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1. The concept of 'superneutrality' of money suggests that a change in the:
Superneutrality is a stronger condition than neutrality. It holds if a change in the steady-state rate of monetary growth (and thus inflation) does not affect real variables such as the real rate of interest or per-capita capital in the long run.
Source: Palgrave Dictionary of Money and Finance, 'neutrality of money', p. 19.
2. In the Cambridge cash-balance approach (\(M = kPY\)), what does the equation represent from a theoretical standpoint?
The Cambridge equation is best interpreted as a theory of the demand for money, where the demand to hold money (M) is a stable proportion (k) of nominal income (PY). This focus on money holding (a stock) contrasts with Fisher's focus on money spending (a flow).
Source: Harris, L. (1985). Monetary Theory, p. 49; Palgrave Dictionary of Money and Finance, 'quantity theory of money', p. 250.
3. The idea of money as a 'veil' over the real economy is a direct consequence of which classical concepts?
The classical dichotomy separates the real and monetary sectors. The homogeneity postulate ensures that demand for goods depends only on relative prices. Together, these imply that the real sector can be determined independently, with money merely setting the absolute price level, thus acting as a 'veil'.
Source: Mizen & Lewis (2000), p. 63-64.
4. In a monetary economy, how does Walras' Law differ from Say's Law?
In a monetary economy, Walras' Law (\(\sum ED_{goods} + ED_{money} = 0\)) allows for an aggregate excess supply of goods (a 'glut') as long as it is matched by an equal value of excess demand for money (hoarding). Say's Law (\(\sum ED_{goods} = 0\)) rules this out by definition.
Source: Mizen & Lewis (2000), p. 57.
5. Patinkin's model with a real balance effect demonstrates that the demand for goods depends on:
By including real balances (M/P) in the demand functions for goods, Patinkin showed that demand depends not only on relative prices but also on the absolute price level (P), as P affects the real value of wealth. This breaks the homogeneity postulate.
Source: Mizen & Lewis (2000), p. 79.
6. An open market sale of bonds by the central bank is a tool used to:
When the central bank sells bonds, it removes reserves from the banking system as commercial banks pay for them. This reduction in the monetary base leads to a multiple contraction of the money supply via the money multiplier.
Source: Palgrave Dictionary of Money and Finance, 'quantity theory of money', p. 251.
7. In Tobin's (1965) money-and-growth model, why is money not superneutral?
Tobin showed that a higher rate of monetary growth (and thus inflation) makes holding money more costly. This induces a portfolio shift away from real balances and towards physical capital. The resulting increase in the capital stock lowers the real rate of interest, demonstrating that a change in the rate of monetary growth affects a real variable.
Source: Palgrave Dictionary of Money and Finance, 'neutrality of money', p. 20.
8. The Fisherian and Cambridge versions of the quantity theory are different in that:
The Fisher (transactions) version focuses on the flow of money being spent over a period. The Cambridge (cash-balance) version focuses on the stock of money that individuals desire to hold at a point in time. Robertson characterized this as the difference between 'money on the wing' and 'money sitting'.
Source: Harris, L. (1985). Monetary Theory, p. 62.
9. In the classical system, what is a 'numéraire'?
In a general equilibrium system, prices are expressed in relative terms. The numéraire is the good that is chosen as the standard of value or unit of account. For example, all prices could be expressed in terms of units of gold.
Source: Mizen & Lewis (2000), p. 54.
10. The dynamic analysis by Archibald and Lipsey shows that the real balance effect is a:
They demonstrated that while an initial increase in real balances creates a temporary excess demand for goods, the resulting price rise eventually restores real balances to their original level. In the new permanent equilibrium, real variables are unchanged, meaning the effect is transitory and money remains neutral in the long run.
Source: Harris, L. (1985). Monetary Theory, p. 80, 83.
11. According to Wicksell's 'cumulative process', when does inflation occur?
Wicksell argued that if banks set a market interest rate below the 'natural rate' (the return on new capital), entrepreneurs would have an incentive to borrow and invest. This excess demand for loans and capital goods would lead to a cumulative, ongoing rise in the price level (inflation).
Source: Mizen & Lewis (2000), p. 67.
12. The 'Banking School' argued that the money supply was endogenous because:
The Banking School held that as long as banks lent against sound 'real bills' (short-term commercial paper), the money supply would automatically adjust to the level of economic activity (the 'needs of trade') and could not be inflationary. This view sees money as demand-determined (endogenous).
Source: Mizen & Lewis (2000), p. 68.
13. In the simple general equilibrium model \(X + M/P = X_0 + M_0/P\), the term \(X_0 + M_0/P\) represents the household's:
This expression represents the total real resources available to the household. It is the sum of their initial endowment of real goods (\(X_0\)) and the real value of their initial money holdings (\(M_0/P\)). This total wealth constrains their choices of consumption (X) and final money holdings (M/P).
