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1. The concept of 'neutrality of money' implies that a change in the quantity of money will, in the long run, affect:
Neutrality of money is the proposition that a change in the money stock causes a proportionate change in the absolute price level but leaves all real variables (relative prices, real income, real interest rate) unaffected in the long run.
Source: Palgrave Dictionary of Money and Finance, 'neutrality of money', p. 17; Mizen & Lewis (2000), p. 69.
2. The Crude Quantity Theory of Money, as expressed by the Fisher Equation \(MV = PT\), assumes that:
For the equation to predict that a change in the money supply (M) leads to a proportionate change in the price level (P), the theory assumes that the velocity of circulation (V) and the volume of transactions (T) are constant or determined exogenously by real factors.
Source: Harris, L. (1985). Monetary Theory, p. 48.
3. The 'classical dichotomy' refers to the theoretical separation of:
The classical dichotomy is the idea that the real side of the economy can be analyzed independently to determine relative prices and real quantities, while the monetary side separately determines the absolute price level, with money acting as a 'veil'.
Source: Mizen & Lewis (2000), p. 63; Subject Guide, Ch 5, p. 60.
4. According to Walras' Law, in an economy with 'n' markets:
Walras' Law states that the sum of the values of excess demands across all markets is identically zero (\(\sum p_i ED_i = 0\)). This implies that if all but one market are in equilibrium (i.e., their excess demands are zero), the final market must also be in equilibrium.
Source: Harris, L. (1985). Monetary Theory, p. 53; Subject Guide, Ch 5, p. 61.
5. Patinkin's 'real balance effect' suggests that the demand for goods is influenced by:
The real balance effect posits that the real value of money balances (M/P) is a component of an individual's wealth. Therefore, a change in the price level (P) alters real wealth, which in turn influences the demand for goods.
Source: Harris, L. (1985). Monetary Theory, p. 63; Mizen & Lewis (2000), p. 78.
6. How did Patinkin resolve the internal inconsistency of the classical model?
Patinkin's solution was to include real money balances as a variable in the excess demand functions for goods. This discards the Homogeneity Postulate and ensures that a change in the absolute price level affects the goods markets, creating a consistent link between the real and monetary sectors.
Source: Harris, L. (1985). Monetary Theory, p. 63-65.
7. In the Cambridge cash-balance equation, \(M = kPY\), the term 'k' represents:
The Cambridge 'k' represents the desired ratio of money holdings to nominal income. It is the reciprocal of the income velocity of money (V). The approach focuses on money as a store of value, or a 'temporary abode of purchasing power'.
Source: Harris, L. (1985). Monetary Theory, p. 49; Subject Guide, Ch 5, p. 59.
8. The 'homogeneity postulate' in the classical barter model states that the demand for goods is homogeneous of degree zero in:
This postulate means that if all money prices and the absolute price level change proportionately (e.g., all double), relative prices remain unchanged, and therefore the demand for real goods does not change. Demand depends only on relative prices, not the absolute level.
Source: Harris, L. (1985). Monetary Theory, p. 56.
9. What is the consequence of the homogeneity postulate for the determination of the absolute price level in a Walrasian barter model?
Because demand for goods depends only on relative prices, any absolute price level is consistent with equilibrium in the goods markets, as long as the relative prices are correct. The goods markets alone cannot determine the absolute price level.
Source: Harris, L. (1985). Monetary Theory, p. 56-57.
10. Say's Law, in its strong form, is an identity stating that:
Say's Law ('supply creates its own demand') in its identity form means that the aggregate excess demand for goods is always zero. This is distinct from Walras' Law, which includes the money market in the sum.
Source: Harris, L. (1985). Monetary Theory, p. 61; Subject Guide, Ch 5, p. 61.
11. In the classical view, what is the primary role of the interest rate?
In the classical loanable funds theory, the interest rate is a real variable determined by the real forces of productivity (governing investment) and thrift (governing saving). It is the price that brings the supply of and demand for loanable funds into equilibrium.
Source: Mizen & Lewis (2000), p. 69.
12. The 'direct effect' of the transmission mechanism in classical theory refers to:
The direct effect, associated with Hume, posits that if people have more money than they desire (an excess supply), they will spend it directly on goods and services. This increased demand for goods causes their prices to rise until equilibrium is restored.
Source: Mizen & Lewis (2000), p. 65.
13. The 'indirect effect' of the transmission mechanism, associated with Thornton and Wicksell, involves:
The indirect mechanism works through the banking system. An increase in the money supply increases bank deposits and reserves, leading to an increased supply of loans. This lowers the market interest rate, stimulating investment demand and subsequently raising the price level.
