Econ 4

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What two institutions did Congress create in order to increase the availability of mortgages in a secondary market?

"Fannie Mae" and "Freddie Mac"

Suppose that velocity is 3 and the money supply is $600 million. According to the quantity theory of money, nominal output equals

$1.8 billion.

Suppose American Bank has $500 in deposits and $200 in reserves and that the required reserve ratio is 10 percent. In this situation, American Bank has

$50 in required reserves.

Suppose you deposit $2000 in currency into your checking account at a branch of Bank of America, which we will assume has no reserves at the time you make your deposit. Also assume that the required reserve ratio is 20% (0.20). (a) Complete the first T-account to the right to show the initial impact of this transaction on Bank of America's balance sheet. step a Assets Change in Reserves ______ Liabilities Change in Deposits_____ Suppose that Bank of America makes the maximum loan it can from the funds you deposited. Using the second T-account, show the initial impact of the loan on Bank of America's balance sheet. The funds will be deposited in another bank. step b Assets Change in Reserves ______ Change in loans_____ Liabilities Change in Deposits_____ Now suppose that whoever took out the loan in (b) makes a deposit in a branch of Citibank. (c) Show the effect of these transactions on the balance sheet for Citibank. step c Assets Change in Reserves ______ Liabilities Change in Deposits_____ What is the maximum increase in checking account deposits that can result from your $2000 deposit and what is the maximum increase in the money supply, respectively?

+2000 +2000 -1600 +1600 0 +1600 +1600 $10,000 and $8,000, respectively

Which of the following is the formula for the tax multiplier?

-MPC/1-MPC

Glenn Rudebusch, an economist at the Federal Reserve Bank of San Francisco, argues that if the Fed had followed the Taylor rule during the recession of 2007−2009, then by the end of 2009 the target for the federal funds rate would have been minus−5 percent. Source: Glenn Rudebusch, "The Fed's Monetary Policy Response to the Current Crisis," FRBSF Economic Letter, May 22, 2009. Suppose the current inflation rate is 2 percent, the target inflation rate is 44 percent, and the real equilibrium federal funds rate is 11 percent. Given that the weight for the output gap is 0.50 and the output gap is minus−4 percent, using the Taylor rule one can calculate that if the weight for the inflation gap exceeds ____ Given that the weight for the inflation gap is 0.50 and the output gap is minus−4 percent, using Taylor rule one can determine that if the weight for the output gap exceeds _____ Given that the weight for the inflation gap is 0.50 and the weight for the output gap is 0.50, using the Taylor rule one can determine that if the output gap is less than ____ Is it possible for the federal funds rate to be negative?

.50 .50 -4.00 No, nominal interest rates have a lower bound of zero

Use the following equation to find the value of y for selected values of x, minus−3less than or equals≤xless than or equals≤3. y equals 2 x squared plus 5 x minus 3y=2x2+5x−3 For each value of x, find the corresponding value for y.

0 -5 -6

If the money supply is growing at a rate of 3 percent per year, real GDP (real output) is growing at a rate of 2 percent per year, and velocity is constant, what will the inflation rate be?

c. Congress enacts significant new legal barriers to firing workers

Similarly, explain why a decrease in the marginal propensity to import would increase the size of the government purchases multiplier. The value of the government purchases multiplier would decrease because in the formula for the multiplier the denominator is

1 minus− [MPC times ×(1 minus−t) minus− MPI]

If the marginal propensity to consume equals 0.75, the tax rate equals 0.10, and the marginal propensity to import equals 0.20, what is the value of the government purchases multiplier? The government purchases multiplier is equal to

1.90

Which of the following is the formula for the government purchases multiplier?

1/1-MPC

Assume that before receiving the discount loan, FNB had no excess reserves. The maximum amount of the $10 million that FNB can issue in loans is

10 million

Assuming a fixed amount of taxes and a closed economy and that the marginal propensity to consume equals .0.90, calculate the value of the following multipliers. Be sure to use a negative sign (-) to show if a multiplier has a negative value. The government purchases multiplier equals The tax multiplier equals The balanced budget multiplier equals

10.0 -9.0 1

Assume that the required reserve ratio is 10%. The maximum total increase in the money supply that can result from the Fed's discount loan is

100 million

If the money supply is growing at a rate of 10 percent per year, real GDP (real output) is growing at a rate of 2 percent per year, and velocity is growing at 3 percent per year instead of remaining constant, what will the inflation rate be?

Suppose that real GDP is currently $13.22 trillion and potential real GDP is $14.0 trillion, or a gap of $800 billion. The government purchases multiplier is 5.0, and the tax multiplier is 4.0. Holding other factors constant, by how much will government purchases need to be increased to bring the economy to equilibrium at potential GDP? Government spending will need to be increased by $ Holding other factors constant, by how much will taxes have to be cut to bring the economy to equilibrium at potential GDP? Taxes will need to be cut by $

160 200

If the government does not take any policy actions, then, in 2017, the value of real GDP will be $_____trillion and the value of the price level will be_____

18 117

If the Fed does not take any policy action, in 2017 the level of real GDP will be _________ and the price level will be _________ If the Fed wants to keep real GDP at its potential level in 2017, it should use _______ policy This means that the trading desk should be_______Treasury bills. If the Fed takes no policy action, the inflation rate in 2017 will be ______ If the Fed uses monetary policy to keep real GDP at its full-employment level, the inflation rate in 2017 will be_____

18.3 118 furthest to the right on grap contractionary selling 3.5% 1.8%

1− [MPC ×(1 −t) − MPI]

d. Workers and firms lower the inflation rate they expect

If the marginal propensity to consume equals 0.80, the tax rate equals 0.25, and the marginal propensity to import equals 0.05, what is the value of the government purchases multiplier? The government purchases multiplier is equal to

2.22

Assuming a fixed amount of taxes and a closed economy and that the marginal propensity to consume equals 0.600.60, calculate the value of the following multipliers. Be sure to use a negative sign (-) to show if a multiplier has a negative value. The government purchases multiplier equals The tax multiplier equals The balanced budget multiplier equals

2.5 -1.5 1

Assuming a fixed amount of taxes and a closed economy and that the marginal propensity to consume equals 0.600.60, calculate the value of the following multipliers. Be sure to use a negative sign (-) to show if a multiplier has a negative value. The government purchases multiplier equals___ The tax multiplier equals _______ The balanced budget multiplier equals___

2.5 -1.5 1

If the government takes no policy actions, the inflation rate in 2017 will be ___ If the government uses fiscal policy to keep real GDP at its potential level, the inflation rate in 2017 will be nothing____

2.6 4.4

Suppose you buy a house for $150,000. One year later, the market price of the house has risen to $160,000. If you made a down payment of 25 percent and took out a mortgage loan for the other 75 percent, the return on your investment in the house is

If the money supply is growing at a rate of 3 percent per year, real GDP (real output) is growing at a rate of 2 percent per year, and velocity is growing at 2 percent per year instead of remaining constant, what will the inflation rate be?

The proportion of younger and less skilled workers in the labor force decreases.

According to the Taylor rule, what is the federal funds target rate under the following conditions? follows≻Equilibrium real federal funds rate equals 3% follows≻Target rate of inflation equals 3% follows≻Current inflation rate equals 2% follows≻Real GDP is 2% below potential real GDP The federal funds target rate equals

3.5%

Assets Liabilities Reserves $10,000 Deposits $70,000 Loans $66,000 Stockholders' equity $6,000 (a) If the required reserve ratio(RR) is 10 percent, this bank currently holds _____ in excess reserves. The maximum amount by which the bank can expand its loans is Complete the following simplified bank balance sheet to show the immediate impact if the bank makes the loans in part (b) by creating deposit accounts for the borrowers within the the bank. Assets Reserves ______ Loans_____ Liabilities Deposits______ Stockholders' equity______

3000 3000 10000 69000 73000 6000

b. The Fed carries out an expansionary monetary policy

If you made a down payment of 15 percent and borrowed the other 85 percent, the return on your investment in the house is

If the required reserve ratio is 0.100.10, the maximum increase in checking account deposits that will result from an increase in bank reserves of $5,000 is $

50,000

Suppose that the equilibrium real federal funds rate is 4 percent and the target rate of inflation is 2 percent. Use the following information and the Taylor rule to calculate the federal funds rate target: Current inflation rate = 2 percent Potential real GDP = $14.711 trillion Real GDP = $14.92 trillion The federal funds target rate is

6.71

During the expansion and deflation of the housing bubble, housing prices rose by

60 percent between January 2000 and July 2005 and then fell by 80 percent between July 2005 and May 2010.

If the required reserve ratio is 0.15, the maximum increase in checking account deposits that will result from an increase in bank reserves of $10,000 is $

66667

There are ________ members of the Board of Governors, who the President of the United States appoints to ________. One of the Board members is appointed Chairman for ________.

7; 14-year nonrenewable terms; a 4-year renewable term

If the money supply is growing at a rate of 10 percent per year, real GDP (real output) is growing at a rate of 2 percent per year, and velocity is constant, what will the inflation rate be?

Suppose that Deja owns a McDonald's franchise. She decides to move her restaurant's checking account to Wells Fargo, which causes the changes shown on the following T-account. Wells Fargo Assets Liabilities Reserves +$100,000 Deposits $100,000 If the required reserve ratio is 0.15, or 15 percent, and Wells Fargo currently has no excess reserves, the maximum loan Wells Fargo can make as result of this transaction is $

85000

Suppose a political candidate hired you to develop two arguments in favor of a flat tax. Consider the following list of arguments about changing to a flat tax: A. There would be a reduction in paperwork and the compliance cost of the tax system. B. The complexities in the current tax code allow the government to pursue other policy goals. C. A change in the tax code would result in a more unequal distribution of income because the marginal tax rate on high-income taxpayers would be reduced. D. There are potential increases in labor supply, savings, and investment from a lower marginal tax rate. Which two out of the above list of arguments would you advance in favor of a flat tax? Consider the same list of arguments about changing to a flat tax. Which two out of the above list of arguments would you advance against a flat tax?

A and D B and C

"A contractionary fiscal policy involves a decrease in government purchases or a decrease in taxes."

A contractionary fiscal policy involves the decrease of government purchases and/or an increase in taxes in order to decrease aggregate demand.

