12 classical monetary theory

7/30/2019 12 Classical Monetary Theory

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6B: Classical and Neoclassical Theories of Money

Business cycles tend to be relatively minor and are quickly and automatically cured so thatthe economy will return to its original full employment equilibrium according to: (a) thepopulation dynamics theory. (b) psychological theories of the business cycle. (c) JosephSchumpeters theory of creative destruction. (d) classical macroeconomic theory. (e) externalshock theory.

A graph showing a positive relationship between the interest rate and the expected inflationrate would illustrate the: (a) Cambridge equation. (b) Friedmans liquidity effect. (c) Fishereffect. (d) Laffer curve. (e) quantity theory of money.

Interest rates on given financial instruments tend to be higher the: (a) shorter the period tomaturity. (b) lower the risk of default. (c) more liquid the asset is. (d) greater is the level ofuncertainty about the real rate of interest that will be received. (e) lower is the face value atmaturity relative to the current market price.

The effect on nominal interest rates of an increase in the rate of monetary growth that is leastconsistent with the other effects is the: (a) expected inflation [Fisher] effect. (b) nominalincome effect. (c) liquidity [Keynes] effect. (d) price level effect.

1. The idea that growth of the money supply at a low fixed percentagerate annually is likely to yield greater macroeconomic stability thanwhen monetary policy is at the discretion of government officials is thefoundation for: (a) neoclassical macroeconomic theory. (b) JohnMaynard Keyness liquidity preference theory. (c) Irving Fishersnatural rate of interest. (d) Abba Lerners wage-price reaction

functions. (e) Milton Friedmans monetary growth rule.

2. According to classical economists, Aggregate Demand primarily determines: (a) levels ofnational output and income. (b) total production in the economy. (c) Aggregate Supply atfull employment. (d) the price level.

3. The income velocity of money in Irving Fishers equation of exchangeis calculated as: (a) nominal money stock/nominal GDP. (b) nominalGDP/nominal money stock. (c) real money stock/real GDP. (d)mc2.

4. The demand for money would be negatively affected by increases in:(a) income (b) expected hikes in interest rates. (c) wealth. (d)uncertainty about future income. (e) expected inflation.

5. Classical macroeconomics views the cost of holding money as: (a)current interest rates. (b) profits from economic investment. (c) goodsthat could be purchased with the money. (d) hard to determinebecause of sticky pricing. (e) the percentage rate of inflation.

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6. According to modern monetarists, short-run shocks to Aggregate Demand or AggregateSupply: (a) are ignored. (b) are assumed away. (c) have no lasting effect on inflation orunemployment. (d) require active discretionary monetary policy.

7. According to the classical macroeconomic model, the: (a) demand for nominal money

can be written as Md = kPQ, or Md = kPy. (b) price level depends primarily on velocity.(c) income velocity of money determines real output. (d) money supply determines realoutput. (e) government should run deficits to reduce unemployment.

8. According to the classical macroeconomic model: (a) output grows when the price levelrises. (b) real output is unaffected by the money supply. (c) employment depends on thevelocity of money. (d) growth of permanent income is impossible.

9. According to the Equation of Exchange: (a) MP=VQ. (b) MV=PQ. (c) price changesrequire velocity changes. (d) in the long run, we're all dead.

10. If the theory that money is neutral in the long run is correct, then: (a) exchange rates are

unaffected by the relative growths of the money supplies of different countries. (b)interest rates are the only real economic variable affected by fiscal policy. (c) moneyillusion may be more significant in the long run than in the short run. (d) changes in themoney supply result in proportional increases in the price level, but ultimately do notaffect real economic variables.

11. If the velocity of money increases and real GDP and the money supplyare constant, the price level will: (a) rise. (b) fall. (c) become morestable. (d) not be affected. (e) None of the above.

