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Macroeconomics 6/c/e
Macroeconomics, 6/e
Rudi Dornbusch, Massachusetts Institute of Technology
Stanley Fischer, International Monetary Fund, on leave from MIT
Richard Startz, University of Washington
Frank Atkins, University of Calgary
Gordon Sparks, Queen's University

Monetary and Fiscal Policy in the Short-Run

Quick Quiz


Expansionary fiscal policy
A)increases the interest rate and the level of investment spending
B)increases the interest rate but decreases income
C)shifts the LM-curve to the right
D)none of the above

The size of the monetary policy multiplier will increase if
A)the LM-curve becomes flatter and the IS-curve becomes steeper
B)the LM-curve becomes steeper and the IS-curve becomes flatter
C)the investment curve becomes more interest-inelastic
D)money demand becomes more interest-elastic

If the Bank of Canada undertakes open market sale of bonds, then
A)the LM-curve will shift to the right
B)the LM-curve will shift to the left which will lead to lower interest rates
C)interest rate will increase and income will fall
D)bond prices will increase and income will fall

One side effect of expansionary fiscal policy is that
A)it always has to be accommodated by monetary policy
B)it reduces consumption spending due to an increase in the interest rates
C)it reduces investment due to an increase in the interest rates
D)it decreases private saving and therefore investment

The liquidity trap exists if
A)the LM-curve is vertical
B)money demand is totally interest inelastic
C)investment is totally interest inelastic
D)a government spending increase is totally crowded out by a decrease in private investment

In the classical case,
A)money demand is totally interest inelastic
B)the fiscal policy multiplier is zero
C)crowding out is complete
D)all of the above

The transmission mechanism
A)refers to the process expansionary fiscal policy being crowded out
B)does not work if investment is totally interest inelastic
C)explains the effects of a shift in the IS-curve
D)relates to the effects of a change in the income tax rate

When the LM-curve is vertical, then
A)fiscal policy has a maximal effect on income
B)monetary multiplier policy multiplier is zero
C)monetary policy has maximal effect, but fiscal policy has no effect on income
D)fiscal policy has no effect on interest rate

Fiscal policy is at its strongest and monetary policy is at its weakest when
A)we are in the liquidity trap
B)we are in the classical case
C)investment is very sensitive to interest rate changes
D)money demand is totally interest inelastic

Policy A is a tight-money/easy -fiscal policy mix and Policy B is an easy-money/tight fiscal policy mix. Compared to Policy B, Policy A will cause a
A)lower level of investment
B)higher level of investment
C)higher level of consumption
D)lower level of saving

Expansionary fiscal policy has no negative impact on the level of investment if
A)money demand is completely interest inelastic
B)the government spending increase is accompanied by a tax increase
C)the government spending increase is accompanied by open market sales by the central bank
D)it is implemented via an investment subsidy rather than an income tax cut

Assume we combine restrictive fiscal policy with expansionary monetary policy. Which is most likely to occur?
A)output and interest rates will both go up
B)output will roughly stay the same but interest rates will go down
C)investment and consumption will both decrease
D)investment and the budget surplus will both decrease

Assume an increase in taxes, which will have negative impact on income. Suppose, the Bank of Canada prevents income from falling by increasing the money supply. As a result,
A)investment will increase
B)consumption will increase
C)both investment and consumption will increase
D)both investment and consumption will fall

According to the IS-LM model, if the governments cuts back its spending, but the Bank of Canada wants to keep income constant, then it should
A)reduce money supply
B)increase money supply
C)keep money supply unchanged
D)none of the above

A tax-cut along with tight money policy should lead to a
A)rise in the interest rate
B)fall in the interest rate
C)increase in investment
D)no change in investment

If government wants to increase investment but keep income constant, it should
A)follow an easy money policy and a tight fiscal policy
B)keep money supply unchanged
C)follow tight monetary policy, but easy fiscal policy.
D)keep fiscal policy unchanged

If the central bank refuses to accommodate a large increase in government spending, the most likely outcome will be
A)a surplus in the current account of the balance of payments due to changing interest rates
B)a decrease in the level of consumption due to changing interest rates
C)a change in the composition of GDP
D)all of the above