Source: Mizen & Lewis (2000), p. 66.
14. What is the effect of including the real balance effect on the homogeneity of the excess demand functions for goods?
By including real balances (M/P) as a variable, the excess demand functions for goods now depend on the absolute price level (P) directly, not just through relative prices. A change in P alone alters real balances and thus affects demand, meaning the functions are no longer homogeneous of degree zero.
Source: Harris, L. (1985). Monetary Theory, p. 63; Mizen & Lewis (2000), p. 79.
15. In Patinkin's corrected classical model, if the nominal money supply (M) doubles, what happens to the price level (P) and the real rate of interest (r) in the new long-run equilibrium?
Patinkin's model, while resolving the dichotomy, preserves the long-run neutrality of money. A doubling of the money supply leads to a doubling of the price level, leaving real balances (M/P) and all other real variables, including the real interest rate, unchanged in the new equilibrium.
Source: Harris, L. (1985). Monetary Theory, p. 66.
16. The 'short-run non-neutrality of money' in many classical and monetarist writings is often attributed to:
Short-run non-neutrality arises because prices and expectations do not adjust instantly. For example, Hume noted the 'intermediate situation, between the acquisition of money and rise of prices' where industry is stimulated. This is due to lags in adjustment.
Source: Palgrave Dictionary of Money and Finance, 'neutrality of money', p. 18.
17. What is the primary mechanism through which a central bank increases the money supply?
The central bank's primary tool is to change the monetary base. It does this by conducting open market operations. To increase the money supply, it purchases government bonds, which increases the reserves of the banking system, leading to a multiple expansion of money.
Source: Palgrave Dictionary of Money and Finance, 'quantity theory of money', p. 251.
18. In a Walrasian general equilibrium model, the role of the 'auctioneer' is to:
The auctioneer is a hypothetical coordinator who facilitates equilibrium. Through a process of 'tâtonnement' (groping), the auctioneer calls out sets of relative prices, observes the resulting excess demands, and adjusts prices until a set is found where all excess demands are zero, at which point trade occurs.
Source: Harris, L. (1985). Monetary Theory, p. 51; Mizen & Lewis (2000), p. 53.
19. The introduction of the real balance effect into the classical model implies that Say's Law:
The real balance effect means a change in the price level affects real wealth, which in turn affects demand for all goods. Therefore, a change in P can cause a situation where there is an aggregate excess supply (or demand) for goods, meaning Say's Law no longer holds as an identity (i.e., \(\sum p_i ED_i\) is not always zero).
Source: Harris, L. (1985). Monetary Theory, p. 63; Mizen & Lewis (2000), p. 80.
20. What is 'superneutrality' of money?
Superneutrality is a stronger condition than neutrality. While neutrality refers to a one-time change in the level of the money supply, superneutrality refers to a change in its rate of growth. If money is superneutral, a change in the steady-state rate of inflation will not affect real variables like the real interest rate.
Source: Palgrave Dictionary of Money and Finance, 'neutrality of money', p. 19.
21. In the classical system, money is often referred to as a 'veil' because:
The 'veil of money' concept suggests that the real sector operates on the basis of relative prices and could function perfectly well without money. Money is a superficial covering that determines the absolute price level but does not change the essential real workings of the economy.
Source: Mizen & Lewis (2000), p. 63-64.
22. The 'tâtonnement' or 'groping' process in a Walrasian market ensures that:
Tâtonnement is a process where the auctioneer calls out prices and individuals signal their desired trades. These are only provisional contracts. No actual trading occurs until the auctioneer finds the price vector at which all markets clear simultaneously.
Source: Harris, L. (1985). Monetary Theory, p. 51.
23. Patinkin argued that the classical dichotomy was invalid because:
This is the core of the inconsistency. The two parts of the dichotomized model yielded two different and incompatible excess demand functions for money. The function derived from the real sector was homogeneous of degree one in prices, while the function from the quantity theory was not, creating a logical contradiction.
Source: Mizen & Lewis (2000), p. 77; Harris, L. (1985), p. 59.
24. A key prediction of the Crude Quantity Theory is that a 10% increase in the money supply will lead to:
The central proposition of the Crude Quantity Theory is that a change in the supply of money causes a proportionate change in the absolute price level, assuming V and T (or Y) are constant.
Source: Harris, L. (1985). Monetary Theory, p. 47.
25. In the simple general equilibrium model from the subject guide, where utility is \(U = X^{1/2}(M/P)^{1/2}\), what is the equilibrium price level (P)?
By solving the household's optimization problem and imposing the market-clearing condition (total demand for goods equals total supply, \(nX = nX_0\)), we find that the equilibrium price level is \(P = M_0 / X_0\). This demonstrates the quantity theory result that prices are proportional to the money supply.
