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Economics of Money, Banking, and Financial Markets 6e (Mishkin)

Chapter 17 The Conduct of Monetary Policy: Strategy and Tactics

17.1 The Price Stability Goal and the Nominal Anchor

1) Price stability is defined as ________.


A) low inflation
B) low and stable inflation
C) stable inflation
D) core inflation
Answer: B
Diff: 1 Type: MC
Skill: Recall
Objective: 17.1 Define and recognize the importance of a nominal anchor

2) The importance of a nominal anchor is to ________.


A) limit the time-inconsistency problem
B) reduce inflation
C) promote low inflation
D) allow discretionary day-to-day monetary policy
Answer: A
Diff: 1 Type: MC
Skill: Recall
Objective: 17.1 Define and recognize the importance of a nominal anchor

3) Inflation leads to ________.


A) price instability
B) lower economic growth
C) public hostility
D) all of the above
Answer: D
Diff: 1 Type: MC
Skill: Recall
Objective: 17.1 Define and recognize the importance of a nominal anchor

4) The nominal anchor ________.


A) acts like behavioural rule
B) leads to inflation
C) creates the time-inconsistency problem
D) avoids the natural rate of unemployment
Answer: A
Diff: 1 Type: MC
Skill: Recall
Objective: 17.1 Define and recognize the importance of a nominal anchor

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5) Describe the time-inconsistency problem as it pertains to monetary policy outcomes.
Answer: The time-inconsistency problem occurs when monetary policymakers are tempted to
pursue a discretionary monetary policy that is more expansionary than firms or people expect
because such a policy would boost economic output (or lower employment) in the short run.

Diff: 1 Type: ES
Skill: Recall
Objective: 17.1 Define and recognize the importance of a nominal anchor

17.2 Other Goals of Monetary Policy

1) The natural rate of unemployment ________.


A) is consistent with full employment
B) is equal to zero
C) equals structural employment
D) is the same as frictional employment
Answer: A
Diff: 1 Type: MC
Skill: Recall
Objective: 17.2 Identify the six potential goals that monetary policymakers may pursue

2) High unemployment ________.


A) results in lower GDP
B) leads to increased human misery
C) cannot be a target of monetary policy
D) A and B only
Answer: D
Diff: 1 Type: MC
Skill: Recall
Objective: 17.2 Identify the six potential goals that monetary policymakers may pursue

3) Current estimates of NAIRU place it between ________ and ________.


A) 4 percent; 6 percent
B) 4 percent; 20 percent
C) 1 percent; 3 percent
D) 1 percent; 4 percent
Answer: A
Diff: 1 Type: MC
Skill: Recall
Objective: 17.2 Identify the six potential goals that monetary policymakers may pursue

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4) The natural rate of output is also known as ________.
A) potential output
B) NAIRU
C) structural output
D) GDP
Answer: A
Diff: 1 Type: MC
Skill: Recall
Objective: 17.2 Identify the six potential goals that monetary policymakers may pursue

5) Interest rate stability is desirable because ________.


A) fluctuations in interest rates create uncertainty
B) it leads to financial market stability
C) stability in the foreign exchange markets
D) all of the above
Answer: D
Diff: 1 Type: MC
Skill: Recall
Objective: 17.2 Identify the six potential goals that monetary policymakers may pursue

6) Increases in interest rates ________.


A) cause large capital losses
B) could lead to bank failures
C) affect consumers' willingness to buy houses
D) all of the above
Answer: D
Diff: 1 Type: MC
Skill: Recall
Objective: 17.2 Identify the six potential goals that monetary policymakers may pursue

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17.3 Should Price Stability Be the Primary Goal of Monetary Policy?

1) Hierarchical mandates ________.


A) puts the goal of price stability first and then allows for other goals
B) requires all goals to be met simultaneously
C) is only used by the Bank of Canada
D) is only used by the Federal Reserve
Answer: A
Diff: 1 Type: MC
Skill: Recall
Objective: 17.3 Summarize the distinctions between hierarchical and dual mandates

2) In the long-run, there is no trade-off between ________ and ________.


A) inflation; unemployment
B) inflation; price stability
C) unemployment; price stability
D) unemployment; economic growth
Answer: A
Diff: 1 Type: MC
Skill: Recall
Objective: 17.3 Summarize the distinctions between hierarchical and dual mandates

3) Which of the following countries have hierarchical mandates?


A) Reserve Bank of New Zealand
B) Bank of Canada
C) Bank of England
D) all of the above
Answer: D
Diff: 1 Type: MC
Skill: Recall
Objective: 17.3 Summarize the distinctions between hierarchical and dual mandates

4) Price stability is often the primary goal of central banks. Describe the five other goals of
monetary policy
Answer: The other objectives of monetary policy are: (1) high employment and output
stability, (2) economic growth, (3) stability of financial markets, (4) interest-rate stability, and
(5) stability in foreign exchange markets.
Diff: 1 Type: ES
Skill: Recall
Objective: 17.3 Summarize the distinctions between hierarchical and dual mandates

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17.4 Inflation Targeting

1) Inflation targeting includes ________.


A) a public announcement of medium-term targets for inflation
B) an institutional commitment to price stability as the primary long run goal
C) an information-inclusive approach in which many variables are used in making decisions
about monetary policy
D) all of the above
Answer: D
Diff: 2 Type: MC
Skill: Recall
Objective: 17.4 Compare and contrast the advantages and disadvantages of inflation targeting

2) The type of monetary policy that is used in Canada, New Zealand, and the United Kingdom
is ________.
A) monetary targeting
B) inflation targeting
C) targeting with an implicit nominal anchor
D) interest-rate targeting
Answer: B
Diff: 1 Type: MC
Skill: Recall
Objective: 17.4 Compare and contrast the advantages and disadvantages of inflation targeting

3) Concerns about a dual mandate include ________.


A) over expansionary policy
B) policies that lead to large output fluctuations
C) time-inconsistency problems
D) decreases in output and unemployment
Answer: A
Diff: 1 Type: MC
Skill: Recall
Objective: 17.4 Compare and contrast the advantages and disadvantages of inflation targeting

4) Which of the following is NOT an element of inflation targeting?