In an article in the American Free Press, Professor Peter Spencer of York University in England is quoted as saying: "This printing of money 'will keep the [deflation] wolf from the door'." In the same article, Ambrose Evans-Pritchard, a writer for the London-based newspaper The Telegraph, is quoted as saying: "Deflation has...insidious traits. It causes shoppers to hold back. Once this psychology gains a grip, it can gradually set off a self-feeding spiral that is hard to stop." Source: Doug French, "We Should Celebrate Price Deflation," American Free Press, November 17, 2008. What is price deflation?

A fall in the price level.

Consider the following choices and determine the correct definition for the monetary rule.

A monetary rule is a plan for increasing the money supply at a constant rate regardless of the prevailing economic condition.

If workers ignore inflation in forming their expectations of the real wage rate, what is the effect of an expansionary monetary policy?

A move up along the short-run Phillips curve.

What effect does expansionary monetary policy have on equilibrium if consumers have rational expectations?

A movement from point A to point C.

What is a banking panic?

A situation in which many banks experience runs at the same time.

What is the "tax wedge"?

A tax wedge is the difference between the pretax and posttax return to an economic activity. For example, a tax on interest income would decrease the posttax return to investment.

A political commentator argues: "Congress and the president are more likely to enact an expansionary fiscal policy than a contractionary fiscal policy because expansionary policies are popular and contractionary policies are unpopular." Briefly explain whether you agree.

Agree because expansionary fiscal policies create employment and increase GDP whereas contractionary fiscal policies impose an artificial recession on the economy

Which of the following conditions make a good suitable for use as a medium of exchange?

All of the above conditions must be met.

Select the answer below that best corrects the following statement: "An expansionary fiscal policy involves an increase in government purchases or an increase in taxes."

An expansionary fiscal policy involves the increase of government purchases and/or a decrease in taxes in order to increase aggregate demand.

Suppose that at the same time Congress and the president pursue an expansionary fiscal policy, the Federal Reserve pursues an expansionary monetary policy. How might an expansionary monetary policy affect the extent of crowding out in the short run?

An expansionary monetary policy would decrease interest rates and thus reduce the extent of crowding out.

What is meant by Professor Spencer's statement "This printing of money 'will keep the [deflation] wolf from the door'"?

An increase in the money supply that exceeds the rate of growth of GDP will increase the price level.

In the graph of the money market shown on the right, what could cause the money demand curve to shift from MD1 to MD2?

An increase in the price level An increase in real GDP.

Are federal expenditures higher today than they were in 1960?

As a percentage of GDP, federal expenditures have increased since 1960.

Are federal purchases higher today than they were in 1960?

As a percentage of GDP, federal purchases have decreased since 1960.

Stock prices rose rapidly in 2005, as did housing prices in many parts of the country. By 2008, both stock prices and housing prices were declining sharply. Some economists have argued that rapid increases and decreases in the prices of assets such as shares of stock or houses can damage the economy. Currently, stabilizing asset prices is not one of the Federal Reserve's policy goals. In what ways would a goal of stabilizing asset prices be different from the four goals listed in this chapter?

Asset prices deal with a specific type of wealth that carries risk associated with individual firms.

Distinguish among money, income, and wealth.

A person's money is the currency held and the checking account balance, income is the earning and wealth is equal to value of assets minus all debts.

In mid-2013, an article in the Economist magazine argued that in the United States, "unemployment is well above the natural rate and inflation is well below the Fed's target and falling." Source: "How Could Markets Possibly Have Misunderstood?" Economist, June 28, 2013. This situation is illustrated by point

Which of the following were important developments in the mortgage market that took place during the 1970s?

Banks began to resell mortgages on the secondary market rather than holding them in their portfolios. Fannie Mae and Freddie Mac began to act as intermediaries between investors and home buyers.

Who borrows money and who lends money at this "target interest rate"?

Banks borrow and banks lend.

How would this action "pump money into the financial system to support lending"?

Banks can make more loans.

Suppose you have $2000 in currency in a shoebox in your closet. One day, you decide to deposit the money in a checking account. How will this action affect the M1 and M2 definitions of the money supply?

Both M1 and M2 will remain unchanged.

Which of the following statements is correct?

Changes in the federal funds rate usually will result in changes in both short-term and long-term interest rates on financial assets. A majority of economists support the Fed's choice of the interest rate as its monetary policy target, but some economists believe the Fed should concentrate on the money supply instead. The effect of a change in the federal funds rate on long-term interest rates is usually smaller than it is on short-term interest rates. All of the above are true.

Why did the Fed help JP Morgan Chase buy Bear Stearns?

Commercial banks would be reluctant to lend to investment banks. Failure of Bear Stearns would lead to a larger investment bank failure.

What is inflation targeting?

Committing the central bank to achieve an announced level of inflation.

A Federal Reserve publication discusses an estimate of the tax multiplier that gives it a value of 1.2 after one year and 2.8 after two years. Source: Sylvain Leduc, "Fighting Downturns with Fiscal Policy," Federal Reserve Bank of San Francisco Economic Letter, June 19, 2009. Why might the tax multiplier have a larger value after two years than after one year?

Consumers are more likely to perceive the tax change as permanent and change their spending choices.

Why would deflation cause "shoppers to hold back," and what does Evans-Pritchard mean when he says, "Once this psychology gains a grip, it can gradually set off a self-feeding spiral that is hard to stop"?

Consumers delay purchases, expecting prices to fall more, and the lack of demand causes prices to fall further.

Changes in interest rates affect aggregate demand. Which of the following is affected by changes in interest rates and, as a result, impacts aggregate demand?

Consumption of durable goods Business investment projects The value of the dollar

What is a contractionary fiscal policy?

Contractionary fiscal policy includes decreasing government spending and increasing taxes to decrease aggregate demand.

In the definition of the money supply, where do credit cards belong?

Credit cards are not included in the definition of the money supply.

What is meant by crowding out?

Crowding out is a decline in private expenditures as a result of increases in government purchases.

on the Phillips curve graph represents the same economic situation as point C on the aggregate demand and aggregate supply graph.

Increased government debt can lead to higher interest rates and, as a result, crowding out of private investment spending. In terms of borrowing (debt-spending), what will offset the effect of crowding out in the long run so that government debt poses less of a problem to the economy?

Debt-spending on research and development. Debt-spending on highways and ports. Debt-spending on education. All of the above

Debt-spending on research and development. Debt-spending on highways and ports. Debt-spending on education. All of the above.

Briefly explain whether you agree or disagree with the following statement: "Assets are things of value that people own. Liabilities are debts. Therefore, a bank will always consider a checking account deposit to be an asset and a car loan to be a liability."

Disagree. Checking accounts represent something that the bank owes to the owner of the account. It is a bank liability.

Do you agree or disagree with the following statement? "I recently read that more than half of the money issued by the government is actually held by people in foreign countries. If that's true, then the United States is less than half as wealthy as the government statistics indicate."

Disagree. Money is currency plus checking deposits. Wealth is the value of assets minus debts.

The U.S. Commerce Department reported the following monthly changes in the sales of durable goods: December 2012 +5.1 percent January 2013 −6.4 percent February 2013 +6.4 percent March 2013 −5.9 percent April 2013 −3.3 percent Source: Kathleen Madigan, "Hard to See Pattern in Durables Goods Report," Wall Street Journal, May 24, 2013. Because durable goods are often purchased with borrowed funds, their sales are very sensitive to changes in interest rates. What is the most likely reason for the variation in durable goods orders during a period of record low interest rates?

Durable goods, especially aircraft, carry large sticker prices, so the dollar value of new orders are quite volatile.

During the recession of 2007−2009, some economists were concerned that the U.S. economy might begin experiencing deflation. An article in the Federal Reserve Bank of San Francisco's Economic Letter stated: "A popular version of the well-known Phillips curve model of inflation predicts that we are on the cusp of a deflationary spiral in which prices will fall at ever increasing rates over the next several years." Source: John C. Williams, "The Risk of Deflation," FRBSF Economic Letter, March 27, 2009. How might a deflationary spiral occur in the Phillips curve model?

During a severe recession, the unemployment rate differs from its equilibrium value, inflation falls, lowering people's future inflation expectations and results in a spiralling deflation.

Does judging whether a deficit is excessive depend in part on whether the country is in a recession?

During a recession, the deficit is higher as tax revenue falls and spending increases making an existing deficit even bigger.

In what ways does the federal budget serve as an automatic stabilizer for the economy?

During a recession, there is an increase in government expenditures for transfer payments and a decrease in taxes as wages and profits fall. During an expansion, there is a decrease in government expenditures for transfer payments and an increase in taxes as wages and profits rise. Both of these occur automatically and both effects help to stabilize aggregate demand.

Workers generally form their expectations of future inflation based on the current conditions in the economy. Which one of the following does not reflect how they form their expectations?

During periods of high inflation, people do not take any particular action until the Fed has controlled the inflation rate.

on the Phillips curve graph represents the same economic situation as point B on the aggregate demand and aggregate supply graph.

An article in the Economist magazine contains the following: "Robert Lucas . . . showed how incorporating expectations into macroeconomic models muddled the framework economists prior to the 'rational expectations revolution' thought they saw so clearly." Source: "How to Know What Causes What," Economist, October 10,2011. What economic framework did economists change as the result of Lucas's arguments?

Economists changed the theory of "adaptive expectations" where people assume that future rates of inflation will follow the past rates of inflation

Consider the figures below and determine which is the best description of what causes the shift from AD1 to AD2.

Example A shows a contractionary monetary policy. The price level and real GDP both fall. Example B shows an expansionary monetary policy. The price level and real GDP both rise. Both A and B

Consider the figures below. Determine which combination of fiscal policies shifted AD 1AD1 to AD 2AD2 in each figure and returned the economy to long-run macroeconomic equilibrium.

Example (A): Expansionary fiscal policy. Example (B): Contractionary fiscal policy.

Consider the figures below. Determine which combination of fiscal policies shifted AD1 to AD2 in each figure and returned the economy to long-run macroeconomic equilibrium.

Example (A): Expansionary fiscal policy. Example (B): Contractionary fiscal policy.

Expansionary fiscal policy

Suppose the economy is in equilibrium in the first period at point (A). In the second period, the economy reaches point (B). We would expect the federal government to pursue what type of policy in order to move AD 2AD2 to AD Subscript 2 comma policyAD2, policy and reach equilibrium (point C) in the second period?If the federal government's policy is successful, what is the effect on the following macroeconomic indicators? Actual real GDP: Potential real GDP: Price level: Unemployment:

Expansionary fiscal policy increases does not change increases decreases

What is an expansionary fiscal policy?

Expansionary fiscal policy includes increasing government spending and decreasing taxes to increase aggregate demand.

