The Arab Academy for Science, Technology and Maritime Transport

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SHEET 6 Money and Inflation

Part 1: True / False Questions 1. Inflation is a one-time rise in the price level. 2. Economists who accept the quantity theory of money argue that inflation is always and everywhere a monetary phenomenon. 3. Economists who accept the quantity theory of money favor a monetary rule because they believe the long-run effects are on the price level, not real output. 4. To deal with stagflation, economists who favor the institutionalist theory of inflation are likely to support an income policy rather than contractionary monetary or fiscal policies. 5. Economists generally agree that when current output is well above potential output there will be significant deflationary pressures. 6. When a bank creates loans, it also creates money. 7. If the reserve ratio is 0.10, the simple money multiplier is equal to 5. 8. Holding money for the speculative motive is holding cash for unexpected events.

Money and Inflation

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Part 2: Multiple Choice Questions 1. Inflation occurs when the price level A. rises and then falls. B. changes. C. increases one year only. D. increases continuously. 2. In the late 1990s and early 2000s Hong Kong experienced deflation. This deflation is: A. a fall in overall prices in Hong Kong. B. the same thing as a devaluation of the Hong Kong dollar. C. the same thing as a depreciation of the Hong Kong dollar. D. a change in the price structure in Hong Kong. 3. Deflation is most likely to produce a situation in which nominal interest rates: A. equal real interest rates. B. are less than real interest rates. C. are greater than real interest rates. D. cease to exist. 4. Deflation is a problem for all of the following reasons except it: A. is often associated with large falls in asset prices. B. may prevent a central bank from lowering the real interest rate as much as it would like. C. can undermine a country's financial system. D. can lead to excessive increases in aggregate demand. 5. The equation of exchange is expressed as: A. MR = PQ. B. MV = PQ. C. MPP = P. D. MR = MC.

Money and Inflation

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Money and Banking Course

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6. According to the quantity theory of money, if the money supply increases by 12 percent, then in the long run prices go: A. down by 12 percent. B. up by less than 12 percent. C. up by 12 percent. D. up by more than 12 percent. 7. In 2008, nominal GDP in the U.S. was about $14 trillion while the money supply (M2) was about $7 trillion. Given this information, the velocity of money in the U.S. in 2008 was: A. 2. B. 7. C. 14. D. 28. 8. Annual inflation in Zimbabwe was 32 percent in 1998, 383 percent in 2003, and increased to more than 100,000 percent in 2009. What would a classical economist who sees great merit in the quantity theory of money look for in trying to explain this rise in inflation? A. A poor distribution of income. B. A very low rate of unemployment. C. A rapid increase in the quantity of money in circulation. D. Very low interest rates. 9. The velocity of money is: A. the average number of months a dollar is held before being spent. B. the average number of times each dollar is spent each year. C. constant. D. inversely related to output. 10. Velocity can be calculated as the ratio of: A. nominal GDP to real GNP. B. nominal GDP to the money supply. C. real GDP to the price level. D. the money supply to the price level.

Money and Inflation

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11. Between 2008 and 2009, the U.S. money supply increased from $7.6 trillion to $8.3 trillion. If there was zero real economic growth, and velocity stayed constant, then according to the quantity theory of money, the U.S. inflation rate during this period would be: A. 3 percent. B. 6 percent. C. 9 percent. D. 12 percent. 12. If the money supply is 500 and velocity is 6, then nominal GDP: A. is 83.33. B. is 500. C. is 3000. D. cannot be determined. 13. Suppose that real output is fixed and equal to 400 while velocity is fixed and equal to 5. Then, if the money supply is equal to 200, the price level will be: A. 2.5. B. 5. C. 7.5. D. 10. 14. In the equation of exchange, if the velocity of money is constant, a 10 percent increase in the money supply must: A. increase the price level by 10 percent. B. result in a higher level of unemployment. C. increase real GDP by 10 percent. D. increase nominal GDP by 10 percent. 15. Economists who believe in the quantity theory of money argue that: A. the causation in the equation of exchange goes from PQ to MV. B. the causation in the equation of exchange goes from MV to PQ. C. the causation in the equation of exchange could go either way. D. there is no causation in the equation of exchange.

