has no effect on the real aggregate output is
commonly called the ________.
A) Lucas critique
B) policy ineffectiveness proposition
C) natural rate hypothesis
D) new Keynesian proposition
Answer: B
Diff: 2 Type: MC
Skill: Recall
shocks
11
34) An important feature of the new classical model is that an expansionary policy, such as an
increase in the rate of money growth, can lead to a decline in aggregate output ________.
A) if the public expects an even more expansionary policy than the one that is actually
implemented
B) if the policy comes as a surprise
C) if the public expects a less expansionary policy than the one that is actually implemented
D) if the policy is anticipated
Answer: A
Diff: 3 Type: MC
Skill: Recall
shocks
35) In the new classical model, an expansionary monetary policy will lead to a decline in
aggregate output if ________.
A) the increase in money supply is less than anticipated
B) the increase in money supply is greater than anticipated
C) the increase in money supply comes as a surprise
D) the Bank of Canada announces the policy decision prior to its implementation
Answer: A
Diff: 2 Type: MC
Skill: Recall
shocks
12
Figure 27-4
36) In the new classical model in Figure 27-4, an anticipated increase in aggregate demand that
is less than expected ________.
A) moves the economy from point 1 to point 2 to point 3
B) moves the economy from point 1 to point 5 to point 3
C) moves the economy from point 1 to point 4 to point 3
D) moves the economy from point 1 to point 3
Answer: B
Diff: 2 Type: MC
Skill: Applied
shocks
37) In the new classical model in Figure 27-4, the initial impact of an anticipated increase in
aggregate demand that is less than expected ________.
B) decreases output from Yn to Y5, and increases the inflation rate from P1 to P5
C) decreases output from Yn to Y4, and increases the inflation rate from P1 to P4
D) does not change output and increases the inflation rate from P1 to P3
Answer: B
Diff: 2 Type: MC
Skill: Applied
shocks
13
38) In the new classical model in Figure 27-4, the long-run effects of an anticipated increase in
aggregate demand that is less than expected ________.
B) decreases output from Yn to Y5, and increases the inflation rate from P1 to P5
D) does not affect the levels of real output or inflation
Answer: C
Diff: 3 Type: MC
Skill: Applied
shocks
39) Demonstrate graphically and explain the short-run and long-run effects of an unanticipated
monetary expansion in the new classical model.
Answer: See figure below.
In the new classical model, unexpected monetary expansion increases aggregate demand. Since
this is unexpected, aggregate supply is not affected, and output increases in the short run. As
expectations adjust, aggregate supply decreases and output returns to the natural rate, with only
the inflation rate rising.
Diff: 2 Type: ES
Skill: Recall
shocks
14
40) Demonstrate graphically and explain the short-run and long-run effects of an anticipated
monetary expansion in the new classical model.
Answer: For anticipated policies, AS shifts with ADS, and real output does not change. The
only effect is to increase prices. The economy moves from point 1 to point 3.
Diff: 2 Type: ES
Skill: Applied
shocks
15
41) In the new classical model, show graphically and explain how an expected monetary
expansion that is less than expected reduces real output in the short run. What is the long-run
result?
Answer: See figure below.
Demand does not increase as much as expected, so aggregate supply decreases more than the
increase in aggregate demand. The result in the short run is a lower aggregate output. In the
long-run, AS adjusts to the actual increase in demand with higher inflation and no increase in
output.
Diff: 2 Type: ES
Skill: Recall
shocks
16
24.2 How Actively Should Policymakers Try to Stabilize Economic Activity?
1) Nonactivists of the policies believe that ________.

A) wages and prices are very flexible
B) the self-correcting mechanism is very rapid
C) government action is unnecessary
D) all of the above
Answer: D
Diff: 2 Type: MC
Skill: Recall
Objective: 24.2 Identify the lags in the policy process, and summarize why they weaken the case
for an activist policy approach
2) Activists of the policies believe that ________.