Suppose the economy is in equilibrium in the first period at point A. In the second period, the economy reaches point B. We would expect the Fed to pursue what type of policy in order to move AD 2AD2, policy and reach equilibrium (point C) in the second period? If the Federal Reserve Bank's policy is successful, what is the effect on the following macroeconomic indicators? Actual real GDP: Potential real GDP: Price level: Unemployment:

Expansionary monetary policy increases does not change increase decreases

For more than 20 years, the Fed has used the federal funds rate as its monetary policy target. It has not targeted money supply at the same time because the

Fed cannot target both at the same time: It has to choose between targeting an interest rate and targeting the money supply.

Which of the following describes a liability on the Federal Reserve's balance sheet?

Federal Reserve notes

As of 1993, the Fed sets targets for which of the following in order to achieve price stability and high employment?

Federal funds rate

What is the difference between federal purchases and federal expenditures?

Federal purchases require that the government receives a good or service in return, whereas federal expenditures include transfer payments.

Which of the following best explains the difference between commodity money and fiat money?

Fiat money has no value except as money, whereas commodity money has value independent of its use as money.

Paul Volcker is credited largely with which of the following?

Fighting inflation by reducing the growth of the money supply. The "Volcker disinflation."

What is the "shadow banking system"?

Financial firms that raise money from investors and provide it to borrowers.

Suppose that Congress changes the law to require all firms to accept paper currency in exchange for whatever they are selling. All of the following are correct except:

Firms lose since they don't have the convenience of credit cards.

What is fiscal policy?

Fiscal policy can be described as changes in government spending and taxes to achieve macroeconomic policy objectives.

Which of the following statements is most accurate regarding fiscal policy and monetary policy?

Fiscal policy includes changes in government spending and taxes and is controlled by the federal government. Monetary policy includes changes in the money supply and interest rates and is controlled by the Federal Reserve. Both policies are intended to achieve macroeconomic objectives.

According to many economists and policymakers, what other options does the Fed have to improve its credibility with workers, firms, and investors?

Following a rules strategy. Following a discretion strategy. Following the Taylor rule.

What is the difference between federal government purchases (spending) and federal government expenditures?

Government purchases are included in government expenditures.

What are the gains to be had from simplifying the tax code?

Greater clarity of the decisions made by households and firms. Increased efficiency of households and firms. Resources from the tax preparation industry freed up for other All of the above.

What are the gains to be had from simplifying the tax code?

Greater clarity of the decisions made by households and firms. Increased efficiency of households and firms. Resources from the tax preparation industry freed up for other endeavors. All of the above.

Which of the following is not a problem of high inflation rates?

High inflation helps to stabilize financial markets.

________ is caused by central banks increasing the money supply at a rate far in excess of the growth rate of real GDP.

Hyperinflation

Why is price stability one of the Fed's monetary policy goals?

If inflation is low, the Fed will have flexibility to lessen the impact of recessions. By achieving price stability, the Fed also promotes economic growth. Rising prices erode the value of money as a medium of exchange and store of value. All of the Above.

Suppose that the economy is currently at potential GDP, and the federal budget is balanced. If the economy moves into recession, what will happen to the federal budget?

If the budget is balanced at potential GDP and the economy moves into recession, then there will be a budget deficit as government expenditures increase and tax revenues decrease.

Which of the following statements about the federal debt is correct?

If the debt becomes very large relative to the economy, then the government may have to raise taxes to high levels or reduce other types of spending to make the interest payments on the debt.

While serving as the president of the Federal Reserve Bank of St. Louis, William Poole stated, "Although my own preference is for zero inflation properly managed, I believe that a central bank consensus on some other numerical goal of reasonably low inflation is more important than the exact number." Source: William Poole,"Understanding the Fed," Federal Reserve Bank of St. Louis Review, Vol. 89, No. 1, January/February 2007, p. 4. Which of the following are benefits that the economy might gain from an explicit inflation target even if the target chosen is not a zero rate of inflation?

Improved accountability for the Fed More accurate expectations of future inflation Better communication between the Fed and the public All of the above

Why doesn't the Phillips curve represent a permanent trade-off between unemployment and inflation in the long run?

In the long run, aggregate supply is vertical.

Which of the following statements is correct?

In the long run, the Phillips curve is a vertical line at the natural rate of unemployment. In the long run, a higher or lower inflation rate has no effect on the unemployment rate. In the long run, a higher or lower price level has no effect on real GDP. All of the above.

Which of the following best describes the difference between crowding out in the short run and in the long run?

In the short run, an increase in government purchases may not fully crowd out private expenditures due to the stimulative effect of an increase in government purchases on aggregate demand. In the long run, most economists believe that a permanent increase in government purchases will result in complete crowding out of private expenditures.

What changes should they make if they decide a contractionary fiscal policy is necessary?

In this case, Congress and the president should enact policies that decrease government spending and increase taxes.

If Congress and the president decide an expansionary fiscal policy is necessary, what changes should they make in government spending or taxes?

In this case, Congress and the president should enact policies that increase government spending and decrease taxes.

A newspaper article contains the statement: "Income is only one way of measuring wealth." Source: Sam Roberts, "As the Data Show, There's a Reason the Wall Street Protesters Chose New York," New York Times, October 25, 2011. Do you agree that income is a way of measuring wealth?

Income is yearly earnings and it doesn't measure wealth which is the value of personal assets less all debts.

According to an article in the New York Times, an official at the Bank of Japan had the following explanation of why monetary policy was not pulling the country out of recession: "Despite recent major increases in the money supply, he said, the money stays in banks." Source: James Brooke, "Critics Say Koizumi's Economic Medicine Is a Weak Tea," New York Times, February 27, 2002. In the quote, when the official says "the money stays in banks," he is referring to ______ in the reserves in banks. But the real problem was that banks were not _____ that reserves The reason for this may have been a lack of ______

Increase lending borrowers

Suppose the economy is in equilibrium in the first period at point (A). In the second period, the economy reaches point (B). What policy would the federal government likely pursue in order to move AD 2AD2 to AD Subscript 2 comma policyAD2, policy and reach equilibrium (point C) in the second period?

Increase government spending

The graph to the right shows a situation in which the economy was in equilibrium at potential GDP (at point A) when the demand for housing sharply declined. What actions can Congress and the president take to move the economy back to potential GDP?

Increase government spending or decrease taxes.

In the figure to the right, which of the following events is most likely to cause a shift in the money demand (MD) curve from MD 1 to MD2 (Point A to Point C)?

Increase in real GDP or increase in the price level

In the figure to the right, which of the following events is most likely to cause a shift in the money demand (MD) curve from MD1 to MD2 (Point A to Point C)?

Increase in real GDP or increase in the price level

John Maynard Keynes is said to have remarked that using an expansionary monetary policy to pull an economy out of a deep recession can be like "pushing on a string." What is Keynes likely to have meant?

Increasing reserves and lowering interest rates may not stimulate economic activity if banks don't lend and businesses don't borrow.

Why do most economists believe that it is important for a country's central bank to be independent of the rest of the country's central government?

Independent central banks are more effective at fighting inflation.

From the discussion in this chapter, which source of government revenue is likely to increase the most in the future?

Individual income taxes.

If Irving Fisher was correct in his prediction about the value of velocity, then the quantity equation can be written to solve for the inflation rate as follows:

Inflation rate = Growth rate of the money supply- Growth rate of real output.

In the figure to the right, when the money supply increased from MS1 to MS2, the equilibrium interest rate fell from 4% to 3%. Why?

Initially, firms hold more money than they want relative to other financial assets. Increased demand for Treasury securities drives up their prices. Increased demand for Treasury securities drives down their interest rate. All of the above.

Which of the following is a monetary policy target used by the Fed?

Interest rate.

The Phillips curve was developed by A.W. Phillips in 1957 and shows the relationship between unemployment and inflation. The curve, shown at the right, indicates what type of relationship between the two variables?

Inverse relationship

How do investment banks differ from commercial banks?

Investment banks do not take deposits. Investment banks generally do not lend to households.

Consider the figure to the right. An increase in government spending shifted the aggregate demand curve from AD 1AD1 to AD 2AD2. As a result, both price level and real GDP increased. What can be said, however, about the increase in real

It increased by less than indicated by a multiplier with a constant price level

It increased by less than indicated by a multiplier with a constant price level.

In the late 1940s, the Communists under Mao Zedong were defeating the government of China in a civil war. The paper currency issued by the Chinese government was losing much of its value, and most businesses refused to accept it. At the same time, there was a paper shortage in Japan. During these years, Japan was still under military occupation by the United States. Some U.S. troops in Japan realized that they could use dollars to buy up vast amounts of paper currency in China, ship it to Japan to be recycled into paper, and make a substantial profit. Under these circumstances, was the Chinese paper currency a commodity money or a fiat money?

It is a commodity money because it has value as recycled paper.

What is the Taylor rule?

It is a rule that links the Fed's target for the federal funds rate to the current inflation rate, real equilibrium federal funds rate, inflation gap and output gap.

What do economists mean by the demand for money?

It is the amount of moneylong —currency and checking account depositslong —that individuals hold.

The Taylor rule for federal funds rate targeting does which of the following?

It links the Fed's target for the federal funds rate to economic variables.

When SRAS 1SRAS1 shifts to SRAS 2SRAS2, the price level increases and the level of real GDP falls. What happens to the short-run Phillips curve when the short-run aggregate supply curve shifts (a supply shock)?

It shifts up such that a given level of unemployment occurs at a higher price level.

During the Civil War, the Confederate States of America printed lots of its own currencylong dash—Confederate dollarslong dash—to fund the war. By the end of the war, nearly 1.5 billion paper dollars had been printed by the Confederate government. Source: "Textual Transcript of Confederate Currency," Federal Reserve Bank of Richmond. How would such a large quantity of Confederate dollars have affected the value of the Confederate currency?

It would have generated high inflation and therefore decreased the value of the Confederate currency.

At the beginning of 2005, Robert Toll, CEO of Toll Brothers, argued that the United States was not experiencing a housing bubble. Instead, he argued that higher house prices reflected restrictions imposed by local governments on building new houses. He argued that the restrictions resulted from "NIMBY"long dash—"Not in My Back Yard"long dash—politics. Many existing homeowners are reluctant to see nearby farms and undeveloped land turned into new housing developments. As a result, according to Toll, "Towns don't want anything built." Source: Shawn Tully, "Toll Brothers: The New King of the Real Estate Boom," Fortune, April 5, 2005. Why would the factors mentioned by Robert Toll cause housing prices to rise?

