Chapter 5: The Behavior of Interest Rates

Question 1

A movement along the bond demand or supply curve occurs when ________ changes

A) bond price
B) income
C) wealth
D) expected return

Answer 1

A

Question 2

When the price of a bond decreases, all else equal, the bond demand curve ________.

A) shifts right
B) shifts left
C) does not shift
D) inverts

Answer 2

C

Question 3

During business cycle expansions when income and wealth are rising, the demand for bonds
________ and the demand curve shifts to the ________, everything else held constant.

A) falls; right
B) falls; left
C) rises; right
D) rises; left

Answer 3

C

Question 4

Everything else held constant, when households save less, wealth and the demand for bonds
________ and the bond demand curve shifts ________.

A) increase; right
B) increase; left
C) decrease; right
D) decrease; left

Answer 4

D

Question 5

Everything else held constant, if interest rates are expected to fall in the future, the demand for
long-term bonds today ________ and the demand curve shifts to the ________.

A) rises; right
B) rises; left
C) falls; right
D) falls; left

Answer 5

A

Question 6

Holding the expected return on bonds constant, an increase in the expected return on common
stocks would ________ the demand for bonds, shifting the demand curve to the ________.
A) decrease; left
B) decrease; right
C) increase; left
D) increase; right

Answer 6

A

Question 7

Everything else held constant, an increase in expected inflation, lowers the expected return on
________ compared to ________ assets.
A) bonds; financial
B) bonds; real
C) physical; financial
D) physical; real

Answer 7

B

Question 8

Everything else held constant, an increase in the riskiness of bonds relative to alternative assets
causes the demand for bonds to ________ and the demand curve to shift to the ________.
A) rise; right
B) rise; left
C) fall; right
D) fall; left

Answer 8

D

Question 9

Everything else held constant, when stock prices become less volatile, the demand curve for
bonds shifts to the ________ and the interest rate ________.
A) right; rises
B) right; falls
C) left; falls
D) left; rises

Answer 9

D

Question 10

Everything else held constant, when stock prices become ________ volatile, the demand curve
for bonds shifts to the ________ and the interest rate ________.
A) more; right; rises
B) more; right; falls
C) less; left; falls
D) less; left; does not change

Answer 10

B

Question 11

Everything else held constant, an increase in the liquidity of bonds results in a ________ in
demand for bonds and the demand curve shifts to the ________.
A) rise; right
B) rise; left
C) fall; right
D) fall; left

Answer 11

A

Question 12

Everything else held constant, when bonds become less widely traded, and as a consequence the
market becomes less liquid, the demand curve for bonds shifts to the ________ and the interest
rate ________.
A) right; rises
B) right; falls
C) left; falls
D) left; rises

Answer 12

D

Question 13

The reduction of brokerage commissions for trading common stocks that occurred in 1975
caused the demand for bonds to ________ and the demand curve to shift to the ________.
A) fall; right
B) fall, left
C) rise; right
D) rise; left

Answer 13

B

Question 14

Factors that decrease the demand for bonds include
A) an increase in the volatility of stock prices.
B) a decrease in the expected returns on stocks.
C) a decrease in the inflation rate.
D) a decrease in the riskiness of stocks.

Answer 14

D

Question 15

During a recession, the supply of bonds ________ and the supply curve shifts to the ________,
everything else held constant.
A) increases; left
B) increases; right
C) decreases; left
D) decreases; right

Answer 15

C

Question 16

In a business cycle expansion, the ________ of bonds increases and the ________ curve shifts to
the ________ as business investments are expected to be more profitable.
A) supply; supply; right
B) supply; supply; left
C) demand; demand; right
D) demand; demand; left

Answer 16

A

Question 17

When the expected inflation rate increases, the real cost of borrowing ________ and bond supply
________, everything else held constant.
A) increases; increases
B) increases; decreases
C) decreases; increases
D) decreases; decreases

