SAMPLE ESSAY EXAM QUESTIONS

Chapter 3

1. Are credit cards money? Are passbook savings accounts money? Explain.

2. Discuss the problems of a barter economy.

3. Discuss the theoretical and empirical approaches to defining money.

4. Discuss the 3 economic functions of money. Which of these is not unique to money?

5. Discuss the weighted average approach to defining money.

6. Should policymakers pay much attention to short-run fluctuations in the money stock? Explain.

Chapter 4

1. Discuss the relationship between bond prices and the interest rate.

2. Define current yield. Describe the conditions under which the current yield is a close approximation to the yield to maturity.

3. Define yield on a discount basis. Explain why it is an incorrect measure of the yield to maturity and explain the direction of the bias.

4. Some financial analysts consider the long-term bond market to be quite risky. Why don't they say the same about the short-term bond market?

5. Distinguish between the interest rate and rate of return.

6. Explain the distinction between real and nominal interest rates. Which is a better measure of economic incentives? Why?

Chapter 5

1. What are the four factors that affect the demand for an asset? What are the effects of changes in these four factors on the quantity demanded of an asset?

2. Describe the concept of the wealth elasticity of demand.

3. Why is it that if the returns to two assets move perfectly together diversification by holding both assets rather than just one provides no benefits? (An example maybe helpful)

4. Show, using an example, how diversification can lower the overall risk facing an investor.

5. "The higher a security's beta, the lower its risk premium." Discuss the accuracy of this statement.

Chapter 6

1. How is the procyclical movement of interest rates (the rise during booms and the fall during recessions) explained by the loanable funds and liquidity preference frameworks? Demonstrate your answer with diagrams.

2. Explain what effect a large federal budget deficit might have on interest rates. Be sure to discuss the "crowding out" effects of deficits. Demonstrate your answer with a diagram.

3. Predict what will happen to interest rates if the public expects a large increase in stock prices. Demonstrate your answer using a diagram.

4. Using both the loanable funds and liquidity preference frameworks, show what the effect is on interest rates when riskiness of bonds rises. Be sure to include the appropriate diagrams in your answer.

5. Will there be an effect on interest rates if brokerage commissions on stocks fall? Why? Demonstrate your answer with a diagram.

6. The President of the United States announces in his press conference that he will fight the high inflation rate with a new anti-inflation program. Predict what will happen if the public believes him. Demonstrate your answer with a diagram.

7. Explain, using a diagram, the effect of a increase in the price level using the liquidity preference framework. Be sure to include a discussion of the adjustment process.

Chapter 7

1. Risk premiums on corporate bonds are usually anticyclical; that is, they decrease during business cycle booms and increase during recessions. Why is this so?

2. Discuss the effect of the effect of a lowering of income tax rates on municipal bond interest rates? Would interest rates on Treasury securities be affected, and if so, how? Demonstrate your answer with diagrams.

3. Explain why securities issued by different corporations will have different yields even when the term to maturity is identical.

4. Explain the pure expectations hypothesis. What does the pure expectations hypothesis imply about a downward sloping yield curve?

5. Explain the preferred habitat theory. How does its explanation of a flat yield curve differ from the pure expectations hypothesis?

6. Compare the underlying assumptions about bond buyers and sellers preferences for the bond maturities differ across pure expectations, market segmentation, and preferred habitat theories.

7. Explain the market segmentation theory. How does this theory explain the empirical fact yield curves usually slope upwards. (Diagrams may be helpful)

Chapter 8

1. If Americans are expected to go on a spending spree and buy twice as much French perfume, Japanese TV's, English sweaters, Swiss watches, and Italian wine, what will happen to the value of the dollar? Carefully explain why you expect this answer and draw the appropriate diagram.

2. If American auto companies are expected to make a breakthrough in computer technology, what will happen to the U.S. exchange rate? Carefully explain why you expect this answer and draw the appropriate diagram.

3. If the demand for a country's exports falls at the same time that tariffs on imports are raised, will the exchange rate tend to appreciate or depreciate in the long run?

4. If the Federal Reserve increases the money supply, what will happen to the exchange rate? Carefully explain why you expect this answer and draw the appropriate diagram.

5. If the French government unexpectedly announces that it will be imposing higher tariffs and quotas on foreign goods one year from now, what will happen to the value of the franc today? Carefully explain why you expect this answer and draw the appropriate diagram.

Chapter 11

1. Can banks make extra profits by borrowing short and lending long? Explain.

2. What is interest rate risk? How can banks manage interest rate risk?

3. Be able to use gap and duration analysis.

Chapter 15

1. What are some of the deficiencies of the simple model of multiple deposit creation? What types of changes need to be made in the model to make it more realistic?

2. Show what happens to the T-accounts of the Fed and the First National Bank when the Fed sells $1000 of securities to the First National Bank. What happens to reserves at the First National Bank?

3. If the Fed loans the First National Bank $1 million and the First National Bank uses the proceeds to buy $1 million of bonds from the Fed, what happens to reserves at the First National Bank? Explain your answer using T-accounts for the Fed and the First National Bank.

4. If the Fed purchases $2 billion of government bonds, what will happen to total reserves? If the required reserve ratio is 10%, how much will checkable deposits increase in the simple deposit-expansion model? Explain and show your work.

5. Assume that the required reserve ratio is equal to 20% and that the First National Bank of Oxford receives a discount loan of $500 from the Fed. By how much can the First National Bank increase its loans? By how much can the banking system potentially increase its loans? Explain.

Chapter 16

1. If the Fed sells $2 million of bonds to Irving the Investor, who pays for the bonds with currency, what happens to reserves and the monetary base? Explain your answer with T-accounts.