A) the self-correcting mechanism through wage and price adjustment is very slow
B) wages and prices are sticky
C) the government needs to pursue active policy to eliminate high unemployment when it
develops
D) all of the above
Answer: D
Diff: 2 Type: MC
Skill: Recall
3) If aggregate output is below the natural rate level, activists of policies would recommend
that the government ________.
A) do nothing
B) try to eliminate the high unemployment by attempting to shift the aggregate supply curve to
the right
C) try to eliminate the high unemployment by attempting to shift the aggregate demand curve
to the right
D) try to eliminate the high unemployment by attempting to shift the aggregate demand curve
to the left
Answer: C
Diff: 2 Type: MC
Skill: Recall
17
4) If aggregate output is below the natural rate level, nonactivists of policies would recommend
that the government ________.
A) do nothing
B) try to eliminate the high unemployment by attempting to shift the aggregate supply curve to
the right
C) try to eliminate the high unemployment by attempting to shift the aggregate demand curve
to the right
D) try to eliminate the high unemployment by attempting to shift the aggregate demand curve
to the left
Answer: A
Diff: 2 Type: MC
Skill: Recall
5) Nonactivists of policies contend that a policy of shifting the aggregate ________ curve will
be costly because it produces ________ volatility in both the price level and output.
A) supply; less
B) supply; more
C) demand; less
D) demand; more
Answer: D
Diff: 2 Type: MC
Skill: Recall
6) The existence of lags prevents the instantaneous adjustment of the economy to policies
changing aggregate demand, thereby strengthening the case for ________.
A) supply-side policy
B) nonactivists
C) activists
D) demand-management policy
Answer: B
Diff: 2 Type: MC
Skill: Recall
18
7) The data lag is ________.
A) the time it takes for policy makers to obtain data indicating what is happening in the
economy
B) the time it takes for policy makers to be sure of what the data are signaling about the future
course of the economy
C) the time it takes to pass legislation to implement a particular policy
D) the time it takes for policy makers to change policy instruments once they have decided on
the new policy
E) the time it takes for the policy actually to have an impact on the economy
Answer: A
Diff: 2 Type: MC
Skill: Recall
8) The recognition lag is ________.

economy
the new policy
Answer: B
Diff: 2 Type: MC
Skill: Recall
9) The legislative lag represents ________.

economy
the new policy
Answer: C
Diff: 2 Type: MC
Skill: Recall
19
10) The implementation lag is ________.
economy
the new policy
Answer: D
Diff: 2 Type: MC
Skill: Recall
11) The effectiveness lag is ________.

economy
the new policy
Answer: E
Diff: 2 Type: MC
Skill: Recall
12) The time it takes for policy makers to obtain data indicating what is happening in the
economy is called ________.
A) the data lag
B) the recognition lag
C) the legislative lag
D) the implementation lag
E) the effectiveness lag
Answer: A
Diff: 2 Type: MC
Skill: Recall
20
13) The time it takes for policy makers to be sure of what the data are signaling about the future
course of the economy is called ________.
A) the data lag
Answer: B
Diff: 2 Type: MC
Skill: Recall
14) The time it takes to pass legislation to implement a particular policy is called ________.
A) the data lag
Answer: C
Diff: 2 Type: MC
Skill: Recall
15) The time it takes for policy makers to change policy instruments once they have decided on
the new policy is called ________.
A) the data lag
Answer: D
Diff: 2 Type: MC
Skill: Recall
21
16) The time it takes for the policy actually to have an impact on the economy is called
________.
A) the data lag
Answer: E
Diff: 2 Type: MC
Skill: Recall
17) The nonactivists who opposed the recent fiscal stimulus package argue that ________.
A) fiscal stimulus would take too long to work because of long implementation lags
B) fiscal stimulus might kick in after the economy had already recovered
C) fiscal stimulus could lead to increased volatility in inflation and economic activity
D) all of the above
E) none of the above
Answer: D
Diff: 2 Type: MC
Skill: Recall
22
24.3 Inflation: Always and Everywhere a Monetary Phenomenon
1) The economist who proposed that, "Inflation is always and everywhere a monetary
phenomenon" was ________.
A) John Maynard Keynes
B) John R Hicks
C) Milton Friedman
D) Franco Modigliani
Answer: C
Diff: 2 Type: MC
Skill: Recall
Objective: 24.3 Explain why monetary policymakers can target any inflation rate in the long-run
but cannot target a level of output in the long-run
2) Complete Milton Friedman's famous proposition: "Inflation is always and everywhere a

________ phenomenon."
A) monetary
B) political
C) policy
D) budgetary
Answer: A
Diff: 2 Type: MC
Skill: Recall
3) At first cut, the simple solution to fighting inflation is ________.