Answer 17

C

Question 18

An increase in the expected inflation rate causes the supply of bonds to ________ and the supply
curve to shift to the ________, everything else held constant.
A) increase; left
B) increase; right
C) decrease; left
D) decrease; right

Answer 18

B

Question 19

Higher government deficits ________ the supply of bonds and shift the supply curve to the
________, everything else held constant.
A) increase; left
B) increase; right
C) decrease; left
D) decrease; right

Answer 19

B

Question 20

Factors that can cause the supply curve for bonds to shift to the right include
A) an expansion in overall economic activity.
B) a decrease in expected inflation.
C) a decrease in government deficits.
D) a business cycle recession.

Answer 20

A

Question 21

When the inflation rate is expected to increase, the ________ for bonds falls, while the ________
curve shifts to the right, everything else held constant.
A) demand; demand
B) demand; supply
C) supply; demand
D) supply; supply

Answer 21

B

Question 22

When the expected inflation rate increases, the demand for bonds ________, the supply of bonds
________, and the interest rate ________, everything else held constant.
A) increases; increases; rises
B) decreases; decreases; falls
C) increases; decreases; falls
D) decreases; increases; rises

Answer 22

D

Question 23

Everything else held constant, when the inflation rate is expected to rise, interest rates will
________; this result has been termed the ________.
A) fall; Keynes effect
B) fall; Fisher effect
C) rise; Keynes effect
D) rise; Fisher effect

Answer 23

D

Question 24

The economist Irving Fisher, after whom the Fisher effect is named, explained why interest rates
________ as the expected rate of inflation ________, everything else held constant.
A) rise; increases
B) rise; stabilizes
C) fall; stabilizes
D) fall; increases

Answer 24

A

Question 25

Everything else held constant, during a business cycle expansion, the supply of bonds shifts to
the ________ as businesses perceive more profitable investment opportunities, while the
demand for bonds shifts to the ________ as a result of the increase in wealth generated by the
economic expansion.
A) right; left
B) right; right
C) left; left
D) left; right

Answer 25

B

Question 26

When the economy slips into a recession, normally the demand for bonds ________, the supply
of bonds ________, and the interest rate ________, everything else held constant.
A) increases; increases; rises
B) decreases; decreases; falls
C) increases; decreases; falls
D) decreases; increases; rises

Answer 26

B

Question 27

When an economy grows out of a recession, normally the demand for bonds ________ and the
supply of bonds ________, everything else held constant.
A) increases; increases
B) increases; decreases
C) decreases; decreases
D) decreases; increases

Answer 27

A

Question 28

Deflation causes the demand for bonds to ________, the supply of bonds to ________, and bond
prices to ________, everything else held constant.
A) increase; increase; increase
B) increase; decrease; increase
C) decrease; increase; increase
D) decrease; decrease; increase

Answer 28

B

Question 29

In the 1990s Japan had the lowest interest rates in the world due to a combination of
A) inflation and recession.
B) deflation and expansion.
C) inflation and expansion.
D) deflation and recession.

Answer 29

D

Question 30

When the interest rate changes,
A) the demand curve for bonds shifts to the right.
B) the demand curve for bonds shifts to the left.
C) the supply curve for bonds shifts to the right.
D) it is because either the demand or the supply curve has shifted.

Answer 30

D

Question 31

The interest rate falls when either the demand for bonds ________ or the supply of bonds
________.
A) increases; increases
B) increases; decreases
C) decreases; decreases
D) decreases; increases

Answer 31

B

Question 32

When the government has a surplus, as occurred in the late 1990s, the ________ curve of bonds
shifts to the ________, everything else held constant.
A) supply; right
B) supply; left
C) demand; right
D) demand; left

Answer 32

B

Question 33

When the government has a surplus, as occurred in the late 1990s, the ________ curve of bonds
shifts to the ________, everything else held constant.
A) supply; right
B) supply; left
C) demand; right
D) demand; left

