ECO Exam 2 Luther

An unanticipated reduction in nominal spending will cause real output and the price level to _____ their anticipated levels. As expectations adjust,__________________. (No monetary policy)

fall below; real output will return to its initial trajectory while the price level declines to a lower trajectory.

An increase in the reserve ratio (R/D) _____ the M1 money multiplier. An increase in the currency to deposit ratio (C/D) _____ the M1 money multiplier.

decreases; decreases

When inflation expectations decrease, the expectations-augmented Phillips curve shifts _____

down

In response to nominal shocks, a price level target is _____ to a nominal spending target; in response to real shocks a price level target is ____ to nominal spending target.

equivalent; inferior

In response to nominal shocks, a price level target is _____ to a nominal spending target; in response to real shocks, a price level target is _____ to a nominal spending target.

equivalent; inferior

No automatic mechanism instead

no automatic mechanism to govern the supply of money in a fiat money regime. Instead, central banks conducts monetary policy on information available to them and ideas good or bad.

Unlike the gold standard, there is _____ mechanism to govern the supply of money in a fiat money regime. How a central bank conducts monetary policy will depend _____.

no automatic; on both the information available to policymakers and the incentives policymakers face

To increase the monetary base, the Fed typically engages in _______ to ________ financial assets

open market operations; purchase

Problems with Political Business Cycle Theory

people know: when elections are held, incumbent wants to be reelected and central bank might try to fool them

A real shock refers to an unanticipated change in _____.

potential output

Consider the standard macroeconomic model developed in Lecture 9. Before expectations adjust, a reduction in nominal spending _____ real output. After expectations adjust, real output _____.

reduces; returns to where it was prior to the shock

Suppose a central bank is committed to hitting a price level target. An unanticipated increase in nominal spending will cause the price level to _____ (relative to its previous trajectory). The central bank will respond by _____ (relative to its previous trajectory) in order to hit its price level target.

rise; decreasing the money supply

Compared to the decade prior, inflation was _____ average in the decade following the Great Recession (2007-2009)

slightly lower

The long-run Phillips curve is conventionally drawn as a line that intersects the horizontal axis at

the natural rate of unemployment

A nominal shock refers to an unanticipated change in _____.

the product of the money supply and the velocity of money

Cause of high rates of inflation (2)

1) Bad ideas- (Naïve PC) deliver higher rates to reduce unemployment 2) Political influence- high inflation benefits politician then they may pressure the central bank for high inflation

Two types of Central Bank Independence

1) Goal Independence (goals they want to achieve) 2) Means Independence (Congress demands low inflation and U* so they can do certain things with its monetary tools)

Modeling Fiat Monies Characteristics (3)

1) Irredeemable paper banknotes are used for transactions 2) Irredeemable paper banknotes are issued exclusively by the central bank 3) Marginal cost of irredeemable paper banknotes is zero

The Fed Failed (4)

1) The Fed's job is to stabilize nominal spending 2) The Fed failed to do its job 3) When it realized it had failed to do its job, it failed to change course 4) When it finally changed course, it failed to tighten monetary policy sufficiently

Problems with the Constrained Supply View (3)

1) Timing seems off 2) Price increases are widespread 3) The evolution of prices is inconsistent with the constrained supply view

Using the rule of 70 to calculate approximately how long it will take prices to double in a country with an inflation rate of 5% per month?

14 months

Use the rule of 70 to calculate approximately how long it will take prices to double in a country with an inflation rate of 3 percent per month.

23.3 months

From September 2008 to September 2014, the monetary base grew roughly _____ percent.

374.3

Suppose nominal spending growth is 5 % and real output growth averages 3%. This implies that inflation averages:

5% - 3% = 2%

Use the rule of 70 to calculate the approximate inflation rate in a country that has seen its price level double in 12.1 years.

5.8 percent per year

Use the rule of 70 to calculate the approximate inflation rate in a country that has seen its price level quadruple in 15.9 years.

8.8 percent per year

The Structure of The Federal Reserve

Board of Governors; 12 District Reserve Banks; Member Banks; The Federal Open Market Committee (FOMC)

Shock to Money Demand (-)

Dm decreases (shift up right) Immediately: PPM decreases What happens next depends on how the central bank manages the Sm

Shock to Money Demand (+)

Dm increases (shift up right) Immediately: PPM increases What happens next depends on how the central bank manages the Sm

According to Abrams (2006), political monetary (or, business) cycle political monetary cycle exists in the United States, but only when the President and the _____ share party allegiance.

Federal Reserve Chair

Monetizing (eroding) Debt (Gov. wants high inflation)

Gov. typically issues debts denominated in their own currency. Inflation erodes the real value of nominal debts over time.

Inflation Target vs Price Level Target

Inflation target: central bank announces its target inflation and then adjust growth rate of money to achieve that target. While Price level target: central banks targets the level of prices or the growth rate of prices. Price level target can help predict the future PPM. Inflation target has a very slow recovery from a negative nominal shock.

Equation of Exchange

M x V = P x Y

It was not until ________ that the Fed really changed course and even that wasn't enough.

May 2022

Philips Curve history

Milton Friedman (1968) criticized the Philips curve by denying there was an exploitable relationship and if anything we would have both higher inflation and higher unemployment. (stagflation)

Equilibrium in the Standard Macroeconomic Model can be described by

Mt*Vt = Pt [Yt*]

Expectations for the future of inflation

Next 10 years inflation will be elevated

Fed should have recognized the problem in ________.

