ECO 301 FINAL EXAM REVIEW QUESTIONS
Which of the following is LEAST likely to lead to departures from the theoretical
presumption that there is a zero lower bound on nominal bond yields?
A) Storage cost associated with holding cash
B) The expectation of earning capital gains from selling the bonds in question before
they mature
C) Expected variation in exchange rates
D) Reduction in expectations of economic growth - Answers - D) Reduciton in
expectations of economic growth
Let I = the nominal interest rate on bonds, im = nominal interest rate on money, r = the
real interest rate on bonds, rm = the real interest rate on money, and pi = the rate of
growth of the price level. Suppose im = 0 and I < 0 and the conditions or assumptions
underlying the theoretical presumption that there is a zero lower bound on nominal
interest rates prevail. Which of the following statements is the most accurate
characterization of how agents in the economy in question will react to these
conditions? - Answers - Under the conditions described, rational agents would prefer to
hold money and there would be no demand for bonds or interest earning assets
True or False:
According to M. Woolford, effective control of the federal funds rate is the best indicator
of successful monetary policy. - Answers - False
True or False:
The efficacy of forward guidance as an unconventional tool of monetary policy is
fundamentally reliant on the fact that in making inter-temporal resource allocation
decisions (for example, how much they will consume now vs how much they will
consume in the future, how much they will work now vs how much they will work in the
future, and investment in physical capital) optimizing agents only consider current
values of relevant variables. - Answers - False
True or False:
Despite its substantial record of successful use of its monetary policy tools to target the
federal funds rate, the Fed abandoned this conventional approach to monetary policy in
its response to the 07-09 recession in favor of unconventional approaches such as
forward guidance and quantitative easing. This abandonment of conventional monetary
policy reflects the view that using conventional monetary policy to create enough
stimulus to restore the economy would have required the Fed to drive the federal funds
rate substantially below its zero lower bound. - Answers - True
, Which of the following actions is the Fed most likely to take if its objective is to twist the
yield curve in order to encourage spending on interest sensitive goods?
A) Substitute purchases of short-term US government bonds for purchases of long-term
bonds.
B) Use its public relations tools to influence market participants into expecting future
short-term interest rates to fall.
C) Use its public relations tools to influence market participants into expecting future
short-term interest rates to rise.
D) Substitute purchases of long-term US government bonds for purchases of short-term
bonds. - Answers - D) Substitute purchases of long-term US government bonds for
purchases of short-term bonds.
True or False:
According to Blinder's definition of quantitative easing, the Fed's use of risk-free US
government bonds to pay for its purchases of very risky-mortgage-backed securities in
response to the 2007-2009 financial crisis did not qualify as quantitative easing because
these actions altered the composition of the Fed's balance sheet. - Answers - False
True or False:
According to Blinder's definition of quantitative easing, the fact that outright increases in
Fed purchases of long-term US government bonds that were accompanied by
compensating reductions in purchases of short-term US government bonds altered the
composition and/or size of the fed's balance sheet is sufficient to classify these actions
as quantitative easing. - Answers - False
For the purposes of this question let iff represent the prevailing value of the federal
funds rate and ioer represent the prevailing value of the interest rate the Fed pays
banks on their excess reserve balances at the Fed. Which of the following conditions is
least likely to prevail in an economy in which reserves are not scarce?
A) iff - ioer = 0
B) Optimizing banks will hold the level of excess reserves that completely insures them
against the risk of reserve deficiencies.
C) The demand curve for reserves in the federal funds market will be perfectly elastic.
D) The demand curve for reserves in the federal funds market will be perfectly inelastic.
- Answers - D) The demand curve for reserves in the federal funds market will be
perfectly inelastic.
Which of the following is LEAST likely to lead to departures from the theoretical
presumption that there is a zero lower bound on nominal bond yields?
A) Storage cost associated with holding cash
B) The expectation of earning capital gains from selling the bonds in question before
they mature
C) Expected variation in exchange rates
D) Reduction in expectations of economic growth - Answers - D) Reduciton in
expectations of economic growth
Let I = the nominal interest rate on bonds, im = nominal interest rate on money, r = the
real interest rate on bonds, rm = the real interest rate on money, and pi = the rate of
growth of the price level. Suppose im = 0 and I < 0 and the conditions or assumptions
underlying the theoretical presumption that there is a zero lower bound on nominal
interest rates prevail. Which of the following statements is the most accurate
characterization of how agents in the economy in question will react to these
conditions? - Answers - Under the conditions described, rational agents would prefer to
hold money and there would be no demand for bonds or interest earning assets
True or False:
According to M. Woolford, effective control of the federal funds rate is the best indicator
of successful monetary policy. - Answers - False
True or False:
The efficacy of forward guidance as an unconventional tool of monetary policy is
fundamentally reliant on the fact that in making inter-temporal resource allocation
decisions (for example, how much they will consume now vs how much they will
consume in the future, how much they will work now vs how much they will work in the
future, and investment in physical capital) optimizing agents only consider current
values of relevant variables. - Answers - False
True or False:
Despite its substantial record of successful use of its monetary policy tools to target the
federal funds rate, the Fed abandoned this conventional approach to monetary policy in
its response to the 07-09 recession in favor of unconventional approaches such as
forward guidance and quantitative easing. This abandonment of conventional monetary
policy reflects the view that using conventional monetary policy to create enough
stimulus to restore the economy would have required the Fed to drive the federal funds
rate substantially below its zero lower bound. - Answers - True
, Which of the following actions is the Fed most likely to take if its objective is to twist the
yield curve in order to encourage spending on interest sensitive goods?
A) Substitute purchases of short-term US government bonds for purchases of long-term
bonds.
B) Use its public relations tools to influence market participants into expecting future
short-term interest rates to fall.
C) Use its public relations tools to influence market participants into expecting future
short-term interest rates to rise.
D) Substitute purchases of long-term US government bonds for purchases of short-term
bonds. - Answers - D) Substitute purchases of long-term US government bonds for
purchases of short-term bonds.
True or False:
According to Blinder's definition of quantitative easing, the Fed's use of risk-free US
government bonds to pay for its purchases of very risky-mortgage-backed securities in
response to the 2007-2009 financial crisis did not qualify as quantitative easing because
these actions altered the composition of the Fed's balance sheet. - Answers - False
True or False:
According to Blinder's definition of quantitative easing, the fact that outright increases in
Fed purchases of long-term US government bonds that were accompanied by
compensating reductions in purchases of short-term US government bonds altered the
composition and/or size of the fed's balance sheet is sufficient to classify these actions
as quantitative easing. - Answers - False
For the purposes of this question let iff represent the prevailing value of the federal
funds rate and ioer represent the prevailing value of the interest rate the Fed pays
banks on their excess reserve balances at the Fed. Which of the following conditions is
least likely to prevail in an economy in which reserves are not scarce?
A) iff - ioer = 0
B) Optimizing banks will hold the level of excess reserves that completely insures them
against the risk of reserve deficiencies.
C) The demand curve for reserves in the federal funds market will be perfectly elastic.
D) The demand curve for reserves in the federal funds market will be perfectly inelastic.
- Answers - D) The demand curve for reserves in the federal funds market will be
perfectly inelastic.