12. Between September 11, 2001 and February 2005, the M1 money

supply grew 3% to 7% faster than measured GDP, which suggests thatduring this period: (a) pessimism among consumers and investorsreduced the velocity of money. (b) the underground economy grewsubstantially. (c) the real wage rate increased faster than prices. (d)the exchange rate of the dollar declined about 30% relative to theEuro.

13. Consumers increased reliance on credit cards and the readyavailability of currency through ATMs has tended to increase the: (a)marginal propensity to consume. (b) velocity of money. (c) averagecosts of transactions. (d) pure economic profits of commercial banks.

(e) M1 money supply.

14. If aggregate output is constant while the money supply and its velocity both double, theequation of exchange predicts that the price level will: (a) double. (b) remain constant. (c)fall by 1/2. (d) quadruple (rise by a factor of 4.)

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15. If technological advances, growth of the labor force, and capital accumulation generateincreases in potential Aggregate Supply of three percent annually, then modernmonetarists would predict that a four percent annual growth rate of the money supplywould cause (a) the price level to rise by 1% annually. (b) average nominal wages to riseby seven percent annually. (c) the price level to fall by 1% annually. (d) annual increases

in the exchange rate of the dollar of 1% against most other currencies. (e) acceleratinginflation.

16. Classical economists would rebut the underconsumptionist theories of economicdownturns (expressed, e.g., by Malthus and Keynes) by stressing that all saving will beinvested because of the flexibility of: (a) interest rates. (b) wage rates. (c) relative prices. (d)nominal prices for goods. (e) monetary prices.

17. Classical economists, modern monetarists, and Keynesians would all agree that: (a)declining investment leads to lower rates of return. (b) economic activity is volatile in amarket economy. (c) equilibrium investment occurs when rates of return equal interestrates. (d) business cycles occur because of volatility in investors' moods.

18. People with surpluses of money adjust by increasing their: (a) efforts to secure higherincomes. (b) consumption or outlays for financial or capital investments. (c) demands formoney. (d) saving rates out of current income. (e) bank balances in checking accounts.

19. Stronger preferences for current consumption over future consumption would beindicated by a: (a) higher interest rate. (b) more rapid rate of investment. (c) largergovernment budget surplus. (d) surplus in the balance of trade.

20. Most modern monetarists argue that central banks should adopt rules so that each year,the: (a) federal budget would balance. (b) money supply would grow by a fixed low

percentage. (c) economy would be fine-tuned countercyclically. (d) interest rate would below to stimulate investment.

21. Milton Friedman asserts that the demand for money is strongly and positively related to:(a) wealth. (b) interest rates on bonds. (c) returns on physical capital. (d) expected rates ofinflation.

22. If the price level falls with a given money supply, real money balances will: (a) fall. (b)rise. (c) not be affected. (d) cause a reduction in national debt. (e) reduce the wealth ofmost households.

23. The early Quantity Theory of Money concluded that, in equilibrium, the price level is: (a)negatively related to the money supply. (b) independent of movements in the money supply. (c)exactly proportional to the money supply. (d) higher when the economy experiences excesscapacity. (e) positively related to the level of national output.

24. The early Quantity Theory of Money was based on assumptions that: (a) prices and realGDP were fixed. (b) real GDP and velocity were constant. (c) prices and real GDP grewas the money supply rose. (d) doubling the money supply would double real GDP.



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25. Complete Milton Friedman's famous statement, "Inflation is always and everywhere a _____phenomenon." (a) recessionary (b) discretionary (c) repressionary (d) monetary

26. The Equation of Exchange is written: (a) MQ = PV. (b) M = QVP. (c) MV = PQ. (d) VP= MQ.

27. Velocity of money is: (a) greater, the more efficient money is in reducing the transactionscosts of exchange. (b) greater, the smaller the ratio of nominal GDP to the price level. (c)lower, the greater the ratio of the transaction demand for money to nominal GDP. (d)unaffected by inflationary expectations.