October 2021

Pt > E(Pt), Yt > Yt* (Price Level greater than expected, real output is greater than desired level of production)

Overproduction

In 1979, President Jimmy Carter appointed _____ to Federal Reserve Chair. This Fed Chair is widely credited with _____.

Paul Volcker; bringing down inflation

Consider the following statements: I. An inflation target anchors expectations about the future purchasing power of the dollar better than a price level target. II. Following a negative shock to nominal spending, a central bank committed to achieving its price level target will promote a fast recovery more effectively than a central bank committed to achieving its inflation target. III. A price level target makes up for past mistakes, whereas an inflation target lets bygones-be-bygones.

Statements II and III are true.

Pt< E(Pt), Yt < Yt* (Price level less than expected, real output is less than desired level of production)

Underproduction

When inflation expectations increase, the expectations-augmented Phillips curve shifts

Up

Production function

Yt= Yt* + a[Pt - E(Pt)] Yt* - potential output Pt - price level

Phillips Curve (Paul Samuelson & Robert Solow)

a curve that shows a inverse relationship between inflation and unemployment and the central bank can reduce unemployment by accepting a higher inflation or reduce inflation and have higher unemployment.

Nominal Spending View

a positive nominal shock boosts spending, but not productivity. As expectations adjust, production returns to normal but prices remain permanently elevated.

Inflation Tax (Gov. wants high inflation)

a tax on those holding nominally-fixed non-interest-bearing assets (cash). -low-income countries rely heavily on this tax.

Federal Open Market Committee (12)

all 7 Board of Governors, the New York Fed President and four of the Reserve Bank Presidents.

Headline Inflation includes ___________. Core Inflation includes_____________.

all prices in the index basket; all prices in the index basket except those for food and energy.

Board of Governors (7 members)

appointed by U.S. President and confirmed by the Senate for a single 14-year term Chairperson serves 4-year term (can be reappointed so long as they remain a governor)

Regional Reserve Bank Presidents (12 members)

appointed by the board of their regional reserve bank and are very insulated from political influence

Empirical Relationship

between Inflation and Unemployment showing a negative relationship but as soon as policymakers exploited it, the data went all over the place

By restoring nominal spending, _____ monetary policy can eliminate periods of under- or over-spending and put the price level back on its expected path.

countercyclical

Expectations-Augmented Phillips Curve

created by Milton Friedman and Edmund Phelps that captures the idea that workers might be fooled by the central bank , but not consistently and persistently

The monetary base (M0) consists of _____.

currency and reserves

The M2 monetary aggregate consists of _____.

currency, checkable deposits, savings deposits, MMMFs, and small-time deposits

Suppose a central bank is committed to hitting a price level target. An unanticipated increase in potential output will cause the price level to _____ (relative to its previous trajectory). The central bank will respond by _____ (relative to its previous trajectory) in order to hit its price level target.

fall; increasing the money supply (relative to its previous trajectory)

Supply of money

fiat monies have no non-monetary use therefore the supply is just the total stocky of money issued by the central bank Increase, shifts right Decrease, shifts left

In the model of fiat money developed in lecture 7, the supply of money is just the total stock of money issued by the central bank because fiat monies _____.

have no non-monetary uses

Inflation, as measured by the Personal Consumption Expenditures Price Index (PCEPI), was _____ on average in the decade before the Great Recession (2007-2009) than it was in the decade after.

higher

The (naïve) Phillips curve was thought to represent a menu of policy options, whereby policymakers could achieve a lower unemployment rate so long as they were willing to put up with _____, and vice-versa

higher inflation

Implicit Theory (Naïve PC)

higher inflation means businesses can offer a higher nominal wage (not-adjusted inflation and less valuable money (quantity) like foreign currency) without offering a higher real wage. Being fooled.

Political Business Cycle Theory (Gov. wants high inflation)

if incumbent can pressure the central bank to engage in expansionary monetary policy ahead of election they may be reelected but expansionary policy cannot permanently increase production so timing is everything before contraction and people adjust their exceptions with that higher inflation.

Rule of 70

if variable grows a x percent per period, it will double roughly every (70/x) periods.

In response to a reduction in nominal spending, a price level targeting central bank will ______ and a nominal income level targeting central bank will _________.

increase the money supply; increase the money supply

Hyperinflation

inflation greater than 50% per month-proof of how bad a central bank-issued fiat money might be managed.

Central Bank Independence

insulating the central bank from short-term politics since politicians are inclined to exploit the inflation rate tax, erode the value of government debt with unexpected inflation, or fool people into over-producing to boost their re-election odds

In the model of fiat money developed in lecture 7, the demand for money is the demand to hold _____.

irredeemable paper banknotes

Equilibrium

is expressed at (p, M) the point where the both curves intersect

Demand for money

is the demand to hold irredeemable paper notes As PPM increases, proportionately LESS money is required to make the same transactions.

Businesses tend to overproduce when the purchasing power of money is _____ expected.

less than

When inflation is lower than expected, borrowers and employers typically

lose, while the lenders and employees gain

Constrained Supply View

negative real shocks (COVID or War in Ukraine) reduce our ability to produce valuable goods and services with the available physical and human capital

The long run Phillips curve is conventionally drawn as a _____ line that intersects the axis at _____.

vertical; the natural rate of unemployment, U*