Money and Inflation

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Money and Banking Course

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16. Which of the following is not one of the assumptions of the quantity theory of money? A. Velocity is constant. B. The money growth rate is constant. C. Real output is independent of the money supply. D. Causation goes from money supply to prices. 17. According to the institutionalist theory of inflation, once nominal wage and price levels have risen, the two options available to government are to: A. increase the money supply and accept inflation or leave the money supply fixed and cause unemployment. B. increase the money supply and accept unemployment or leave the money supply fixed and cause inflation. C. decrease the money supply and accept inflation or increase the money supply and cause unemployment. D. increase the money supply and accept both unemployment and inflation or decrease the money supply and eliminate both. 18. According to the institutional model of inflation, the main factors causing inflation are: A. velocity and money supply. B. nominal wages and price-setting processes. C. real wages and monopolistic competition. D. the invisible hand and its social norms. 19. The central banks of developing and transitional countries: A. issue large quantities of money because they want to reduce inflation. B. issue large quantities of money because they want to cause hyperinflation. C. know that issuing large quantities of money will cause inflation. D. believe that they can issue large quantities of money without causing inflation. 20. According to the institutionalist theory of inflation: A. money supply increases are the only cause of inflation. B. money supply increases occur because government is trying to decrease aggregate demand. C. money supply increases are a consequence of the inflation process. D. there is no link between money supply and inflation.

Money and Inflation

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21. Economists who believe in the institutionalist theory of inflation argue that: A. causation in the equation of exchange goes from PQ to MV. B. causation in the equation of exchange goes from MV to PQ. C. the equation of exchange is invalid. D. there is no relationship between PQ and MV. 22. Cost-push inflation occurs when: A. output is above potential output. B. output equals potential output. C. price increases are not related to demand pressures. D. price increases are related to demand pressures. 23. Demand-pull inflation is most consistent with which of the following statements? A. Price increases lead to money supply increases. B. Price increases are the result of output being too low relative to potential. C. Money supply increases lead to excess demand and price increases. D. Higher oil prices in the early 1970s produced demand-pull inflation. 24. The short-run Phillips curve is: A. vertical. B. horizontal. C. upward sloping. D. downward sloping. 25. The short-run Phillips curve suggests that an increase in the rate of inflation will accompany: A. a decrease in the unemployment rate. B. an increase in the unemployment rate. C. an increase in expected inflation. D. a decrease in expected inflation. 26. Stagflation is the combination of: A. high and accelerating inflation and low unemployment. B. high and accelerating inflation and high unemployment. C. low and decelerating inflation and high unemployment.

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D. low and decelerating inflation and low unemployment. 27. According to advocates of the quantity theory of money, the relationship between inflation and growth is: A. downward sloping. B. upward sloping. C. vertical. D. horizontal. 28. Bank reserves are: A. real assets deposited at banks. B. cash and deposits a bank keeps on hand or at the central bank. C. loans issued by banks deposited into checking accounts. D. checks held by depositors. 29. Bank required reserves are: A. a financial asset for the Fed. B. a financial liability for the bank. C. counted as money. D. a financial liability for the Fed. 30. The actual reserve ratio: A. usually is less than the required reserve ratio. B. usually is equal to the required reserve ratio. C. usually is greater than the required reserve ratio. D. can be greater than or less than the required reserves ratio to deposits depending on the currency to deposit ratio. 31. If the reserves in U.S. banks totaled $8,000 and total deposits were $100,000, the banking system's reserve ratio would be: A. .08. B. .10. C. .80 D. .92

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32. The fraction of deposits a bank must hold in the form of reserves is called the: A. reserve ratio. B. excess reserve ratio. C. required reserve ratio. D. currency to reserve ratio. 33. Suppose total deposits in the First Bank of Commerce are $100,000 and required reserves are $10,000. Based on this information, the required reserve ratio is: A. 0.10. B. 0.9. C. 1. D. 10. 34. If the required reserve ratio is 0.12, the amount a bank can lend out is equal to: A. 12 percent of its deposits. B. 12 percent of its reserves. C. 88 percent of its deposits. D. 88 percent of its reserves. 35. A single bank has a reserve requirement of 10 percent. This means that if a customer deposits $100 million, the bank may lend out: A. $9 million. B. $10 million. C. $90 million. D. $91 million. 36. When a bank makes a loan, the money supply: A. does not increase. B. decreases. C. increases. D. may increase or decrease depending on how the loan is used.

