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Chapter 21Monetary Policy Strategy: The International Experience

Multiple Choice

1) Overly expansionary monetary policy

(a) leads to high inflation.(b) decreases the efficiency of the economy.(c) hampers economic growth.(d) does all of the above.(e) does only (a) and (b) of the above.

Answer:Question Status: Previous Edition


(a) leads to high inflation.(b) can produce serious recessions. (c) leads to deflation. (d) does all of the above.(e) does only (a) and (b) of the above.



(a) decreases the efficiency of the economy.(b) hampers economic growth.(c) leads to deflation.(d) all of the above.(e) does only (a) and (b) of the above.


767 Frederic S. Mishkin • Economics of Money, Banking, and Financial Markets, Seventh Edition


(a) leads to deflation.(b) decreases the efficiency of the economy.(c) can produce serious recessions. (d) does all of the above.(e) does only (a) and (b) of the above.


5) Monetary policy that is too tight can

(a) produce serious recessions in which output falls and unemployment rises.(b) lead to deflation, which, in turn, can help trigger financial crises.(c) lead to inflation, which decreases the efficiency of the economy.(d) do all of the above.(e) do only (a) and (b) of the above.


6) Monetary policy that is too tight can

(a) produce serious recessions in which output falls and unemployment rises.(b) lead to inflation, which, in turn, can help trigger financial crises.(c) lead to inflation, which decreases the efficiency of the economy.(d) do all of the above.(e) do only (a) and (b) of the above.


7) A central feature of monetary policy strategies in all countries is the use of a nominal variable that monetary policymakers use as an intermediate target to achieve an ultimate goal such as price stability. Such a variable is called a nominal

(a) anchor.(b) benchmark.(c) tether.(d) guideline.


8) A central feature of monetary policy strategies in all countries is the use of a nominal anchor, which is a nominal variable that monetary policymakers use as

(a) an operating target, such as the federal funds interest rate.(b) an intermediate target, such as the federal funds interest rate.(c) an intermediate target to achieve an ultimate goal such as price stability. (d) an operating target to achieve an ultimate goal such as exchange rate stability.


Chapter 21 Monetary Policy Strategy: The International Experience 768

9) A nominal anchor

(a) is a necessary element in successful monetary policy strategies.(b) is a nominal variable that monetary policymakers use as intermediate target to achieve an

ultimate goal such as price stability.(c) forces a nation’s monetary authority to keep the price level from growing or falling too fast.(d) is all of the above.(e) is only (a) and (b) of the above.


10) A nominal anchor

(a) can help promote price stability.(b) is a necessary element in successful monetary policy strategies.(c) forces a nation’s monetary authority to keep the price level from growing or falling too fast.(d) can do all of the above.(e) can do only (a) and (b) of the above.


11) Economic variables that can serve as a nominal anchor for monetary policy include

(a) the exchange rate.(b) the inflation rate.(c) the federal budget deficit.(d) all of the above.(e) both (a) and (b) of the above.

Answer:Question Status: New


(a) the exchange rate.(b) the inflation rate.(c) the money supply.(d) all of the above.(e) both (a) and (b) of the above.



(a) the unemployment rate.(b) the inflation rate.(c) the federal budget deficit.(d) all of the above.(e) both (a) and (b) of the above.



14) A nominal anchor promotes price stability by

(a) outlawing inflation.(b) stabilizing interest rates.(c) keeping inflation expectations low.(d) keeping economic growth low.(e) all of the above.


15) The theory that monetary policy conducted on a discretionary, day-by-day basis leads to poor long-run outcomes is referred to as the

(a) adverse selection problem.(b) moral hazard problem.(c) time-consistency problem.(d) nominal-anchor problem.

Answer:Question Status: Revised

16) The _____ problem of discretionary policy arises because economic behavior is influenced by what firms and people expect the monetary authorities to do in the future.

(a) moral hazard(b) time-consistency(c) nominal-anchor(d) rational-expectation


17) If the central bank pursues a monetary policy that is more expansionary than what firms and people expect, then the central bank must be trying to

(a) boost output in the short run.(b) constrain output in the short run.(c) constrain prices.(d) boost prices in the short run.


18) The time-consistency problem in monetary policy can occur when the central bank conducts policy

(a) using a nominal anchor. (b) using a strict and an inflexible rule.(c) on a discretionary, day-by-day basis.(d) using a flexible, discretionary rule.