Source: Subject Guide, Ch 5, p. 64.
26. The 'real balance effect' is considered a 'wealth effect' because:
A fall in the price level increases the real value (purchasing power) of a given stock of nominal money, making the holder wealthier in real terms. This increase in real wealth then leads to an increase in demand for goods.
Source: Harris, L. (1985). Monetary Theory, p. 70.
27. In a Walrasian system, if there is an excess supply in the goods market, Walras' Law implies there must be:
Walras' Law states that the sum of excess demands across all markets is zero. If there is an excess supply of goods (a negative excess demand), there must be a corresponding positive excess demand for money to maintain the identity \(\sum p_i ED_i = 0\).
Source: Harris, L. (1985). Monetary Theory, p. 53.
28. The Cambridge approach to the quantity theory is considered a:
The Cambridge equation \(M = kPY\) is best interpreted as a demand-for-money function, where the demand for nominal money balances is a proportion (k) of nominal income (PY). This contrasts with Fisher's focus on the flow of transactions.
Source: Harris, L. (1985). Monetary Theory, p. 48-49.
29. According to Hume's analysis of the transmission mechanism, an increase in the quantity of money is favorable to industry only:
Hume argued that the stimulative effect of money occurs only in the short run, during the transition period when the new money is circulating but before prices have fully adjusted upwards. This is a classic statement of short-run non-neutrality.
Source: Palgrave Dictionary of Money and Finance, 'neutrality of money', p. 18 (quoting Hume).
30. A central bank can decrease the money supply by:
An open market sale involves the central bank selling bonds to commercial banks. The banks pay for these bonds with their reserves, which reduces the monetary base and leads to a multiple contraction of the money supply.
Source: Palgrave Dictionary of Money and Finance, 'quantity theory of money', p. 251.
31. In the Archibald and Lipsey critique of Patinkin's static real balance effect, a one-time increase in the money supply leads to:
Archibald and Lipsey showed that in a dynamic, sequential analysis, the initial wealth effect is temporary. The resulting increase in demand pushes up prices, which reduces real balances over successive periods until they return to their original level. The real balance effect is a transitory, not a permanent, phenomenon.
Source: Harris, L. (1985). Monetary Theory, p. 80.
32. The 'homogeneity postulate' is a property of which type of economic model?
The homogeneity postulate, which states that demand for goods depends only on relative prices, is a key feature of a Walrasian general equilibrium model of a barter economy. Patinkin showed this postulate is what makes the model inconsistent when money is introduced via the quantity theory.
Source: Harris, L. (1985). Monetary Theory, p. 54.
33. What is the key difference between Walras' Law and Say's Law?
Walras' Law states that the sum of excess demands over all 'n' markets (goods and money) is zero. Say's Law, in its identity form, states that the sum of excess demands over the 'n-1' goods markets alone is zero, precluding a general glut of goods.
Source: Harris, L. (1985). Monetary Theory, p. 61.
34. If the velocity of money (V) doubles and the money supply (M) is halved, what happens to nominal income (PY) according to the quantity equation?
From the equation \(MV = PY\), nominal income is \(PY\). If M is halved (\(0.5M\)) and V is doubled (\(2V\)), the new nominal income is \((0.5M)(2V) = MV = PY\). The two changes exactly offset each other, leaving nominal income unchanged.
Source: Subject Guide, Ch 5, p. 58-59.
35. The 'loanable funds' theory of the interest rate states that the interest rate is determined by:
In the classical loanable funds doctrine, the interest rate is the 'price' of funds, determined in the real sector by the equilibrium between the supply of funds from savers (driven by thrift) and the demand for funds by firms for investment (driven by productivity).
Source: Mizen & Lewis (2000), p. 69.
36. Why does Patinkin's real balance effect provide a 'bridge' between the real and monetary sectors?
By making the demand for goods a function of real money balances (M/P), the real balance effect ensures that a change in the absolute price level (P) has a real effect on the goods market. This breaks the classical dichotomy and creates a consistent link between the two sectors.
Source: Subject Guide, Ch 5, p. 63.
37. In a simple Walrasian model, how are relative prices determined?
In a Walrasian system with n-1 goods, there are n-2 independent market-clearing equations. These are sufficient to solve for the n-2 independent relative prices, which determine the equilibrium of the real sector.
Source: Subject Guide, Ch 5, p. 61.
38. The 'neutrality of money' is a property of:
Neutrality is a long-run proposition. It compares two different long-run equilibrium states, one before and one after a change in the money supply, and concludes that real variables are ultimately unaffected.
Source: Palgrave Dictionary of Money and Finance, 'neutrality of money', p. 18.