A) reducing the growth rate of the money supply
B) limiting the number of terms that politicians can serve in elective office
C) returning the economy to barter by prohibiting the use of fiat money
D) to impose price controls on businesses that attempt to raise prices
Answer: A
Diff: 2 Type: MC
Skill: Applied
23
4) "How do we prevent the inflationary fire from igniting again and stop the roller coaster ride
in the inflation rate of the last 40 years?" Milton Friedman's famous proposition suggests the
simple solution: ________.
A) reduce the number of terms that politicians are allowed to serve
B) reduce the growth rate of the money supply
C) reduce the marginal tax rate on low-income wage earners
D) increase the marginal tax rates on businesses that hike prices in excess of 5 percent per year
Answer: B
Diff: 2 Type: MC
Skill: Applied
5) Milton Friedman's proposition concerning the cause of inflation implies a simple solution to
the inflation problem: ________.
A) reduce government budget deficits
B) limit the ability of fiscal policymakers to bring pressure to bear on the monetary authority
C) limit the number of terms that politicians are allowed to serve
D) reduce the growth rate of the money supply
Answer: D
Diff: 2 Type: MC
Skill: Applied
6) Milton Friedman's proposition that inflation is always and everywhere a monetary

phenomenon holds only if ________.
A) government budget deficits do not rise continually
B) the unemployment rate does not rise continually
C) the inflation rate rises continually
D) Canada does not experience more than one negative supply shock per decade
Answer: C
Diff: 2 Type: MC
Skill: Recall
24
24.4 Causes of Inflationary Monetary Policy
1) To say that inflation is a monetary phenomenon seems to beg the question: ________.
A) Why does inflationary monetary policy occur?
B) Why do politicians seek reelection?
C) Why is the Fed independent?
D) Why does the US Treasury print so much money?
Answer: A
Diff: 2 Type: MC
Skill: Recall
Objective: 24.4 Identify the sources of inflation and the role of monetary policy in propagating
inflation
2) The combination of a successful wage push by workers and the government's commitment to
high employment leads to ________.
A) demand-pull inflation
B) supply-side inflation
C) supply-shock inflation
D) cost-push inflation
Answer: D
Diff: 2 Type: MC
Skill: Recall
inflation
3) If workers do not believe that policymakers are serious about fighting inflation, they are
most likely to push for higher wages, which will ________ aggregate ________ and lead to
unemployment or inflation or both, everything else held constant.
A) decrease; demand
B) increase; demand
C) decrease; supply
D) increase; supply
Answer: C
Diff: 2 Type: MC
Skill: Recall
inflation
25
4) If workers believe that government policymakers will increase aggregate demand to avoid a
politically unpopular increase in unemployment when workers demand higher wages, then
workers will not fear higher unemployment and their wage demands will result in ________.
B) hyperinflation
C) deflation
D) cost-push inflation
Answer: D
Diff: 2 Type: MC
Skill: Recall
inflation
5) If policymakers set a target for unemployment that is too low because it is less than the
natural rate of unemployment, this can set the stage for a higher rate of money growth and
________.
A) cost-push inflation
B) demand-pull inflation
C) cost-pull inflation
D) demand-push inflation
Answer: B
Diff: 2 Type: MC
Skill: Recall
inflation
6) Theoretically, one can distinguish a demand-pull inflation from a cost-push inflation by

comparing ________.
A) how fast prices rise relative to wages
B) the unemployment rate with its natural rate level
C) when prices rise relative to wages
D) government debt to real GDP
Answer: B
Diff: 2 Type: MC
Skill: Recall
inflation
26
7) Demand-pull inflation can result when ________.
A) policymakers set an unemployment target that is too high
B) a persistent budget deficit is financed by selling bonds to the public
C) a persistent budget deficit is financed by selling bonds to the central bank
D) workers get numerous wage increases
Answer: C
Diff: 2 Type: MC
Skill: Recall
inflation
8) Which of the following is least likely to lead to inflationary monetary policy?

A) Rising unemployment
B) Expanding federal budget deficits
C) Declining oil prices
D) Conflict in the Middle East
Answer: C
Diff: 2 Type: MC
Skill: Applied
inflation
9) Which of the following is most likely to lead to inflationary monetary policy?

