AP Macro Monetary Policy 2 — Questions and Answers
Question 1: When the Federal Reserve sells government securities on the open market, what is the immediate effect on bank reserves?
- Bank reserves increase
- Bank reserves decrease (Correct answer)
- Bank reserves are unaffected
- Bank reserves double
Correct answer: Bank reserves decrease
Selling securities removes money from the banking system as banks pay for them, reducing reserves.
Question 2: Which of the following best describes the money multiplier?
- The rate at which the Fed prints new currency
- The ratio of the money supply to the monetary base (Correct answer)
- The interest rate charged between commercial banks
- The percentage of deposits banks must hold in reserve
Correct answer: The ratio of the money supply to the monetary base
The money multiplier equals 1/reserve requirement and shows how much the money supply expands per dollar of reserves.
Question 3: If the required reserve ratio is 20%, what is the maximum money multiplier?
- 2
- 4
- 5 (Correct answer)
- 20
Correct answer: 5
The money multiplier equals 1 divided by the reserve requirement: 1/0.20 = 5.
Question 4: Contractionary monetary policy is most appropriate when an economy is experiencing:
- High unemployment and low inflation
- A recession with falling GDP
- Demand-pull inflation above the target rate (Correct answer)
- Deflation and declining consumer spending
Correct answer: Demand-pull inflation above the target rate
Contractionary policy raises interest rates to cool excessive demand and bring inflation back to target.
Question 5: The prime rate is best described as:
- The rate the Fed charges member banks
- The interest rate banks charge their most creditworthy customers (Correct answer)
- The yield on 10-year Treasury bonds
- The rate on overnight federal funds loans
Correct answer: The interest rate banks charge their most creditworthy customers
The prime rate is the benchmark rate commercial banks use for loans to their best corporate customers.
Question 6: When the Fed lowers the discount rate, which of the following most likely occurs?
- Banks borrow less from the Fed
- Commercial lending rates typically rise
- Banks are encouraged to borrow more from the Fed (Correct answer)
- The money supply contracts
Correct answer: Banks are encouraged to borrow more from the Fed
A lower discount rate makes it cheaper for banks to borrow from the Fed, encouraging more borrowing and lending.
Question 7: Which scenario represents an example of the liquidity trap?
- Interest rates rise so high that borrowing collapses
- Even near-zero interest rates fail to stimulate borrowing and spending (Correct answer)
- The Fed cannot sell enough bonds to reduce the money supply
- Banks hold excess reserves because loan demand is too high
Correct answer: Even near-zero interest rates fail to stimulate borrowing and spending
A liquidity trap occurs when monetary policy loses effectiveness because interest rates are already near zero and cannot fall further.
AP Macro Monetary Policy 2
When the Federal Reserve sells government securities on the open market, what is the immediate effect on bank reserves?