19) In the face of rising unemployment, a central bank that conducts monetary policy on a discretionary, day-by-day basis may be tempted to pursue monetary policy that is more expansionary than they had announced. If the policy leads to high inflation with no reduction in unemployment it is because

(a) workers and firms, knowing that the central bank has discretion, raised their expectations of prices, wages, and inflation.

(b) the monetary anchor proved to be an inaccurate indicator of the direction of inflation.(c) of both of the above reasons.(d) of neither of the above reasons; it was simply bad luck.


20) A professor tells his students that if they do not do well on the midterm exam, he will assign a ten-page research paper. Students are likely to be skeptical because

(a) they know that the professor may renege to avoid the extra work of grading the papers. (b) they have been covering moral hazard and adverse selection problems in financial markets. (c) of both of the above reasons.(d) of neither of the above reasons.


21) The discrepancy between announcements (what policymakers say they are going to do) and actions (what they subsequently in fact do) is called

(a) moral hazard.(b) bait-and-switch.(c) time consistency.(d) nominal-anchor consistency.


22) If the central bank conducts monetary policy on a discretionary, day-by-day basis and announces a policy of low inflation

(a) workers and firms will almost certainly believe the announcement, because they know that the central bank does not want to lose credibility.

(b) workers and firms will likely doubt the announcement, because they know that the central bank does not want to lose credibility.

(c) workers and firms will be skeptical of the announcement, because they know that the central bank may want to renege if economic conditions change.

(d) workers and firms will not believe the announcement, because they know that the central bank will not want low inflation if unemployment rises.



23) A central bank may pursue a discretionary policy resulting in high inflation

(a) because a low-inflation policy is not desirable.(b) in response to political pressure.(c) because a high-inflation policy increases output.(d) all of the above.(e) both (a) and (c) of the above.


24) A central bank may pursue a discretionary policy resulting in high inflation

(a) because central banks think this policy will lower unemployment.(b) in response to political pressure.(c) because a high-inflation policy increases output.(d) all of the above.(e) both (a) and (b) of the above.


25) Targeting the exchange rate can take the form of fixing the value of the domestic currency

(a) to a commodity such as gold.(b) to that of a large, low-inflation country.(c) to that of a country that has a higher inflation rate than the domestic country.(d) to any of the above.(e) to only (a) and (b) of the above.


26) Under an exchange-rate targeting rule for monetary policy, a crawling peg

(a) fixes the value of the domestic currency to a commodity such as gold.(b) fixes the value of the domestic currency to that of a large, low-inflation country.(c) allows the domestic currency to depreciate at steady rate so that inflation in the pegging country

can be higher than that of the anchor country.(d) allows the domestic currency to depreciate at steady rate so that inflation in the pegging country

can be lower than that of the anchor country.



27) Advantages of exchange-rate targeting include:

(a) The nominal anchor of an exchange-rate target directly contributes to keeping inflation under control by tying the inflation rate for internationally traded goods to that found in the anchor country.

(b) An exchange-rate target provides an automatic rule for the conduct of monetary policy that helps mitigate the time-consistency problem.

(c) An exchange-rate target has the advantage of simplicity and clarity, as it is easily understood by the public.

(d) All of the above.(e) Only (a) and (b) of the above.



(a) If it is credible, the exchange-rate target anchors inflation expectations to the inflation rate in the anchor country.

(b) An exchange-rate target forces a tightening of monetary policy when there is a tendency for the domestic currency to depreciate or a loosening of policy when there is a tendency for the domestic currency to appreciate, so that discretionary, time-consistent policy is less of an option.

(c) An exchange-rate target has the advantage of leaving the country less open to a speculative attack on its currency.




(a) An exchange-rate target provides an automatic rule for the conduct of monetary policy that helps mitigate the time-consistency problem.

(b) An exchange-rate target has the advantage of simplicity and clarity, as it is easily understood by the public.

(c) An exchange-rate target has the advantage of leaving the country less open to a speculative attack on its currency.



30) Both France and the United Kingdom successfully used exchange-rate targeting to lower inflation in the late 1980s and early 1990s by tying the value of their currencies to the

(a) U.S. dollar.(b) German mark.(c) Swiss franc.(d) Euro.



31) Disadvantages of exchange-rate targeting include:

(a) An exchange-rate target has the disadvantage of leaving the country more open to a speculative attack on its currency.

