Chapter 7 Practice Question Answers
1. Answer: A. A recession is said to occur when the contraction phase of the business cycle lasts two quarters (six months) or more. A contraction phase is typically measured through gross domestic product.
2. 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.
3. Answer: C. The Fed monitors several economic indicators when making monetary policy decisions. The Fed tightens the money supply to control rising prices. A central bank may tighten the money supply if there is a drop in the value of the country’s currency to make it less attractive to foreign investors. (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.
4. 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 economy, but it could cause the Fed to tighten the money supply if this coincident indicator in combination with certain leading indicators suggests inflation. However, a widening in credit spreads indicates an economic contraction and might move the Fed to increase the money supply.
5. Answer: B. A normal yield curve reflects the fact that bonds with longer maturities tend to pay higher yields than bonds with shorter maturities. A flat yield curve is when short-, medium-, and long-term bonds all pay relatively similar yields. An inverted yield curve is when short-term bonds pay low