Macro Unit 4.5 - 4.7 Quiz

In the short run, a contraction in the money supply will most likely change the nominal interest rate and aggregate demand in which of the following ways?

Nominal Interest Rates/Aggregate Demand

• Increase/decrease

• Increase/increase

• Increase/not change

• decrease/decrease

• decrease/increase

If the money supply stays constant but the demand for money decreases, the equilibrium interest rate and quantity of money will change in which of the following ways?

Interest Rate/Quantity of Money

• Increase/decrease

• Increase/not change

• Decrease/decrease

• Decrease/increase

• Decrease/not change

The public wants to hold $10 billion in money. The monetary base is $2 billion and the money multiplier is 4. Based on the above data, which of the following will most likely occur?

• The monetary base will increase.

• The nominal interest rate will increase.

• The money multiplier will increase.

• The money demand curve will shift right.

• Spending will increase.

Answer explanation

The money supply is $8 billion and money demand is $10 billion. Therefore, there is a shortage in the money market, and market forces will drive the nominal interest rate to increase towards equilibrium.

Which of the following changes would cause an increase in the equilibrium nominal interest rate?

• An increase in the monetary base

• An increase in the money supply

• An increase in real income

• A decrease in the amount of cash the public wants to hold

• A decrease in the price level

Answer explanation

An increase in real income increases the demand for money and the equilibrium nominal interest rate.

Which of the following will most likely result in a country's lower real interest rate?

• The nation provides an investment tax credit to new businesses.

• The citizens of the nation increase their savings for retirement.

• The nation is experiencing political instability and economic risk.

• The nation’s central bank sells government bonds in the open market.

• The nation’s government increases its borrowing to finance spending on capital projects.

Answer explanation

This will increase the supply of loanable funds and result in a lower real interest rate.

Which of the following changes must have happened in the loanable funds market to cause a decrease the equilibrium real interest rate?

• A decrease in private savings

• A decrease in the expected inflation rate

• An increase in government spending on highways financed by borrowing

• An increase in foreign financial capital inflows

• An investment tax credit for plant and equipment

Answer explanation

An increase in foreign financial capital inflows shifts the supply of loanable funds to the right and decreases the equilibrium real interest rate.

Which of the following must be true if the loanable funds market is in equilibrium?

• Government spending equals tax revenues.

• Investment spending equals national savings.

• Investment spending equals private savings.

• Borrowing equals lending.

• Foreign inflows of financial capital equal investment spending.

Answer explanation

The statement “borrowing equals lending” encompasses all the participants in the loanable funds market: the government, domestic private investment, and savings and capital flows.

The graph above shows the effect of a monetary policy action on aggregate demand. Which of the following will shift the aggregate demand curve in the direction shown?

• A decrease in the money supply

• A decrease in the monetary base

• A decrease in the overnight interbank lending rate

• An increase in the required reserve ratio

• The sale of bonds to the private sector by the central bank

Answer explanation

A decrease in the overnight interbank lending rate requires an increase in the supply of reserves, which increases the money supply and shifts the aggregate demand curve to the right.

Which monetary policy action could the Fed implement in order to control inflation?

• Target a lower overnight interbank lending rate

• Sell government bonds to the public

• Lower the discount rate

• Lower the required reserve ratio

• Increase the monetary base

Answer explanation

Selling government bonds to the public will decrease the money supply, which increases nominal interest rates, decreases interest-sensitive spending, decreases aggregate demand, and reduces inflation.

Which of the following will most likely increase when the Fed sells government bonds on the open market?

• Bank reserves

• Price of bonds

• Money supply

• Nominal interest rates

• The required reserve ratio