Chapter 16

Practice Quiz
Monetary Policy
1. Keynes gave which of the following as a motive for people holding money?
a. Transactions demand.
b. Speculative demand.
c. Precautionary demand.
d. All of the above.
ANS:
d. These are the three motives for holding currency and checkable deposits (M1) rather
than stocks, bonds, or other nonmoney forms of wealth.
2. A decrease in the interest rate, other things being equal, causes a (an)
a. upward movement along the demand curve for money.
b. downward movement along the demand curve for money.
c. rightward shift of the demand curve for money.
d. leftward shift of the demand curve for money.
ANS:
b. At a lower interest rate, money is demanded because the opportunity cost of holding
money is lower.
3. Assume the demand for money curve is stationary and the Fed increases the money
supply. The result is that people
a. increase the supply of bonds, thus driving up the interest rate.
b. increase the supply of bonds, thus driving down the interest rate.
c. increase the demand for bonds, thus driving up the interest rate.
d. increase the demand for bonds, thus driving down the interest rate.
ANS:
d. See Exhibit 2 in the text.
4. Assume the demand for money curve is fixed and the Fed decreases the money supply.
The result is a temporary
a. excess quantity of money demanded.
b. excess quantity of money supplied.
c. increase in the price of bonds.
d. increase in the demand for bonds.

ANS:
a. See Exhibit 2 in the text.
5. Assume the demand for money curve is fixed and the Fed increases the money supply.
The result is that the price of bonds
a. rises.
b. remains unchanged.
c. falls.
d. does none of the above.
ANS:
a. The result is an excess beyond the amount people wish to hold and they buy bonds
which drives the price of bonds upward.
6. Using the aggregate supply and demand model, assume the economy is in equilibrium
on the intermediate portion of the aggregate supply curve. A decrease in the money
supply will decrease the price level and
a. lower both the interest rate and the real GDP.
b. raise both the interest rate and real GDP.
c. lower the interest rate and raise real GDP.
d. raise the interest rate and lower real GDP.
ANS:
d. The decrease in money supply increases the interest rate which decreases investment.
Since investment is a component of aggregate demand, the aggregate demand curve shifts
leftward and real GDP declines.
7. Based on the equation of exchange, the money supply in the economy is calculated as
a. M = V/PQ.
b. M = V(PQ).
c. MV = PQ.
d. M = PQ - V.
ANS:
c. The equation of exchange is MV = PQ rewritten, M = PQ/V
8. The V in the equation of exchange represents the
a. variation in the GDP.
b. variation in the CPI.
c. variation in real GDP.
d. average number of times per year a dollar is spent on final goods and services.

ANS:
d. In the equation of exchange, GDP is defined as PQ and the CPI is an index to measure
the price level (P).
9. Which of the following is not an issue in the Keynesian-monetarist debate?
a. The importance of monetary vs. fiscal policy.
b. The importance of a change in the money supply.
c. The importance of a crowding-out effect.
d. All of the above are part of the debate.
ANS:
d. Monetarists believe the effects of monetary policy are more powerful than fiscal
policy. They view the shape of the investment demand curve as less steep, so the
crowding-out effect is significant. Keynesians disagree.
10. Keynesians reject the influence of monetary policy on the economy. One argument
supporting this Keynesian view is that the
a. money demand curve is horizontal at any interest rate.
b. aggregate demand curve is nearly flat.
c. investment demand curve is nearly vertical.
d. money demand curve is vertical.
ANS:
c. If the investment demand curve is nearly vertical, changes in money supply and
resulting changes in interest rate have little effect on investment and aggregate demand.

11. Starting from an equilibrium at E1 in Exhibit 12, a rightward shift of the money
supply curve from MS1 to MS2 would cause an excess
a. demand for money, leading people to sell bonds.
b. supply of money, leading people to buy bonds.
c. supply of money, leading people to sell bonds.
d. demand for money, leading people to buy bonds.
ANS:
b. An excess quantity of money supplied causes people to buy bonds. The greater demand
for bonds causes the price of bonds to increase and the interest rate to decrease.
12. Beginning from an equilibrium at E2 in Exhibit 12, a decrease in the money supply
from $600 billion to $400 billion causes people to
a. sell bonds and drive the price of bonds down.
b. buy bonds and drive the price of bonds up.
c. buy bonds and drive the price of bonds down.
d. sell bonds and drive the price of bonds up.
ANS:
a. An excess quantity of money demanded causes people to sell bonds. The greater supply
of bonds on the market causes the price of bonds to decrease and the interest rate to
increase.

13. In Exhibit
13, a move
from M1 to M2
a. increases
the money
supply,
causing the
interest rate to
rise from i2 to
i1.
b. increases
the money
supply, causing the interest rate to fall from i1 to i2.
c. decreases the money supply, causing the interest rate to rise from i2 to i1.
d. decreases the money supply, causing the interest rate to fall from i1 to i2.
e. has no effect on the money supply or the interest rate.
ANS:
b. A rightward shift in the vertical money supply curve (M1 -M2) creates a new
equilibrium at i2.

14. In Exhibit 13, the Fed believes the economy is at AD3, how might it engineer a
decline in the price level?
a. By decreasing the money supply, the interest rate falls, investment rises, and aggregate
demand falls, causing the price level to fall.
b. By decreasing the money supply, the interest rate rises, investment rises, and aggregate
demand rises, causing the price level to fall.
c. By decreasing the money supply, the interest rate rises, investment falls, and aggregate
demand falls, causing the price level to fall.
d. By increasing the money supply, the interest rate rises, investment rises, and aggregate
demand falls, causing the price level to fall.
e. By increasing the money supply, the interest rate rises, investment falls, and aggregate
demand rises, causing the price level to fall.
ANS:
c. A leftward shift in the money supply curve from MS2 to MS1 causes an increase in the
interest rate from i2 to i1. The result is less business and investment spending (I2 to I1).
Since I is a component of AD, AD3 shifts leftward and the price level falls.
15. The Monetarist transmission mechanism through which monetary policy affects the
price level, real GDP, and employment depends on the
a. indirect impact of changes on the interest rate.
b. indirect impact of changes on profit expectations.
c. direct impact of changes in fiscal policy on aggregate demand.
d. direct impact of changes in the money supply on aggregate demand.
ANS:
d. In contrast, the Keynesian monetary transmission mechanism operates through changes
in the interest rate and business investment spending.