A) A public announcement of medium-term numerical targets for inflation
B) An institutional commitment to price stability as the primary long-run goal
C) An information-inclusive approach in which only monetary aggregates are used in making
decisions about monetary policy
D) Increased accountability of the central bank for attaining its inflation objectives
Answer: C
Diff: 3 Type: MC
Skill: Recall
Objective: 17.4 Compare and contrast the advantages and disadvantages of inflation targeting

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5) The first country to adopt inflation targeting was ________.
A) the United Kingdom
B) Canada
C) New Zealand
D) Australia
Answer: C
Diff: 1 Type: MC
Skill: Applied
Objective: 17.4 Compare and contrast the advantages and disadvantages of inflation targeting

6) New Zealand adopted inflation targeting in ________.


A) 1990
B) 1991
C) 1992
D) 1994
Answer: A
Diff: 2 Type: MC
Skill: Recall
Objective: 17.4 Compare and contrast the advantages and disadvantages of inflation targeting

7) The Reserve Bank of New Zealand ________.


A) is one of the most independent central banks
B) as the sole objective of price stability
C) negotiates with the minister of finance to make a Policy Targets Agreement
D) all of the above
Answer: D
Diff: 2 Type: MC
Skill: Recall
Objective: 17.4 Compare and contrast the advantages and disadvantages of inflation targeting

8) Tight monetary policy in New Zealand ________.


A) brought inflation down to below 2 percent
B) reduced unemployment
C) experienced a growth rate occasionally greater than 5 percent
D) all of the above
Answer: D
Diff: 2 Type: MC
Skill: Recall
Objective: 17.4 Compare and contrast the advantages and disadvantages of inflation targeting

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9) Canada's adoption of inflation targeting led to an unemployment rate of ________.
A) above 10 percent
B) nearly 8 percent
C) over 5 percent
D) 5 percent
Answer: A
Diff: 1 Type: MC
Skill: Recall
Objective: 17.4 Compare and contrast the advantages and disadvantages of inflation targeting

10) In both New Zealand and Canada, what has happened to the unemployment rate since the
countries adopted inflation targeting?
A) The unemployment rate increased sharply.
B) The unemployment rate remained constant.
C) The unemployment rate has declined substantially after a sharp increase.
D) The unemployment rate declined sharply immediately after the inflation targets were
adopted.
Answer: C
Diff: 1 Type: MC
Skill: Applied
Objective: 17.4 Compare and contrast the advantages and disadvantages of inflation targeting

11) The United Kingdom uses ________ as its nominal anchor.


A) inflation target
B) monetary aggregates
C) interest rate target
D) none of the above
Answer: A
Diff: 2 Type: MC
Skill: Recall
Objective: 17.4 Compare and contrast the advantages and disadvantages of inflation targeting

12) Peak inflation in the United Kingdom was ________ in ________.


A) 9 percent; 1991
B) 4 percent; 1997
C) 12 percent; 1991
D) 8 percent; 1995
Answer: A
Diff: 2 Type: MC
Skill: Recall
Objective: 17.4 Compare and contrast the advantages and disadvantages of inflation targeting

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13) The target inflation range set by the Bank of England is ________.
A) 1-4 percent
B) 1-3 percent
C) 2-4 percent
D) 2-3 percent
Answer: A
Diff: 2 Type: MC
Skill: Recall
Objective: 17.4 Compare and contrast the advantages and disadvantages of inflation targeting

14) Which of the following is an advantage of inflation targeting?


A) There is simplicity and clarity of the target.
B) Inflation targeting does not rely on a stable money-inflation relationship.
C) It is understood by the public and is transparent.
D) All of the above.
Answer: D
Diff: 1 Type: MC
Skill: Recall
Objective: 17.4 Compare and contrast the advantages and disadvantages of inflation targeting

15) Which of the following is an advantage to inflation targeting?


A) There is a delayed signal about achievement of the target.
B) Inflation targets could impose a rigid rule on policymakers.
C) There is potential for larger output fluctuations.
D) There is transparency.
Answer: D
Diff: 1 Type: MC
Skill: Recall
Objective: 17.4 Compare and contrast the advantages and disadvantages of inflation targeting

16) Which of the following is an advantage to inflation targeting?


A) There is a delayed signal about achievement of the target.
B) Inflation targets could impose a rigid rule on policymakers.
C) There is potential for larger output fluctuations.
D) It increases accountability of the central bank.
Answer: D
Diff: 1 Type: MC
Skill: Recall
Objective: 17.4 Compare and contrast the advantages and disadvantages of inflation targeting

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17) Which of the following is an advantage to inflation targeting?
A) There is a delayed signal about achievement of the target.
B) Inflation targets could impose a rigid rule on policymakers.
C) There is potential for larger output fluctuations.
D) The performance has been quite good.
Answer: D
Diff: 1 Type: MC
Skill: Recall
Objective: 17.4 Compare and contrast the advantages and disadvantages of inflation targeting

18) Which of the following is an advantage to inflation targeting?


A) There is a delayed signal about achievement of the target.
B) Inflation targets could impose a rigid rule on policymakers.
C) There is potential for larger output fluctuations.
D) It is easily understood by the public.
Answer: D
Diff: 1 Type: MC
Skill: Recall
Objective: 17.4 Compare and contrast the advantages and disadvantages of inflation targeting

19) Which of the following is a disadvantage of inflation targeting?


A) There is transparency.
B) Inflation targeting does not rely on a stable money-inflation relationship.
C) It imposes a rigid rule.
D) Inflation targeting reduces the effects of inflation shocks.
Answer: C
Diff: 1 Type: MC
Skill: Recall
Objective: 17.4 Compare and contrast the advantages and disadvantages of inflation targeting

20) Which of the following is a disadvantage of inflation targeting?


