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Table of Contents

  1. Chapter Twenty-One: The Role of Money in Macroeconomics

Chapter Twenty-One: The Role of Money in Macroeconomics

1
Question 1

What is the current UK inflation target?

a)
b)
c)
d)
e)
Correct.Incorrect. The answer is d) 2% annual inflation of the CPIYour answer has been saved.
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2
Question 2

Monetary policy decisions and a new MPC forecast (published in the Inflation Report) appear at what frequency?

a)
b)
c)
d)
e)
Correct.Incorrect. The answer is c) There is a policy announcement every month and a new forecast every three months.Your answer has been saved.
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3
Question 3

A cut in interest rates by policy makers will:

a)
b)
c)
d)
e)
Correct.Incorrect. The answer is a) Raise investment and this shifts AD to the right.Your answer has been saved.
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4
Question 4

A policy of lowering interest rates will be associated with an increase in the money supply (other things being equal) because:

a)
b)
c)
d)
e)
Correct.Incorrect. The answer is d) The higher money supply will create an excess demand for bonds, bond prices rise and interest rates fall.Your answer has been saved.
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5
Question 5

Which of the following statements about money demand is correct?

a)
b)
c)
d)
e)
Correct.Incorrect. The answer is c) The demand for real money balances is positively related to real income and negatively related to interest rates.Your answer has been saved.
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6
Question 6

'Neutrality' of money implies:

a)
b)
c)
d)
e)
Correct.Incorrect. The answer is a) That if we change all monetary values in the same proportion nothing real changes.Your answer has been saved.
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7
Question 7

'Money illusion' is said to occur:

a)
b)
c)
d)
e)
Correct.Incorrect. The answer is e) When a change in money prices and incomes lead an agent to change his/her real behaviour even though all real choices are unchanged.Your answer has been saved.
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8
Question 8

Which of the following is not a correct statement about the IS curve?

a)
b)
c)
d)
e)
Correct.Incorrect. The answer is e) The IS curve will shift to the left if there is an exogenous increase in export demand.Your answer has been saved.
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9
Question 9

Which of the following is not a correct statement about the LM curve?

a)
b)
c)
d)
e)
Correct.Incorrect. The answer is c) As the nominal money stock increases the LM curve shifts to the left.Your answer has been saved.
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10
Question 10

Assume that a DVD costs £10. What information will this convey to:
(a) an individual who has no understanding of what sterling is;
(b) the same person who is now given £100 so s/he can buy DVDs;
What additional information would the aforementioned individual need in order to place a value on a DVD?

Hint: re-read 'Money as a veil' pp463.Hint

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Question 11

If a person is said to have 'money illusion', what does that mean about her/his behaviour? Does this mean that the person is foolish?

Hint: re-read 'Money illusion' pp 463-64. In answering the second question, you may wish to consider scenarios when a person is most likely to suffer from money illusion.Hint

12
Question 12

Why does it take time for economic agents to adjust to a change in the price level?

Hint: re-read 'The process of price level changes' pp 464.Hint

13
Question 13

Why is there an inverse relationship between the price of a bond and the rate of interest?

Hint: re-read 'The rate of interest and present value' pp 465-66. It may help to answer this question by thinking about a worked example. For example, why would the price of a bond fall from £500 to £250 if the rate of interest doubled from 5% to 10%?Hint

14
Question 14

What factors will determine the amount of money you set aside for:
(a) transactions purposes;
(b) precautionary purposes;
(c) speculative purposes.

To what extent is each of these motives for holding money related to GDP?

Hint: re-read 'The demand for money' pp467-70. Hint

15
Question 15

What are the policy making implications of the quantity theory of money?

Hint: re-read real and nominal money balances' pp469-70, including Box 21.1 (p470). In answering this question, you may wish to think about the information you would need in order to use the theory effectively to underpin the macroeconomic policy you have identified. To help you answer this, you are also referred back to Box 20.2 (p 452).Hint

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Question 16

Draw a diagram to show the relationship between the demand for money and the nominal rate of interest. Under what circumstances might the demand curve for money become horizontal?

Hint: re-read 'Total demand for money' pp 469-70, including Figure 21.1. The situation to which the question refers is known as a 'liquidity trap'. Consider what will happen if investors can only envisage a rise in interest rates. What does this mean about bond prices and the demand for money? The liquidity trap scenario is discussed in more detail in 'Case Study 2: Limits of monetary policy: Japan in the early 2000s' pp487-88.Hint

17
Question 17

Draw a flow chart to show the process by which disequilibrium in the money market leads to an equilibrium interest rate and money quantity.

Hint: re-read 'Monetary equilibrium and the interest rate' pp471-72.Hint

18
Question 18

Show how a change in interest rates will result in a shift in the aggregate spending curve and in the aggregate demand curve.

Hint: re-read 'Interest rates as the monetary policy instrument' pp 472-75, including figures 21.4 (p474) and 21.5 (p476). To ensure that you understand this process, you may wish to draw a flow chart to illustrate the changes you have drawn.Hint

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Question 19

In what sense is the simple accelerator model 'naïve'?

Hint: re-read 'Box 21.2: The accelerator theory of investment' pp 474-75. You may want to think why it is inappropriate to assume that α is fixed. Consider also the potential impact of firm owners' expectations. Hint

20
Question 20

What is the Taylor Rule?

Hint: re-read 'Policy responses' pp478-79 and 'Box 21.4: Monetary policy reactions and the Taylor rule' p479. Hint

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Question 21

Why do you think that the incoming 1997 Labour Government opted to delegate the power to set interest rates from the Chancellor of the Exchequer to the Bank of England (via the Monetary Policy Committee)?

Hint: re-read 'Implementation of monetary policy' pp 481-84. Consider what it means to say that the Monetary Policy Committee has 'instrument independence' but not 'goal independence'. Hint

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Question 22

Assume that the level of output does not coincide with that at which the IS and LM curves intersect. Explain the process by which the equilibrium output and interest rate emerges.

Hint: re-read 'Appendix: An alternative derivation of the AD curve: IS/LM' pp 490-96. If the syllabus of your economics course includes IS/LM analysis, it is recommended that you are able to derive each curve and understand what is meant by the equilibrium where they intersect. In answering the question, you may wish to start by considering what impact the non-equilibrium interest rate will have in the goods market.Hint

23
Question 23

To what extent is the IS/LM framework motivated by 'Keynesian' assumptions?

Hint: as a starting point you may wish to consider the main differences that exist between the IS/LM framework and the AD/AS framework. Hint