Answer 33

B

Question 34

When rare coin prices become volatile, the ________ curve for bonds shifts to the ________,
everything else held constant.
A) demand; right
B) demand; left
C) supply; right
D) supply; left

Answer 34

A

Question 35

If people expect real estate prices to increase significantly, the ________ curve for bonds will
shift to the ________, everything else held constant.
A) demand; right
B) demand; left
C) supply; left
D) supply; right

Answer 35

B

Question 36

Everything else held constant, when prices in the art market become more uncertain,
A) the demand curve for bonds shifts to the left and the interest rate rises.
B) the demand curve for bonds shifts to the left and the interest rate falls.
C) the demand curve for bonds shifts to the right and the interest rate falls.
D) the supply curve for bonds shifts to the right and the interest rate falls.

Answer 36

C

Question 37

Everything else held constant, when real estate prices are expected to decrease
A) the demand curve for bonds shifts to the left and the interest rate rises.
B) the demand curve for bonds shifts to the left and the interest rate falls.
C) the demand curve for bonds shifts to the right and the interest rate falls.
D) the supply curve for bonds shifts to the right and the interest rate falls.

Answer 37

C

Question 38

Everything else held constant, when the government has higher budget deficits
A) the demand curve for bonds shifts to the left and the interest rate rises.
B) the demand curve for bonds shifts to the left and the interest rate falls.
C) the supply curve for bonds shifts to the right and the interest rate falls.
D) the supply curve for bonds shifts to the right and the interest rate rises.

Answer 38

D

Question 39

If stock prices are expected to climb next year, everything else held constant, the ________ curve
for bonds shifts ________ and the interest rate ________.
A) demand; left; rises
B) demand; right; rises
C) demand; left; falls
D) supply; left; rises

Answer 39

A

Question 40

If prices in the bond market become more volatile, everything else held constant, the demand
curve for bonds shifts ________ and interest rates ________.
A) left; rise
B) left; fall
C) right; rise
D) right; fall

Answer 40

A

Question 41

If brokerage commissions on stocks fall, everything else held constant, the demand for bonds
________, the price of bonds ________, and the interest rate ________.
A) decreases; decreases; increases
B) decreases; decreases; decreases
C) increases; decreases; increases
D) increases; increases; increases

Answer 41

A

Question 42

If the expected return on bonds increases, all else equal, the demand for bonds increases, the
price of bonds ________, and the interest rate ________.
A) increases; decreases
B) increases; increases
C) decreases; decreases
D) decreases; increases

Answer 42

A

Question 43

In the figure above, a factor that could cause the supply of bonds to shift to the right is:
A) a decrease in government budget deficits.
B) a decrease in expected inflation.
C) a recession.
D) a business cycle expansion.

Answer 43

D

Question 44

In the figure above, a factor that could cause the demand for bonds to decrease (shift to the left)
is:
A) an increase in the expected return on bonds relative to other assets.
B) a decrease in the expected return on bonds relative to other assets.
C) an increase in wealth.
D) a reduction in the riskiness of bonds relative to other assets.

Answer 44

B

Question 45

In the figure above, the price of bonds would fall from P1 to P2
A) inflation is expected to increase in the future.
B) interest rates are expected to fall in the future.
C) the expected return on bonds relative to other assets is expected to increase in the future.
D) the riskiness of bonds falls relative to other assets.

Answer 45

A

Question 46

In the figure above, a factor that could cause the supply of bonds to increase (shift to the right)
is:
A) a decrease in government budget deficits.
B) a decrease in expected inflation.
C) expectations of more profitable investment opportunities.
D) a business cycle recession.

Answer 46

C

Question 47

In the figure above, a factor that could cause the demand for bonds to shift to the right is:
A) an increase in the riskiness of bonds relative to other assets.
B) an increase in the expected rate of inflation.
C) expectations of lower interest rates in the future.
D) a decrease in wealth

Answer 47

C

Question 48

In the figure above, the price of bonds would fall from P2 to P1 if
A) there is a business cycle recession.
B) there is a business cycle expansion.
C) inflation is expected to increase in the future.
D) inflation is expected to decrease in the future.

