Alexander College

ECON 291 Canadian Macroeconomic Policy

Practice Questions

1. Multiple choice questions.

1) An open market purchase by the Bank of Canada will

A) increase the nominal interest rate.

B) increase the nominal money supply.

C) increases the supply of corporate bonds on the open market.

D) reduce the price level.

2) Which of the following would decrease the full-employment level of output?

A) A beneficial supply shock.

B) An increase in the capital stock.

C) A decrease in labour supply.

D) A decrease in the future marginal productivity of capital.

3) Which market adjusts the most quickly in response to shocks to the economy?

A) the asset market

B) the labour market

C) the goods market

D) The asset, labour, and goods markets adjust at about the same speed to eliminate a disequilibrium in the macroeconomy.

4) Which of the following statements is not true?

A) Classical macroeconomists think that prices and wages adjust rapidly in response to the shocks.

B) Keynesian macroeconomists think that it may take several years for the economy to reach general equilibrium.

C) Classical and Keynesian macroeconomists both agree that money is neutral in the long run.

D) Keynesian macroeconomists argue that money is neutral in the short run but not in the long run.

5) The Canadian interest rate is 2 percent and the US interest rate is 3 percent. If the interest parity condition holds, we expect

A) the Canadian dollar to appreciate by 1 percent.

B) the Canadian dollar to depreciate by 5 percent.

C) the US dollar to appreciate by 1 percent.

D) the US dollar to depreciate by 5 percent.

6) A temporary supply shock would

A) shift the IS curve down and leave the FE line unchanged.

B) shift the IS curve down and shift the FE line to the left.

C) shift the IS curve up but leave the FE line unchanged.

D) have no effect on the IS curve.

7) Canada's response to the 2008 financial crisis and recession was

A) a contractionary fiscal policy and a contractionary monetary policy.

B) a contractionary fiscal policy and an expansionary monetary policy.

C) an expansionary fiscal policy and a contractionary monetary policy.

D) an expansionary fiscal policy and an expansionary monetary policy.

8) An increase in the Canadian budget deficit will cause

A) a current account surplus in Canada only if it reduces national saving.

B) a current account surplus in Canada only if it increases national saving.

C) a current account deficit in Canada only if it increases national saving.

D) a current account deficit in Canada only if it reduces national saving.

9) In a closed economy, an expansionary fiscal policy will lead to

A) an increase in output and an increase in the interest rate.

B) an increase in output and a decrease in the interest rate.

C) a decrease in output and an increase in the interest rate.

D) a decrease in output and a decrease in the interest rate.

10) In a closed economy, suppose the intersection of the IS and LM curves is to the right of the FE line. An increase in the price level would most likely eliminate a disequilibrium among the asset, labour, and goods markets by

A) shifting the LM curve up.

B) shifting the IS curve up.

C) shifting the IS curve down.

D) shifting the FE curve to the left.

11) Classical economists think general equilibrium is attained relatively quickly because

A) the real interest rate adjusts quickly.

B) the level of output adjusts quickly.

C) the exchange rate adjusts quickly.

D) the price level adjusts quickly.

12) Under an assumption of monetary neutrality, a change in the nominal money supply has

A) no effect on the price level.

B) a less than proportionate effect on the price level.

C) a proportionate effect on the price level.

D) a more than proportionate effect on the price level.

13) If the nominal exchange rate rises 2%, domestic inflation is 3%, and foreign inflation is 4%, what is the percent change in the real exchange rate?

A) 5%

B) 3%

C) 1%

D) -1%

14) A temporary increase in government purchases, given the level of output, will lead to

A) a higher desired consumption and a higher desired national saving.

B) a lower desired consumption and a lower desired national saving.

C) a higher desired consumption and a lower desired national saving.

D) a lower desired consumption and a higher desired national saving.

15) The DEBTLAND's economic growth is 5 percent and the interest rate paid on debt is also 5 percent. If the primary deficit to GDP ratio is 2 percent, the DEBTLAND's debt-GDP ratio will change by

A) 3 percent.

B) 5 percent.

C) 7 percent.

D) 2 percent.

16) A decrease in taxes on the current generation would have no effect on consumption or national saving if

A) individuals face borrowing constraints.

B) individuals increase their consumption by less than the tax cut.

C) consumers bequeath all of the tax cut to the next generation.

D) consumers are not forward looking concerning their future tax burden.

17) Which of the following statements about the structural surplus or cyclically adjusted surplus is true?

A) An expansionary fiscal policy lowers the structural surplus.

B) An increase in tax rates raises the structural surplus.

C) A contractionary fiscal policy raises the structural surplus.

D) A and C.

18) The Central Bank can increase the money supply by

A) increasing the currency-deposit ratio.

B) increasing the monetary base.

C) increasing reserve requirements.

D) increasing the discount rate.

19) Which of the following statements about the effectiveness of the fiscal and the monetary policies in response to a recession in a small open economy (with flexible exchange rate) is true?

A) In recession, fiscal policy is ineffective, but monetary policy is effective.

B) In recession, fiscal policy is effective, but monetary policy is ineffective.

C) In recession, both fiscal and monetary policies are effective.

D) In recession, both fiscal and monetary policies are in effective.

20) Assume that the reserve-deposit ratio is 0.2. The Bank of Canada carries out open-market operations, purchasing $1,000,000 worth of bonds from banks. This action increased the money supply by $2,600,000. What is the currency-deposit ratio?

A) 0.2

B) 0.3

C) 0.4

D) 0.5

2. True, false, or uncertain? Briefly explain. Note: no explanation, no credits.

1) Money is neutral, both in long run and in short run.
2) In a small open economy, an increase in government spending will cause investment to be crowded out.
3) When there is an upward pressure for inflation rate, the Bank of Canada should either reduce overnight rate target or conduct open market sales.
4) In the Mundell-Fleming model, both fiscal policy and monetary policy are effective (i.e., can change output level).

5) An increase in the average tax rate will decrease labour supply, but an increase in the marginal tax rate will increase labour supply.

3. Short answer questions.

1) Briefly discuss the idea of "twin deficit." In your answer, include historical evidence, if any, and explain why some economists do not agree with the idea. Is Ricardian equivalence proposition consistent with the idea of twin deficit? Why?

2) Using the IS-LM model for a small open economy, analyze the effects of the following events on output and the real interest rate in the short run and the long run. In each case, discuss the differences between the classical and the Keynesian models.

a. A rise in taxes.

b. A boom in the economy of the major trading partner.

c. The central bank follows a contractionary monetary policy.

3) The financial crisis and recession that started in the U.S. in 2008 spread worldwide rapidly. Explain what government and Bank of Canada could do in response to recession, and comment on the fiscal and the monetary policies conducted in Canada. 

4) The money supply is $12 million, currency held by the public is $2 million, and the reserve-deposit ratio is 0.2.

a. What is the quantity of bank deposits?

b. What is the quantity of bank reserves?

c. What is the quantity of the monetary base?

d. What is the money multiplier (give a number)?

5) Why should government smooth tax rates? If they do so, what happens to deficits over the business cycle?