It would keep the supply of housing from increasing.

What are the largest asset and the largest liability of a typical bank?

Loans are the largest asset and deposits are the largest liability of a typical bank.

Recall that "securitization" is the process of turning a loan, such as a mortgage, into a bond that can be bought and sold in secondary markets. An article in the Economist notes: That securitization caused more subprime mortgages to be written is not in doubt. By offering access to a much deeper pool of capital, securitization helped to bring down the cost of mortgages and made home-ownership more affordable for borrowers with poor credit histories. Source: "Ruptured Credit," Economist, May 15, 2008. What is a "subprime mortgage," and would a subprime borrower be likely to pay a higher or a lower interest rate than a borrower with a better credit history?

Loans granted to borrowers with flawed credit histories; a higher interest rate.

Which of the following is NOT a monetary policy goal of the Federal Reserve bank (the Fed)?

Low prices

The Federal Reserve uses two definitions of the money supply, M1 and M2, because

M1 is a narrow definition focusing more on liquidity, whereas M2 is a broader definition of the money supply.

Suppose you decide to withdraw $100 in currency from your checking account. What is the effect on M1? Ignore any actions the bank may take as a result of your having withdrawn the $100.

M1 remains unchanged.

Jill makes a deposit into her savings account at the local bank with $100 in cash. As a result of this transaction,

M1 will decrease by $100.

Beginning in 2008, the Federal Reserve and the U.S. Treasury Department responded to the financial crisis by intervening in financial markets in unprecedented ways. Which of the following is one of the unprecedented actions of the Fed?

Making loans to primary dealers and holders of mortgage-backed securities.

What is a "classic type of run"?

Many depositors simultaneously decide to withdraw their money from a bank.

Which of the following statements concerning the Phillips curve is correct?

Many economists and policymakers in the 1960s viewed the Phillips curve as a structural relationship.

Which can be changed more quickly: monetary policy or fiscal policy?

Monetary policy can be changed more quickly than fiscal policy. Monetary policy can be changed at any of the FOMC meetings and the smaller number of individuals involved makes it easier to change policy.

What is the advantage of holding money?

Money can be used to buy goods, services, or financial assets.

Which of the following is included in M2 but not M1?

Money market deposit accounts in banks

In a speech delivered in June 2008, Timothy Geithner, then president of the Federal Reserve Bank of New York and later U.S. Treasury secretary, said: The structure of the financial system changed fundamentally during the boom. . . . [The] non-bank financial system grew to be very large. . . . [The] institutions in this parallel financial system [are] vulnerable to a classic type of run, but without the protections such as deposit insurance that the banking system has in place to reduce such risks. Source: Timothy F. Geithner, "Reducing Systemic Risk in a Dynamic Financial System," Remarks at the Economics Club of New York, June 9, 2008. a. What did Geithner mean by the "non-bank financial system"?

Money market mutual funds, hedge funds, and other financial firms that raise money from investors and provide it to firms and households.

Which one of the following is not one of the policy tools the Fed uses to control the money supply?

Moral suasion.

Which one of the following is not the formula for the quantity theory of money?

M×Y=P×V.

Consider the figure to the right. Can the Fed achieve a $900 billion money supply (MS) AND a 5% interest rate (point C)?

No. The Fed cannot target both the money supply and the interest rate simultaneously.

The English economist William Stanley Jevons described a world tour during the 1880s by a French singer, Mademoiselle Zelie. One stop on the tour was a theater in the Society Islands, part of French Polynesia in the South Pacific. She performed for her usual fee, which was one-third of the receipts. This turned out to be three pigs, 23 turkeys, 44 chickens, 5000 coconuts, and "considerable quantities of bananas, lemons, and oranges." She estimated that all of this would have had a value in France of 4000 francs. According to Jevons, "as Mademoiselle could not consume any considerable portion of the receipts herself, it became necessary in the meantime to feed the pigs and poultry with the fruit." Source: W. Stanley Jevons, Money and the Mechanism of Exchange, New York: D. Appleton and Company, 1889, pp. 1-2. Do the goods Mademoiselle Zelie received as payment fulfill the four functions of money

No. The goods are not a store of value.

After September 11, 2001, the federal government increased military spending on wars in Iraq and Afghanistan. Is this increase in spending considered fiscal policy?

No. The increase in defense spending after that date was designed to achieve homeland security objectives.

Which of the following is not a correct comparison between a contractionary fiscal policy in the basic aggregate demand and aggregate supply model and in the dynamic aggregate demand and aggregate supply model?

None of the above are correct statements about the two models.

Which of the following is not a correct comparison between a contractionary monetary policy in the basic aggregate demand and aggregate supply model and in the dynamic aggregate demand and aggregate supply model?

None of the above are correct statements about the two models.

How can the Fed fight a combination of rising unemployment and rising inflation?

Not easily; neither expansionary nor contractionary monetary policy can solve both problems simultaneously.

Which one of the following is not a function of money?

Open market operation.

Suppose the economy is in equilibrium in the first period at point A. In the second period, the economy reaches point B. What policy would the Fed likely pursue in order to move AD 2AD2 to AD Subscript 2 comma policyAD2, policy and reach equilibrium (point C) in the second period? (What policy will increase the price level and increase actual real GDP?)

Open market purchase of government securities

Suppose the economy is in equilibrium in the first period at point A. In the second period, the economy reaches point B. What policy would the Fed likely pursue in order to move AD 2AD2 to AD, policy and reach equilibrium (point C) in the second period?

Open market purchase of government securities.

According to a Congressional Budget Office report: CBO projects that the population age 65 or older will increase by 87 percent between now and 2037, compared with an increase of just 12 percent over that period in the number of people ages 20 to 64....CBO...estimates that, unless changes are made to Social Security, spending for the program will rise from 5.0 percent of GDP today to 6.2 percent by 2037. Source: Congressional Budget Office, The 2012 Long-Term Budget Outlook, June 2012, p. 65. Who are the baby boomers?

People born between World War II and 1965.

In the figure to the right, at what point is the inflation rate stable? That is, at what point can we refer to the inflation rate as the nonaccelerating inflation rate of unemployment ?

Point C

If the Federal Reserve is late to recognize a recession and implements an expansionary policy too late, the result could be an increase in inflation during the beginning of the next phase. Even though the goal had been to reduce the severity of the recession, the poor timing caused another problem: inflation. This is an example of what type of policy?

Procyclical policy

Which one of the following is not one of the monetary policy goals of the Fed?

Reduce income inequality.

"The multiplier effect means that an increase in one component of aggregate demand will result in a larger increase in total aggregate demand," your economics professor states. "Moreover, the multiplier effect also works in reverse." What does your professor mean when she says that the multiplier effect works in reverse?

She means that a decrease in some component of aggregate demand will result in a larger decrease in total aggregate demand.

Why would securitization give mortgage borrowers access to a deeper pool of capital?

Since banks could resell mortgages to investors, they had access to more funds than just their own deposits.

Why would deposit insurance provide the banking system with protection against runs?

Since most depositors are insured, it is less likely that panicked buyers will simultaneously withdraw funds.

Which of the following are reasons why the federal government uses the CPI when deciding how much to increase Social Security payments to retired workers to keep the purchasing power of the payments from declining?

The CPI continues to be the most widely used measure of inflation.

Why might European governments have felt the need to support their banks in order to avoid another Lehman moment?

The European governments wanted to avoid wider economic repercussions resulting from bank failures that could undermine the financial positions of other firms and lead to a further reduction in prices of financial assets.

The text explains that the United States has a "fractional reserve banking system." Why do most depositors seem to be unworried that banks loan out most of the deposits they receive?

The FDIC insures deposits up to $250,000.

Which of the following best explains how the Federal Reserve acts to help prevent banking panics?

The Fed acts as a lender of last resort, making loans to banks so that they can pay off depositors.

Which of the following statements is true about the Fed under the leadership of Chairman Alan Greenspan between 1987 and 2006?

The Fed attempted to enhance its credibility by announcing its monetary policy action at the conclusion of each FOMC meeting.

The Fed uses monetary policy to offset the effects of a recession (high unemployment and falling prices when actual real GDP falls short of potential GDP) and the effects of a rapid expansion (high prices and wages). Can the Fed, therefore, eliminate recessions?

The Fed can only soften the magnitude of recessions, not eliminate them.

Which tool is the most important?

The Fed conducts monetary policy principally through open market operations.

In the graph of the money market shown on the right, what could cause the money supply curve to shift from MS1 to MS2?

The Fed decreases the money supply by deciding to sell U.S. Treasury securities.

Why would the Fed intentionally use contractionary monetary policy to reduce real GDP?

The Fed intends to reduce inflation, which occurs if real GDP is greater than potential GDP.

Which of the following statements is true about the Fed's monetary policy targets?

The Fed is forced to choose between the interest rate and the money supply as its monetary policy target.

Which of the following is a monetary policy response to the economic recession of 2007-2009 and the accompanying financial crisis?

The Fed provided loans directly to corporations by purchasing commercial paper. The Fed purchased large amounts of mortgage-backed securities. The Fed expanded the eligibility for discount loans to firms other than commercial banks. All of the above were responses.

Nobel laureate Milton Friedman and his followers belong to a school of thought known as monetarism. What do the monetarists argue the Fed should target?

The Fed should target the money supply, not the interest rate, and that it should adopt the monetary growth rule.

What can we expect from the Federal Reserve Bank if it seeks to move the economy in the direction of long-run macroeconomic equilibrium?

The Fed will pursue an expansionaryan expansionary monetary policy.

Which of the following accurately describes expansionary monetary policy?

The Federal Reserve causes an increase in the money supply.

Which of the following accurately describes a recent change in the Federal Reserve's balance sheet?

The Federal Reserve has more loans to financial markets and institutions on the assets side of its balance sheet.

Which of the following accurately describes contractionary monetary policy?

The Federal Reserve increases interest rates.

What is the cyclically adjusted budget deficit or surplus?

The cyclically adjusted budget deficit or surplus is the deficit or surplus in the federal government's budget if the economy were at potential GDP.

What is the long-run effect of a permanent increase in government spending?

The decline in investment, consumption, and net exports exactly offsets the increase in government spending; therefore, real GDP remains unchanged.

What is the discount rate?

The discount rate is the rate at which the Fed lends to banks.

Which of the following is not a correct comparison between an expansionary fiscal policy in the basic aggregate demand and aggregate supply model and in the dynamic aggregate demand and aggregate supply model?