Answer 48

B

Question 49

What is the impact on interest rates when the Federal Reserve decreases the money supply by
selling bonds to the public?

Answer 49

Bond supply increases and the bond supply curve shifts to the right. The new
equilibrium bond price is lower and thus interest rates will increase.

Question 50

Use demand and supply analysis to explain why an expectation of Fed rate hikes would cause
Treasury prices to fall.

Answer 50

The expected return on bonds would decrease relative to other assets resulting in a decrease in the demand for bonds. The leftward shift of the bond demand curve results in a new lower equilibrium price for bonds.

Question 51

1) In the Keynesian liquidity preference framework, an increase in the interest rate causes the
demand curve for money to ________, everything else held constant.
A) shift right
B) shift left
C) stay where it is
D) invert

Answer 51

C

Question 52

A lower level of income causes the demand for money to ________ and the interest rate to
________, everything else held constant.
A) decrease; decrease
B) decrease; increase
C) increase; decrease
D) increase; increase

Answer 52

A

Question 53

When real income ________, the demand curve for money shifts to the ________ and the interest
rate ________, everything else held constant.
A) falls; right; rises
B) rises; right; rises
C) falls; left; rises
D) rises; left; rises

Answer 53

B

Question 54

When real income ________, the demand curve for money shifts to the ________ and the interest
rate ________, everything else held constant.
A) falls; right; rises
B) rises; right; rises
C) falls; left; rises
D) rises; left; rises

Answer 54

A

Question 55

In the Keynesian liquidity preference framework, a rise in the price level causes the demand for
money to ________ and the demand curve to shift to the ________, everything else held
constant.
A) increase; left
B) increase; right
C) decrease; left
D) decrease; right

Answer 55

B

Question 56

When the price level ________, the demand curve for money shifts to the ________ and the
interest rate ________, everything else held constant.
A) falls; left; falls
B) rises; right; falls
C) falls; left; rises
D) rises; right; rises

Answer 56

D

Question 57

When the price level ________, the demand curve for money shifts to the ________ and the
interest rate ________, everything else held constant.
A) falls; left; falls
B) rises; right; falls
C) falls; left; rises
D) rises; right; rises

Answer 57

D

Question 58

When the price level falls, the ________ curve for nominal money ________, and interest rates
________, everything else held constant.
A) demand; decreases; fall
B) demand; increases; rise
C) supply; increases; rise
D) supply; decreases; fall

Answer 58

A

Question 59

When the price level falls, the ________ curve for nominal money ________, and interest rates
________, everything else held constant.
A) demand; decreases; fall
B) demand; increases; rise
C) supply; increases; rise
D) supply; decreases; fall

Answer 59

B

Question 60

When the Fed decreases the money stock, the money supply curve shifts to the ________ and the
interest rate ________, everything else held constant.
A) right; rises
B) right; falls
C) left; falls
D) left; rises

Answer 60

D

Question 61

When the Fed ________ the money stock, the money supply curve shifts to the ________ and the
interest rate ________, everything else held constant.
A) decreases; right; rises
B) increases; right; falls
C) decreases; left; falls
D) increases; left; rises

Answer 61

B

Question 62

________ in the money supply creates excess ________ money, causing interest rates to
________, everything else held constant.
A) A decrease; demand for; rise
B) An increase; demand for; fall
C) An increase; supply of; rise
D) A decrease; supply of; fall

Answer 62

A

Question 63

________ in the money supply creates excess demand for ________, causing interest rates to
________, everything else held constant.
A) An increase; money; rise
B) An increase; bonds; fall
C) A decrease; bonds; rise
D) A decrease; money; fall

Answer 63

B

Question 64

When the price level falls, the ________ curve for nominal money ________, and interest rates
________, everything else held constant.
A) demand; decreases; fall
B) demand; increases; rise
C) supply; increases; rise
D) supply; decreases; fall

Answer 64

A

Question 65

In the figure above, one factor not responsible for the decline in the demand for money is
A) a decline the price level.
B) a decline in income.
C) an increase in income.
D) a decline in the expected inflation rate.