A) Declining oil prices
B) Resolution of conflict in the Middle East
C) The enactment of a free-trade agreement with Mexico
D) Rising unemployment
Answer: D
Diff: 2 Type: MC
Skill: Recall
inflation
10) Which of the following is most likely to lead to inflationary monetary policy?
A) Declining oil prices
B) Resolution of conflict in the Middle East
C) The enactment of a free-trade agreement with Mexico
D) Rising government budget deficits
Answer: D
Diff: 2 Type: MC
Skill: Recall
inflation
27
11) Because policies in Canada were too expansionary from 1965 through 1973, Canada
suffered ________.
B) cost-push inflation, as workers sought higher wages in order to keep up with inflation
C) both demand-pull and cost-push inflation
D) neither demand-pull nor cost-push inflation
Answer: A
Diff: 2 Type: MC
Skill: Applied
inflation
12) Explain and show graphically why continuous monetary growth is needed to generate
inflation. Describe how the inflation process is generated.
Answer: Only continuous monetary growth can cause continuous increases in aggregate
demand of the sort needed to generate inflation. Other factors can increase demand and the
price level, but none can increase demand continuously. In the graph, the monetary expansion
shifts AD to the right. The increase in output above the natural rate increases wages, shift AS to
the left. Monetary expansion shifts AD repeatedly, and wages continue to adjust.
Diff: 2 Type: ES
Skill: Recall
inflation
28
13) Why a cost-push inflation is a monetary phenomenon? Use the appropriate graph to support
your answer.
Answer: Students must use a graph similar to the one below. Initially the economy is on point
1 with an aggregate output equal to the normal rate output. Supposing that workers succeed in
seeking higher wages as they want to increase their real wages. The effect of such an increase
will be similar to a negative supply shock and will shift the short-term aggregate supply curve
to the left so that the economy slides to point 1'. If we have an activist government with a high
employment target point 1' is associated with increased unemployment and lower output, so the
government will implement policies to raise the aggregate demand and shift the aggregate
demand curve to AD2 so that we will return to the natural rate level of output at point 2 with a
higher price level. Workers may be encouraged to seek even higher wages due to the increased
price level and if they succeed and the government continues to accommodate this the economy
will move from point 2 to 2', 3, 3', and 4 on the graph. But the continuous shift of the demand
curve to the right cannot be sustained by fiscal policy as government spending and tax cuts
have limits. This policy can only be sustained to create inflation only with an increasing money
supply. Thus, a cost-push inflation is a monetary phenomenon because it cannot occur without
the monetary authorities pursuing an accommodating policy of a higher rate of money growth.
Diff: 3 Type: ES
Skill: Recall
inflation
29
24.5 Monetary Policy at the Lower Bound
1) The MP curve is drawn on a graph with the ________ on the horizontal axis and the
________ on the vertical axis.
A) inflation rate, aggregate output
B) nominal interest rate, inflation rate
C) real interest rate, aggregate output
D) inflation rate, real interest rate
Answer: D
Diff: 2 Type: MC
Skill: Recall
Objective: 24.5 Explain the unique challenges that monetary policymakers face at the zero lower
bound, and illustrate how nonconventional monetary policy can be effective under such
conditions
2) When nominal interest rates are above zero, the MP curve has a ________slope because
when the inflation rate increases the monetary authorities will ________ the real interest rate.
A) negative; raise
B) negative; lower
C) positive; raise
D) positive; lower
Answer: C
Diff: 2 Type: MC
Skill: Recall
conditions
3) A liquidity trap occurs when ________.

