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Monetary Policy Test – AP MacroeconomicsName: ____________________________________ Date: ______________ Period: _________Favorite Tree : ______________Multiple Choice: Choose the best answer for the following questions from the choices that follow (2.63 points each):A contraction in the money supply will most likely change the nominal interest rate and aggregate demand in which of the following ways in the short run? Nominal Interest RateAggregate Demand Increase Decrease Increase Increase Increase Not change Decrease Decrease Decrease Increase Of the following, the most liquid asset is mutual fundscurrency time deposits demand deposits savings deposits If the central bank buys bonds from individuals on the open market and banks do not loan out any excess reserves created by the open market purchase, which of the following will happen?The money supply will increase. Why? Even though no loans were made to “create money”, the money supply increased because the Fed purchase of bonds “created money.”The money supply will remain unchanged.Loans to the private sector will increase.Demand Deposits will increase.The level of actual reserves will decrease. If the Federal Reserve wants to lower the Federal Funds Rate it shouldraise the discount rate.raise the reserve requirement.sell government securities. buy government securities. decrease taxes.Assume that the public holds part of its money in cash and the rest in checking accounts. If the central bank lowers the reserve requirement from 16 percent to 8 percent, the possible expansion of the money supply will decrease by more than half decrease by half decrease by less than half exactly double increase by less than double. Why? Deposit expansion will not double because all money lent out is not redeposited, but held as cash by the public.Which of the following actions by the Federal Reserve of the United States increases the money supply? Buying government bonds on the open market Selling government bonds on the open market Increasing the reserve requirement Increasing the discount rate Increasing the federal funds rate An increase in the price level will most likely cause which of the following? A leftward shift of the aggregate demand curve An increase in the demand for money An increase in the real interest rate A decrease in the nominal interest rate (E) An increase in the supply of moneyIf the central bank raises the required reserve ratio, the money multiplier and the money supply will change in which of the following ways? Money Multiplier Money SupplyIncrease Increase Increase Decrease Increase No change (D) Decrease No change (E) Decrease Decrease If aggregate demand is growing faster than aggregate supply, the Federal Reserve is most likely to sell securities on the open market. Why? When AD is greater than AS, we have inflation.increase bond prices increase income taxes decrease the discount rate decrease the required reserve ratioWhich of the following is true of the opportunity cost of holding cash? It is zero. It is represented by the value of the dollar. It is equal to the price level. It decreases as the price level rises. It increases as the interest rate rises.If the required reserve ratio is 10 percent, Bank Two’s actual reserves are $50 million and its demand deposits are $200 million, what are its excess reserves?$20 million$30 million Why? Required Reserves = .10 x $200 Million = $20 Million. Excess Reserves = AR – RR = $50 Million - $20 Million.$150 million $120 million$180 million Assume that the reserve requirement for demand deposits is 20 percent, that banks hold no excess reserves, and that the public holds no currency. If the central bank sells $10,000 worth of government securities to commercial banks, the money supply would have which maximum change listed below?increase of $40,000decrease of $40,000 decrease of $50,000. So the multiplier works in reverse. 1/rr = 1/.20 = 5; 5 x $10,000 = $50,000 decrease (selling bonds decreases the money supply). (D) increase of $50,000 (E) increase of $10,000When the central bank sells government bonds on the open market, which of the following will most likely increase? Bank reserves Price of bonds Money supply (D) Nominal interest rates (E) The required reserve ratio If nominal gross domestic product in a country is $1,600 and the money supply is $400, what is the velocity of money? 400 10 4 Why? MV = PQ; $400 x V = PxQ or Nominal GDP of $1, 600, so V = 4 ($1600/400)2 (E) 0.5 Which of the following is a determinant of the amount of money the commercial banking system can create? The marginal propensity to consume The marginal propensity to save The total number of banks The size of the federal debt (E) The reserve requirementThe money demanded for the purpose of purchasing goods and services is known as an asset demand a derived demand excess reserves a transactions demand balance of payments Expansionary monetary policy will most likely cause interest rates and investment to change in which of the following ways in the short run? Interest Rates Investment (A) Increase Increase (B) Increase Decrease (C) Decrease Increase (D) Decrease Decrease (E) No change Increase A bank has $800 million in demand deposits, $100 Million in loans, $100 Million in excess reserves and $200 million in required reserves. As such, the reserve requirement must be ________. 