A) There is simplicity and clarity of the target.
B) Inflation targeting does not rely on a stable money-inflation relationship.
C) There is a delayed signal on the achievement of the target.
D) Inflation targeting reduces the effects of inflation shocks.
Answer: C
Diff: 1 Type: MC
Skill: Recall
Objective: 17.4 Compare and contrast the advantages and disadvantages of inflation targeting

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21) Which of the following is a disadvantage of inflation targeting?
A) There is simplicity and clarity of the target.
B) Inflation targeting does not rely on a stable money-inflation relationship.
C) It imposes a rigid rule.
D) Inflation targeting reduces the effects of inflation shocks.
Answer: C
Diff: 1 Type: MC
Skill: Recall
Objective: 17.4 Compare and contrast the advantages and disadvantages of inflation targeting

22) Which of the following is disadvantage of inflation targeting?


A) There is simplicity and clarity of the target.
B) Inflation targeting does not rely on a stable money-inflation relationship.
C) It may lead to larger output fluctuations.
D) Inflation targeting reduces the effects of inflation shocks.
Answer: C
Diff: 1 Type: MC
Skill: Recall
Objective: 17.4 Compare and contrast the advantages and disadvantages of inflation targeting

23) Inflation targeting has the potential to reduce the likelihood that the central bank will fall
into the time-inconsistency trap of trying to ________ output and employment in the short run
by pursuing overly ________ monetary policy.
A) lower; tight
B) expand; expansionary
C) lower; expansionary
D) expand; tight
Answer: B
Diff: 2 Type: MC
Skill: Recall
Objective: 17.4 Compare and contrast the advantages and disadvantages of inflation targeting

24) The decision by inflation targeters to choose inflation targets ________ zero reflects the
concern of monetary policymakers that particularly ________ inflation can have substantial
negative effects on economic growth.
A) below; high
B) below; low
C) above; high
D) above; low
Answer: D
Diff: 2 Type: MC
Skill: Recall
Objective: 17.4 Compare and contrast the advantages and disadvantages of inflation targeting

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25) What are the advantages inflation targeting?
Answer: The advantages of inflation targeting include: 1. the simplicity and clarity of a
numerical target for the inflation rate; 2. does not rely on a stable money-inflation relationship;
3. there is increased accountability of the central bank; 4. reduces the effects of inflationary
shocks.
Diff: 2 Type: ES
Skill: Recall
Objective: 17.4 Compare and contrast the advantages and disadvantages of inflation targeting

26) What are the disadvantages inflation targeting?


Answer: The disadvantages of inflation targeting include: 1. there is a delayed signal about the
achievement of the target; 2. it could lead to a rigid rule where the only focus is the inflation
rate (has not happened in practice); 3. if sole focus is the inflation rate, larger output
fluctuations can occur (has not happened in practice).
Diff: 2 Type: ES
Skill: Recall
Objective: 17.4 Compare and contrast the advantages and disadvantages of inflation targeting

17.5 Lessons for Monetary Policy Strategy from the Global Financial Crisis

1) Did the financial crisis reveal that developments in the financial sector were less important
than previously thought?
Answer: No. Financial developments had very significant impacts on the economy and that
financial frictions could have a major disruptive impact on the economies of many countries.
Diff: 2 Type: ES
Skill: Recall
Objective: 17.5 List the four lessons learned from the global financial crisis, and discuss what
they mean for inflation targeting

2) Why is the zero lower bound on interest rates a serious problem?


Answer: The other nonconventional monetary policy tools are complicated and unpredictable.
Diff: 2 Type: ES
Skill: Recall
Objective: 17.5 List the four lessons learned from the global financial crisis, and discuss what
they mean for inflation targeting

3) What are some of the costs of cleaning up after a financial crisis?


Answer: High and persistent unemployment, increased government debt and increased
likelyhood of defaults on government debt.
Diff: 2 Type: ES
Skill: Recall
Objective: 17.5 List the four lessons learned from the global financial crisis, and discuss what
they mean for inflation targeting

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4) Did the Great Moderation protect economies from financial instability.
Answer: No, The apparent stability of the economy obscured the fact that financial
developments could create new problems for the economy.
Diff: 2 Type: ES
Skill: Applied
Objective: 17.5 List the four lessons learned from the global financial crisis, and discuss what
they mean for inflation targeting

17.6 Should Central Banks Try to Stop Asset-Price Bubbles

1) The two types of asset-price bubbles are ________ and ________ bubbles.
A) credit-driven; debt driven
B) rational; optimistic
C) irrational exuberance; optimistic
D) credit-driven; irrational exuberance
Answer: D
Diff: 1 Type: MC
Skill: Recall
Objective: 17.6 Summarize the arguments for and against central bank policy responses to asset-
price bubbles

2) Define the two types of asset-price bubbles and explain why one of these is more is more
problematic for the economy.
Answer: The two types of asset-price bubbles are credit-driven bubbles and those driven by
irrational exuberance. Credit-driven bubbles occur when, as a result of overly easy monetary
policy, credit becomes relatively available at low interest rates. This fuels the demand for
different classes of assets causing their prices to rise, creating the expectation of further price
rises and yet further increases in demand. When these bubbles end, the falling asset prices
cause widespread financial problems leading to possibly a financial crisis. Bubbles driven by
irrational exuberance are fueled by overly optimistic expectations. The bursting of these
bubbles cause losses to speculators but not a a widespread financial crisis.
Diff: 2 Type: ES
Skill: Applied
Objective: 17.6 Summarize the arguments for and against central bank policy responses to asset-
price bubbles

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3) Give five reasons why central banks should not try to prick an asset-price bubble.
Answer: The answer should include (1) a discussion of how difficult it is to identify asset-price
bubbles, (2) the recognition that rising interest rates may reinforce the expectations of rising
prices, (3) the possibility that raising interest rates to deal with one particular asset-price bubble
might adversely affect the values of other assets, (4) the recognition that the attempts to prick
an asset-price bubble might have detrimental effects on the overall economy , and (5) the
possibility of an aggressive response by monetary authorities to offset the repercussions of the
bursting of an asset-price bubble.
Diff: 3 Type: ES
Skill: Recall
Objective: 17.6 Summarize the arguments for and against central bank policy responses to asset-
price bubbles

