Chapter 28.2

Question 1

Most central banks accept that, in the long run, monetary policy has an effect on
A) the level of aggregate demand.
B) the price level and the inflation rate only.
C) the level of investment demand.
D) all real economic variables.
E) real GDP and the price level.

Answer 1

B

Question 2

Many central banks have established formal targets for the rate of inflation because of the following fundamental observations about economic relationships:
1. there are high costs associated with inflation
2. high inflation causes high unemployment
3. monetary policy is the cause of sustained inflation
A) 1 only
B) 2 only
C) 3 only
D) 1 and 3 only
E) 1, 2, and 3

Answer 2

D

Question 3

High inflation is costly to firms and individuals. Of the following, who is most adversely affected by high inflation?
A) a homeowner with a 25-year fixed-rate mortgage
B) a student with student loans repayable in nominal terms at a fixed rate of interest
C) a student with student loans repayable on an indexed basis at a variable rate of interest
D) a senior whose retirement income is an indexed pension plan
E) a senior whose retirement income is fixed in dollar terms

Answer 3

E

Question 4

Which of the following describes the cause of a sustained inflation?
A) the monetary transmission mechanism
B) an aggregate demand shock significant enough to cause a substantial rise in the price level
C) continual monetary expansion
D) an aggregate supply shock significant enough to cause a substantial rise in the price level
E) simultaneous AD and AS shocks

Answer 4

C

Question 5

Given its existing policy regime of “inflation targeting,” the Bank of Canada would likely react to a large positive aggregate demand shock by
A) lowering the bank rate.
B) buying bonds from the open market.
C) increasing its target for the overnight interest rate.
D) decreasing its target for the overnight interest rate.
E) ignoring the shock and allowing the economy to adjust.

Answer 5

C

Question 6

Given its existing policy regime of “inflation targeting,” the Bank of Canada would likely react to a large negative AD shock by
A) raising the bank rate.
B) selling bonds on the open market.
C) increasing its target for the overnight interest rate.
D) decreasing its target for the overnight interest rate.
E) ignoring the shock and allowing the economy to adjust.

Answer 6

D

Question 7

The long-run target currently used by the Bank of Canada is to set
A) M2 = real GDP/M1.
B) a long-run target range for the overnight lending rate.
C) a long-run target range for the Canadian-U.S. exchange rate.
D) a long-run target range for the 5-year mortgage rate.
E) a long-run target range for the inflation rate.

Answer 7

E

Question 8

Consider the following statement about inflation targeting: A policy of inflation targeting acts as an automatic stabilizer in the economy, just like the automatic fiscal stabilizers. Choose the most appropriate response to this statement. The statement is
A) true, because an inflationary gap is met with a contractionary monetary policy.
B) true, because a recessionary gap is met with an expansionary monetary policy.
C) not true, because inflation targeting requires active policy decisions by the Bank of Canada, whereas fiscal stabilizers need no policy implementation.
D) not true, because inflation targeting automatically maintains inflation within the target range, whereas fiscal stabilizers require government policy decisions.
E) true, because inflation targeting and fiscal stabilizers are essentially the same policy tool.

Answer 8

C

Question 9

Because of the volatility of food and energy prices, the Bank of Canada pays more attention in the short run to changes in ________ than to changes in ________.
A) core inflation; total CPI inflation
B) total CPI inflation; core inflation
C) total CPI inflation; inflation of the GDP deflator
D) inflation of the GDP deflator; total CPI inflation
E) the nominal exchange rate; the real exchange rate

Answer 9

A

Question 10

One problem with focusing on the CPI when conducting monetary policy is that
A) many elements in the CPI change for reasons unrelated to the state of the Canadian economy.
B) it is closely related to the value of M2.
C) changes in monetary policy have little effect on the CPI, especially in the long run.
D) the CPI is too stable to accurately reflect the changes occurring in the Canadian economy.
E) the CPI distorts the value of commercial bank reserves.

Answer 10

A

Question 11

Most central banks in the developed countries focus their attention on
A) the elimination of output gaps.
B) reducing unemployment.
C) the reduction and control of inflation.
D) alleviating the harmful effects of inflation.
E) the growth of potential output.

Answer 11

C

Question 12

High and uncertain inflation is damaging to the economy because
A) the price system is no longer capable of effectively signalling changes in relative scarcity through changes in relative prices.
B) individuals who receive their incomes in fixed nominal terms are made worse off.
C) there can be unexpected reallocations of real income between workers and firms.
D) there can be unexpected reallocations of real income between borrowers and lenders.
E) All of the above.