28. The neutrality of money in the long run (a) prevents short run speculative bubbles. (b) is acrucial conclusion of classical economists and monetarists. (c) implies that Phillips curvesare smoothly parabolic. (d) helps explain the desirability of backing the money supply withprecious metals. (e) is logically necessary for the operation of the equation of exchangeMV=PQ.

29. The notion that market adjustments automatically cure swings in business cycles iscentral to the ideas of: (a) Malthus and his population S-curves. (b) Schumpeter longwaves. (c) Marxist cycles of exploitation. (d) modern business psychology. (e) classicaland neo-classical macroeconomic theorists.

30. Higher inflationary expectations make borrowers willing to pay the higher nominalinterest rates that lenders insist on according to the: (a) Keynes effect. (b) natural real rateof interest theory, as refined by Irving Fisher and, more recently, Milton Friedman fromearlier work by Knut Wicksell. (c) conflict theory of interest. (d) liquidity avoidancetheory. (e) Phillips curve hypothesis.

31. If persistent, huge federal budget deficits were consistently accommodated by FEDpurchases of U.S. bonds, Milton Friedman and most other monetarists would predict that,in the long run, there would be: (a) disinflation in relative prices, but higherunemployment. (b) lower interest rates and faster economic growth. (c) better jobopportunities and less stagflation. (d) increases in the price level, but not in aggregateoutput.

32. Say's Law is a cornerstone for: (a) Marxist macroeconomics. (b) Keynesian economics.(c) classical macroeconomics. (d) Schumpeterian business cycles.

33. Many Japanese workers receive about half of their annual income as year-end bonuses.Compared with the U.S. practice of paying workers monthly or weekly, the Japanesebonus system: (a) makes money more efficient in exchange. (b) raises average moneybalances held as a percentage of annual income. (c) lowers average money balances heldas a percentage of annual income. (d) decreases the use of credit.



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30 n the diagram, region a equals: (a)the demand for money. (b) thesupply of money. (c) asset balances.(d) transactions balances.

31. Region b in the diagram is equal to:

(a) precautionary balances. (b) assetbalances. (c) transactions balances.(d) precautionary plus assetbalances.

32. The classical macroeconomic model concludes that: (a) production costs determine the

price level. (b) absolute (aka nominalormonetary) prices are proportional to the moneysupply. (c) interest rate changes cause velocity changes. (d) a tradeoff between inflationand unemployment is unavoidable.

33. Classical macroeconomists contended that the only reason we hold money is to: (a) hoardwealth. (b) earn high interest income. (c) make transactions. (d) perpetuate capitalism.

34. Classical economists believed that: (a) workers react to changes in real wages with a lag.(b) involuntary unemployment is a persistent problem. (c) workers quickly react tochanges in real wages. (d) unemployment is primarily involuntary. (e) fiscal policy isrequired to combat unemployment.

35. According to the natural real rate of interest hypothesis: (a) contractionary monetarypolicies permanently reduce real interest rates. (b) the real rate of interest is thepercentage purchasing power paid by a borrower to a lender. (c) monetary growth lowersnominal interest rates in the long run. (d) the natural unemployment rate equals thenominal interest rate.

36. Many modern monetarists (most notably, Milton Friedman) believe that discretionarymonetary policies should be replaced with: (a) the equation of exchange. (b) Keynesiandiscretionary policies. (c) a monetary growth rule. (d) a zero growth rule. (e) presidentialdiscretion.

37. Milton Friedman's views are LEAST consistent with the idea that: (a)unstable Aggregate Demand can cause depression and inflation. (b)velocity is more predictably stable than the money supply. (c) themoney supply should grow at a fixed annual rate of about 2 to 5percent. (d) increases in government spending will quickly cure arecession.



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38. Milton Friedman believes it likely that an increase in the rate ofmonetary growth will cause nominal interest rates to: (a) rise becausenominal income, the price level, and expected inflation will all rise,swamping the Keynesian liquidity effect. (b) fall because inflation willreduce the willingness of financial investors to borrow. (c) rise because

foreign investors will view U.S. financial securities more favorably. (d)fall because it will be easier for the U.S. Treasury to fund any federaldeficit.