(b) Shocks that change interest rates in the anchor country lead to corresponding changes in interest rates in the target country.

(c) Since an exchange-rate target requires the central bank to tighten monetary policy when there is a tendency for the domestic currency to depreciate or to loosen policy when there is a tendency for the domestic currency to appreciate, the time-consistency problem is more likely to occur.

(d) All of the above are disadvantages.(e) Only (a) and (b) of the above are disadvantages.



(a) An exchange-rate target has the disadvantage of leaving the country less open to a speculative attack on its currency.

(b) Shocks that change interest rates in the anchor country lead to corresponding changes in interest rates in the target country.

(c) Since an exchange-rate target requires the central bank to tighten monetary policy when there is a tendency for the domestic currency to appreciate or to loosen policy when there is a tendency for the domestic currency to depreciate, the time-consistency problem is more likely to occur.




(a) An exchange-rate target has the disadvantage of leaving the country more open to a speculative attack on its currency.

(b) An exchange-rate target has the disadvantage of weakening the accountability of policymakers, particularly in emerging market countries, because the public finds it harder to ascertain the central bank’s policy actions.

(c) Since an exchange-rate target requires the central bank to tighten monetary policy when there is a tendency for the domestic currency to depreciate or to loosen policy when there is a tendency for the domestic currency to appreciate, the time-consistency problem is more likely to occur.



34) An emerging market country that successfully used exchange-rate targeting to lower its inflation from above 100 percent in 1988 to below 10 percent in 1994 (before devaluation) was

(a) Thailand. (b) Mexico.(c) Philippines.(d) Indonesia.




(a) The targeting country cannot pursue an independent monetary policy.(b) The targeting country is open to speculative attack on its currency whenever the anchor country

pursues tight monetary policy.(c) The targeting country is open to speculative attack on its currency whenever the anchor country

pursues expansionary monetary policy.(d) Both (a) and (b) of the above.(e) Both (a) and (c) of the above.



(a) The anchor country cannot pursue an independent monetary policy.(b) The targeting country is open to speculative attack on its currency whenever the anchor country

pursues tight monetary policy.(c) The targeting country is open to speculative attack on its currency whenever the anchor country

pursues expansionary monetary policy.(d) Both (a) and (b) of the above.(e) Both (a) and (c) of the above.


37) Exchange-rate targeting has the disadvantage that

(a) countries lose the ability to pursue a monetary policy that differs from the anchor country.(b) countries are open to speculative attacks on its currency, especially if unemployment rises.(c) shocks are transmitted from the anchor country to the domestic economy.(d) all of the above occur.(e) only (a) and (b) of the above occur.

Answer:Question Status: Study Guide

38) (I) Exchange-rate targeting has the disadvantage of leaving the targeting country open to speculative attacks on its currency. (II) Exchange-rate targeting has the advantage of reducing central bank discretion, reducing the likelihood of time-consistent monetary policy.

(a) Both (I) and (II) are true.(b) Both (I) and (II) are false.(c) (I) is true, (II) is false.(d) (I) is false, (II) is true.



39) The tight monetary policy in Germany following reunification meant that the countries in the European Exchange Rate Mechanism were subject to a _____ shock that led to a decline in economic growth and a rise in unemployment.

(a) negative supply(b) negative demand(c) positive supply(d) positive demand


40) When Germany’s tight monetary policy following reunification forced the other countries in the ERM to adopt tight monetary policies to keep their currencies pegged to the mark, speculators

(a) began to doubt that these countries would maintain high interest rates for long.(b) came to believe that these countries’ commitment to the exchange-rate peg would weaken.(c) sold the currencies of countries like France, Spain, Sweden, Italy, and the United Kingdom on

the expectation that these countries would allow their currencies to depreciate relative to the mark.

(d) did all of the above.(e) did only (a) and (b) of the above.


41) When Germany’s tight monetary policy following reunification forced the other countries in the ERM to adopt tight monetary policies to keep their currencies pegged to the mark, speculators

(a) were convinced that these countries would maintain the tight monetary policy.(b) came to believe that these countries’ commitment to the exchange-rate peg would not weaken.(c) sold the currencies of countries like France, Spain, Sweden, Italy, and the United Kingdom on

the expectation that these countries would allow their currencies to depreciate relative to the mark.