Answer 12

E

Question 13

It is widely accepted by economists that monetary policy is the most important determinant of a country's 
A) level of real GDP.
B) level of potential output.
C) aggregate supply curve.
D) long-run rate of inflation.
E) long-run rate of economic growth.

Answer 13

D

Question 14

As of 2015, the Bank of Canada's policy objective is to maintain inflation at or near the target of
A) 0%.
B) 1%.
C) 2%.
D) 3%.
E) 4%.

Answer 14

C

Question 15

The Bank of Canada's formal policy target is \_\_\_\_\_\_\_\_. It's current target is to keep the annual inflation rate close to \_\_\_\_\_\_\_\_%. 
A) core inflation; 1
B) core inflation; 0
C) the money supply; 2
D) CPI inflation; 2
E) the money supply; 1

Answer 15

D

Question 16

In an effort to maintain inflation at its targeted level the Bank of Canada designs its policies, in the short run, to
A) eliminate all unemployment.
B) keep real GDP close to potential output.
C) minimize the growth of the money supply.
D) allow the aggregate supply curve to close any output gaps.
E) eliminate all negative shocks to the economy.

Answer 16

B

Question 17

An example of how inflation targeting by the Bank of Canada helps to stabilize the economy is
A) firms and households are aware of the announced inflation target and adjust their behaviour so as to maintain this level of actual inflation.
B) when a recessionary gap reduces the rate of inflation (below the target level) the Bank of Canada will implement an expansionary monetary policy, which helps to close the gap.
C) when the actual inflation rate falls below the targeted level of inflation, then commercial banks automatically increase deposit creation.
D) when an output gap opens in the economy, the inflationary target adjusts to close the gap.
E) when an output gap opens in the economy, the Bank of Canada chooses the inflation target appropriate for closing the gap.

Answer 17

B

Question 18

In the short run the Bank of Canada aims to ________, in an effort to ________.
A) enhance any positive shocks; keep inflation within its target band
B) reduce any positive or negative output gaps; keep inflation close to the official target
C) ignore any shocks as they are automatically adjusting; keep GDP growth constant
D) keep actual output within 1%-3% of potential output; keep the money supply growing at a constant rate
E) ignore any shocks as they are automatically adjusting; keep inflation within its target band

Answer 18

B

Question 19

The economic variables that the Bank of Canada tries to influence are ________ in the short run and ________ in the long run.
A) the distribution of income; the unemployment rate
B) real GDP; the path of the price level
C) the distribution of income; economic efficiency
D) real GDP; the exchange rate
E) the exchange rate; the rate of inflation

Answer 19

B

Question 20

20) Inflation targeting
A) is irrelevant to the stability of the economy because of the long-run neutrality of money.
B) is a destabilizing policy because it requires the Bank of Canada to engage in inappropriate policy responses.
C) is a stabilizing policy because the Bank of Canada’s policy adjustments act to stabilize real GDP growth.
D) should be replaced with fiscal policy targeting because of the long-run neutrality of money.
E) creates output gaps that must be then offset with fiscal policy stabilizers.

Answer 20

C

Question 21

Suppose output is at its potential level and then there is a sudden increase in food and energy prices. This increase
A) makes inflation targeting easier because it makes these problems less relevant.
B) makes inflation targeting harder because these are closely related to excess demand in the economy.
C) would be unlikely to lead to an immediate policy response because it would not appear in “core” inflation.
D) would be offset by a decline in the Canadian dollar, making these price increases irrelevant.
E) is closely related to changes in core inflation so the Bank of Canada uses these for targeting inflation.

Answer 21

C

Question 22

Inflation that is fully anticipated by workers, firms, and consumers
A) leads to reductions in real incomes for all workers.
B) is hard to predict.
C) improves the efficiency of the price system.
D) does not impact the purchasing power of individuals whose incomes are fully indexed to inflation.
E) has no real or nominal effects in the economy.

Answer 22

D

Question 23

Which of the following goods are included in Canada's measure of "core inflation"?
A) natural gas
B) a new car
C) fresh vegetables
D) excise tax on gasoline
E) coffee

Answer 23

B

Question 24

Consider a central bank that chooses to implement its monetary policy by expanding the money supply by a fixed percentage amount in every year. One important disadvantage with this approach to monetary policy is that it may
A) lead to sustained inflation.
B) be destabilizing if the demand for money is unstable.
C) lead to stable growth of national income.
D) be inconsistent with the Bank of Canada Act.
E) create a recessionary output gap.