The dynamic model assumes that potential GDP is constantly growing while the basic model assumes that it is static. In the dynamic model, expansionary policy would be used when demand does not grow sufficiently; in the basic model, expansionary policy would be used when demand falls. If the economy is below full employment, expansionary fiscal policy will cause an increase in the price level in both models. All of the above are correct statements about the two models.

What is it about these variables that makes future budget deficits difficult to predict?

The economic variables respond to economic shocks, making them less predictable.

What is the difference between the federal budget deficit and federal government debt?

The federal budget deficit is the year-to-year short fall in tax revenues relative to government spending (T < G + TR), financed through government bonds. The federal government debt is the accumulation of all past deficits.

As the figure to the right indicates, the Fed can affect both the money supply and interest rates. However, in recent years, the Fed targets interest rates in monetary policy more often than it does the money supply. Which interest rate does the Fed target?

The federal funds rate

In 2013, one article in the Wall Street Journal noted that: "The Fed's Board of Governors kept the discount rate unchanged at 0.75%," while another article predicted that: "The Fed can be expected to state again that the target rate won't change until mid-2015." Sources: Michael J. Casey, "Let's Get This Over and Done With, Fed," Wall Street Journal, June 19, 2013; and Sarah Portlock and Eric Morath, "Some Fed Officials See 'Diminished' Downside Risks," Wall Street Journal, February 26, 2013. What is the name of the "target interest rate" mentioned in this article?

The federal funds rate.

Who is responsible for fiscal policy?

The federal government controls fiscal policy.

If the short-run aggregate supply curve (SRAS) were a horizontal line, what would be the impact on the size of the government purchases and tax multipliers

The impact of the multiplier would be larger if the SRAS curve is horizontal.

b. Why does an estimate of the size of the multiplier matter in evaluating the effects of an expansionary fiscal policy?

The larger the multiplier, the greater the effects of an expansionary fiscal policy.

Which of the following statements regarding the 2009 stimulus package is true?

The largest category of expenditures was health care, social services, and education; and the largest category of tax cuts was individual tax cuts.

Suppose that during one period, the velocity of money is constant and during another period, it undergoes large fluctuations. During which period will the quantity theory of money be more useful in explaining changes in the inflation rate?

The period where velocity is constant because when velocity is constant the changes in the money supply can be shown to be the main cause of inflation.

An article in the Economist argued that: "heavy public debt risks more than just crowding out private investment. It can, in the extreme, bring on insolvency." Source: "Running Out of Road," Economist, June 16, 2011. What does the article mean by "heavy public debts"?

The public debt is considered to be heavy when it as a percentage of GDP debt is rather high.

How does the quantity theory provide an explanation about the cause of inflation?

The quantity equation shows that if the money supply grows at a faster rate than real GDP, then there will be inflation.

Explain whether you agree with this argument: If the Fed actually ever carried out a contractionary monetary policy, the price level would fall. Because the price level has not fallen in the United States over an entire year since the 1930s, we can conclude that the Fed has not carried out a contractionary policy since the 1930s.

The statement is false. A contractionary policy could result in a lower rate of inflation rather than a fall in the price level.

In a newspaper column, author Delia Ephron described a conversation with a friend who had a large balance on her credit card on which the friend was being charged an interest rate of 18 percent per year. The friend was worried about ever being able to pay off the debt. Ephron was earning only 0.4 percent interest on her bank certificate of deposit (CD). She considered withdrawing the money from her CD and using it to make a loan to her friend so her friend could pay off her credit card balance: "So I was thinking that all of us earning 0.4 percent could instead loan money to our friends at 0.5 percent. ... [M]y friend would get out of debt [and] I would earn $5 a month instead of $4." Source: Delia Ephron, "Banks Taketh, but Don't Giveth," New York Times, January 27, 2012. Why don't more people use their savings to make loans rather than keeping the funds in bank accounts that earn very low rates of interest?

There is a risk that the borrower won't pay the money back.

Why do you think that a deflationary spiral did not actually occur during or after the recession of 2007−2009?

There was a world-wide increase in oil prices and an increase in food prices during that time.

Which of the following decisions does the textbook discuss as an action by the Fed during Chairman Alan Greenspan's term that possibly contributed to the financial crisis of 2007-2009?

The Fed's decision to keep the target for the federal funds rate at 1 percent for more than 18 months after the end of the 2001 recession.

Suppose that the expected inflation rate increases from 4 percent to 6 percent. What will happen to the short-run Phillips curve?

The short-run trade-off between uemployment and inflation will be worse than before as the economy moves to a higher short-run Phillips curve.

"Their commercial-lending businesses, funded by their stable deposit bases, make them steady earners." Source: Karen Richardson,"Clean Books Bolster Traditional Lenders," Wall Street Journal, April 30, 2007, p. C1. What is commercial lending?

This is when banks make loans to businesses.

Why does a $1 increase in government purchases lead to more than a $1 increase in income and spending?

Through the government purchases multiplier, the $1 increase in government spending will lead to an increase in aggregate demand and national income, which will lead to an increase in induced spending.

In response to problems in financial markets and a slowing economy, the Federal Open Market Committee (FOMC) began lowering its target for the federal funds rate from 5.25 percent in September 2007. Over the next year, the FOMC cut its federal funds rate target in a series of steps. Writing in the New York Times, economist Steven Levitt observed, "The Fed has been pouring more money into the banking system by cutting the target federal funds rate to 0 to 0.25 percent in December 2008." Source: Steven D. Levitt, "The Financial Meltdown Now and Then," New York Times, May 12, 2009. What is the relationship between the federal funds rate falling and the money supply increasing?

To decrease the federal funds rate, the Fed must increase the money supply.

In the figure to the right, expected inflation is initially at 1.5%. When expected inflation increases to 4.5%, which of the following will occur?

To have 3.5% unemployment rate, inflation would be 7.5%. Unemployment reaches the natural rate of 5%. At the natural rate of unemployment, inflation is 4.5%. All of the above.

Which of the following was the Fed's objective in using "quantitative easing" and "Operation Twist"?

To increase aggregate demand. To keep interest rates on 10-year Treasury notes low. To keep interest rates on mortgages low. All of the above.

How does lowering the target for the federal funds rate "pour money" into the banking system?

To increase the money supply, the Fed buys bonds on the open market, which increases bank reserves.

Why do few economists argue that it would be a good idea to balance the federal budget every year?

To keep a balanced budget during a recession, taxes would have to increase and government expenditures would have to decrease, which would further reduce aggregate demand and deepen the recession.

How does a budget deficit act as an automatic stabilizer and reduce the severity of a recession?

Transfer payments to households increase. Consumers spend more than they would in the absence of social insurance programs, like unemployment. During recessions, tax obligations fall due to falling wages and profits. All of the above.

Suppose that the Federal Reserve engages in an open market sale of $3939 million in U.S. Treasury bills to banks. In the T-accounts for the Fed and for the banking system shown here, fill in the missing information. Federal Reserve Assets _____ -$39 million Liabilities reserves _____ -$39 million Banking System Assets Liabilities Treasury bills $39 million _____ -39 million Liabilities

Treasury Bills Reserves

An editorial in the Wall Street Journal declares that: "We don't put much stock in future budget forecasts because they depend on so many variables." Source: "Fiscal Revelation," Wall Street Journal, February 6, 2007, p. A 16. Which of the following variables would a forecast of future federal budget deficits depend on?

Wage growth. GDP growth. Profit growth. Demographics. All of the above are important variables to consider.

When is it considered "good policy" for the government to run a budget deficit?

When borrowing is used for long-lived capital goods.

The article also stated that Japanese Prime Minister Shinzo Abe was pressuring the Bank of Japan, the Japanese central bank, to take steps to hit an inflation target of 2 percent. Why would the Bank of Japan, the Japanese central bank, be reluctant to raise its target for short-term interest rates if the price level is falling?

When the target rate increases, money growth slows down, and inflation should decrease.

How do the banks "create money"?

When there is an increase in checking account deposits, banks gain reserves and make new loans, and the money supply expands.

What is the Fed doing to increase the credibility of its policies?

Whenever a change in policy is announced, the change actually takes place. Announcing the federal funds target rate.

The paper currency of the United States is technically called "Federal Reserve Notes." The following excerpt is from the Federal Reserve Act: "Federal Reserve Notes...shall be redeemed in lawful money on demand at the Treasury Department of the United States, in the city of Washington, District of Columbia, or at any other Federal Reserve bank." If you took a $20 bill to the Treasury Department or Federal Reserve bank, with what type of "lawful money" is the government likely to redeem it?

With another Reserve Note of equal value.

Why should the retirement of the baby boomers cause a large increase in the growth rate of spending by the federal government on Social Security?

With the retirement of the baby boomers, there will be more individuals collecting Social Security than currently.

Indicate the two main objections to the idea that the short-run Phillips curve is vertical.

Workers and firms might not have rational expectations. Contracts with workers keep wages sticky.

Which of the following formulas represents the expression for equilibrium real GDP?

Y=C-(MPC*T)+I+G/1-MPC

Does government spending ever reduce private spending?

Yes, due to crowding out.

Suppose that you are a bank manager, and the Federal Reserve raises the required reserve ratio from 10 percent to 12 percent. What actions would you need to take?

You would have to reduce loans to make up for the necessary increase in reserves.

Suppose you decide to withdraw $100 in cash from your checking account. Which one of the following choices accurately shows the effect of this transaction on your bank's balance sheet.

Your bank's balance sheet shows a decrease in reserves by $100 and a decrease in deposits by $100.

"People lined up on the veranda of the American mission hospital here from miles around to barter for doctor visits and medicines, clutching scrawny chickens, squirming goats and buckets of maize." Source: Celia W. Dugger, "Zimbabwe Health Care, Paid With Peanuts," New York Times, December 18, 2011. The people buying medical services at this hospital could not use money to pay for the medical services they were buying because the

Zimbabwean currency was worthless.