39. An increase in the required reserve ratio by the central bank will:
A higher reserve ratio (r) means banks must hold a larger fraction of each deposit in reserve, so they can lend out less. This reduces the size of the re-lending process, thereby decreasing the money multiplier \(m = (c+1)/(c+r)\).
Source: Palgrave Dictionary of Money and Finance, 'quantity theory of money', p. 251.
40. In the classical model, if an economy is at full employment, an increase in the money supply will lead primarily to:
With real output (T or Y) fixed at the full-employment level and velocity (V) assumed constant, the quantity equation \(MV = PY\) dictates that an increase in the money supply (M) must be fully reflected in a proportional increase in the price level (P).
Source: Harris, L. (1985). Monetary Theory, p. 48-49.
41. The 'real bills doctrine' was a flawed argument used by the Bank of England which stated that:
The Bank argued it was passively facilitating trade and not causing inflation. However, as Ricardo and Wicksell pointed out, if the discount rate was kept 'too low' (below the natural rate), it would lead to an excessive creation of credit and money, causing inflation, regardless of the quality of the bills.
Source: Mizen & Lewis (2000), p. 68.
42. What is the effect of the real balance effect on Say's Law?
The real balance effect means a change in the price level can cause a uniform excess demand or supply across all goods markets. This contradicts Say's Law as an identity (which states aggregate excess demand for goods is always zero). However, Say's Law can still hold as an equilibrium condition (i.e., when the money market is also in equilibrium).
Source: Mizen & Lewis (2000), p. 80.
43. The 'Currency School' advocated that a mixed paper-gold currency should:
In line with Ricardo, the Currency School believed that the money supply should be strictly tied to the gold reserve to ensure stability and prevent the over-issue of paper money by banks. They argued against the discretion of the Banking School's 'real bills doctrine'.
Source: Mizen & Lewis (2000), p. 68.
44. In Patinkin's model, why is money not neutral in the short run after an increase in the money supply?
An increase in M, at the initial price level, increases real balances (M/P). This wealth effect causes an excess demand for goods. This excess demand is a real effect that occurs before prices have fully adjusted. The subsequent price rise eventually restores neutrality, but the initial impact is on real demand.
Source: Harris, L. (1985). Monetary Theory, p. 64-65.
45. The 'natural rate of interest' in Wicksell's theory is the rate that is:
Wicksell's natural rate is the real rate of interest required to clear the loanable funds market, determined by the productivity of capital. The 'market rate' is the rate set by banks. Inflation or deflation occurs when the market rate diverges from the natural rate.
Source: Mizen & Lewis (2000), p. 67.
46. If the demand for money is \(M^d = 0.25PY\), what is the income velocity of money (V)?
The Cambridge equation is \(M = kPY\) and the Fisher equation is \(MV = PY\). In equilibrium, \(kPY = M\), so \(PY/M = 1/k\). Since \(V = PY/M\), it follows that \(V = 1/k\). If k = 0.25, then V = 1/0.25 = 4.
Source: Harris, L. (1985). Monetary Theory, p. 50.
47. The 'homogeneity postulate' implies that if all individual money prices double, the demand for any specific good will:
If all money prices double, the absolute price level also doubles, but all relative prices (e.g., \(p_i/p_j\)) remain unchanged. Since demand in this framework depends only on relative prices and real endowments, demand for goods remains unchanged.
Source: Harris, L. (1985). Monetary Theory, p. 54.
48. In the context of the classical dichotomy, Patinkin's key insight was that money-holding decisions and goods-purchasing decisions are:
Patinkin's analysis undermined the dichotomy by showing that the decision to buy or sell goods is simultaneous with the decision to decrease or increase money holdings. Therefore, the excess demand for goods and the excess demand for money are interdependent and cannot be analyzed in separate sectors.
Source: Mizen & Lewis (2000), p. 78.
49. A primary reason for the short-run non-neutrality of money, according to Fisher, was:
Fisher's theory of the business cycle ('the dance of the dollar') was based on the idea that when a monetary expansion causes inflation, the nominal interest rate lags behind. This causes the real interest rate to fall, which stimulates borrowing and investment, affecting real activity in the short run.
Source: Palgrave Dictionary of Money and Finance, 'neutrality of money', p. 18.
50. If a monetary authority increases the required reserve ratio, it is attempting to:
Increasing the required reserve ratio forces banks to hold a larger fraction of deposits as reserves, reducing the amount available for lending. This directly reduces the money multiplier, and for a given monetary base, leads to a contraction in the overall money supply.
Source: Palgrave Dictionary of Money and Finance, 'quantity theory of money', p. 251.