(d) did all of the above.(e) did only (a) and (b) of the above.


42) (I) The biggest cost of exchange-rate targeting in an industrialized country is the loss of an independent monetary policy. (II) Because of the past record of Italian monetary policy, the Italians were the most favorable of all towards the European Monetary Union.




43) Because many emerging market countries have not developed the political or monetary institutions that allow the successful use of discretionary monetary policy,

(a) they have little to gain from pegging their exchange rate to an anchor country like the U.S. or Germany.

(b) they have little to gain from using a nominal anchor, because it would mean a monetary policy that is overly expansionary.

(c) they have very little to gain from an independent monetary policy, but a lot to lose.(d) they would be better off giving their central bankers the independence to use discretion, rather

than take their discretion away through any nominal anchor.


44) Emerging market countries are in effect between a rock and a hard place because

(a) they would be wise to adopt the monetary policy of the United States by pegging their currencies to the dollar, but this policy leaves them open to speculative attacks.

(b) to avoid speculative attacks on their currencies they must peg their exchange rates to an anchor country, but this means giving central bankers in these countries too much discretion.

(c) to avoid speculative attacks on their currencies they must peg their exchange rates to an anchor country, but this means giving central bankers in these countries too little discretion.

(d) by adopting the monetary policy of the anchor country through an exchange rate peg, these countries allow for too little monetary expansion and thereby sacrifice economic growth for price stability.


45) For emerging market nations, the disadvantages of exchange rate targeting include

(a) weakening the accountability of policymakers since the exchange rate loses its ability to signal central bank policy actions.

(b) opening the country to speculative attacks on its currency, which have far more serious consequences in emerging markets than in industrialized nations.

(c) lack of transparency, as the public in emerging market nations does not understand how to determine whether the target strategy is working.

(d) all of the above.(e) only (a) and (b) of the above.


46) (I) In industrialized countries, the biggest cost to exchange-rate targeting is the loss of an independent monetary policy to deal with domestic considerations. (II) In emerging market economies, fear of exchange-rate depreciations can make overly expansionary, time-consistent monetary policy less likely.

(a) I is true, II is false.(b) I is false, II is true.(c) Both are true.(d) Both are false.



47) Exchange-rate targeting

(a) is probably not the best monetary policy strategy for industrialized countries unless domestic monetary and political institutions are not conducive to good monetary policymaking.

(b) is probably the best monetary policy strategy for emerging market countries, especially in countries where the long-term bond market is essentially nonexistent.

(c) can constrain central bankers from adopting overly expansionary, time-consistent monetary policy, but at the cost of a loss of an independent policy to deal with domestic considerations.

(d) All of the above are true.(e) Only (a) and (b) of the above are true of exchange-rate targeting.


48) Exchange-rate targeting

(a) is probably not the best monetary policy strategy for emerging market countries because it is not sufficiently transparent, as citizens in these countries do not understand exchange rates.

(b) is probably the best monetary policy strategy for industrial countries because it provides a check on information that is communicated through the long-term bond market.

(c) can constrain central bankers from adopting overly expansionary, time-consistent monetary policy, but at the cost of a loss of an independent policy to deal with domestic considerations.

(d) All of the above are true.(e) Only (a) and (b) of the above are true of exchange-rate targeting.


49) A currency board

(a) is a variant of the fixed-exchange target in which the commitment to the fixed exchange rate is especially strong because the conduct of monetary policy is taken completely out of the hands of the central bank.

(b) has the advantage the money supply can expand only when dollars (the anchor currency) are exchanged for domestic currency.

(c) may be effective in bringing down inflation quickly and in decreasing the likelihood of a successful speculative attack against the currency.

(d) is all of the above.(e) is only (a) and (b) of the above.


50) Compared to exchange-rate targeting, a currency board has all of the same advantages plus it reduces the likelihood that the country adopting a currency board experiences

(a) a transmission of shocks from the anchor country.(b) speculative attacks on its currency.(c) below normal growth when the anchor country experiences a recession.(d) all of the above.(e) only (a) and (b) of the above.



51) A variant of the fixed-exchange target in which the commitment to a fixed exchange rate is especially strong because the conduct of monetary policy is taken completely out of the hands of the central bank is called

(a) a currency board.(b) a monetary policy board.(c) an Argentina board.(d) a peg board.


