Test Bank (chapter 09) - Macroeconomics, 6e (Blanchard╱Johnson).doc

Macroeconomics, 6e (Blanchard/Johnson)Chapter 9: The Crisis9.1 Multiple Choice Questions1) The Case-Shiller index is normalized to equal 100 in JanuaryA) 1999.B) 1990.C) 2000.D) 2001.Answer: CDiff: 12) The Case-Shiller index reached its peak inA) 2006.B) 2007.C) 2005.D) 2008.Answer: ADiff: 13) By 2006, about _ of all U.S mortgages were subprimes.A) 10%B) 20%C) 30%D) 25%Answer: BDiff: 14) The mortgage is said to be underwater whenA) the value of the house exceeds the value of the mortgage.B) the house is flooded.C) the value of the mortgage exceeds the value of the house.D) none of the aboveAnswer: CDiff: 15) In mid-2008, estimated losses on mortgages were estimated to be about _ of U.S. GDP.A) 2%B) 5%C) 7%D) 9%Answer: ADiff: 16) Which of the followings is NOT a banks assets?A) reservesB) loansC) government bondsD) checkable depositsAnswer: DDiff: 17) Suppose bank A has assets of 100, liabilities of 80, and capital of 20. Its capital ratio isA) 20%.B) 25%.C) 11%.D) 10%.Answer: ADiff: 18) Suppose bank A has assets of 100, liabilities of 80, and capital of 20. Its leverage ratio isA) 4.B) 5.C) 10.D) 9.Answer: BDiff: 19) Suppose bank A has assets of 100, liabilities of 60, and capital of 40. Its capital ratio isA) 40%.B) 66%.C) 25%.D) 60%.Answer: ADiff: 110) Suppose bank A has assets of 100, liabilities of 60, and capital of 40. Its leverage ratio isA) 1.5.B) 2.5.C) 0.6.D) 0.4.Answer: BDiff: 111) The first structured investment vehicle (SIV) was set up by _ in 1988. A) J.P. MorganB) ChaseC) CitigroupD) Goldman SachsAnswer: CDiff: 112) AIG provide CDS againstA) insolvency.B) default risk.C) illiquidity.D) none of the aboveAnswer: BDiff: 113) Securitization can NOT help financial intermediariesA) diversify their portfolios.B) avoid bankruptcy.C) attract more investors to buy and hold their securities.D) decrease the cost of borrowing. Answer: BDiff: 114) Collaterailzed debt obligations (CDOs) were first issued inA) 1980s.B) 1990s.C) 2000.D) 2001.Answer: ADiff: 115) Ted spread isA) the difference between the riskless rate and the rate at which banks are willing to lend to each other.B) the difference between the riskless rate and the yield on corporate bonds.C) the difference between the riskless rate and return on stocks.D) none of the aboveAnswer: ADiff: 116) FDIC deposit insurance is _ per account.A) $100,000B) $150,000C) $200,000D) $250,000Answer: DDiff: 117) _ was introduced in October 2008 to clean up banks. A) liquidity facilitiesB) wholesale fundingC) TARPD) fire saleAnswer: CDiff: 118) American Recovery and Reinvestment Act 2009 calls for A) both tax reductions and government spending reductions.B) both tax reductions and government spending increases.C) both tax increases and government spending increases.D) both tax increases and government spending reductions.Answer: BDiff: 119) Firms with _ratings are considered the safest.A) AAAB) BBBC) CCCD) BBAnswer: ADiff: 120) LIBOR rate isA) interbank loan rate.B) the riskless rate.C) TED spread.D) discount rate.Answer: ADiff: 121) Which of the following conditions will most likely coincide with the existence of a liquidity trap?A) inflation is risingB) inflation is constantC) inflation is zeroD) individuals prefer to hold only money and not bondsE) the real interest rate is negativeAnswer: DDiff: 122) When a liquidity trap situation exists, we know thatA) an open market operation will have no effect on the supply of money.B) an open market operation will have no effect on the monetary base.C) fiscal policy will have no effect on the demand for goods.D) expansionary monetary policy will be deflationary.E) none of the aboveAnswer: EDiff: 123) Suppose a liquidity trap situation exists. Which of the following is most likely to occur if taxes are cut?A) no change in output and no change in the interest rateB) an increase in output and an increase in the interest rateC) an increase in output and little change in the interest rateD) an increase in output and a reduction in the interest rateE) none of the aboveAnswer: CDiff: 124) An open market purchase of bonds by the central bank will cause which of the following when a liquidity trap situation exists?A) the interest rate will decrease.B) the interest rate will not change.C) output will increase.D) the money supply, M, will not change.E) none of the aboveAnswer: BDiff: 125) An open market sale of bonds by the central bank will cause which of the following when a liquidity trap situation exists?A) the interest rate will increaseB) the interest rate will not changeC) output will decreaseD) the money supply, M, will not changeE) none of the aboveAnswer: EDiff: 126) Which of the following will occur when an economy is faced with a liquidity trap situation?A) a reduction in the price level will cause a rightward shift in the aggregate demand curveB) a reduction in the price level will cause a leftward shift in the aggregate demand curveC) the aggregate demand curve is now verticalD) the aggregate demand curve is now upward slopingAnswer: CDiff: 127) The primary cause of the reduction in the nominal money supply during the early years of the Great Depression wasA) the Feds sale of bondsB) the Feds purchase of bondsC) a reduction in the money multiplierD) none of the aboveAnswer: CDiff: 128) When a liquidity trap situation exists, the most appropriate policy to increase output would beA) a central bank sale of bonds.B) an increase in government spending.C) a central bank purchase of bonds.D) none of the aboveAnswer: BDiff: 129) The reduction in Japanese stock prices in the 1990s was most likely the result of which of the following?A) contractionary monetary policyB) contractionary fiscal policyC) the