4) What are credit booms and why might a policy of leaning against a credit boom be preferred
to leaning against asset-price bubbles?
Answer: Credit booms occur when it becomes much easier for investors to borrow because of
lower interest costs and laxer credit standards and consequently greater risk taking by investors.
Policies designed to insure that credit standards do not become laxer will do a better job of
dealing with credit-driven bubbles which are more damaging to the economy.
Diff: 3 Type: ES
Skill: Applied
Objective: 17.6 Summarize the arguments for and against central bank policy responses to asset-
price bubbles

5) Why might a policy of low interest rates encourage excessive risk taking?
Answer: When yields on safe investments become very low and real returns are extremely low,
investors are induced to seek higher returns and are therefore subject to higher risk levels.
Diff: 2 Type: ES
Skill: Recall
Objective: 17.6 Summarize the arguments for and against central bank policy responses to asset-
price bubbles

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17.7 Tactics: Choosing the Policy Instrument

1) Which of the following is not an operating instrument?


A) Nonborrowed reserves
B) Monetary base
C) Overnight interest rate
D) Bank rate
Answer: D
Diff: 1 Type: MC
Skill: Recall
Objective: 17.7 Describe and assess the four criteria for choosing a policy instrument

2) Which of the following is a potential operating instrument for the central bank?
A) The monetary base
B) The M1 money supply
C) GDP
D) The Bank rate
Answer: A
Diff: 1 Type: MC
Skill: Recall
Objective: 17.7 Describe and assess the four criteria for choosing a policy instrument

3) Which of the following is not an operating instrument?


A) Nonborrowed reserves
B) Monetary base
C) Overnight funds interest rate
D) Bank rate
Answer: D
Diff: 1 Type: MC
Skill: Recall
Objective: 17.7 Describe and assess the four criteria for choosing a policy instrument

4) Which of the following is a potential operating instrument for the central bank?
A) The monetary base
B) The exchange rate
C) The inflation rate
D) The bank rate
Answer: A
Diff: 1 Type: MC
Skill: Recall
Objective: 17.7 Describe and assess the four criteria for choosing a policy instrument

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5) Which of the following is a potential operating instrument for the central bank?
A) Nonborrowed reserves
B) The overnight funds rate
C) The monetary base
D) Each of the above
Answer: D
Diff: 1 Type: MC
Skill: Recall
Objective: 17.7 Describe and assess the four criteria for choosing a policy instrument

6) A potential policy instrument for the Bank of Canada is ________.


A) the monetary base
B) borrowed reserves
C) the overnight funds rate
D) the nonborrowed monetary base
E) All of the above
Answer: E
Diff: 1 Type: MC
Skill: Recall
Objective: 17.7 Describe and assess the four criteria for choosing a policy instrument

7) Due to the lack of timely data for the price level and economic growth, the Bank of Canada's
strategy ________.
A) targets the exchange rate, since the Bank of Canada can control this variable
B) targets the price of gold, since it is closely related to economic activity
C) uses an intermediate target, such as an interest rate
D) stabilizes the consumer price index, since the Bank of Canada can control the CPI
Answer: C
Diff: 1 Type: MC
Skill: Recall
Objective: 17.7 Describe and assess the four criteria for choosing a policy instrument

8) If the central bank targets a monetary aggregate, it is likely to lose control over the interest
rate because ________.
A) of fluctuations in the demand for reserves
B) of fluctuations in the consumption function
C) bond values will tend to remain stable
D) of fluctuations in the business cycle
Answer: A
Diff: 2 Type: MC
Skill: Recall
Objective: 17.7 Describe and assess the four criteria for choosing a policy instrument

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9) Fluctuations in the demand for reserves cause the Bank of Canada to lose control over a
monetary aggregate if the Bank of Canada targets ________.
A) a monetary aggregate
B) the monetary base
C) an interest rate
D) nominal GDP
Answer: C
Diff: 2 Type: MC
Skill: Recall
Objective: 17.7 Describe and assess the four criteria for choosing a policy instrument

10) Interest rates are difficult to measure because ________.


A) data on them are not available in a timely manner
B) real interest rates depend on the hard-to-determine expected inflation rate
C) they fluctuate too often to be accurate
D) they cannot be controlled by the Bank of Canada
Answer: B
Diff: 1 Type: MC
Skill: Recall
Objective: 17.7 Describe and assess the four criteria for choosing a policy instrument

11) Which of the following criteria need not be satisfied for choosing an intermediate target?
A) The variable must be measurable.
B) The variable must be controllable.
C) The variable must be predictable.
D) The variable must be stable.
Answer: D
Diff: 1 Type: MC
Skill: Recall
Objective: 17.7 Describe and assess the four criteria for choosing a policy instrument

12) Which of the following is not a requirement in selecting an intermediate target?


A) Measurability
B) Controllability
C) Flexibility
D) Predictability
Answer: C
Diff: 1 Type: MC
Skill: Recall
Objective: 17.7 Describe and assess the four criteria for choosing a policy instrument

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13) When it comes to choosing an policy instrument, both the ________ rate and ________
aggregates are measured accurately and are available daily with almost no delay.
A) three-month T-bill; monetary
B) three-month T-bill; reserve
C) overnight rate; monetary
D) overnight rate; reserve
Answer: D
Diff: 1 Type: MC
Skill: Recall
Objective: 17.7 Describe and assess the four criteria for choosing a policy instrument

14) Which of the following best explains why the Bank of Canada does not use nominal GDP
as an intermediate target?
A) Nominal GDP has little connection with Bank policy goals.
B) Nominal GDP is unaffected by open market operations.
C) The Bank has little direct control over nominal GDP.
D) None of the above.
Answer: C
Diff: 2 Type: MC
Skill: Applied
Objective: 17.7 Describe and assess the four criteria for choosing a policy instrument

15) Which of the following criteria must be satisfied when selecting an intermediate target?
A) The variable must be measurable and frequently available.
B) The variable must be controllable with the use of the central bank's policy tools.
C) The variable must have a predictable impact on the policy goal.
D) Each of the above.
Answer: D
Diff: 2 Type: MC
Skill: Recall
Objective: 17.7 Describe and assess the four criteria for choosing a policy instrument