52) A currency board arrangement has important advantages over a monetary policy that just uses an exchange-rate target.

(a) The money supply can expand only when dollars (the anchor currency) are exchanged for domestic currency, reducing the likelihood of inflationary monetary policy.

(b) Because the currency board involves a stronger commitment by the central bank to the fixed exchange rate, inflation may drop more quickly and the likelihood of a speculative attack on the currency may be reduced.

(c) The central bank can no longer act as a lender of last resort.(d) All of the above are advantages of a currency board.(e) Only (a) and (b) of the above are advantages of a currency board.


53) Solutions to the problems created by a lack of transparency and commitment to an exchange-rate target include:

(a) the adoption of a currency board.(b) dollarization.(c) monetization.(d) all of the above.(e) only (a) and (b) of the above.


54) The key advantage of dollarization is that

(a) it completely avoids the possibility of a speculative attack on the domestic currency.(b) it allows the government to capture the revenue from issuing currency, which is called

seignorage.(c) the domestic central bank can still function as a lender of last resort.(d) it does all of the above.(e) it does only (a) and (b) of the above.



55) Disadvantages of dollarization include

(a) elimination of the seignorage revenue the government captures from issuing currency.(b) losing the central bank as a lender of last resort.(c) elimination of the possibility of a speculative attack on the domestic currency.(d) all of the above.(e) only (a) and (b) of the above.


56) Disadvantages of dollarization include all of the following except

(a) elimination of the seignorage revenue the government captures from issuing currency.(b) losing the central bank as a lender of last resort.(c) elimination of the possibility of a speculative attack on the domestic currency.(d) all of the above.(e) only (a) and (b) of the above.


57) A country that dollarizes

(a) maximizes its seignorage.(b) earns the same amount of seignorage as it would with a currency board.(c) earns the same amount of seignorage as it would with exchange-rate targeting.(d) eliminates its seignorage.(e) must pay seignorage to other governments to use their currency.


58) The revenue a government gains from issuing money is

(a) interest.(b) rent.(c) seignorage.(d) the national dividend.(e) the inflation tax.


59) The seignorage for a government is greater for _____ than for _____.

(a) dollarization; a currency board(b) dollarization; exchange-rate targeting(c) dollarization; monetary targeting(d) dollarization; inflation targeting(e) exchange-rate targeting; dollarization



60) Governments or central banks earn seignorage because

(a) they pay no interest on currency and use the currency to purchase income-earn assets such as bonds.

(b) they pay a low rate of interest on the currency they issue.(c) they pay a low rate of interest on the bonds they issue.(d) they issue currency to cover their deficits.(e) they sell bonds to redeem the currency they previously issued.


61) Exchange-rate targeting is not an option for the United States because

(a) the United States is already dollarized.(b) the United States does not have enough gold for a fixed exchange rate.(c) the Fed has adopted a monetary targeting strategy.(d) the Fed has adopted an inflation targeting strategy.(e) the United States is too large.


62) Countries and areas that are too large for exchange-rate targeting include

(a) the United States.(b) Japan.(c) the European Monetary Union.(d) all of the above.(e) both (a) and (b) of the above.


63) The two countries that have officially engaged in monetary targeting for over 20 years starting at the end of 1974 have been

(a) Japan and Canada.(b) Canada and Germany.(c) Germany and Switzerland.(d) Switzerland and Japan.(e) Switzerland and Canada.


64) The reason that monetary targeting still has strong advocates is because of the success of monetary policy in

(a) Japan and Canada.(b) Canada and Germany.(c) Canada and Switzerland.(d) Switzerland and Japan.(e) Switzerland and Germany.



65) As practiced by Germany and Switzerland, monetary targeting policies

(a) put great stress on making policy clear, simple, and understandable to the public by announcing a numerical inflation goal.

(b) have been quite flexible in practice, especially when compared to Friedman-like monetary targeting.

(c) have been used to gradually reduce inflation.(d) can be described by all of the above.(e) can be described by only (a) and (b) of the above.


66) The lessons to be learned from German and Swiss monetary targeting include:

(a) a monetary targeting regime can restrain inflation in the longer run, even when the regime permits substantial target misses.

(b) adherence to a rigid policy rule has not been found to be necessary to obtain good inflation outcomes.

(c) frequent target misses are permissible if the objectives of monetary policy are clearly stated and the central bank communicates its strategy to the public, thereby enhancing the transparency of monetary policy and the accountability of the central bank.