Suppose the inflation rate has been 15 percent for the past four years. The unemployment rate is currently at the natural rate of unemployment of 5 percent. The Federal Reserve decides that it wants to permanently reduce the inflation rate to 5 percent. To do this, the Fed would use

a contractionary

If actual real GDP in 2006 occurs at point B and potential GDP occurs at LRAS06, we would expect the Federal Reserve Bank to pursue ______monetary policy. If the Fed's policy is successful, what is the effect of the policy on the following macroeconomic indicators? Actual real GDP _________ Potential real GDP ________ Price level _________ Unemployment ________

a contractionary decrease doesn't change decrease increase

Year Potential Real GDP Real GDP Price Level 2016 $17.7 trillion $17.7 trillion 110.0 2017 $18.1 trillion $18.3 trillion 115.5 If the Fed wants to keep real GDP at its potential level in 2017, it should use____ policy. The trading desk should be____T-bills If the Fed's policy is successful in keeping real GDP at its potential level in 2017, state whether each of the following will be higher, lower, or the same as it would have been if the Fed had taken no action: i. Real GDP will be_______it would have been if the Fed had taken no action. Full-employment real GDP will be ____ it would have been if the Fed had taken no action. The inflation rate will be_____it would have been if the Fed had taken no action. The unemployment rate will be____it would have been if the Fed had taken no action.

a contractionary selling lower than the same as lower than higher than

According to an article in Business Week, many workers who retired in the year 2000 expected to live off the interest they would receive from bank certificates of deposit or money market mutual funds. "Then came disinflationlong dash—and a steep fall in interest rates." Source: Peter Coy, "The Surprise Threat to Nest Eggs," Business Week, July 28, 2003. Disinflation is

a decline in the inflation rate.

In the fall of 2011, investors began to fear that some European governments, particularly Greece and Italy, might default on the bonds they had issued, making the prices of the bonds fall sharply. Many European banks owned these bonds, and some investors worried that these banks might also be in financial trouble. An article in the Economist magazine referred to the "prospect of another Lehman moment." The article noted that, "Governments are once again having to step in to support their banks." Source: "Here We Go Again," Economist, October 8, 2011. What did the article mean by a "Lehman moment"? A "Lehman moment" meant

a deepening of the financial crisis brought about by bankruptcy of a major bank.

Congress and the president enact a temporary cut in payroll taxes. This is an example of

a discretionary fiscal policy.

If the government cuts taxes in order to increase aggregate demand, the action is called

a discretionary fiscal policy.

Which of the following is not one of the monetary policy goals of the Federal Reserve ("the Fed")?

a high foreign exchange rate of the U.S. dollar relative to other currencies

According to the Taylor Rule, if the Fed reduces its target for the inflation rate, the result will be

a higher target federal funds rate.

Economists who believed that the Phillips curve represented a structural relationship believed that the curve represented

a permanent trade-off between unemployment and inflation.

In a real business cycle model, which of the following best explains an increase in real GDP above the full-employment level?

a positive technology shock

In a column in the Financial Times, the prime minister and the finance minister of the Netherlands argue that the European Union, an organization of 27 countries in Europe, should have "a commissioner for budgetary discipline." They believe that: "The new commissioner should be given clear powers to set requirements for the budgetary policy of countries that run excessive deficits." Source: Mark Rutte and Jan Kees de Jager, "Expulsion from the Eurozone Has to Be the Final Penalty," Financial Times, September 7, 2011. An "excessive" budget deficit in this context is

a relatively large budget deficit as a percentage of GDP beyond the European Union's deficit and debt rules .

The "Volcker disinflation" was

a significant reduction in the inflation rate between 1979 and 1989, under the leadership of Fed Chairman Paul Volcker.

The short-run Phillips curve exhibits ____, whereas the long-run Phillips curve shows _____

a trade-off between inflation and unemployment no trade-off between inflation and unemployment

A student says the following: "I understand why the Fed uses expansionary policy but I don't understand why it would ever use contractionary policy. Why would the government ever want the economy to contract?" The government would want the economy to contract when real GDP is

above potential GDP and the price level is rising.

If actual inflation is higher than expected inflation, the

actual real wage is less than the expected real wage: unemployment falls.

A monetary policy intended to bring about disinflation will cause a greater increase in unemployment if workers and firms had

adaptive expectations, in which case they would change their expectations of future inflation only after current inflation had decreased.

Alan Greenspan

agreed with Paul Volcker about the importance of keeping inflation low.

If something is to be considered as money, it has to fulfill

all four functions

The following appears in a Federal Reserve publication: "In practice, monetary policymakers do not have up-to-the-minute, reliable information about the state of the economy and prices. Information is limited because of lags in the publication of data. Also, policymakers have less-than-perfect understanding of the way the economy works, including the knowledge of when and to what extent policy actions will affect aggregate demand. The operation of the economy changes over time, and with it the response of the economy to policy measures. These limitations add to uncertainties in the policy process and make determining the appropriate setting of monetary policy...more difficult." Source: Board of Governors of the Federal Reserve System, The Federal Reserve System: Purposes and Functions, Washington, DC, 1994. If the Fed itself admits that there are many obstacles in the way of effective monetary policy, why does it still engage in active monetary policy rather than use a monetary growth rule, as suggested by Milton Friedman and his followers? Policymakers at the Fed believe that

although it is not perfect, active monetary policy is still a stabilizing force in the economy.

The revenue the federal government collects from the individual income tax declines during a recession. This is an example of

an automatic stabilizer.

The total the federal government pays out for unemployment insurance decreases during an expansion. This is an example of

an automatic stabilizer.

Year Potential GDP Real GDP Price Level 2016 $17.8 trillion $17.8 trillion 113.7 2017 $18.2 trillion $17.8 trillion 115.9 If Congress and the president want to keep real GDP at its potential level in 2017, they should use______ which would mean ______

an expansionary fiscal policy increasing government spending or cutting taxes

If Lucas and Sargent were right,

an expansionary monetary policy would not work if people had rational expectations, since they will use all available information including knowledge of the effects of the Fed's monetary policy.

The U.S. penny is made primarily of zinc. There have been several times in recent years when zinc prices have been high and it has cost the U.S. Treasury more than one cent to manufacture a penny. There are currently about 1.4 billion pennies in circulation. Economist François Velde of the Federal Reserve Bank of Chicago has proposed making the current penny worth 5 cents. Source: Austan Goolsbee, "Now That a Penny Isn't Worth Much, It's Time to Make It Worth 5 Cents," New York Times, February 1, 2007. The effect of this proposal would cause______the value of M1. Is this change likely to have much impact on the economy?

an increase in no

The federal government's budget surplus was $263.2 billion in 2000 and $128.2 billion in 2001. A decrease in the federal government's budget surplus can be the result of

an increase in government purchases. a recession. a decrease in taxes. all above

Which of the following is not an example of monetary policy?

an increase in taxes

Consider the formula for the multiplier effect Which of the following could cause an increase in overall economic activity, according to this formula?

an increase in the multiplier

Consider the formula for the multiplier effect. Which of the following could cause an increase in overall economic activity, according to this formula?

an increase in the multiplier

The effect on the economy of tax reduction and simplification is

an increase in the quantity of real GDP supplied at every price level, and a shift in the long-run aggregate supply curve.

What is the purpose of the Taylor rule? The Taylor rule is used to

analyze and predict how the Fed targets the federal funds rate.

An article in the Economist states that the value of potential GDP: "is almost impossible to pin down in real time since the economy's equilibrium long-run stock of capital and labour are so difficult to estimate with precision...." Source: "Remembering When the Future Kept Getting Bigger," Economist, May 24, 2012. By "real time," the article means

at any point in actual time.

The difficulty of estimating potential GDP matters for policymakers because ideally, equilibrium GDP should occur

at potential GDP.

Changes in taxes and spending that happen without actions by the government are called

automatic stabilizers.

In the securitization process,

banks grant loans to households and bundle the loans into securities that are then sold to investors.

The decline in housing prices that began in 2006 led to rising defaults among which borrowers?

borrowers who had made only small down payments alt-A and subprime borrowers borrowers with adjustable-rate mortgages All of the above.

When Burns refers to "the current environment," he means the 1970s, a period in which

both inflation and unemployment worsened.

During the 1980s and 1990s, the relationship between growth in M2 and inflation

broke down, and the Fed announced that it would no longer set targets for M2.

To reduce a budget deficit,

budgetary policies such as increasing taxes and cutting expenditures can be used.

To increase the money supply, the FOMC directs the trading desk, located at the Federal Reserve Bank of New York, to

buy U.S. Treasury securities from the public.

If the Federal Open Market Committee (FOMC) decides to increase the money supply, it orders the trading desk at the Federal Reserve Bank of New York to

buy U.S. Treasury securities.

What is "quantitative easing"? Quantitative easing involved the Fed's

buying longer term Treasury securities that are not usually involved in open market operations.

When the Federal Open Market Committee (FOMC) decides to increase the money supply, it ___________ U.S. Treasury securities. If the FOMC wishes to decrease the money supply, it _______U.S. Treasury securities.

buys sells

The concept of a nonaccelerating inflation rate of unemployment (NAIRU) helps us to understand why in the long run, the Federal Reserve

can affect the inflation rate but not the unemployment rate.

If the long-run aggregate supply curve is vertical, then the Phillips curve

cannot be downward sloping in the long run.

Friedrich Schneider, an economist at the Johannes Kepler University of Linz in Austria, made the following observation about China: "The average Chinese trusts neither the Chinese banks nor the Communist Party." Source: David Barboza, "Chinese Way of Doing Business: In Cash We Trust," New York Times, April 30, 2013. If Schneider is correct, businesses and consumers might prefer to carry out transactions by using

cash

The large budget deficits of $1.4 trillion in fiscal year 2009 and $1.3 trillion in fiscal year 2010 were

caused partly by the increase in government spending including spending to bail out failed financial institutions and by the deep decline in tax revenues as incomes and profits fell.

By repercussions, Keynes means that an initial increase in autonomous expenditures will

change production by an amount greater than the initial increase in autonomous expenditures.

Suppose that Congress and the president were committed to balancing the budget each year. How does what happened during 2013 provide insight into difficulties they might run into in trying to balance the budget every year. Because government spending and tax revenues

change with GDP, balancing the budget annually would result in economic disruptions.

When Robert Shiller asked a sample of the general public what they thought caused inflation, the most frequent answer he received was "greed." Most economists would argue that inflation is caused by

changes in both aggregate demand and aggregate supply.

The Federal Reserve acting as the lender of last resort to prevent a bank panic

constitutes offering discount loans to distressed banks, but the "bail out of the banks" involved providing funds to the banks in exchange for ownership in those banks.