Answer 65

C

Question 66

In the figure above, the decrease in the interest rate from i1 to i2 can be explained by
A) a decrease in money growth.
B) a decline in the expected price level.
C) an increase in income.
D) an increase in the expected price level.

Answer 66

B

Question 67

In the figure above, the factor responsible for the decline in the interest rate is
A) a decline the price level.
B) a decline in income.
C) an increase in the money supply.
D) a decline in the expected inflation rate.

Answer 67

C

Question 68

In the figure above, the factor responsible for the decline in the interest rate is
A) a decline the price level.
B) a decline in income.
C) an increase in the money supply.
D) a decline in the expected inflation rate.

Answer 68

B

Question 69

Milton Friedman called the response of lower interest rates resulting from an increase in the
money supply the ________ effect.
A) liquidity
B) price level
C) expected-inflation
D) income

Answer 69

A

Question 70

Of the four effects on interest rates from an increase in the money supply, the initial effect is,
generally, the
A) income effect.
B) liquidity effect.
C) price level effect.
D) expected inflation effect.

Answer 70

B

Question 71

In the liquidity preference framework, a one-time increase in the money supply results in a
price level effect. The maximum impact of the price level effect on interest rates occurs
A) at the moment the price level hits its peak (stops rising) because both the price level and
expected inflation effects are at work.
B) immediately after the price level begins to rise, because both the price level and expected
inflation effects are at work.
C) at the moment the expected inflation rate hits its peak.
D) at the moment the inflation rate hits it peak.

Answer 71

A

Question 72

Of the four effects on interest rates from an increase in the money supply, the one that works in
the opposite direction of the other three is the
A) liquidity effect.
B) income effect.
C) price level effect.
D) expected inflation effect.

Answer 72

A

Question 73

It is possible that when the money supply rises, interest rates may ________ if the ________
effect is more than offset by changes in income, the price level, and expected inflation.
A) fall; liquidity
B) fall; risk
C) rise; liquidity
D) rise; risk

Answer 73

C

Question 74

When the growth rate of the money supply increases, interest rates end up being permanently
lower if
A) the liquidity effect is larger than the other effects.
B) there is fast adjustment of expected inflation.
C) there is slow adjustment of expected inflation.
D) the expected inflation effect is larger than the liquidity effect.

Answer 74

A

Question 75

When the growth rate of the money supply is increased, interest rates will fall immediately if the
liquidity effect is ________ than the other money supply effects and there is ________
adjustment of expected inflation.
A) larger; fast
B) larger; slow
C) smaller; slow
D) smaller; fast

Answer 75

B

Question 76

If the Fed wants to permanently lower interest rates, then it should raise the rate of money
growth if
A) there is fast adjustment of expected inflation.
B) there is slow adjustment of expected inflation.
C) the liquidity effect is smaller than the expected inflation effect.
D) the liquidity effect is larger than the other effects.

Answer 76

D

Question 77

If the liquidity effect is smaller than the other effects, and the adjustment to expected inflation is
slow, then the
A) interest rate will fall.
B) interest rate will rise.
C) interest rate will initially fall but eventually climb above the initial level in response to an
increase in money growth.
D) interest rate will initially rise but eventually fall below the initial level in response to an
increase in money growth.

Answer 77

C

Question 78

If the liquidity effect is smaller than the other effects, and the adjustment to expected inflation is
immediate, then the
A) interest rate will fall.
B) interest rate will rise.
C) interest rate will fall immediately below the initial level when the money supply grows.
D) interest rate will rise immediately above the initial level when the money supply grows.