16) If the desired intermediate target is an interest rate, then the preferred policy instrument will
be a(n) ________ variable like the ________.
A) interest rate; three-month T-bill rate
B) interest rate; overnight rate
C) monetary aggregate; monetary base
D) monetary aggregate; nonborrowed base
Answer: B
Diff: 1 Type: MC
Skill: Recall
Objective: 17.7 Describe and assess the four criteria for choosing a policy instrument

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17) Explain and demonstrate graphically how targeting nonborrowed reserves can result in
overnight rate instability.
Answer: When nonborrowed reserves are held constant, increases in the demand for reserves
result in the overnight rate increasing and decreases in the demand for nonborrowed reserves
result in the overnight rate declining. Since fluctuations in demand do not cause monetary
policy actions, the result is the overnight rate will fluctuate. See Figure 18-3 in the textbook.
Diff: 3 Type: ES
Skill: Recall
Objective: 17.7 Describe and assess the four criteria for choosing a policy instrument

18) Explain and demonstrate graphically how targeting the overnight rate can result in
fluctuations in nonborrowed reserves.
Answer: With a overnight rate target, fluctuations in demand for reserves require similar
changes in the nonborrowed reserves to keep the overnight rate constant. See Figure 18-4 in the
textbook.
Diff: 3 Type: ES
Skill: Recall
Objective: 17.7 Describe and assess the four criteria for choosing a policy instrument

19) What criteria apply when choosing a policy instrument?


Answer: Three criteria apply when choosing a policy instrument: The instrument must be
observable and measurable, it must be controllable by the central bank, and it
must have a predictable effect on the goals.
Diff: 3 Type: ES
Skill: Recall
Objective: 17.7 Describe and assess the four criteria for choosing a policy instrument

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17.8 Tactics: The Taylor Rule

1) According to the Taylor rule, the Bank of Canada should raise the overnight interest rate
when inflation ________ the Bank of Canada's inflation target or when real GDP ________ the
Bank of Canada's output target.
A) rises above; drops below
B) drops below; drops below
C) rises above; rises above
D) drops below; rises above
Answer: C
Diff: 2 Type: MC
Skill: Recall
Objective: 17.8 Interpret and assess the performance of the Taylor rule as a hypothetical policy
instrument for setting the federal funds rate

2) According to the Taylor rule, the overnight interest rate should be set at ________.
A) + ior - 0.5( - ) - 0.5(y - y)
B) + ior + 0.5( - ) + 0.5(y - y)
C) r +
D) r -
Answer: B
Diff: 1 Type: MC
Skill: Recall
Objective: 17.8 Interpret and assess the performance of the Taylor rule as a hypothetical policy
instrument for setting the federal funds rate

3) According to the Taylor rule, the overnight interest rate should be set at ________.
A) + ior - 0.5( - ) - 0.5(y - y)
B) - ior - 0.5( - ) - 0.5(y - y)
C) r +
D) r -
E) none of the above
Answer: E
Diff: 1 Type: MC
Skill: Recall
Objective: 17.8 Interpret and assess the performance of the Taylor rule as a hypothetical policy
instrument for setting the federal funds rate

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4) Using Taylor's rule, when the equilibrium real overnight rate is 3 percent, the positive output
gap is 2 percent, the target inflation rate is 1 percent, and the actual inflation rate is 2 percent,
the nominal overnight rate target should be ________.
A) 5 percent
B) 5.5 percent
C) 6 percent
D) 6.5 percent
Answer: D
Diff: 1 Type: MC
Skill: Applied
Objective: 17.8 Interpret and assess the performance of the Taylor rule as a hypothetical policy
instrument for setting the federal funds rate

5) Using Taylor's rule, when the equilibrium real overnight rate is 2 percent, there is no output
gap, the actual inflation rate is zero, and the target inflation rate is 2 percent, the nominal
overnight rate should be ________.
A) 0 percent
B) 1 percent
C) 2 percent
D) 3 percent
Answer: B
Diff: 1 Type: MC
Skill: Applied
Objective: 17.8 Interpret and assess the performance of the Taylor rule as a hypothetical policy
instrument for setting the federal funds rate

6) According to the Taylor Principle, when the inflation rate rises, the nominal interest rate
should be ________ by ________ than the inflation rate increase.
A) increased; more
B) increased; less
C) decreased; more
D) decreased; less
Answer: A
Diff: 1 Type: MC
Skill: Recall
Objective: 17.8 Interpret and assess the performance of the Taylor rule as a hypothetical policy
instrument for setting the federal funds rate

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Copyright 2017 Pearson Canada, Inc.
7) If the Taylor Principle is not followed and nominal interest rates are increased by less than
the increase in the inflation rate, then real interest rates will ________ and monetary policy will
be too ________.
A) rise; tight
B) rise; loose
C) fall; tight
D) fall; loose
Answer: D
Diff: 3 Type: MC
Skill: Applied
Objective: 17.8 Interpret and assess the performance of the Taylor rule as a hypothetical policy
instrument for setting the federal funds rate

8) The rate of inflation tends to remain constant when ________.


A) the unemployment rate is above the NAIRU
B) the unemployment rate equals the NAIRU
C) the unemployment rate is below the NAIRU
D) the unemployment rate increases faster than the NAIRU increases
Answer: B
Diff: 1 Type: MC
Skill: Recall
Objective: 17.8 Interpret and assess the performance of the Taylor rule as a hypothetical policy
instrument for setting the federal funds rate

9) The rate of inflation increases when ________.