(d) all of the above.(e) only (a) and (b) of the above.


67) German and Swiss monetary policy is actually closer in practice to _____ targeting than it is to Friedman-like _____ targeting, and thus might be thought of as “hybrid” inflation targeting.

(a) monetary; inflation(b) monetary; exchange-rate(c) inflation; monetary(d) inflation; exchange-rate(e) exchange-rate; monetary


68) A major advantage of _____ targeting over _____ targeting is that it enables a central bank to adjust its monetary policy to cope with domestic considerations.

(a) exchange-rate; monetary(b) exchange-rate; inflation (c) monetary; exchange-rate(d) monetary; inflation



69) A major disadvantage of _____ targeting compared to _____ targeting is that it prevents a central bank from adjusting its monetary policy to cope with domestic considerations.

(a) exchange-rate; monetary(b) inflation; exchange-rate(c) monetary; exchange-rate(d) monetary; inflation



(a) exchange-rate; monetary(b) exchange-rate; exchange-rate (c) monetary; monetary (d) monetary; exchange-rate


71) Monetary targeting has the advantage that it

(a) provides almost immediate accountability for monetary policy to keep inflation low, thus helping to constrain the monetary policymaker from falling into the time-consistency trap.

(b) enables the central bank to choose goals for inflation that may differ from those of other countries and allows some response to output fluctuations.

(c) completely avoids the possibility of a speculative attack on the domestic currency.(d) does all of the above.(e) does only (a) and (b) of the above.


72) Monetary targeting has the advantage that it

(a) provides the central bank with greater discretion than is provided under an exchange-rate targeting policy, thereby helping to constrain the monetary policymaker from falling into the time-consistency trap.

(b) enables the central bank to choose goals for inflation that may differ from those of other countries and allows some response to output fluctuation.

(c) completely avoids the possibility of a speculative attack on the domestic currency.(d) does all of the above.(e) does only (a) and (b) of the above.



73) If the relationship between the monetary aggregate and the goal variable is weak, then

(a) monetary aggregate targeting is superior to exchange-rate targeting.(b) monetary aggregate targeting is superior to inflation targeting.(c) inflation targeting is superior to exchange-rate targeting.(d) monetary aggregate targeting will not work.(e) inflation targeting will not work.


74) If the relationship between the monetary aggregate and the goal variable is weak, then

(a) monetary aggregate targeting is superior to exchange-rate targeting.(b) monetary aggregate targeting will not work.(c) monetary aggregate targeting is inferior to inflation targeting.(d) both (a) and (c) of the above are true.(e) both (b) and (c) of the above are true.


75) If the relationship between the monetary aggregate and the goal variable is weak, then monetary aggregate targeting

(a) no longer provides an adequate signal about the stance of monetary policy.(b) will not help fix inflation expectations. (c) will not be a good guide for assessing the accountability of the central bank.(d) will do all of the above.(e) will do only (a) and (b) of the above.


76) The European Central Bank’s monetary policy strategy

(a) targets exchange rates.(b) is based on a currency board.(c) is a dollarization policy.(d) is a hybrid strategy targeting money growth with elements of inflation targeting.(e) is a hybrid strategy targeting both inflation and unemployment.


77) The goal of the European Central Bank’s monetary policy is

(a) an exchange rate target.(b) a money growth target.(c) an inflation target.(d) an unemployment target.(e) an interest rate target.



78) A breakdown of the money growth-inflation relationship is

(a) a disadvantage for countries using a monetary-targeting regime.(b) not a disadvantage for countries using an exchange-rate targeting regime.(c) not a disadvantage for countries using an inflation-targeting regime.(d) all of the above.(e) only (a) and (c) of the above.

Answer: Question Status: Study Guide

79) (I) Monetary aggregate targeting will not work if the relationship between the monetary aggregate and the goal variable is weak. (II) Canada was the first nation to adopt inflation targeting in 1991.



80) The first country to adopt inflation targeting was

(a) New Zealand.(b) Canada.(c) the United Kingdom.(d) Australia.


81) Inflation targeting has the advantage that it

(a) it is readily understood by the public and is thus highly transparent.(b) enables monetary policy to focus on domestic considerations and to respond to shocks to the

domestic economy.(c) the relationship between money and inflation is not crucial to its success.(d) does all of the above.(e) does only (a) and (b) of the above.