Answer 78

D

Question 79

In the figure above, illustrates the effect of an increased rate of money supply growth at time
period 0. From the figure, one can conclude that the
A) liquidity effect is smaller than the expected inflation effect and interest rates adjust quickly
to changes in expected inflation.
B) liquidity effect is larger than the expected inflation effect and interest rates adjust quickly
to changes in expected inflation.
C) liquidity effect is larger than the expected inflation effect and interest rates adjust slowly to
changes in expected inflation.
D) liquidity effect is smaller than the expected inflation effect and interest rates adjust slowly
to changes in expected inflation.

Answer 79

A

Question 80

In the figure above, illustrates the effect of an increased rate of money supply growth at time
period 0. From the figure, one can conclude that the
A) Fisher effect is dominated by the liquidity effect and interest rates adjust slowly to changes
in expected inflation.
B) liquidity effect is dominated by the Fisher effect and interest rates adjust slowly to changes
in expected inflation.
C) liquidity effect is dominated by the Fisher effect and interest rates adjust quickly to
changes in expected inflation.
D) Fisher effect is smaller than the expected inflation effect and interest rates adjust quickly to
changes in expected inflation.

Answer 80

C

Question 81

The figure above illustrates the effect of an increased rate of money supply growth at time
period T0. From the figure, one can conclude that the
A) liquidity effect is smaller than the expected inflation effect and interest rates adjust quickly
to changes in expected inflation.
B) liquidity effect is larger than the expected inflation effect and interest rates adjust quickly
to changes in expected inflation.
C) liquidity effect is larger than the expected inflation effect and interest rates adjust slowly to
changes in expected inflation.
D) liquidity effect is smaller than the expected inflation effect and interest rates adjust slowly
to changes in expected inflation.

Answer 81

C

Question 82

The figure above illustrates the effect of an increased rate of money supply growth at time
period T0. From the figure, one can conclude that the
A) Fisher effect is dominated by the liquidity effect and interest rates adjust slowly to changes
in expected inflation.
B) liquidity effect is dominated by the Fisher effect and interest rates adjust slowly to changes
in expected inflation.
C) liquidity effect is dominated by the Fisher effect and interest rates adjust quickly to
changes in expected inflation.
D) Fisher effect is smaller than the expected inflation effect and interest rates adjust quickly to
changes in expected inflation

Answer 82

A

Question 83

The figure above illustrates the effect of an increased rate of money supply growth at time
period T0. From the figure, one can conclude that the
A) liquidity effect is smaller than the expected inflation effect and interest rates adjust quickly
to changes in expected inflation.
B) liquidity effect is larger than the expected inflation effect and interest rates adjust quickly
to changes in expected inflation.
C) liquidity effect is larger than the expected inflation effect and interest rates adjust slowly to
changes in expected inflation.
D) liquidity effect is smaller than the expected inflation effect and interest rates adjust slowly
to changes in expected inflation.

Answer 83

D

Question 84

The figure above illustrates the effect of an increased rate of money supply growth at time
period T0. From the figure, one can conclude that the
A) Fisher effect is dominated by the liquidity effect and interest rates adjust slowly to changes
in expected inflation.
B) liquidity effect is dominated by the Fisher effect and interest rates adjust slowly to changes
in expected inflation.
C) liquidity effect is dominated by the Fisher effect and interest rates adjust quickly to
changes in expected inflation.
D) Fisher effect is smaller than the expected inflation effect and interest rates adjust quickly to
changes in expected inflation.

Answer 84

A

Question 85

Interest rates increased continuously during the 1970s. The most likely explanation is
A) banking failures that reduced the money supply.
B) a rise in the level of income.
C) the repeated bouts of recession and expansion.
D) increasing expected rates of inflation.

Answer 85

D

Question 86

Using the liquidity preference framework, what will happen to interest rates if the Fed increases
the money supply?

Answer 86

The Fedʹs actions shift the money supply curve to the right. The new equilibrium interest rate will be lower than it was previously.