Source: Subject Guide, Ch 5, p. 63.
14. The short-run non-neutrality of money, where an increase in M temporarily boosts output, was explained by Hume as resulting from:
Hume's classic argument was that the stimulative effect occurs 'in this interval or intermediate situation, between the acquisition of money and rise of prices'. This lag means that for a time, real activity is affected before the system returns to long-run neutrality.
Source: Palgrave Dictionary of Money and Finance, 'neutrality of money', p. 18.
15. What is the primary reason that Patinkin's real balance effect is considered a 'wealth effect'?
The effect works through the channel of wealth. A fall in the price level increases the real value of nominal money holdings. Since these money holdings are part of an individual's wealth, their real wealth increases, leading them to increase their demand for goods.
Source: Harris, L. (1985). Monetary Theory, p. 70.
16. In the classical model, the demand for labor is a function of the:
In classical theory, firms are rational and free of money illusion. They base their hiring decisions on the real cost of labor (the nominal wage divided by the price level), not the nominal wage itself.
Source: Palgrave Dictionary of Money and Finance, 'neutrality of money', p. 18.
17. The 'natural rate of unemployment' is the rate that:
The natural rate is the equilibrium rate of unemployment determined by real, structural factors in the economy, such as market imperfections, costs of information, and mobility. It is the rate that would be 'ground out by the Walrasian system of general equilibrium equations'.
Source: Palgrave Dictionary of Money and Finance, 'quantity theory of money', p. 258.
18. The Arrow-Debreu model of general equilibrium is built on which two basic principles?
The Arrow-Debreu model is founded on: 1) optimizing behavior by all economic agents (firms maximize profits, households maximize utility) given a set of prices, and 2) the setting of prices such that supply equals demand in all markets (market clearing).
Source: Mizen & Lewis (2000), p. 90.
19. A major problem in applying the Arrow-Debreu framework to a monetary economy is that:
A major stumbling block is that the standard Arrow-Debreu model has no role for money. With a full set of markets and costless exchange, there is no need for a medium of exchange. This makes it difficult to use as a foundation for monetary theory without modification.
Source: Mizen & Lewis (2000), p. 92.
20. In the context of the classical dichotomy, what was Patinkin's fundamental objection?
Patinkin's analysis showed that the sectors could not be held apart. Since the decision to sell goods is also a decision to acquire money, the excess demand for money and the excess supply of goods are interdependent. Any attempt to partition the sectors into two independent blocks is therefore inconsistent.
Source: Mizen & Lewis (2000), p. 78.
21. The 'money-in-the-utility-function' approach is a method to:
This approach gets around the problem that money is not consumed directly by assuming that holding real balances provides utility, perhaps as a proxy for the convenience and liquidity services money offers. This creates a direct demand for money within the standard optimization framework.
Source: Mizen & Lewis (2000), p. 94.
22. The 'cash-in-advance' constraint is a modeling device that assumes:
Proposed by Clower, this approach imposes a restriction that goods cannot be bought with other goods, but only with money held in advance. It is a way of formally building the medium-of-exchange function of money into a general equilibrium model.
Source: Mizen & Lewis (2000), p. 95.
23. In the simple general equilibrium model, if a household's utility function is \(U = X^{1/2}(M/P)^{1/2}\), what does this imply about their preferences?
This specific Cobb-Douglas utility function implies that the household allocates its budget equally between the two 'goods' that provide utility: consumption of real goods (X) and the liquidity services from holding real money balances (M/P).
Source: Subject Guide, Ch 5, p. 63.
24. The 'price-specie-flow mechanism' describes how, under a gold standard, a trade imbalance is corrected by:
This classical mechanism, described by Hume, posits that a country with a trade deficit would experience an outflow of gold (specie). This would reduce its money supply, lowering its price level and making its goods more competitive, thus automatically correcting the deficit.
Source: Palgrave Dictionary of Money and Finance, 'quantity theory of money', p. 255.
25. If the central bank lowers the required reserve ratio, the money supply is expected to increase because:
Lowering the required reserve ratio (r) increases the money multiplier (m = (c+1)/(c+r)). This means that for any given amount of reserves in the banking system, a larger total amount of loans and deposits can be supported, leading to an expansion of the money supply.
Source: Palgrave Dictionary of Money and Finance, 'quantity theory of money', p. 251.
26. The Fisher effect describes the tendency for the:
The Fisher effect posits that arbitrage between real and nominal assets will cause the nominal interest rate to fully incorporate the expected rate of inflation, such that the underlying real rate of interest is unaffected.
