Chapter 6, Problem 1QAP

(a)

To determine

Whether the given statement is true, false or uncertain.

Answer to Problem 1QAP

The statement is false.

Explanation of Solution

The nominal interest rate is measured in terms of money and the real interest rate, which is adjusted for inflation, is measured in terms of goods. Thus, the given statement is false.

(b)

To determine

Whether the given statement is true, false or uncertain.

Answer to Problem 1QAP

The statement is true.

Explanation of Solution

The difference between the expected inflation rate and the nominal interest rate is equal to the real interest rate.

Thus, any changes in real interest rate will lead to movement in nominal interest rate, keeping expected inflation constant. Hence, the given statement is true.

(c)

To determine

Whether the given statement is true, false or uncertain.

Answer to Problem 1QAP

The statement is true.

Explanation of Solution

During 2013, the nominal interest rate in the US was around 0.25 as the economy was recovering from sub-prime crises. Thus, it is true that the nominal interest rate was at the zero level bound in the US in 2013.

(d)

To determine

Whether the given statement is true, false or uncertain.

Answer to Problem 1QAP

The statement is true.

Explanation of Solution

The relation between expected inflation, nominal interest rate and real interest rate is given as followsL

  $realinterestrate=\left[nominalinterestrate-expectedinflationrate\right]$

Thus, it is true that when expected inflation increases, the real rate of interest falls.

(e)

To determine

Whether the given statement is true, false or uncertain.

Answer to Problem 1QAP

The statement is false.

Explanation of Solution

There are different types of bonds with different levels of risk involved. Thus, the statement that all bonds have similar risk of default and hence pay equal rates of interest is false.

(f)

To determine

Whether the given statement is true, false or uncertain.

Answer to Problem 1QAP

The statement is true.

Explanation of Solution

It is the central bank of the economy that sets nominal rate of interest. Thus, the given statement that the nominal interest rate is set by the central bank is true.

(g)

To determine

Whether the given statement is true, false or uncertain.

Answer to Problem 1QAP

The statement is true.

Explanation of Solution

The leverage ratio is a bank's debt ratio against its equity/capital. A high leverage ratio implies that a firm has done a lot of investment from the credit taken.

Thus, chances of bankruptcy increase with higher leverage ratio.

However, if the credit taken is used in an efficient manner, then high leverage ratio leads to a rise in expected profit.

Thus, the statement that a rise in a banks’s leverage ratio leads to increase in both the expected profit of the bank and the risk of the bank going bankrupt is true.

(h)

To determine

Whether the given statement is true, false or uncertain.

Answer to Problem 1QAP

The statement is false.

Explanation of Solution

The rate at which money is borrowed is known as the borrowing rate and the policy rate measures the lending rate of the central bank. The two rates may differ in context of risk premium.

Thus, the statement that real borrowing rate and the real policy rate always move on the same direction is false.

(i)

To determine

Whether the given statement is true, false or uncertain.

Answer to Problem 1QAP

The statement is true.

Explanation of Solution

Financial crises include loss in the value of assets, stock market crashes and other currency crises.

In such situations, it gets difficult to measure the assets of banks and other financial intermediaries. Thus, the given statement is true.

(j)

To determine

Whether the given statement is true, false or uncertain.

Answer to Problem 1QAP

The statement is true.

Explanation of Solution

A high leverage implies high debt-equity ratio and in case of low liquidity, financial institutions are not able to convert their assets into cash easily.

Thus, the statement when a bank has high leverage and low liquidity, it may have to sell assets at fire sale prices is true.

(k)

To determine

Whether the given statement is true, false or uncertain.

Answer to Problem 1QAP

The statement is true.

Explanation of Solution

Any deposit by public with the banks includes the liabilities of the banks. Banks have to present such deposits on immediate demand of the public. However, assets owned by banks cannot be converted into money easily.

Thus, the given statement that banks and other financial intermediaries have assets that are less liquid than their liabilities is true.

(l)

To determine

Whether the given statement is true, false or uncertain.

Answer to Problem 1QAP

The statement is false.

Explanation of Solution

The housing prices in the US economy fell significantly2005 onwards. Thus, the given statement that house prices rose constantly in the U.S. economy since 2000 is false.

(m)

To determine

Whether the given statement is true, false or uncertain.

Answer to Problem 1QAP

The statement is true.

Explanation of Solution

Fiscal policy refers toincrease in government spending or decrease in tax rates. Such policy help in stimulating aggregate demand to reduce recession.

Thus, the given statement that the fiscal stimulus program adopted by the United States in relation to the financial crises helped counter the fall in aggregate demand and reduce the size of the recession is true.

(n)

To determine

Whether the given statement is true, false or uncertain.

Answer to Problem 1QAP

The statement is true.

Explanation of Solution

Fiscal policy involves large government expenditure which further leads to rise in budget deficit.

Thus, the given statement that fiscal stimulus program adopted by the United States included a large increase in the deficit measured as a percent of GDP is true.