A) the central bank cannot lower policy rates below zero
B) government spending crowds out private investment
C) planned investment equals zero
D) money is no longer considered a liquid asset
Answer: A
Diff: 2 Type: MC
Skill: Recall
conditions
30
4) When nominal interest rates are zero, the MP curve has a ________ slope because monetary
authorities ________ lower the nominal interest rate and the real interest rate ________ as
inflation rates decline.
A) positive; cannot; falls
B) negative; cannot; rises
C) positive; can; falls
D) negative; can; rises
Answer: B
Diff: 2 Type: MC
Skill: Recall
conditions
5) If inflation was 1% and the monetary authorities set the nominal interest set at the zero lower
bound, the real interest rate would be ________.
A) -1%
B) 0%
C) 1%
D) 2%
Answer: A
Diff: 2 Type: MC
Skill: Applied
conditions
6) The AD curve is drawn on a graph with the ________ on the horizontal axis and the
________ on the vertical axis.
A) aggregate output; inflation rate
B) aggregate output; real interest rate
C) inflation rate; aggregate output
D) inflation rate; real interest rate
Answer: A
Diff: 2 Type: MC
Skill: Recall
conditions
31
7) When nominal interest rates are above zero, the AD curve has a ________ slope because
when the inflation rate increases the monetary authorities will ________ the real interest rate as
inflation rises which will ________ investment and aggregate output.
A) negative; raise; decrease
B) negative; lower; increase
C) positive; raise; increase
D) positive; lower; increase
Answer: B
Diff: 2 Type: MC
Skill: Recall
conditions
8) When nominal interest rates are are zero, the AD curve has a ________ slope because when
aggregate output decreases the monetary authorities ________ lower the nominal interest rate.
As inflation rises the real interest rate _______which will ________ investment and aggregate
output.
A) negative; can; increases; decrease
B) negative; cannot; decrease; increase
C) positive; cannot; increases; decrease
D) positive; can; decreases; decrease
Answer: C
Diff: 2 Type: MC
Skill: Recall
conditions
9) A sudden shortage of liquidity during a financial crisis will shift the ________ curve to the
________.
A) AS; right
B) AS; left
C) AD; right
D) AD; left
Answer: D
Diff: 2 Type: MC
Skill: Recall
conditions
32
10) Financial frictions affect the ________ curve by ________ the real interest rate for
investment causing investment and aggregate output to ________.
A) AD; increasing; decrease
B) AD; decreasing; increase
C) AS; increasing; decrease
D) AS; decreasing; increase
Answer: A
Diff: 2 Type: MC
Skill: Recall
conditions
11) Explain why the self-correcting mechanism is on longer operational when nominal interest
rates are at the zero lower bound.
Answer: The self-correcting mechanism normally works by having wages and prices fall when
the aggregate output level falls below its potential level. As this causes inflation to fall and
possibly turn negative, real interest rates rise causing investment to fall and aggregate output to
continue to fall below potential.
Diff: 2 Type: ES
Skill: Applied
conditions
12) What three forms does non-conventional monetary policy take?

Answer: Liquidity provision, asset purchases or quantitative easing and management of
expectations.
Diff: 2 Type: ES
Skill: Recall
conditions
13) What are the objectives of quantitative easing?

Answer: QE is intended to reduce financial frictions by injecting liquidity into financial
markets which will lower credit spreads and the spread between long- and short-term interest
rates.
Diff: 2 Type: ES
Skill: Recall
conditions
33
14) How does a commitment by monetary authorities to maintain low, short-term policy rates
affect long-term interest rates?
Answer: Since long-term rates reflect both current short-term and expected future short-term
interest rates, maintaining low policy rates will affect long-term rates. This follows directly
from the expectations theory of interest rates.
Diff: 2 Type: ES
Skill: Applied
conditions
34

Mishkin 6ce TB Ch24

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Mishkin 6ce TB Ch24

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

Chapter 24 Monetary Policy Theory

24.1 Response of Monetary Policy to Shocks

3) According to the new classical model, ________.

8) In the new classical model, ________.

9) In the new classical model, ________.

10) In the new classical model, ________.

32) The policy ineffectiveness proposition ________.

1) Nonactivists of the policies believe that ________.

2) Activists of the policies believe that ________.

8) The recognition lag is ________.

9) The legislative lag represents ________.

11) The effectiveness lag is ________.

2) Complete Milton Friedman's famous proposition: "Inflation is always and everywhere a

3) At first cut, the simple solution to fighting inflation is ________.

6) Milton Friedman's proposition that inflation is always and everywhere a monetary

6) Theoretically, one can distinguish a demand-pull inflation from a cost-push inflation by

8) Which of the following is least likely to lead to inflationary monetary policy?

9) Which of the following is most likely to lead to inflationary monetary policy?

3) A liquidity trap occurs when ________.

12) What three forms does non-conventional monetary policy take?

13) What are the objectives of quantitative easing?

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