2. If the Fed lends a bank an additional $100 million but depositors withdraw $50 million and hold it as currency, what will happen to reserves and the monetary base? Explain your answer with T-accounts.

3. Explain the distinction between the borrowed base and the nonborrowed base. Why do economists bother to make this distinction? Explain.

4. Assume that the Fed begins to pay interest on those deposits banks maintain at the Federal Reserve, inducing banks to hold more excess reserves. How can the Fed prevent the money supply from falling? Explain.

5. Predict what will happen to the money supply if the Fed increases the required reserve ratio on checkable deposits but banks lower the excess reserve ratio.

Chapter 17

1. Predict what would happen to the money supply if cigarette smoking were made illegal.

2. Predict what would happen to the money supply if penalties for early withdrawal were eliminated.

3. If Congress reduced the penalties for check forgery, what would happen to the money supply?

4. Describe how the Ohio savings and loan crisis in early 1985 may have affected the currency-deposit ratio and the level of excess reserves in Ohio. Explain your answer.

5. What would you predict would happen to the money supply if expected inflation suddenly rises?

6. The Fed has recently been discussing the possibility of paying interest on excess reserves. If this

occurred, what would happen to the level of excess reserves?

Chapter 18

1. Explain the Theory of Bureaucratic behavior? Give some examples that are consistent with the theory.

2. Discuss how independent is the Fed.

3. Discuss the cases for and against independence of the Fed.

4. Discuss the structure and monetary policy functions of the Board of Governors of the Federal Reserve.

5. Discuss the relative power of each of the components of the Federal Reserve. Be sure to explain the source of power for each of the components.

Chapter 20

1. Discuss the differences between defensive and dynamic open market operations.

2. Discuss the lender of last resort function of the Fed? Why is it needed?

3. Discuss the announcement effect of discount policy.

Chapter 21

1. What are the goals of monetary policy? Describe, using a diagram, the strategy Fed uses to achieve these goals.

2. Classify the following as either operating targets or intermediate targets and explain the reasons for your classification.

a. The Fed Funds rate.

b. The monetary base.

c. M1

3. Evaluate the following statement: "The Fed can pursue a monetary aggregate target and control the interest rate." Be sure to include the appropriate diagram.

4. Compare the interest rate to monetary aggregates on the grounds of controllability and measurability.

5. Compare the monetary base to M1 on the grounds of controllability and measurability. Which do you prefer as an intermediate target? Why?

Chapter 22

1. Why does a balance of payments deficit for the United States have a different effect on its international reserves than a balance of payments deficit for the Netherlands?

2. Why were speculative attacks on a currency more prevalent under the Bretton Woods system than under the current managed float system?

3. Answer true, false, or uncertain: "If a country wants to keep its exchange rate from changing, it must give up some control over its money supply."

4. Even if a gold standard might reduce inflation, why do many economists oppose a return to the gold standard?

5. Describe the mechanism involving flows of gold that enables the gold standard to keep exchange rates fixed at par value. What does this mechanism indicate about the ability of a country to control its monetary policy under a gold standard?

6. How can persistent U.S. balance of payments deficits help stimulate world inflation?

Chapter 26

1. Suppose government spending is raised at the same time that the money supply is lowered. What will happen to the position of the Keynesian aggregate demand curve? The monetarist aggregate demand curve? Carefully explain the rationale behind your answer.

2. Suppose the emergence of personal computers has increased the productivity of workers. Using aggregate supply and demand analysis, carefully describe the effect of PC's on the price level and aggregate output in the short run and the long run. Be sure to include the appropriately labeled diagram.

3. Assume the following two events occur. First, OPEC raises oil prices. Second, government spending increases. Using aggregate supply and demand analysis, describe the effects of each event on both the price level and aggregate output in the short run and long run. Be sure to include the appropriately labeled diagram.

Chapter 28

1. What do economists mean by the word inflation?

2. How do monetarists explain inflation? How do Kenyesians explain inflation?

3. Distinguish between cost push and demand-pull inflation.

4. How can deficits cause inflation?

5. What was the cause of the rise of inflation between 1960 and 1980?

6. Discuss the 5 policy lags that affect the implementation of monetary and fiscal policy. Be sure to point out the differences in the lags between monetary and fiscal policy.

7. Using aggregate supply and demand analysis, explain the appropriate activist response to a negative supply shock. Be sure to include the appropriately labeled diagram.

8. How does the existence of worker expectations affect the case for activist policy?

Chapter 30

1. Explain the differences between new classical and new keynesian models (i.e., model assumptions, anticipated versus unanticipated policy). Explain your answer with the aid of a diagram.

2. Demonstrate with the aid of a diagram why it is important to policymakers that people believe them when they say they are going to adopt anti-inflationary policy. Demonstrate your answer with the aid of a diagram.

3. Evaluate this statement. "The new classical model does not eliminate the policymaker's ability to reduce unemployment because they can always pursue policies that are more expansionary than the public expects."

4. Suppose that a treaty limiting the number of nuclear weapons is signed with the Russians. The result of the treaty is that the public expects military and hence government spending to be reduced. If the new classical view of the economy is correct and government spending does affect the aggregate demand curve, predict what will happen to aggregate output and the price level is reduced in line with public's expectations. How would the answer change in the new keynesian model is the correct description of the economy. Be sure to include the appropriate diagram.

5. Suppose that Congress increases government spending $100 billion this year but the public anticipates a $200 billion increase in government spending. If the new classical view of the economy is correct and government spending does affect aggregate demand, predict what will happen to aggregate output and the price level. How would the answer change if the traditional model is the correct description of the economy. Be sure to include the appropriate diagram.