1.

The most important tool of monetary policy is controlled by:

A. Governors of the 50 states

B. The Federal Open Market Committee

C. The U.S. Congress and the president

D. The Board of Governors

D. The board of Governors of the Federal Reserve System is primarily responsible for
controlling the monetary policy. However, board of governors of Federal Reserve
System is nominated by the US Congress and the president.

2. Which of the following contributes to making the Federal Reserve an

"independent" policy-making body?

A. Its role is written into the U.S. Constitution.

B. Members of the Board of Governors are appointed for 14-year terms.

C. There are 12 different Federal Reserve banks.

D. The Federal Reserve has three policy tools: discount rate, required reserve ratio,
and open-market operations.

A. Its role is written into the U.S. Constitution. Though the members of the board are
nominated by the US Congress and the President, the board however operates without
official obligation to accept the requests or advice of any elected official with regard to
actions on the money supply.

3. True or False: All else equal, if the government attempts to balance the budget
during an economic boom (when the economy is at full employment and over
heating,) the attempt will cause inflation.

True
 False

True- Balanced budget refers to a mechanism when the revenue is equal to expenditure.
During economic boom, the public spending more and there is surplus money supply in
the economy. In this situation, it is imperative for the fed reserve to control the money
supply in the economy by reducing its own expenditure, so as to prevent an inflationary
trend in the economy. But when the revenue is equal to the expenditure, instead of money
supply going down, it increases further in form of government expenditure.

4. Suppose that the Government is running a large budget deficit. To avoid the
crowding out effect, the central bank may:

A. Uses expansionary monetary policy to insulate the effects of the deficit on interest
rates

B. Increases the money supply to insulate the effects of the deficit on interest rates

C. All these choices

D. Conducts an open-market purchase of government bonds when the government

runs a budget deficit

C. All the three options are correct. Crowding out effect occurs when the government
takes a measure like increasing tax rate or interest rate to meet the deficit. However, this
puts a pressure on the private investment. Hence, the three options mentioned above
increases the monetary base without creating a crowding effect.

5. Which of the following is true of fiscal and monetary policy in the open economy?

A. In the open economy, expansionary fiscal policy leads to a larger increase in real
GDP compared with the same policy in a closed economy.

B. Expansionary monetary policy may cause a current account surplus.

C. Expansionary monetary policy leads to international capital inflow into the United
States.

D. Expansionary fiscal policy may cause a capital account deficit.

C. Expansionary monetary policy leads to international capital inflow into the United
States because the environment is made favorable for investments when the government
opts for expansionary policy.

6. Suppose that the debt to GDP ratio in a hypothetical country reaches 200%. For
many years, investors had been willing to lend to the government at very low
interest rates. But now, investors become worried that the government might
default on its debt -- that is, might refuse to pay the investors back. As a result, the
investors are now willing to lend to the government only if they receive a high
interest rate of 20%. (Several years before Argentina defaulted on its debt, investors
demanded interest rates on its debt of more than 20% per year, so 20% is not an
unrealistic number.)

Suppose that debt is equal to 180 trillion ducats and GDP is equal to 90 trillion
ducats. If interest payments are equal to the interest accrued in a given year, how
much would the government's interest payments on its debt be as a percentage of
GDP?
A. 20%

B. 2%

C. 12%

D. 40%

E. 4%

D. 20% of 180= 360.

36/90 x 100= 40%

7. If government spending is increased by $100 billion and it is paid for with a tax
increase of $100 billion, GDP

A. Rises

B. May rise, fall, or remain the same depending on the size of the multiplier

C. Stays the same

D. Falls
B. A rise in government spending backed by tax increase of the same amount, will in turn
affect consumption but impact is dependent on the multiplier and not necessarily reduces
the consumption by the same proportion.

8. One problem with using fiscal policy to solve economic problems is that:

A. Fiscal policy is controlled by elected officials.

B. Fiscal policy has immediate effects that are unpredictable.

C. Fiscal policy has no multiplier effect, which means that large changes in spending
are required.

D. Fiscal policy can only increase, not decrease, aggregate demand.

A. Politics is one of the main problems in fiscal policy. The fiscal policy is often used as
a campaign tactic, which nullifies its positive impact.

9. The crowding-out effect refers to which of the following?

A. Increases in consumption spending that leave fewer resources available for the
economy to use to create capital

B. Reductions in private spending that offset increases in government purchase

because of the way the government purchases are financed

C. Price increases that result in less purchasing power for consumers

D. Reductions in aggregate demand that occur as the government enacts a fiscal

policy that is intended to eliminate an inflationary gap

B. Crowding out effect occurs when the government takes a measure like increasing tax
rate or interest rate to meet the deficit or to finance its purchases.

10.

GDP= 500
C = 400
G= 100
I = 50
(ex-im) = -50
Unemployment = 0%
Inflation = 100 %

In the economy above the Government decided to reduce inflation by creating a

budget surplus. Some consequences of this policy are.

