Question

1. To reduce the money supply, the Federal Reserve:

a) buys government bonds.

b) sells government bonds.

c) creates demand deposits.

d) destroys demand deposits.

2. If the reserve-deposit ratio is less than one, and the monetary base increases by $1 million, then the money supply will

a) increase by $1 million.

b) decrease by $1 million.

c) increase by more than $1 million

d) decrease by more than $1 million.

3. When people want to hold _____ money, the income velocity of money increases, and the money demand parameter k _______.

a) more; increase

b) less; increase

c) more; decrease

d) less; decrease

4. The ex post real interest rate will be greater than the ex ante real interest rate when the:

a) rate of inflation is increasing

b) rate of inflation is decreasing

c) actual rate of inflation is greater than the expected rate of inflation

d) actual rate of inflation is less than the expected rate of inflation

Answer 1

(1) (b)

To reduce money supply, Fed sells bonds and to increase money supply, Fed buys bonds.

(2) (c)

Money multiplier (MM) = 1 / reserve ratio (RR)

Increase in money supply = Increase in monetary base (MB) x MM

If RR < , MM > 1 and so, Increase in money supply > Increase in MB.

(3) (d)

When people hold less (more) money, velocity increases (decreases) and value of k decreases (increases).

(4) (d)

Ex-ante Real interest rate = Nominal rate - Expected inflation

Ex-post Real interest rate = Nominal rate - Actual inflation

So, nominal rate remaining the same, when Actual inflation < Expected inflation, then Ex-post Real interest rate > Ex-ante Real interest rate.