(a) does not require a strong relationship between a monetary aggregate and inflation for the central bank to achieve success.

(b) enables a central bank to choose goals for inflation that may differ from those of other countries and allows it to respond to output fluctuations.

(c) increases the accountability of the central bank, reducing the likelihood that the central bank will fall into the time-inconsistency trap.

(d) does all of the above.(e) does both (a) and (b) of the above.




(a) is easily understood by the public and is thus highly transparent.(b) has the potential to reduce political pressures on the central bank to pursue inflationary monetary

policy and thereby reduce the likelihood of time-consistent policymaking.(c) is not readily understood by the public, giving central bankers the freedom to pursue

discretionary policy with a great deal of freedom.(d) does both (a) and (b) of the above(e) does both (b) and (c) of the above.



(a) inflation; monetary (b) inflation; exchange-rate(c) exchange-rate; monetary(d) exchange-rate; exchange-rate


85) A major disadvantage of _____ targeting compared to _____ targeting is that it prevents a central bank from adjusting its monetary policy to cope with domestic considerations.

(a) exchange-rate; inflation (b) inflation; exchange-rate (c) inflation; monetary(d) monetary; exchange-rate


86) The decision by inflation targeters to choose inflation targets ____ zero reflects the concern of monetary policymakers that particularly _____ inflation can have substantial negative effects on real economic activity.

(a) below; high(b) below; low(c) above; high(d) above; low


87) Targeting inflation rates of ____ zero makes periods of deflation ____ likely.

(a) above; less(b) above; more(c) above; equally(d) below; less(e) below; equally



88) Referring to the new popularity of inflation targeting, it is noted that, “An unusual feature of the _____ legislation is that the governor of the Reserve Bank is held highly accountable for the success of monetary policy. If the goals set forth in the Policy Targets Agreement are not satisfied, the governor is subject to dismissal.”

(a) Canadian(b) New Zealand(c) United Kingdom(d) Australian


89) Inflation targets can increase the central bank’s flexibility in responding to declines in aggregate spending. Declines in aggregate _____ that cause the inflation rate to fall below the floor of the target range will automatically stimulate the central bank to _____ monetary policy without fearing that this action will trigger a rise in inflation expectations.

(a) demand: tighten(b) demand; loosen(c) supply; tighten(d) supply; loosen


90) Inflation targeting’s critics argue that

(a) the signal between monetary policy actions and evidence of success is too long delayed.(b) it imposes a rigid rule on policymakers, taking away their ability to respond to shocks to the

economy.(c) it has the potential for making output fluctuations more pronounced.(d) it does all of the above.(e) it does only (a) and (b) of the above.


91) With a _____ target, a decline in projected real output growth would automatically imply a _____ in the central bank’s inflation target.

(a) monetary; rise (b) monetary; decrease(c) nominal GDP; rise(d) nominal GDP; decrease



92) When all is said and done, _____ targeting has almost all the benefits of _____ targeting, but without the problems that arise from potential confusion about what nominal GDP is or the political complications that arise because nominal GDP requires announcement of a potential GDP growth path.

(a) inflation; nominal GDP(b) inflation; monetary (c) nominal GDP; inflation(d) nominal GDP; monetary


93) Targeting nominal GDP has the disadvantage that

(a) there is a lack of timely information, as nominal GDP is reported quarterly rather than monthly.(b) the public may confuse nominal with real GDP.(c) policymakers must calculate long-run potential GDP growth.(d) all of the above are true.(e) both (a) and (b) of the above are true.


94) Monetary policy rules that target nominal anchors would target any of the following except

(a) the inflation rate.(b) monetary aggregates. (c) nominal GDP. (d) the unemployment rate.(e) the nominal exchange rate.


95) In the United States, the Federal Reserve System targets

(a) exchange rates.(b) the money supply.(c) an implicit nominal anchor.(d) the inflation rates.(e) the value of stock prices.


96) The Fed’s “just do it” approach has the advantage that

(a) it enables the Fed to focus on domestic considerations.(b) it does not rely on a stable money-inflation relationship.(c) it has worked to keep inflation low and the economy growing.(d) it has done all of the above.(e) it has done only (a) and (b) of the above.