Money and Inflation

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37. If people held all their money as cash: A. money would no longer be a financial liability of the Fed. B. money would lose its value as a store of wealth. C. banks would still be able to create money by making loans. D. banks could not create money. 38. The process of money multiplier depends on: A. the public holding all the currency. B. the banks holding all the currency. C. the Fed holding all the currency. D. foreigners holding all the currency. 39. The amount of money ultimately created per dollar deposited when people hold no cash is found using the: A. money demand ratio. B. excess reserve ratio. C. required reserve ratio. D. simple money multiplier. 40. The formula for the simple money multiplier is: A. 1/e where e is the excess reserve ratio. B. 1/r where r is the reserve ratio. C. 1/r where r is the required reserve ratio. D. 1/c where c is the ratio of cash people hold to deposits. 41. As the reserve ratio goes up, the simple money multiplier goes: A. up, and more money will be created. B. down, and less money will be created. C. up, and less money will be created. D. down, and more money will be created. 42. The higher the reserve ratio, the: A. greater the money multiplier. B. more money will be created.

Money and Inflation

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C. smaller the money multiplier. D. greater the level of required reserves. 43. If the reserve ratio is 0.25, the simple money multiplier is: A. 4. B. 5. C. 20. D. 25. 44. Suppose the money multiplier is 5. If individuals hold no cash, what is the reserve ratio? A. 0.10. B. 0.20. C. 0.25. D. 0.80. 45. If the required reserve ratio is .10 and individuals hold no cash, what is the maximum amount of money that can be created from a $2 million deposit in the banking system? A. $2 million. B. $4 million. C. $20 million. D. $200 million. 46. Excess reserves equal: A. total deposits. B. total deposits minus required reserves. C. total reserves. D. total reserves minus required reserves. 47. The amount of money ultimately created per dollar deposited when people hold cash is the: A. money multiplier. B. excess reserve ratio. C. required reserve ratio. D. simple money multiplier.

Money and Inflation

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48. The formula for the money multiplier when people hold cash is: A. (1 + c)/(r + c). B. (r + c)/(1 + c). C. (1 + c)/(1 + r). D. (r + c)/(1 + r). 49. In real-world, the money multiplier: A. is the same as the simple money multiplier. B. differs from the simple money multiplier because in the real world people hold cash. C. differs from the simple money multiplier because in the real world banks hold excess reserves. D. differs from the simple money multiplier because in the real world banks do not hold excess reserves. 50. In the real world, the currency to deposit ratio: A. is negative. B. is zero. C. is greater than 0 but less than or equal to 1. D. is greater than 1. 51. If the cash-to-deposit ratio is 0.15 and the reserve ratio is 0.05, then the amount of money created per dollar deposited in the banking system is: A. $4.25. B. $5.75. C. $7.25. D. $2.75. 52. If the ratio of currency to deposits is 20 percent and the reserve ratio is 10 percent, then a $100 addition to deposits will result in a: A. $300 addition to the money supply. B. $400 addition to the money supply. C. $500 addition to the money supply. D. $1,000 addition to the money supply.

Money and Inflation

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53. If I am worried about the price of assets such as bonds falling, I may be more inclined to hold money instead. You hold cash for the: A. transactions motive. B. precautionary motive. C. speculative motive. D. impulsive motive. 54. Some colleges charge for student parking. Currently, your college does not charge for parking but the administration announced a possible charge of $2 per day. You are not sure when the new parking policy will start; therefore you decide to maintain a $5 bill in your wallet. You hold cash for the: A. transactions motive. B. precautionary motive. C. speculative motive. D. impulsive motive.

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Money and Banking Course