If actual real GDP in 2006 occurs at point B and potential GDP occurs at LRAS 06LRAS06, we would expect the federal government to pursue a(n) ____ fiscal policy.

contractionary

William McChesney Martin, who was Federal Reserve chairman from 1951 to 1970, was once quoted as saying, "The role of the Federal Reserve is to remove the punchbowl just as the party gets going." When he said "to remove the punchbowl," he meant to engage in ____ policy

contractionary

If actual real GDP in 2006 occurs at point B and potential GDP occurs at LRAS 06, we would expect the federal government to pursue a(n) _____ fiscal policy. If the government's policy is successful, what is the effect of the policy on the following macroeconomic indicators? Actual real GDP Potential real GDP Price level Unemployment

contractionary decreases doesn't change decreases increases

The most important role of the Federal Reserve in today's U.S. economy is

controlling the money supply to pursue economic objectives.

In 1968, Herbert Stein, who would later serve on President Nixon's Council of Economic Advisors, wrote, "Some who would opt for avoiding inflation would say that in the long run such a policy would cost little, if any, additional unemployment." Source: Herbert Stein, The Fiscal Revolution in America, Chicago: University of Chicago Press, 1969, p. 382. Stein's statement was

correct

The M1 measure of the money supply includes which of the following components?

currency in circulation checking account deposits in banks holdings of traveler's checks All of the above.

"Today...the main purpose [of government's issuing bonds] is to let craven politicians launch projects they know the public, at the moment, would rather not fully finance. The tab for these projects will not come due, probably, until after the politicians have long since departed for greener (excuse the expression) pastures." Source: Paul Carpenter, "The Bond Issue Won't Be Repaid by Park Tolls," (Allentown, PA) Morning Call, May 26, 2002. Borrowing is a bad idea to pay for ____ but a good idea to pay for ____

current expenses long-lived capital goods

One-time tax rebates, such as those in 2001 and 2008, increase consumption spending by less than a permanent tax cut because one-time tax rebates increase

current income.

One-time tax rebates, such as those in 2001 and 2008, increase consumption spending by less than a permanent tax cut because one-time tax rebates increase

current income.

Look carefully at the following list. a. The coins in your pocket. b. The funds in your checking account. c. The funds in your savings account. d. The traveler's check that you have left over from a trip. e. Your Citibank Platinum MasterCard. Which of the things above are NOT included in the M1 definition of the money supply?

c & e

As the price of a single good rises, the quantity demanded of that good tends to _______________. As overall prices (the price level) rise, the quantity demanded of output tends to _________________.

decrease decrease

A higher required reserve ratio _________ the value of the simple deposit multiplier.

decreases

An increase in the amount of excess reserves that banks keep _________ the value of the real-world deposit multiplier.

decreases

In the figure to the right, the opportunity cost of holding money ______ when moving from Point A to Point B on the money demand curve.

decreases

If the government's policy is successful, what is the effect of the policy on the following macroeconomic indicators? Actual real GDP Potential real GDP Price level Unemployment

decreases does not change decreases increases

Complete the following table for a static AD-AS model: Recession Expansionary ↑Gov't spending or_______ Real GDP and price level _________ Rising inflation Contractionary _______ or up arrow Taxes Real GDP and price level ________

decreases taxes rise decreases government spending falls

As your actions and those of other bank managers reduced the amount of loans made, we would expect that the money supply would end up

decreasing

The following is from a message by President Hoover to Congress, dated May 5, 1932: "I need not recount that the revenues of the Government as estimated for the next fiscal year show a decrease of about $1,700,000,000 below the fiscal year 1929, and inexorably require a broader basis of taxation and a drastic reduction of expenditures in order to balance the Budget. Nothing is more necessary at this time than balancing the Budget." According to the statement, balancing the Budget would require

decreasing government purchases and increasing taxes.

According to an article in the Economist magazine, in 2013 the Japanese economy was experiencing falling prices "on everything from chocolate bars to salad." Source: "Waging a New War," Economist, March 9, 2013. What is the term for a falling price level?

deflation

Look again at the chart on prices during the early 1930s: Year Consumer Price Index %-Change in Prices 1929 17.1 − 1930 16.7 −2.3% 1931 15.2 −9.0 1932 13.7 −9.9 1933 13.0 −5.1 Which of the following terms best describes the situation during 1933?

deflation

Which of the following is not a factor that helped lead to the financial crisis of 2007-2009?

deposit insurance for commercial banks

Which of the following is the largest liability of a typical bank?

deposits

In a speech in September 1975, then Fed chairman Arthur Burns said the following: "There is no longer a meaningful trade-off between unemployment and inflation. In the current environment, a rapidly rising level of consumer prices will not lead to the creation of new jobs...Highly expansionary monetary and fiscal policies might, for a short time, provide some additional thrust to economic activity. But inflation would inevitably accelerate- a development that would create even more difficult economic problems than we have encountered over the past year." Source: Arthur F. Burns, "The Real Issues of Inflation and Unemployment," in Federal Reserve Bank of New York, Federal Reserve Readings on Inflation, February 1979. Burns's views in this speech are______ the views at the Fed in the late 1960s.

different than

A significant reduction in the inflation rate is called

disinflation.

In order for deflation to take place in 2018, the economy_____ also have to be experiencing a recession.

does

During the 2012 presidential election campaign, Texas Governor Rick Perry criticized the actions of Fed Chair Ben Bernanke. Perry argued that: "Printing more money to play politics at this particular time in American history is almost. . . treasonous in my opinion." An article in the Wall Street Journal commented that despite Perry's remarks, ". . . Bernanke is willing to embrace the political independence embedded in his role to do what Fed officials think the economy needs." Source: Sudeep Reddy, "Rick Perry's Attack on Bernanke Highlights Political Risks Facing the Fed," Wall Street Journal, August 16, 2011. The "political independence" embedded in the role of Fed chair

enables the Fed to pursue policies independent of the administration in power.

The Fed expects that controlling that one interest rate would allow it to meet its goals for inflation and unemployment because lower short-term interest rates

encourage lending and stimulate economic activity.

Congress passed legislation to create the Federal Reserve System in 1913 in order to

end the instability created by bank panics by acting as a lender of last resort.

Whenever banks gain reserves and make new loans, the money supply ___________; and whenever banks lose reserves, and reduce their loans, the money supply __________.

expands; contracts

In 1995, some economists argued that the natural rate of unemployment was 6 percent. Then Fed chairman Alan Greenspan was convinced that the natural rate was actually about 5 percent. If Greenspan had accepted the view that the natural rate was 6 percent and the target inflation rate would remain the same, monetary policy during the late 1990s might have been more_____ than it was.

expansionary

What actions can the government take to bring real GDP to its potential level in 2017? In order to bring real GDP to its potential level in 2017, the government can engage in____fiscal policy by either ____ government spending or ___ taxes

expansionary increasing decreasing

The Fed's strategy of increasing the money supply and lowering interest rates in order to increase real GDP is called

expansionary monetary policy.

Robert Shiller asked a sample of the general public and a sample of economists the following question: "Do you agree that preventing high inflation is an important national priority, as important as preventing drug abuse or preventing the deterioration in the quality of our schools?" Fifty-two percent of the general public, but only 18 percent of economists, fully agreed. The general public believes that inflation is a bigger problem than economists do because the general public believes that real wages

fall until a full inflation correction takes place

General Juan Peron, the former dictator of Argentina, once said of the labor market in his country, "Prices have gone up the elevator, and wages have had to use the stairs." Source: Robert J. Shiller, "Why Do People Dislike Inflation?" in Christina D. Romer and David H. Romer, eds., Reducing Inflation: Motivation and Strategy, Chicago: University of Chicago Press, 1997. In this situation, real wages in Argentina were ___ Unemployment was likely to have been relatively ____

falling low

A simplified tax code would reduce economic efficiency by increasing the number of decisions households and firms make solely to reduce their tax payments.

false

Decreasing the tax rate decreases the value of the government purchases multiplier.

false

During 2005, the FOMC was concerned that the inflation rate would begin to accelerate due to the continued boom in the housing market, so the Fed started decreasing the target for the federal funds rate.

false

Even though the core PCE is a better measure of the inflation rate than is the CPI, the CPI is still more widely used because the core PCE includes energy and food prices, which do not affect the cost of living of a typical consumer.

false

For the Fed to succeed in reducing the severity of business cycles, it must act precisely when a recession or an acceleration of inflation can be seen in the economic data.

false

If the Fed decides to carry out an expansionary monetary policy because it believes aggregate demand will not increase enough to keep the economy at potential GDP, the inflation rate will most likely be lower than it would have been without the policy.

false

Monetary policy should be designed to rarely, if ever, influence investors' expectations of future interest rates.

false

The higher the tax rate, the larger the multiplier effect.

false

An article in the New York Times in 1993 stated the following about Fed Chairman Alan Greenspan's decision to no longer announce targets for the money: "Since the late 1970's, the Federal Reserve has made many of its most important decisions by setting a specific target for growth in the money supply ... and often adjusted interest rates to meet them." Source: Steven Greenhouse, "Fed Abandons Policy Tied to Money Supply," New York Times, July 23, 1993. If the Fed would no longer have a specific target for the money supply, it would be targeting the

federal funds rate.

An article in the Wall Street Journal notes that before the financial crisis of 2007minus−2009, the Fed "managed just one short-term interest rate and expected that to be enough to meet its goals for inflation and unemployment" Source: Jon Hilsenrath, "Easy-Money Era a Long Game for Fed," March 17, 2013 The short-term interest rate the article is referring to is the

federal funds rate.

The interest rate that banks charge each other for overnight loans is called the

federal funds rate.

To affect economic variables such as real GDP or the price level, the monetary policy target the Federal Reserve has generally focused on is the

federal funds rate.

By raising the discount rate, the Fed leads banks to make _________ loans to households and firms, which will _________ checking account deposits and the money supply.

fewer; decrease

Former president Ronald Reagan once stated that inflation "has one cause and one cause alone: government spending more than government takes in." Source: Edward Nelson, "Budget Deficits and Interest Rates," Monetary Trends, Federal Reserve Bank of St. Louis, March 2004. The statement is correct in that such expansionary _______ policy is likely to stimulate aggregate_______which can cause inflation.

fiscal demand

As a result of this policy, the unemployment rate will be____ the natural rate of 5 percent and the inflation rate will be edging ____ slowly

greater than down

In terms of the economy, "just as the party gets going" refers to a situation in which real GDP_______ potential GDP, which will result in_____ the inflation rate.

greater than increase

Due to the American Recovery and Reinvestment Act of 2009 (the stimulus package), from 2009 through 2011, the federal budget deficit was

greater than 8 percent of GDP but fell to 4 percent of GDP in 2013.