Source: Palgrave Dictionary of Money and Finance, 'neutrality of money', p. 18.
27. In the context of a Walrasian system, what does it mean for the system to be 'overidentified'?
Patinkin's critique included the charge that the classical model was overidentified (or overdetermined). After accounting for Walras' Law, there were effectively 'n' independent equations to determine only 'n-1' unknowns (the relative prices), which is a logical inconsistency.
Source: Mizen & Lewis (2000), p. 74.
28. The 'shoe-leather costs' of inflation refer to:
When inflation is high, the opportunity cost of holding money is high. Individuals and firms therefore try to minimize their cash holdings, which requires more frequent trips to the bank or more intensive cash management. The resources (time, effort, wearing out shoes) spent on this are the 'shoe-leather costs'.
Source: Palgrave Dictionary of Money and Finance, 'neutrality of money', p. 22.
29. In the simple general equilibrium model, why is money neutral?
All these factors contribute. Because real output is fixed by endowments, a change in the money supply must be fully absorbed by a change in the price level to clear the market. The model shows P = Mo/Xo. A doubling of Mo leads to a doubling of P, leaving real balances (M/P) and real consumption (X) unchanged in the new equilibrium.
Source: Subject Guide, Ch 5, p. 64.
30. The 'natural rate of unemployment' hypothesis implies that the long-run Phillips Curve is:
The natural rate hypothesis states that in the long run, unemployment is determined by real structural factors and is independent of the rate of inflation. Therefore, the long-run Phillips Curve is a vertical line at the natural rate of unemployment.
Source: Palgrave Dictionary of Money and Finance, 'quantity theory of money', p. 258.
31. What is the primary reason for the short-run, downward-sloping Phillips Curve in the natural rate framework?
In the short run, an unanticipated increase in inflation can temporarily lower real wages (if nominal wages don't adjust immediately), inducing firms to hire more labor and reducing unemployment. This creates a temporary trade-off, but it disappears once expectations adjust.
Source: Palgrave Dictionary of Money and Finance, 'quantity theory of money', p. 258.
32. The 'Lucas critique' suggests that:
The Lucas critique argues that because rational agents change their behavior in response to new policies, the structural parameters of econometric models estimated on past data will not be stable under a new policy regime. This makes it difficult to use such models to predict the effects of policy changes.
Source: Palgrave Dictionary of Money and Finance, 'neutrality of money', p. 19.
33. In the classical model, what ensures that the loanable funds market clears?
The real interest rate is the 'price' of loanable funds. It adjusts to equilibrate the supply of funds (from saving) and the demand for funds (for investment), ensuring the market clears.
Source: Mizen & Lewis (2000), p. 69.
34. The 'homogeneity postulate' is inconsistent with the real balance effect because:
The homogeneity postulate states that demand for goods is homogeneous of degree zero in absolute prices (i.e., depends only on relative prices). The real balance effect shows that a change in the absolute price level alters real wealth (M/P) and thus affects the demand for goods, directly contradicting the postulate.
Source: Harris, L. (1985). Monetary Theory, p. 63.
35. In a simple classical model, if the money supply grows at 5% and real output grows at 2%, the quantity theory predicts the inflation rate will be:
In rate-of-change form, the quantity equation is \(g_M + g_V = g_P + g_Y\). Assuming velocity is constant (\(g_V = 0\)), the rate of inflation (\(g_P\)) is the growth rate of money minus the growth rate of real output. So, \(g_P = 5\% - 2\% = 3\%\).
Source: Subject Guide, Ch 5, p. 59.
36. The 'overlapping generations' model provides a rationale for the existence of money as a:
In the OLG model, individuals live for two periods, working when young and retired when old. With non-storable goods, they need an asset to transfer consumption from their working period to their retirement period. Fiat money can serve this store-of-value function.
Source: Mizen & Lewis (2000), p. 93.
37. A key problem with the classical dichotomy that Patinkin identified was that it created two incompatible excess demand functions for which market?
The inconsistency arose in the money market. The excess demand for money derived from the real sector (via Walras' Law) was homogeneous of degree one in prices, while the excess demand for money from the quantity theory was non-homogeneous. A single variable cannot be described by two inconsistent functions.
Source: Mizen & Lewis (2000), p. 77.
38. According to the classical theory, the 'indirect transmission mechanism' for monetary policy requires the existence of:
The indirect mechanism, associated with Thornton and Wicksell, works through the credit market. An increase in the money supply increases bank reserves, which lowers the market interest rate on loans, stimulating investment and then prices. This requires a banking system to intermediate the funds.
Source: Mizen & Lewis (2000), p. 66.
39. If the central bank increases the monetary base, but commercial banks decide to hold all of the increase as excess reserves, what will be the effect on the money supply?