12.5%50%10%25% Why? rr = RR/CD = 200/800 = 25%.(E) 20% Which of the following will lead to an increase in the money supply? A decrease in income tax rates A decrease in government spending Open-market purchase of securities by the central bank Increased borrowing by the federal government by issuing new bonds An increase in the discount rate If the reserve requirement is 20 percent and the central bank buys $20,000 in government bonds on the open market, the money supply will increase by a maximum of $80,000 (B)increase by a maximum of $100,000 Why? multiplier = 1/rr = 1/.20 = 5; 5 x all $20,000 = $100,000. Even if the money went into demand deposits the ultimate answer is the same since you would add back the original deposit as it is all “new money from the Fed.(C)decrease by a maximum of $80,000 (D)decrease by a maximum of $4,000 (E)decrease by a maximum of $100,000To most effectively reduce inflation, the central bank would (A) sell bonds, lower the discount rate, and increase the reserve ratio (B) buy bonds, lower the discount rate, and lower the reserve ratio. (C) buy bonds, raise the discount rate, and increase the reserve ratio.(D) sell bonds, raise the discount rate, and increase the reserve ratio.(E) sell bonds, lower the discount rate, and lower the reserve ratio. Assume that the reserve ratio is 10%. Marwa deposits $1 million in cash into her checking account at First Bank. The deposit will initially increase excess reserves at first bank by (A) $100,000 (B) $900,000 Why? RR = .10 x $1 Million or $100,000 so AR – RR = ER; $1 Million - $100,000 = $900,000.(C) $1 million(D) $9 million(E) $10 millionAnswer Question 23 in the space provided below: (25 points total)23.Assume that you are a member of the Fed’s FOMC. The U.S. is experiencing high inflation and you want to return the economy to the full-employment equilibrium level of real GDP.a)1. Would you prescribe and expansionary or contractionary monetary policy to get the country out of inflation?2. What three monetary policy tools could be used to remedy the situation?a) Raise Reserve Requirement b) Raise Discount Rate c) Sell bonds3. How would you utilize those tools?See # 2b)Draw and properly label a Money Market Graph which shows the effect of your policy action taken in part a above on that market.c)Draw and properly label an AD/AS graph which shows the economic condition of the U.S. both before and after your policy action is taken in part a above.d)How would your monetary policy action taken in part a above effect:1. AD and real output (real GDP) down2. the price level down3. the unemployment rate. up4. the money supply down5 bank reserves down6. Nominal Interest Rate. upe)1.Draw and properly label a foreign exchange market graph which shows what happens to the value of the U.S. Dollar as a result of the actions taken above.2.Will the dollar appreciate or depreciate? Why? The higher interest rates in the US will attract foreign investment in financial investments like bonds.3.What will happen to Xn, AD, and Real GDP?All go down. Why? U.S. exports decrease as our products become more expensive to the world while imports increase as U.S. buying power rises.. As such, Xn (exports – imports) decline. As Xn is part of AD/GDPr, they both decline slightly.24) (17 points) FUN Bank25145995270500 Assets Liabilities45720013461900Required Reserves $ 200Demand Deposits $2,000Excess Reserves 400 Total $2,000Loans 900Bonds 500Total $2,000a) What is the reserve requirement ratio?rr = RR/CD = $200/$2,000 = 10%b) How much can this bank loan out?All of its $400 in Excess Reserves c) How much can the entire banking system expand the money supply by making loans?Use the multiplier or 1/rr = 1/.10 = 10; 10 x $400 = $4,000 d) If the Fed bought the $500 in bonds from FUN Bank, what would be the immediate effect on the money supply? How much of this purchase could FUN bank loan out?Rises by all $500 as it is “new money” from the Fed. It can loan all of it. No need to reserve any money since it is the bank’s cash and not in a demand deposit.e) How much could the money supply ultimately increase through the entire banking system from this $500 bond purchase? 1/.10 = 10; 10 x$500 = $5,000f) Suppose that Squidward, one of FUN Bank’s customers, withdraws $100 from his checking account. What effect would this withdrawal have on the following:The money supply No change. The composition changes from checking to cash. 2) Required Reserves Decrease to $190. How? Demand Deposits drop from $2,000 to $1,900. When you recalculate RR’s = $1,900 x .10 = $190 3) Excess ReservesDecrease to $310. With RR’s now at $190, loans at $900, bonds at $500 and Total Assets now $1,900, ER must be $310 ................
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