A. The Current Account becomes more negative

B. Interest rates fall

C. The Current Account becomes more positive

D. The value of the dollar increases

D. when the governments sucks the money from economy in form of revenues and does
not push that money back into economy, the money supply in the economy reduces. This
makes the dollar value increase.

11. Which of the following is true of fiscal and monetary policy in the open
economy?

A. Expansionary fiscal policy may cause a capital account deficit.

B. In the open economy, expansionary fiscal policy leads to a larger increase in real
GDP compared with the same policy in a closed economy.

C. Expansionary monetary policy leads to international capital inflow into the United
States.

D. Expansionary monetary policy may cause a current account surplus.

C. The expansionary monetary policy leads to foreign capital inflow because of lower
interest rates.

12. The relationship between income and spending is summarized by the

equilibrium condition:

Y = C + I + G + (X - IM)

A trade deficit occurs when a country imports more than it exports, so that (X - IM)
< 0. To consider potential sources of a trade deficit, it is convenient to rewrite the
above expression:
(X - IM) = (S - I) - (G - T)

Use this relationship to answer the question below.

12.1. According to the expression above, a trade deficit may be caused by:

A. High taxes

B. Low investment

C. Low domestic savings

D. Low government spending

C. When a country does not have enough savings (domestic investments) to finance all
the available investment opportunities in its economy, it has to depend on foreign capital
to meet the cost of import, this in turn causes trade deficit.

The relationship between income and spending is summarized

by the equilibrium condition:

Y = C + I + G + (X - IM)

A trade deficit occurs when a country imports more than it exports, so that (X - IM)
< 0. To consider potential sources of a trade deficit, it is convenient to rewrite the
above expression:

(X - IM) = (S - I) - (G - T)

Use this relationship to answer the question below.

12.2. Suppose that U.S. policymakers decide that they want to reduce the trade
deficit. You are an economic advisor who is responsible for weighing the potential
benefits and drawbacks of various policy responses. You consider including the
following in your statement to policymakers:

I. "U.S. policymakers need to consider ways to reduce the capital account and
improve the current account."

II. "If Congress and the president approve legislation to raise taxes on household
spending, this could help alleviate the U.S. trade deficit."

III. "When the Fed pursued expansionary monetary policy beginning in 2000, this
led to a depreciation of the U.S. dollar and an increase in net exports."
IV. "Imposing tariffs on imports into the U.S. is the best way to reduce the trade
deficit because it will lead to a depreciation of the U.S. dollar."

V. "The government could mitigate the trade deficit through attracting new foreign
capital into the U.S. with higher interest rates."

Which of the above statements is correct?

A. II, III, and V

B. IV only

C. I, II, and III

D. I, II, III, IV, and V

E. III and V

F. IV and V

D. All the options above are correct. If the capital account reduces and current account
improves, the trade deficit will go down. If the taxes are imposed on house hold
spending, the savings go higher, which would once again lead to reduction in trade
deficit. Dollar depreciation makes exports attractive and imports more expensive. Hence,
the third statement is also true. Same applies to fourth and fifth statement also.

13. True or False: In an open economy, changes in international capital flows

magnify the effects of monetary policy, but weaken the effects of fiscal policy on real
GDP.

True

False

True- An expansionary monetary policy leads to downward pressure on the interest rate,
capital outflows, and depreciation, hence the real GDP improves.
14. Once the Central Bank announces its decision to tighten interest rates, ____,
this causes_____, this causes _____, and this causes ______. Both _____ and _____
help contract GDP.

i )commercial bank reserves to fall,

ii ) the value of the currency to rise,
iii )interest rates to fall,
iv )sells government bonds
v) interest rates to rise
vi) the value of the currency to fall

A. iv, i, v, ii -- ii and v

B. iv, i, vi, ii-- i and vi

C. iv, i, vi, ii-- ii and iv

D. i, ii, v, iii-- iii and v

E. iv, i, vi, iii-- iii and iv

A. In state of inflation, the government sells bonds to control money supply, so it sells
govt. securities. These are purchased by commercial banks. The reserves of commercial
bank go down, and hence to meet the reserve requirement, the banks offer higher rate of
interest to gather money from public. This raises the value of the currency.

Rise in the value of currency, makes import cheaper and increases trade deficit. Rise in
interest rates will curb consumption. Hence both are detrimental for GDP.

15. According to the rational expectations concept:

A. No expectations, no disappointments

B. Most people see the past as a predictor of the future

C. People rely on past experience to adapt to expected future events

D. People with rational expectations use every possible piece to anticipate future
events

D. Rational expectation theory states that the people in the economy make choices based
on their rational outlook, available information and past experiences. Hence, option B
and C give an incomplete assessment of rational expectation theory.