Practice Questions 4

1. Identifications: Define and briefly explain the significance of each of the following terms:

Real money balances
Quantity theory of money
Velocity of Money
Equation of Exchange
Stability of money demand
Missing money
Speculative demand
Liquidity preference theory
Disposable income
Autonomous consumption
Expenditure multiplier
Animal spirits
Inventory investment
Aggregate demand function
Crowding out
Money supply target
Interest-Rate Target
Natural level of output
Long run money neutrality

2. True/False/or Uncertain. Briefly explain your answer.

a. There was no liquidity trap during the Great Depression because the estimated money demand function using Great Depression data predicted money demand function of the 1970s.

b. Velocity of money has been fairly constant in the U.S. since 1970s.

c. Increasing volatility in bond and stock returns raises demand for money.

d. During periods of slowdown, businesses decrease their inventories.

e. Output falls if an increase in government spending is matched by an equal increase in taxes.

f. If consumption, investment and net exports are insensitive to interest rates, the IS curve is horizontal.

g. An excess demand for money resulting from a rise in the demand for money can be eliminated only by a rise in interest rates.

h. As the price level rises, the equilibrium level of output determined in the IS-LM model rises.

i. If the money demand curve is shifting to the left, the LM curve is shifting to the right.

j. A stock market crash leads to the shift of the IS curve to the left.

3. Essay Questions

1. Discuss the following statement

"The most likely cause of the instability of the money demand function after 1973 is the rapid pace of financial innovation occurring after 1973".

2. Discuss using the IS-LM framework, how President Bush's tax cuts and Greenspan's expansionary monetary policy may steer the economy out of Recession.

3. Discuss using the IS-LM framework, why monetary policy may be ineffective in stimulating the Japanese economy. Do you think that the Japanese can export their way out of recession?

4. Discuss the following statement.

"If a policy-maker has credible prior information that the money demand function is of the classical Fisher-Pigou form, he will avoid fiscal policy to stimulate the economy".