Chapter 1 Practice Question Answers

1. 1. Answer: A. A recession is said to occur when the contraction phase of the business cycle lasts more than two quarters (six months). A contraction phase is typically measured through gross domestic product (GDP).
2. 2. Answer: A. If the Fed buys Treasuries, more money goes into the economy, causing interest rates to drop. When interest rates are low, credit is more available, so people and businesses spend more, thereby stimulating the economy.
3. 3. Answer: D. The Federal Reserve Board uses three tools to implement monetary policy: open market operations, discount window lending, and altering the reserve requirements. While the Fed may be able to alter the value of the dollar, it is not one its tools to implement monetary policy.
4. 4. Answer: C. The Fed usually lowers interest rates to stimulate an economy. The Fed may do this if there is a drop in housing starts. The Fed may choose to raise interest rates if there is an increase in the CPI or the PPI.
5. 5. Answer: C. The Fed monitors several economic indicators when making monetary policy decisions. The Fed tightens the money supply to control rising prices. When a central bank tightens the money supply, it causes interest rates to rise. Higher interest rates attract foreign investors, and this increased investment raises the value of the currency. (But because of the special place of the dollar in the world market, the Fed rarely alters interest rates based on the strength of the dollar.) If the GDP declines, the Fed may try to stimulate the economy by loosening the money supply.
6. 6. Answer: C. The Federal Reserve may tighten the money supply by raising interest rates if it suspects a rise in inflation suggested by a rise in the CPI. The Fed may also raise interest rates if there is an increase in the trade deficit, to reduce the flow of dollars out of the country and attract foreign investors. A rise in non-farm payroll generally signals a healthy