MEcon Master of Economics Master of Economics: Money, Banks, and Interest Rates 2 — Questions and Answers
Question 1: Which theory posits that the nominal interest rate equals the real interest rate plus expected inflation?
- Purchasing Power Parity
- Fisher Effect (Correct answer)
- Liquidity Preference Theory
- Loanable Funds Theory
Correct answer: Fisher Effect
The Fisher Effect states that nominal interest rates adjust one-for-one with changes in expected inflation, keeping the real rate constant.
Question 2: When a central bank engages in open market purchases, what immediately happens to bank reserves?
- Reserves decrease as banks sell bonds
- Reserves increase as the central bank buys bonds (Correct answer)
- Reserves are unaffected because bonds are private assets
- Reserves decrease due to the money multiplier
Correct answer: Reserves increase as the central bank buys bonds
Open market purchases inject reserves into the banking system because the central bank pays for bonds by crediting seller banks' reserve accounts.
Question 3: A bank has $500M in deposits and a required reserve ratio of 10%. It holds $60M in reserves. What is the bank's excess reserve position?
- $10M excess (Correct answer)
- $60M excess
- $10M deficit
- $50M deficit
Correct answer: $10M excess
Required reserves are $50M (10% × $500M), so with $60M held, excess reserves equal $10M.
Question 4: In the money market model, what happens to the equilibrium interest rate when real GDP rises, ceteris paribus?
- It falls because money supply expands automatically
- It rises because money demand increases (Correct answer)
- It is unchanged because the central bank offsets it
- It falls because bond prices rise
Correct answer: It rises because money demand increases
Higher real GDP raises the transactions demand for money, shifting the money demand curve right and pushing equilibrium interest rates up.
Question 5: Which type of financial institution accepts deposits and is primarily funded by those deposits to make mortgage loans?
- Mutual fund
- Savings and loan association (thrift) (Correct answer)
- Insurance company
- Hedge fund
Correct answer: Savings and loan association (thrift)
Savings and loan associations (thrifts) are deposit-taking institutions historically focused on funding residential mortgages.
Question 6: The 'lender of last resort' function of a central bank is designed primarily to prevent:
- Inflation caused by excess money supply
- Bank runs that spread into systemic financial panics (Correct answer)
- Government budget deficits from rising
- Exchange rate depreciation
Correct answer: Bank runs that spread into systemic financial panics
By providing emergency liquidity to solvent but illiquid banks, a lender of last resort halts contagious bank runs before they become systemic crises.
Question 7: If the velocity of money is stable and real output grows at 3% per year, what money growth rate is consistent with 2% inflation according to the Quantity Theory?
- 1%
- 2%
- 5% (Correct answer)
- 6%
Correct answer: 5%
MV = PY implies %ΔM = %ΔP + %ΔY = 2% + 3% = 5% when velocity is constant.
MEcon Master of Economics Master of Economics: Money, Banks, and Interest Rates 2
Which theory posits that the nominal interest rate equals the real interest rate plus expected inflation?