A) the unemployment rate equals the NAIRU
B) the unemployment rate exceeds the NAIRU
C) the unemployment rate is less than the NAIRU
D) the unemployment rate increases faster than the NAIRU increases
Answer: C
Diff: 1 Type: MC
Skill: Recall
Objective: 17.8 Interpret and assess the performance of the Taylor rule as a hypothetical policy
instrument for setting the federal funds rate

21
Copyright 2017 Pearson Canada, Inc.
10) Explain the Taylor rule, including the formula for setting the overnight rate target, and the
components of the formula. If the Bank of Canada were to use this rule, how many goals would
it use to set monetary policy?
Answer: The Taylor rule specifies that the target overnight rate should be set to equal the
equilibrium real overnight rate, plus the rate of inflation (for the Fisher effect), plus one-half
times the output gap, plus one-half times the inflation gap. The formula is
overnight rate target = equilibrium real overnight rate + inflation rate + (output gap) +

(inflation gap)
The output gap is the percentage deviation of real GDP from potential full-employment real
GDP. The inflation gap is the difference between actual inflation and the central bank's target
rate of inflation. The equilibrium real overnight rate is the real rate consistent with full
employment in the long run. The inflation rate is the actual rate of inflation. The Taylor rule
sets the overnight rate recognizing the goals of low inflation and full employment (or
equilibrium long-run economic growth).
Diff: 3 Type: ES
Skill: Recall
Objective: 17.8 Interpret and assess the performance of the Taylor rule as a hypothetical policy
instrument for setting the federal funds rate

17.9 Web Appendix 1: Monetary Targeting

1) Under monetary targeting, a central bank announces an annual growth rate target for
________.
A) a monetary aggregate
B) a reserve aggregate
C) the monetary base
D) GDP
Answer: A
Diff: 1 Type: MC
Skill: Recall
Objective: Appendix: Monetary targeting

2) During the years 1979 to 1982, the Federal Reserve's announced policy was monetary
targeting. During this time period the Federal Reserve ________.
A) hit all of their monetary targets
B) did not hit any of their monetary targets because it is believed that controlling the money
supply was not the intent of the Federal Reserve
C) did not hit any of their monetary targets because they were unrealistic
D) hit about half of their monetary targets
Answer: B
Diff: 2 Type: MC
Skill: Applied
Objective: Appendix: Monetary targeting

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Copyright 2017 Pearson Canada, Inc.
3) In July 1993, Board of Governors Chairman Alan Greenspan testified in Congress that the
Fed would no longer use what as a guide for conducting monetary policy?
A) The inflation rate
B) Monetary aggregates
C) Implicit nominal anchors
D) The federal funds rate
Answer: B
Diff: 1 Type: MC
Skill: Applied
Objective: Appendix: Monetary targeting

4) Compared to the United States, Japan's experience with monetary targeting performed
________.
A) better with regard to the inflation rate and output fluctuations
B) worse with regard to the inflation rate and output fluctuations
C) better with regard to the inflation rate, but worse with regard to output fluctuations
D) worse with regard to the inflation rate, but better with regard to output fluctuations
Answer: A
Diff: 1 Type: MC
Skill: Applied
Objective: Appendix: Monetary targeting

5) What does the Bank of Japan use as its daily operating target to conduct monetary policy?
A) Monetary aggregates
B) Non borrowed reserves
C) The inter-bank market interest rate
D) Reserve aggregates
Answer: C
Diff: 1 Type: MC
Skill: Applied
Objective: Appendix: Monetary targeting

6) Since 1978, the Bank of Japan has used an interest rate as its daily operating target
________.
A) providing additional evidence that interest rate smoothing is inconsistent with reducing
inflation
B) because money growth in Japan is very volatile
C) with very good success, suggesting that an interest rate operating target is not necessarily a
barrier to successful monetary policy
D) A and C only.
Answer: C
Diff: 2 Type: MC
Skill: Applied
Objective: Appendix: Monetary targeting

23
Copyright 2017 Pearson Canada, Inc.
7) One of the factors that contributed to the success German policymakers had using a
monetary targeting type policy was that ________.
A) they used a rigid target for the money growth rate
B) they implemented policy so their inflation rate goal was met in the short run
C) the money target was flexible to allow the Bundesbank to concentrate on other goals as
needed
D) they rarely communicated the intentions of policy to the public in order to keep the public
from panicking
Answer: C
Diff: 2 Type: MC
Skill: Applied
Objective: Appendix: Monetary targeting

8) Which of the following is the best description of the monetary policy strategy followed by
the European Central Bank (ECB)?
A) The ECB follows monetary targeting.
B) The ECB follows inflation targeting.
C) The ECB has a hybrid strategy with elements of both monetary targeting and inflation
targeting.
D) The ECB has a Fed-like "just do it" approach.
Answer: C
Diff: 1 Type: MC
Skill: Applied
Objective: Appendix: Monetary targeting

9) Which of the following is an advantage to monetary targeting?


A) There is an immediate signal on the achievement of the target.
B) It does not rely on a stable money-inflation relationship.
C) It implies lack of transparency.
D) It implies smaller output fluctuations.
Answer: A
Diff: 1 Type: MC
Skill: Recall
Objective: Appendix: Monetary targeting

10) Which of the following is an advantage to monetary targeting?


A) There is almost immediate accountability.
B) It does not rely on a stable money-inflation relationship.
C) It implies lack of transparency.
D) It implies smaller output fluctuations.
Answer: A
Diff: 1 Type: MC
Skill: Recall
Objective: Appendix: Monetary targeting

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Copyright 2017 Pearson Canada, Inc.
11) Which of the following is a disadvantage to monetary targeting?
A) It relies on a stable money-inflation relationship.
B) There is a delayed signal about the achievement of a target.
C) It implies larger output fluctuations.
D) It implies a lack of transparency.
Answer: A
Diff: 1 Type: MC
Skill: Recall
Objective: Appendix: Monetary targeting

12) Which of the following is a NOT an advantage to monetary targeting?