39. Monetarists would say that the primary cause of inflation is (a) the lack of fiscalresponsibility. (b) too fast a rate of increase in the money supply. (c) high interest rates,which increase the cost of borrowing. (d) unstable investment demand.

40. This graph hints that eventhough peoples incomestypically vary across their

lifetimes, most try to smooththeir rates of consumption. Aneconomist who could use thisgraph to illustrate his theory is:(a) Milton Friedman. (b) AdamSmith. (c) Frank Knight. (d)Robert Merton. (e) JohnKenneth Galbraith.

41. Most classical theorists and modern monetarists believe that the: (a)capitalist system is unstable. (b) money supply ultimately determinesAggregate Demand, but not Aggregate Supply. (c) velocity of money isunstable. (d) money supply should grow faster than money demand toprevent inflation. (e) money supply should be used to "fine tune" theeconomy.

42. Wages and prices are assumed to adjust almost instantaneously andwith equal rapidity to given equal rates of excess demand or excesssupply according to: (a) Lerner wage-price reaction functions. (b) suchmodern variants of neoclassical economic theory as the theory of

efficient markets. (c) traditional Keynesian theory of business cycles.(d) modern behavioral economics. (e) the new Keynesian theories ofbusiness cycles.



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43. Natural rate theory suggests that if policy makers continually aim for a target interest ratebelow the natural rate, maintaining the target rate would require: (a) high real interest ratesand low nominal interest rates. (b) constant or declining rates of inflation. (c) actual inflationto exceed expected inflation continuously. (d) tariff barriers to prevent competition fromcheap labor.

44. The classical demand for money was summarized in the late 19th century at EnglandsCambridge University in an equation written: (a) [G-T] = [S-I] + [M-X]. (b) V = MQ/P.(c) C=I=G=(X-M) = Y. (d) Md = kPQ, or Md =kY. (e) MV=PQ.

45. Suppose P = CPI/100. According to the Cambridge version of classical monetarytheory, the cost of holding a dollar is: (a) [$1/P], so that it is negatively related to [thereciprocal of] the price level. (b) the interest forgone by holding $1 instead of investingin capital. (c) the security sacrificed by holding $1 during an inflationary period. (d) thepurchasing power lost because of inflation.

46. The idea that natural rates of unemployment and interest would be unaffected in the long run

by the time paths of the economy if different macro policies were pursued is mostconsistent with: (a) hysterisis. (b) stochastic macroequilibration. (c) neoclassicalmacroeconomics and Milton Friedmans monetarist theory. (d) a horizontal long runPhillips curve. (e) asymmetric wage and price reaction functions.

47. The notion that, ex ante, the nominal interest rate equals the real interest rate plus theexpected rate of inflation [in = r

* + E()] is called the: (a) classical paradigm (b) Fisherequation. (c) Hume conjecture. (d) Keynesian equation. (e) monetarist equation. (f) Marshallequation.

48. A rise in the price level is mirrored by an increase in the demand for money, a functionknown as the: (a) price-level effect. (b) law of one price. (c) inflation effect. (d) inflation

risk effect. (e) law of increasing price.

49. Many early business cycle theories focused on: (a) external shocks. (b) changing interestrates. (c) decisions of the Fed. (d) all of the above.

50. A monetary growth rule would dictate that the money supply would grow at: (a) anincreasing rate each year. (b) a rate lower than that of years past. (c) a fixed ratecompatible with historical GDP growth. (d) a rate equal to the previous years inflationrate.

51. Milton Friedman argued that ______ policy does not strongly affect aggregate demand,

but _________ policy does based on an equation of the general form 0

>> 1: PQ = B +oM + 1(G-T/Y).: (a) fiscal \ monetary. (b) discount \ open market. (c) fiscal monetary;

0; 1. (d) tax \ spending.