end of a speculative bubbleD) an increase in inflationAnswer: CDiff: 130) One of the possible solutions for the Japanese slump is toA) implement macroeconomic policies to create inflation.B) maintain a constant aggregate price level.C) maintain the real interest rate at its original level.D) none of the aboveAnswer: ADiff: 131) The Nikkei, a Japanese stock price index, reached its peak in which of the following years?A) 1980B) 1985C) 1989D) 1992E) 1995Answer: CDiff: 132) Which of the following has been suggested as a possible solution to the Japanese slump?A) disinflationary macroeconomic policyB) budget deficit reduction packagesC) banking reformD) all of the aboveE) none of the aboveAnswer: CDiff: 19.2 Essay Questions1) Was the sharp house price increase from 2000 to 2006 justified?Answer: Some increase in prices was clearly justified: The 2000s were a period of unusually low interest rates. As a result, mortgage rates were also low, increasing the demand for housing and thus pushing up the price. Other factors were also at work. Mortgage lenders became increasingly willing to make loans to more risky borrowers, increasing the demand for housing.2) Capital can help prevent banks from bankruptcy. Explain why things can still go wrong even if a banks holds some capital.Answer: First, the assets may decline in value by so much that the capital the bank holds is not enough to cover losses. Second, the bank may be still solvent but become illiquid. 3) First, explain leverage ratio. Second, discuss why banks had high leverage ratio.Answer: Leverage ratio is defined as the ratio of assets to capital. There appears to be a number of reasons why banks had high leverage ratio: First, banks probably underestimated the risk they were taking.Second, the compensation system and bonus payments also gave incentives to managers to go for high expected returns without fully taking the risk of bankruptcy into account. Third, while financial regulation required banks to keep their capital ratio above some minimum, banks found new ways of avoiding the regulation, by creating new financial structures such as SIVs4) Explain securitization and its advantages.Answer: Securitization is the creation of securities based on a bundle of assets (for example, a bundle of loans, or a bundle of mortgages).For instance, a mortgage-based security, or MBS for short, is a title to the returns from a bundle of mortgages, with the number of underlying mortgages often in the tens of thousands. The advantage is that many investors, who would not want to hold individual mortgages, will be willing to buy and hold these securities. This increase in the supply of funds from investors is, in turn, likely to decrease the cost of borrowing.5) What were the immediate effects of the financial crisis on the macro economy. Answer: The immediate effects of the financial crisis on the macro economy were two-fold: first, a large increase in the interest rates at which people and firms could borrow; second, a dramatic decrease in confidence.6) Discuss the initial policy responses to the financial crisis.Answer: 1) In order to prevent a run by depositors, federal deposit insurance was increased from $100,000 to $250,000 per account. 2) The Fed provided widespread liquidity to the financial system.3) The government introduced a program, called the Troubled Asset Relief Program,or TARP, aimed at cleaning up banks. 4) The Fed decreased interest rate to zero. 5) In terms of fiscal policy, US government used a combination of reductions in taxes and increases in spending: The American Recovery and Reinvestment Act, was passed in February 2009. It called for $780 billion in new measures, in the form of both tax reductions and spending increases, over 2009 and 2010.7) Suppose a liquidity trap exists. Graphically illustrate and explain the effects of an increase in money supply using the IS-LM model.Answer: Given that the liquidity trap already exists, we know that the equilibrium in the IS-LM model occurs where the IS curve intersects the LM curve on the horizontal portion of the LM curve. When M increases,any increase in the money supply will simply be held by individuals and i will not fall. 8) Suppose a liquidity trap exists and output is below its natural level. Graphically illustrate and explain if the economy can return to its natural level using the AS-AD model.Answer: Given that the liquidity trap already exists, we know that AD curver is vertical. As output is belowits natural level, the aggregate supply curve shifts down over time. The price level keeps decreasing, but this does not lead to an increase in output.9) Explain what is meant by the liquidity trap. Also discuss the implications of a liquidity trap for the shapes of the money demand and LM curves.Answer: A liquidity trap occurs when the nominal interest rate equals zero and, therefore, can no longer fall. Usually, when there is an increase in the money supply, there would be an excess demand for bonds, an excess supply of money and the interest rate would fall. When i = 0, the return on bonds and money is the same. So, any increase in the money supply will simply be held by individuals and i will not fall. This implies that the money demand curve becomes horizontal at the zero interest rate. It also implies that LM curve becomes horizontal at the zero interest rate.10) Suppose a liquidity trap exists. Graphically illustrate and explain the effects of an increase in government spending using the IS-LM model.Answer: Given that the liquidity trap already exists, we know that the equilibrium in the IS-LM model occurs where the IS curve intersects the LM curve on the horizontal portion of the LM curve. When G increases, demand will increa