A) It relies on a stable money-inflation relationship.
B) There is a delayed signal about the achievement of a target.
C) It implies larger output fluctuations.
D) It implies a lack of transparency.
Answer: A
Diff: 1 Type: MC
Skill: Recall
Objective: Appendix: Monetary targeting

13) If the relationship between the monetary aggregate and the goal variable is weak, then
________.
A) monetary aggregate targeting is superior to exchange-rate targeting
B) monetary aggregate targeting is superior to inflation targeting
C) inflation targeting is superior to exchange-rate targeting
D) monetary aggregate targeting will not work
Answer: D
Diff: 2 Type: MC
Skill: Recall
Objective: Appendix: Monetary targeting

14) Why has the ECB seemed to have decided to try to "have its cake and eat it, too"?
Answer: The ECB's strategy is somewhat unclear and has been subject to criticism. Although
the "below, but close to, 2 percent" goal for inflation sounds like an inflation target, the ECB
has repeatedly stated that it does not have an inflation target. By not committing too strongly to
either a monetary-targeting strategy or an inflation-targeting strategy the ECB seems to have
decided to try to "have its cake and eat it, too." The resulting difficulty of assessing the ECB's
strategy has the potential to reduce the accountability of the institution.
Diff: 2 Type: ES
Skill: Applied
Objective: Appendix: Monetary targeting

25
Copyright 2017 Pearson Canada, Inc.
15) What are the advantages of monetary targeting?
Answer: One advantage of monetary targeting is that information on whether the central bank
is achieving its target is known almost immediatelyfigures for monetary aggregates are
typically reported within a couple of weeks. Thus monetary targets can send almost immediate
signals to the public and markets about the stance of monetary policy and the intentions of the
policymakers to keep inflation in check. In turn, these signals help fix inflation expectations
and produce less inflation. Monetary targets also allow almost immediate accountability for
monetary policy to keep inflation low, thus helping to constrain the monetary policymaker from
falling into the time-inconsistency trap.
Diff: 2 Type: ES
Skill: Recall
Objective: Appendix: Monetary targeting

17.10 Wed Appendix 2: A Brief History of Bank of Canada Policymaking

1) During the 1960s and early 1970s, the Bank of Canada used ________ as the intermediate
target in the conduct of monetary policy.
A) the interest rate
B) the exchange rate
C) the monetary base
D) None of the above
Answer: A
Diff: 1 Type: MC
Skill: Applied
Objective: Appendix: Outline Bank of Canada policy procedures from a historical perspective

2) During the 1960s and early 1970s, the Bank of Canada used ________ as the intermediate
target(s), to keep the foreign exchange and domestic bonds markets functioning smoothly.
A) the exchange rate and the interest rate
B) the interest rate
C) the monetary base
D) None of the above
Answer: B
Diff: 1 Type: MC
Skill: Applied
Objective: Appendix: Outline Bank of Canada policy procedures from a historical perspective

3) During the 1960s and early 1970s, the Bank of Canada's policy of using interest rates at the
intermediate target was ________.
A) expansionary and resulted in double digit inflation
B) contractionary and resulted in a decrease in the inflation rate
C) neither expansionary nor contractionary
D) None of the above
Answer: A
Diff: 1 Type: MC
Skill: Applied
Objective: Appendix: Outline Bank of Canada policy procedures from a historical perspective
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Copyright 2017 Pearson Canada, Inc.
4) In the 1975-1981 period, the Bank of Canada selected an interest rate as an operating target
than a reserve aggregate primarily because it ________.
A) had no interest in targeting a monetary aggregate, as evidenced by its unwillingness to target
a reserve aggregate
B) was still very concerned with interest rate stability
C) was committed to the real bills doctrine
D) was committed to keeping the foreign exchange and domestic bonds markets functioning
smoothly
E) None of the above
Answer: E
Diff: 1 Type: MC
Skill: Applied
Objective: Appendix: Outline Bank of Canada policy procedures from a historical perspective

5) In the 1975-1981 period, the Bank of Canada selected a monetary aggregate as an


intermediate target than an interest rate primarily because it ________.
A) was concerned about inflation
B) was still very concerned with achieving interest rate stability
C) was committed to the real bills doctrine
D) was committed to keeping the foreign exchange and domestic bonds markets functioning
smoothly
Answer: A
Diff: 1 Type: MC
Skill: Applied
Objective: Appendix: Outline Bank of Canada policy procedures from a historical perspective

6) In the 1975-1981 period, the Bank of Canada used ________ as the intermediate target of
monetary policy.
A) the growth rate of M1
B) the growth rate of M2
C) the interest rate
D) the exchange rate
Answer: A
Diff: 1 Type: MC
Skill: Applied
Objective: Appendix: Outline Bank of Canada policy procedures from a historical perspective

7) In the 1975-1981 period, the Bank of Canada used ________ as the operating target and
________ as the intermediate target of monetary policy.
A) an interest rate; a monetary aggregate
B) a monetary aggregate; an interest rate
C) the monetary base; a monetary aggregate
D) a monetary aggregate; inflation
Answer: A
Diff: 1 Type: MC
Skill: Applied
Objective: Appendix: Outline Bank of Canada policy procedures from a historical perspective
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Copyright 2017 Pearson Canada, Inc.
8) During the 1975-1981 period, the Bank of Canada decided to target the growth rate of M1
because it ________.
A) was the most prominent measure of money
B) had a stable demand
C) had a predictable relationship with income and prices
D) All of the above.
Answer: D
Diff: 1 Type: MC
Skill: Applied
Objective: Appendix: Outline Bank of Canada policy procedures from a historical perspective

9) During the 1975-1981 period, although the Bank of Canada was successful in keeping actual
M1 growth within the target range, ________.
A) the inflation rate by the end of the 1970s was almost at the same level as when monetary
gradualism was introduced in 1975
B) the inflation rate remained high
C) the demand for M1 became unstable
D) All of the above.
Answer: D
Diff: 1 Type: MC
Skill: Applied
Objective: Appendix: Outline Bank of Canada policy procedures from a historical perspective

10) During the 1975-1981 period, although the Bank of Canada was successful in keeping
actual M1 growth within the target range, ________.
A) the inflation rate by the end of the 1970s was almost at the same level as when monetary
gradualism was introduced in 1975
B) a series of financial innovations motivated individuals and firms to substitute out of M1 and
into M2
C) the growth rate of M2 increased
D) All of the above.
Answer: D
Diff: 1 Type: MC
Skill: Applied
Objective: Appendix: Outline Bank of Canada policy procedures from a historical perspective