Answer 24

B

Question 25

Most economists now accept the proposition that
A) an ideal monetary policy would allow the money supply to grow at a constant rate.
B) to reduce the long-run rate of inflation there must be a sustained monetary contraction.
C) monetary policy leaves real GDP and the overnight lending rate unaffected in the short run.
D) lowering the Bank Rate will have no effect on desired investment in the short run but will have a direct effect on core inflation.
E) monetary policy is the only policy tool available for influencing aggregate demand.

Answer 25

E

Question 26

Suppose Canadian real GDP is currently equal to potential GDP. Then, because of events elsewhere in the world, European investors decide to hold fewer Canadian financial assets, which leads to a sustained depreciation of the Canadian dollar. If the Bank of Canada is committed to its inflation target then it should
A) implement an expansionary monetary policy by increasing its target for the overnight interest rate.
B) implement an expansionary monetary policy by decreasing its target for the overnight interest rate.
C) not intervene in the economy at all since this shock will not have any real effects in the short run.
D) implement a contractionary monetary policy by increasing its target for the overnight interest rate.
E) implement a contractionary monetary policy by decreasing its target for the overnight interest rate.

Answer 26

D

Question 27

Suppose Canadian real GDP is currently equal to potential GDP. Then the Canadian dollar depreciates due to the reduced demand by European producers to purchase Canadian-made raw materials. If the Bank of Canada is committed to its inflation target then it should
A) implement an expansionary monetary policy by increasing its target for the overnight interest rate.
B) implement an expansionary monetary policy by decreasing its target for the overnight interest rate.
C) not intervene in the economy at all since this shock will not have any real effects in the short run.
D) implement a contractionary monetary policy by increasing its target for the overnight interest rate.
E) implement a contractionary monetary policy by decreasing its target for the overnight interest rate.

Answer 27

B

Question 28

Which of the following events would justify the Bank of Canada implementing an expansionary monetary policy, while maintaining its commitment to its inflation target?
A) An appreciation of the Canadian dollar due to increases in the world prices of Canadian exports.
B) A depreciation of the Canadian dollar due to persistent current account deficits of Canada.
C) An oil-price shock that results in Canadian inflation.
D) The U.S. economy increasing its demand for Canadian goods and services.
E) A major decline in the Canadian stock market.

Answer 28

E

Question 29

Suppose Canadian real GDP is equal to potential GDP. An appreciation of the Canadian dollar then implies that the Bank of Canada should engage in
A) a loosening of monetary policy because of the excess demand for Canadian products that is creating the appreciation.
B) a tightening of monetary policy because of the excess demand for Canadian products that is creating the appreciation.
C) no change in monetary policy because the exchange rate is always allowed to float freely.
D) an increase in inflation because of the higher cost of imports.
E) either a contractionary or an expansionary policy, depending on the cause of the appreciation.

Answer 29

E

Question 30

Suppose Canadian real GDP is equal to potential GDP. A significant and sustained appreciation of the Canadian dollar on the foreign-exchange market then requires the Bank of Canada to
A) engage in expansionary monetary policy to counter the rise in the dollar.
B) engage in contractionary monetary policy to counter the rise in the dollar.
C) identify the cause of the change in the exchange rate before taking any action to adjust policy.
D) increase the target band for the inflation rate.
E) increase the target band for the overnight lending rate.

Answer 30

C

Question 31

Suppose Canadian real GDP is equal to potential GDP. A significant and sustained appreciation of the Canadian dollar would likely lead the Bank to engage in a contractionary monetary policy if the Bank’s policy experts traced the cause of the appreciation to
A) a decrease in the overnight lending rate.
B) an increase in the desire of non-residents to purchase Canadian financial assets.
C) an increase in the desire of non-residents to purchase more Canadian goods and services.
D) a reduction in Canada’s core inflation rate.
E) a recession in Canada.

Answer 31

C

Question 32

Suppose Canadian real GDP is equal to potential GDP. A significant and sustained appreciation of the Canadian dollar would likely lead the Bank to engage in an expansionary monetary policy if the Bank’s policy experts traced the cause of the appreciation to
A) a decrease in the overnight lending rate.
B) an increase in the desire of non-residents to purchase Canadian financial assets.
C) an increase in the desire of non-residents to purchase more Canadian goods and services.
D) a reduction in Canada’s core inflation rate.
E) a recession in Canada.

Answer 32

B