R02 Fiscal and monetary policy: free practice questions

1. Question 1 of 5

   What is fiscal policy?

   Option A: The Bank of England's buying and selling of giltsOption B: The use of Government spending and taxation to influence demandOption C: The control of exchange rates by the TreasuryOption D: The use of interest rates by the central bank to control inflation

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   The answer is B: The use of Government spending and taxation to influence demand

   Fiscal policy uses Government spending and taxation to influence demand and economic activity: more spending or lower taxes in a downturn, less spending or higher taxes in a boom.

   Why the other options are wrong

   A

   That's quantitative easing, a monetary tool.

   C

   The UK has a floating exchange rate.

   D

   That's monetary policy.

2. Question 2 of 5

   What does monetary policy try to control?

   Option A: Wage rises in the public sectorOption B: The level of the FTSE 100Option C: Interest rates and the money supplyOption D: Government spending and tax rates

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   The answer is C: Interest rates and the money supply

   Monetary policy aims to stabilise the economy by controlling interest rates and the money supply. In most developed economies this rests with independent central banks such as the Bank of England.

   Why the other options are wrong

   A

   Pay isn't set through monetary policy.

   B

   Monetary policy doesn't target share prices.

   D

   That's fiscal policy.

3. Question 3 of 5

   What is the 'velocity of circulation' of money?

   Option A: The rate at which the MPC changes Bank RateOption B: The proportion of money held as notes and coinsOption C: The ratio of nominal GDP to the stock of moneyOption D: How quickly banks process payments each day

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   The answer is C: The ratio of nominal GDP to the stock of money

   Velocity of circulation is nominal GDP divided by the stock of money. The faster the velocity, the greater the effect of a given stock of money on prices.

   Why the other options are wrong

   A

   It isn't about rate changes.

   B

   That isn't velocity.

   D

   It's an economic ratio, not a processing speed.

4. Question 4 of 5

   Roughly how long do most economists think it takes for a change in interest rates to have its full effect on inflation?

   Option A: About five years, a full economic cycleOption B: About six months, or two MPC meetingsOption C: Between 18 months and two yearsOption D: About one month after the change is made

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   The answer is C: Between 18 months and two years

   Interest rate changes take time to work: most economists think 18 months to two years for the full effect on inflation. The shift to two- to five-year fixed rate mortgages may have lengthened the lag.

   Why the other options are wrong

   A

   The usual estimate is 18 months to two years.

   B

   Most economists think it takes longer.

   D

   The effect takes far longer.

5. Question 5 of 5

   Why did central banks turn to quantitative easing after the 2008 global financial crisis?

   Option A: Interest rates were near zero and couldn't usefully be cut furtherOption B: To reduce the money supply and curb rapidly rising inflationOption C: To strengthen their currencies against the dollarOption D: To raise long-term interest rates across the whole economy

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   The answer is A: Interest rates were near zero and couldn't usefully be cut further

   With rates at the zero lower bound, central banks injected money directly by buying government bonds from investors. QE was used again in response to the COVID-19 pandemic.

   Why the other options are wrong

   B

   QE injects money; it doesn't reduce the money supply.

   C

   Currency strength wasn't the aim.

   D

   QE purchases tend to push yields down.

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