11) When interest rates in the United States increased sharply in late 1979, the Bank of Canada
responded by an extremely restrictive monetary policy to ________.
A) resist depreciation of the Canadian dollar
B) resist the possible inflationary shock from import prices
C) A and B only.
D) None of the above.
Answer: C
Diff: 1 Type: MC
Skill: Applied
Objective: Appendix: Outline Bank of Canada policy procedures from a historical perspective

28
Copyright 2017 Pearson Canada, Inc.
12) The Bank of Canada formally abandoned monetary targeting ________.
A) in November 1982
B) because of the uncertainty about the stability of M1
C) because of the uncertainty about monetary aggregates as reliable guides to monetary policy
D) All of the above.
Answer: D
Diff: 1 Type: MC
Skill: Applied
Objective: Appendix: Outline Bank of Canada policy procedures from a historical perspective

13) During the 1982-1988 period, the Bank of Canada looked at a list of factors in order to
design and implement monetary policy. This list included ________.
A) the interest rate
B) the exchange rate
C) the money supply
D) All of the above.
E) A and B only.
Answer: D
Diff: 1 Type: MC
Skill: Applied
Objective: Appendix: Outline Bank of Canada policy procedures from a historical perspective

14) During the 1982-1988 period, the Bank of Canada ________.


A) looked at a list of factors in order to design and implement monetary policy
B) switched its focus to a range of broad monetary aggregates, but no aggregate was found
suitable as a guide for conducting monetary policy
C) A and B only.
D) None of the above.
Answer: A
Diff: 1 Type: MC
Skill: Applied
Objective: Appendix: Outline Bank of Canada policy procedures from a historical perspective

15) During the 1982-1988 period, the Bank of Canada used ________ as the operating target
and ________ as the intermediate target.
A) the interest rate; the exchange rate
B) the monetary base; the interest rate
C) the short-term interest rate; the long-term interest rate
D) the interest rate; the money supply
Answer: A
Diff: 1 Type: MC
Skill: Applied
Objective: Appendix: Outline Bank of Canada policy procedures from a historical perspective

29
Copyright 2017 Pearson Canada, Inc.
16) The Bank of Canada's anti-inflation policy during the 1982-1988 period can be viewed as
one where ________ became the operating target and ________ was the intermediate target.
A) the interest rate; the inflation rate
B) the interest rate; the exchange rate
C) the monetary base; the inflation rate
D) the monetary base; the exchange rate
Answer: B
Diff: 1 Type: MC
Skill: Applied
Objective: Appendix: Outline Bank of Canada policy procedures from a historical perspective

17) The Bank of Canada adopted inflation targets ________.


A) because the 1982-1988 checklist approach to policy made it difficult for the Bank to control
money growth and inflation
B) following a three-year campaign to promote price stability as the long-term goal of
monetary policy
C) by announcing explicit targets for the inflation rate, rather than for money growth
D) All of the above.
Answer: D
Diff: 1 Type: MC
Skill: Applied
Objective: Appendix: Outline Bank of Canada policy procedures from a historical perspective

18) Since 1989, the Bank of Canada used ________ as the operating target and ________ as the
ultimate goal of monetary policy.
A) the overnight interest rate; the exchange rate
B) the overnight interest rate; the inflation rate
C) the monetary base; the inflation rate
D) None of the above.
Answer: B
Diff: 1 Type: MC
Skill: Applied
Objective: Appendix: Outline Bank of Canada policy procedures from a historical perspective

19) In its most recent attempt in lowering the inflation rate, the Bank of Canada announces
explicit targets for the rate of change in the CPI, because the CPI ________.
A) is the most commonly used and understood price measure in Canada
B) comes out monthly and without revisions, whereas other price measures are frequently
revised
C) A and B only.
D) None of the above.
Answer: C
Diff: 1 Type: MC
Skill: Recall
Objective: Appendix: Outline Bank of Canada policy procedures from a historical perspective

30
Copyright 2017 Pearson Canada, Inc.
20) The midpoint of the Bank of Canada's inflation target range is ________.
A) 3 percent
B) 2 percent
C) 1 percent
D) None of the above.
Answer: B
Diff: 1 Type: MC
Skill: Applied
Objective: Appendix: Outline Bank of Canada policy procedures from a historical perspective

21) In its most recent attempt in lowering the inflation rate, the Bank of Canada announces
explicit targets for the rate of change in "core CPI," because ________.
A) core CPI excludes volatile components, such as food, energy, and the effect of indirect taxes
B) core inflation is useful in assessing whether trend inflation is on track for the medium term
C) A and B only.
D) None of the above.
Answer: C
Diff: 1 Type: MC
Skill: Recall
Objective: Appendix: Outline Bank of Canada policy procedures from a historical perspective

22) Bank of Canada policy since 1989 suggests ________.


A) that it is finally using a monetary aggregate as its intermediate target
B) that it is less concerned with fluctuations in the overnight interest rate
C) that it is more concerned with exchange rates than with interest rates
D) None of the above.
Answer: D
Diff: 1 Type: MC
Skill: Recall
Objective: Appendix: Outline Bank of Canada policy procedures from a historical perspective

23) The Bank of Canada can engage in preemptive strikes against a rise in inflation by
________ the overnight rate; it can act preemptively against negative demand shocks by
________ the overnight rate.
A) raising; lowering
B) raising; raising
C) lowering; lowering
D) lowering; raising
Answer: A
Diff: 1 Type: MC
Skill: Recall
Objective: Appendix: Outline Bank of Canada policy procedures from a historical perspective

31
Copyright 2017 Pearson Canada, Inc.
24) International policy coordination refers to ________.
A) central banks in major nations acting without regard to the global consequences of their
policies
B) central banks in major nations pursuing only domestic objectives
C) central banks adopting policies in pursuit of joint objectives
D) central banks all adopting identical policies
Answer: C
Diff: 1 Type: MC
Skill: Recall
Objective: Appendix: Outline Bank of Canada policy procedures from a historical perspective

32
Copyright 2017 Pearson Canada, Inc.