The money multiplier process depends on banks lending out their excess reserves. If banks simply hold the new reserves, the re-lending cycle does not start. The money supply (M=C+D) will not change, while the monetary base (MB=C+R) increases. The money multiplier effectively falls to offset the increase in the base.
Source: Based on the logic of the money multiplier in EC3115 - Monetary Economics Unit E Lectures.
40. In the Walrasian system, why are only \(n-1\) equations independent in a system of \(n\) markets?
Walras' Law implies a linear dependence among the market-clearing equations. Because the sum of all excess demands must be zero, if the first \(n-1\) markets are in equilibrium, the nth market is guaranteed to be in equilibrium as well. Therefore, one equation is redundant.
Source: Mizen & Lewis (2000), p. 91.
41. The 'real balance effect' is essential for the internal consistency of a classical model that includes both a Walrasian real sector and a Quantity Theory monetary sector because it:
The real balance effect resolves Patinkin's inconsistency. By making the demand for goods dependent on real balances (M/P), it ensures that the excess demand functions for goods are no longer homogeneous of degree zero in prices. This creates a consistent link with the money market, where demand also depends on the absolute price level.
Source: Harris, L. (1985). Monetary Theory, p. 63-65.
42. According to the Cambridge cash-balance theory, a general move from weekly to monthly wage payments would:
If income payments are less frequent (monthly vs. weekly), individuals must hold larger average cash balances to cover their expenditures over the longer interval. This increases the desired proportion of income held as money, increasing 'k'.
Source: Harris, L. (1985). Monetary Theory, p. 50.
43. The neutrality of money proposition is a central feature of:
The idea that money is neutral in the long run—affecting only nominal variables—is a cornerstone of classical and neoclassical monetary thought, from Hume through to modern monetarism.
Source: Mizen & Lewis (2000), p. 63.
44. In Liviatin's extension of the Archibald-Lipsey model, what happens if the locus of temporary equilibria (SS') is steeper than the locus of permanent equilibria (LL')?
If the SS' locus is steeper, a departure from equilibrium (e.g., to E2) leads to a dynamic path that moves further and further away from the permanent equilibrium point (E1), resulting in an unstable, explosive path for prices and real balances.
Source: Harris, L. (1985). Monetary Theory, p. 81, 84.
45. The 'real bills doctrine' is an argument for why the money supply should be considered:
The doctrine holds that as long as banks issue money only in response to demand for loans backed by real goods (real bills), the money supply will automatically be appropriate for the level of economic activity. This is a classic argument for an endogenous money supply.
Source: Mizen & Lewis (2000), p. 68.
46. A key difference between the 'direct' and 'indirect' transmission mechanisms is that the indirect mechanism explicitly includes:
The direct mechanism involves excess money being spent directly on goods. The indirect mechanism, developed by Thornton and Wicksell, posits that the monetary expansion first impacts the loan market, lowering the interest rate, which then stimulates investment and prices.
Source: Mizen & Lewis (2000), p. 66-67.
47. In the simple general equilibrium model, if the initial endowment of goods (Xo) doubles while the money supply (Mo) stays the same, the price level (P) will:
The equilibrium price level is given by \(P = M_0 / X_0\). If \(X_0\) doubles to \(2X_0\), the new price level will be \(P' = M_0 / (2X_0) = 0.5P\). The price level will be halved.
Source: Subject Guide, Ch 5, p. 64.
48. The existence of 'money illusion' would violate which core assumption of the classical neutrality-of-money proof?
The rigorous proof of neutrality depends on individuals being free of money illusion. This means their real behavior (e.g., demand for goods) does not change when all nominal values (prices, nominal money, nominal bonds) change in the same proportion, as this does not affect their real budget constraint. This is the property of homogeneity of degree zero.
Source: Palgrave Dictionary of Money and Finance, 'neutrality of money', p. 17.
49. Why does the introduction of an interest-bearing asset (bonds) complicate the Archibald-Lipsey conclusion that a unique, stable equilibrium is always restored?
In Liviatin's analysis, adding an interest-bearing asset means income depends on asset holdings. This makes the LL' curve upward-sloping. Depending on its slope relative to the SS' curve, the system can become unstable (diverging from equilibrium) or have no equilibrium at all.
Source: Harris, L. (1985). Monetary Theory, p. 81-84.
50. The classical dichotomy implies that the real sector and monetary sector are determined recursively. What does this mean?
Dichotomization means the system can be solved sequentially or recursively. First, the real sector equations are solved for all relative prices and real quantities. Then, taking real income as given, the quantity theory equation is used to solve for the absolute price level.
Source: Mizen & Lewis (2000), p. 63.