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52. According to Milton Friedman, John Maynard Keynes liquidity preference analysisignored the possibility that: (a) interest rates respond to changes in the money supply. (b)changes in the money supply may affect other segments of the economy, raising interestrates. (c) changes in the money supply are sometimes intentional, leading to anticipatedchanges in the interest rates. (d) consumers will attempt to offset any losses of purchasing

power from expected inflation.

53. According to the quantity theory of money, in the long run, the dominant determinant ofthe price level is: (a) expected inflation. (b) average exchange rate. (c) governmentspending. (d) interest rate. (e) money supply.

54. According to the quantity theory of money, in the long run, the money supply is the soledeterminant of: (a) the price level. (b) real exchange rates. (c) government spending. (d)real interest rates. (e) money supply.

55. Ben Bernanke is among many central bankers all over the world who increasingly favor:(a) setting the growth of the money supply at a low fixed percentage rate regardless of

short run economic conditions. (b) expanding the money supply at rates that wouldprecisely yield price level stability. (c). pursuing deflationary policies that would reducenominal interest rates to zero. (d) targeting inflation at a low rate (2% or so) tosignificantly reduce the risk of deflation.

56. Between September 11, 2001, and March 2004, the: (a) money supply grew faster thanGDP. (b) income velocity of money increased sharply. (c) exchange rate of the dollarincreased relative to the euro, the pound, and the yen. (e) federal funds rate increasedbecause of increases in the perceived riskiness of financial investments.

57. Effects of an increase in the money supply on interest rates do not include the: (a) price-

level effect. (b) income effect. (c) liquidity effect. (d) velocity effect. (e) Fisher effect.

58. If transaction motives dominate the demand for money, then after the price level hasincreased people are most likely to: (a) consume even more than usual so there is nochance the money will devalue even further. (b) hold a greater real quantity ofmoney[M/P]. (c) hold a greater nominal quantity of money [M]. (d) consume more in theshort run but then slow to their original level of consumption.

59. The phenomenon that interest rates rise in response to an increase in expected inflation isknown as the: (a) liquidity effect (b) the inflation effect (c) the Fisher effect (d) theKeynesian effect

60. Using a statistical analysis of the equation PQ = a + b0M + b1(G-T/Y), Milton Friedmanthought he had shown that ______ policy does not work, but that _________ policy does,because subscripts b__>b__:. (a) fiscal; monetary; 1; 0 (b) monetary; fiscal; 1; 0. (c)fiscal, monetary; 0; 1 (d) monetary; fiscal; 0; 1

61. The ex ante equation iN = r* + E[Pe] and the ex post equation: r = iN P

e are mathematicalcharacterizations of the: (a) theory of rational expectations. (b) law of interest rates. (c)Fisher effect. (d) law of inflation.



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62. Which effect is named after the first American economist who identified a positiverelationship between expected inflation and interest rates?. (a) Marx effect. (b) Nasheffect. (c) Irving effect. (d) Fisher effect.

63. Pre-1930s versions of neoclassical macro theory and Keynesian theory per the General

Theory [1936] differ least about the: (a) importance of liquidity in determining optimalasset portfolios. (b) flexibility of wages, prices, and interest rates. (c) possibility thatunemployment may be involuntary in the short run. (d) validity of the equation ofexchange [MV=PQ] and the quantity theory of money in long run equilibrium. (e) (f)opportunity cost of holding money.

64. Classical macroeconomic theory neither assumes nor concludes that, in a macroeconomicequilibrium: (a) the willingness of firms to operate depends critically on expectations thatthere is a ready market for their products. (b) a societys production possibilities frontieris determined almost solely by the state of technology and available resources. (c) peoplecan find a job almost immediately if they are willing to accept a wage commensuratewith their productivity. (d) the nominal quantity of money demanded will be preciselyproportional to the price level.


12 classical monetary theory

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