97) Disadvantages of the Fed’s “just do it” approach include:

(a) a lack of transparency, which creates doubt about the future course of inflation and output, and makes it hard to hold the Fed accountable.

(b) low accountability that may make the Fed more susceptible to the time-consistency problem. (c) the strong dependence on the preferences, skills, and trustworthiness of the individuals in charge

of the central bank.(d) all of the above.(e) only (a) and (b) of the above.


98) When compared to the Fed’s _____ anchor approach, _____ targeting can make the institutional framework for the conduct of monetary policy more consistent with democratic principles.

(a) nominal; inflation(b) implicit; monetary(c) nominal; monetary(d) implicit; inflation


99) Economists critical of the Fed’s implicit targeting strategy point out that

(a) the lack of transparency of this policy approach creates unnecessary volatility in financial markets.

(b) the opacity of this policymaking strategy makes it difficult to hold the Fed accountable to Congress and the public.

(c) the policy has not been very successful, as inflation and unemployment have been too high in the 1990s.

(d) all of the above are true.(e) only (a) and (b) of the above are true.


100) Targeting __________ can help promote operational independence of the central bank, because it can reduce the tensions between central bank independence and democratic principles.

(a) exchange-rate(b) monetary(c) inflation(d) nominal GDP



101) The monetary policy strategy that provides an automatic rule for the conduct of monetary policy is

(a) exchange-rate targeting.(b) monetary targeting.(c) inflation targeting.(d) the implicit nominal anchor.(e) all of the above.


102) The monetary policy strategy that provides an immediate signal on target achievement is



103) The monetary policy strategy that does not allow the policy to focus on domestic considerations is



104) The monetary policy strategy that relies on a stable money-income relationship is



105) The monetary policy strategy that results in the loss of an independent monetary policy is




106) The monetary policy strategy that suffers a lack of transparency is



107) The monetary policy strategy that provides the least accountability is



108) The monetary policy strategy that directly ties down the price of internationally traded goods is



109) A monetary policy strategy that allows for a focus on domestic considerations is

(a) monetary targeting.(b) inflation targeting.(c) the implicit nominal anchor.(d) all of the above.(e) both (a) and (b) of the above.


110) The monetary policy strategy that has the advantage of simplicity and clarity of target is

(a) exchange-rate targeting.(b) monetary targeting.(c) inflation targeting.(d) the implicit nominal anchor.(e) both (a) and (c) of the above.



111) The monetary policy strategy that is subject to speculative attacks on the currency is



112) The monetary policy strategy that has been a demonstrated success in the United States is



113) A monetary policy strategy that does not rely on a stable money-income relationship is

(a) monetary targeting.(b) inflation targeting.(c) the implicit nominal anchor.(d) all of the above.(e) both (b) and (c) of the above


114) The monetary policy strategy that increases the accountability of the central bank is



115) The monetary policy strategy that reduces the effects of inflationary shocks is




116) The monetary policy strategy that prevents a central bank from printing money and acting as a lender of last resort is

(a) exchange-rate targeting.(b) adoption of a currency board.(c) dollarization.(d) all of the above.(e) both (b) and (c) of the above.


117) The monetary policy strategy that prevents a central bank from printing money and acting as a lender of last resort is

(a) exchange-rate targeting.(b) adoption of a currency board.(c) the implicit nominal anchor.(d) all of the above.(e) both (b) and (c) of the above.


118) The monetary policy strategy that permits a central bank to print money and act as a lender of last resort is

(a) exchange-rate targeting.(b) adoption of a currency board.(c) dollarization.(d) all of the above.(e) both (b) and (c) of the above.


119) The monetary policy strategy that allows a central bank to print money and act as a lender of last resort is

(a) exchange-rate targeting.(b) monetary targeting.(c) dollarization.(d) all of the above.(e) both (a) and (b) of the above.



120) The monetary policy strategy that allows a central bank to print money and act as a lender of last resort is

(a) exchange-rate targeting.(b) monetary targeting.(c) inflation targeting.(d) all of the above.(e) both (a) and (b) of the above.


Essay Questions

1) Explain the time-consistency problem. What is the likely outcome of discretionary policy? What are the solutions to the time-consistency problem?

2) Explain the 1992 crisis that led to the breakdown of the European Union’s Exchange Rate Mechanism. What disadvantages of exchange-rate targeting were exhibited during this crisis?

3) What are the advantages and disadvantages of inflation targeting?

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