An article in the Wall Street Journal referred to the chair of the Fed as "the nation's top economic position." Source: Jon Hilsenrath, "Summers Hedges His Doubts on Fed's Bond Buying," Wall Street Journal, July 31, 2013. This statement is true because the Chairman of the Fed

has the ability to influence interest rates for the world's top reserve currency.

This would mean that for any given rate of unemployment, the associated inflation rate would be____, and for any given inflation rate, the associated rate of unemployment would be ____

higher higher

If Congress and the president are successful in keeping real GDP at its potential level in 2017, state whether each of the following will be higher, lower, or the same as it would have been if they had taken no action: Real GDP will be Potential real GDP will be The inflation rate will be The unemployment rate will be

higher the same higher lower

One risk of trying to reduce unemployment with loose monetary policy is

higher inflation.

What does Feldstein mean by a "behavioral response" to tax cuts? The behavioral response will be that people in

higher tax brackets will experience an increase in taxable income and thus will work more.

Slow growth in aggregate demand leads to

higher unemployment and lower inflation.

Very high rates of inflation are called

hyperinflation.

Workers, firms, banks, and investors in financial markets care about the future rate of inflation because

if actual inflation turns out to be different from the expected inflation, real wages, profits, and interest will be different from their expected values.

Ben Bernanke believes that the credibility of the Fed's policy announcements is particularly important because

if monetary policy is to be effective, workers, firms, and investors in stock and bond markets have to view the Fed's announcements as credible.

Such views are rare today because

in the long run there is no tradeoff between inflation and unemployment.

There is a strong link between changes in the money supply and inflation

in the long run.

Savings account balances, small-denomination time deposits, and noninstitutional money market fund shares are

included only in M2.

In the context of what was happening in the economy in 1929, President Hoover was ______in saying that, in 1932, nothing was more necessary than balancing the federal government's budget.

incorrect

Therefore, the statement above is

incorrect

"The Fed has an easy job. Say it wants to increase real GDP by $200 billion. All it has to do is increase the money supply by that amount." The statement is ______ because an increase in the money supply_______affect real GDP directly.

incorrectly does not

As a result, when compared to Y1, real GDP would

increase

If the Federal Reserve purchases $110 million worth of U.S. Treasury bills from the public, the money supply will

increase

The Reserve Bank of India might be afraid that additional interest rate cuts would cause inflation to increase because it would

increase aggregate demand sufficiently to increase the price level

Compared to P1, the price level would

increase if aggregate demand increased more than long-run aggregate supply.

How might heavy public debts lead to crowding out? Heavy public debt will

increase interest rates and crowd out the interest sensitive spending such as investment, consumption and net exports and will decrease aggregate output.

Writing in the Wall Street Journal, Martin Feldstein, an economist at Harvard University, argues that: "behavioral responses" of taxpayers to the cuts in marginal tax rates enacted in 1986 resulted in "an enormous rise in the taxes paid, particularly by those who experienced the greatest reductions in marginal tax rates." Source: Martin Feldstein, "The Tax Reform Evidence from 1986," Wall Street Journal, October 24, 2011. Cuts in marginal tax rates will

increase marginal net-of-tax income, increase the supply of labor and increase total taxes as people work longer hours.

Between the beginning of 2009 and the end of 2010, real GDP ________, while employment ________.

increased by 4.0 percent; declined by 3.3 million

b. In terms of its effect on the long-run growth rate of real GDP, it is likely to matter more if the additional government spending involves

increased spending on highways and bridges.

If the federal government's policy is successful, what is the effect on the following macroeconomic indicators? Actual real GDP Potential real GDP Price level Unemployment

increases does not change increases decreases

If the Fed's policy is successful, what is the effect on the following indicators? Actual real GDP: Potential real GDP: Price level: Unemployment:

increases does not change increases decreases

Over time, potential GDP ________, which is shown by the ________ curve shifting to the right.

increases; long-run aggregate supply

In terms of Phillips curve analysis, Poole's claim that "it might take a very long time before the (output gap) would be able to offset what's going on with inflation expectations" implies that

inflation expectations would adjust slowly so that there is a prolonged trade-off between unemployment and inflation.

When the central bank commits to conducting policy in a manner that achieves the goal of holding inflation to a publicly announced level, it is using

inflation targeting.

If the Fed is too slow to react to a recession and applies an expansionary monetary policy only after the economy begins to recover, then

inflation will be higher than if the Fed had not acted.

Some economists argue that because increases in government spending crowd out private spending, increased government spending will reduce the long-run growth rate of real GDP. a. This is most likely to happen if the private spending being crowded out is

investment spending

Quantitative easing may have led investors, banks, and pension funds to engage in excessive risk taking because

investors would seek out alternative investments with higher returns and higher risks.

The cyclically adjusted budget deficit

is measured as if the economy were at potential real GDP.

The real-world money multiplier

is smaller than the simple deposit multiplier because banks keep excess reserves and households hold excess cash.

The prime rate

is the basis of the interest rate on many other types of loans

The federal funds rate

is the rate that banks charge each other for short-term loans of excess reserves.

A countercyclical policy is one that

is used to attempt to stabilize the economy.

The Fed uses policy targets of interest rate and/or money supply because

it can affect the interest rate and the money supply directly and these in turn can affect unemployment, GDP growth, and the price level.

On January 1, 2002, Germany officially adopted the euro as its currency, and the deutsche mark stopped being legal tender. According to an article in the Wall Street Journal, even 10 years later many Germans continued using the deutsche mark, and many stores in Germany continued to accept it. Source: Vanessa Fuhrmans, "Who Needs the Euro When You Can Pay with Deutsche Marks?" Wall Street Journal, July 18, 2012. It is possible for people to continue to use a currency when the government that issued it has replaced it with another currency because

it is still accepted as legal tender for transactions.

In late 2012, the U.S. Treasury sold the last of the stock it purchased in the insurance company AIG. The Treasury earned a profit on the $22.7 billion it had invested in AIG in 2008. An article in Wall Street Journal noted that: "This step in AIG's turnaround, which essentially closes the book on one of the most controversial bailouts of the financial crisis, seemed nearly unattainable in 2008, when the insurer's imminent collapse sent shockwaves through the global economy." . Source: Jeffrey Sparshott and Erik Holm, "End of a Bailout: U.S. Sells Last AIG Shares," New York Times, December 11, 2012. The federal government bailed out AIG because

it was the largest insurance company in the nation and the government feared the repercussions of a failure of AIG.

The government bailout was controversial because

it was expensive, and other companies suffered through bankruptcy and failure.

If a tax cut has supply-side effects, then

it will affect both aggregate demand and aggregate supply.

Keynes appears unconcerned if government spending is wasteful because

it will still lead to an increase in production and employment.

If the economy moves into recession, monetarists argue that the Fed should

keep the money supply growing at a constant rate.

A negative supply shock, such as the OPEC oil price increases of the early 1970s, can be illustrated by a shift to the ______________ of the short-run aggregate supply curve and a shift _________________ of the short-run Phillips curve.

left; up

When the Federal Reserve provides liquidity to banks by lending to them, it is acting as a

lender of last resort

The federal government's day-to-day activities include running federal agencies like the Environmental Protection Agency, the FBI, the National Park Service, and the Immigration and Customs Enforcement. Spending on these types of activities make up

less than 10 percent of federal government expenditures.

As a result of crowding out in the short run, the effect on real GDP of an increase in government spending is often

less than the increase in government spending.

A movement from point A to point C could be caused by

long run effects of contractionary monetary policy.

The article also notes that after the financial crisis, "the Fed is working through a broader spectrum of interest rates." The reference to "a broader spectrum of interest rates" means that the Fed began to focus on

longer term Treasury rates and mortgage rates.

Why is the Fed sometimes said to have a "dual mandate"? The Fed is said to have a" dual mandate" because

maintaining price stability and high employment are the two most important goals of the Fed that are explicitly mentioned in the Employment Act of 1946.

The Federal Reserve may try to lower the federal funds rate to

make people more willing to borrow

According to Peter Heather, a historian at King's College London, during the Roman Empire, the German tribes east of the Rhine River produced no coins of their own but used Roman coins instead: "Although no coinage was produced in Germania, Roman coins were in plentiful circulation and could easily have provided a medium of exchange (already in the first century, Tacitus tells us, Germani of the Rhine region were using good-quality Roman silver coins for this purpose)." Source: Peter Heather, The Fall of the Roman Empire: A New History of Rome and the Barbarians, New York:Oxford University Press, 2006, p. 89. When sellers are willing to accept money in exchange for goods and services, money is acting as a

medium of exchange.

Milton Friedman would have liked the Fed to follow a monetary rule where the

money supply is increased every year by a percentage rate equal to the long-run growth rate of real GDP.

What is fiat money?

money that is authorized by a central bank and that does not have to be exchanged for gold or some other commodity money

According to the multiplier effect, an initial decrease in government purchases decreases real GDP by______the initial decrease in government purchases.

more than

The multiplier effect implies that, for a $100 increase in some autonomous component of aggregate demand, the total increase in aggregate demand will be

more than $100

The multiplier effect implies that, for a $100 increase in some autonomous component of aggregate demand, the total increase in aggregate demand will be

more than $100

"Real GDP is currently $17.7 trillion, and potential real GDP is $17.4 trillion. If Congress and the president would decrease government purchases by $300 billion or increase taxes by $300 billion, the economy could be brought to equilibrium at potential GDP." If government purchases were to decrease by $300 billion or if taxes were increased by $300 billion, the equilibrium level of real GDP would decrease by

more than $300 billion.

The financial firms of the shadow banking system were

more vulnerable than commercial banks to bank runs because they were more highly leveraged than commercial banks.

Problems of credit availability would affect a homebuilder such as Hovnanian Enterprises because

most potential homeowners need mortgages to buy homes.

In The General Theory of Employment, Interest, and Money, John Maynard Keynes wrote this: "If the Treasury were to fill old bottles with banknotes, bury them at suitable depths in disused coal mines which are then filled up to the surface with town rubbish, and leave it to private enterprise...to dig the notes up again... there need be no more unemployment and, with the help of the repercussions, the real income of the community...would probably become a good deal greater than it is." In this statement, Keynes is discussing the important macroeconomic effect called the ___ effect

multiplier

Which of the following is not a correct comparison between an expansionary monetary policy in the basic aggregate demand and aggregate supply model and in the dynamic aggregate demand and aggregate supply model?

n the dynamic model, expansionary policy would be used when demand does not grow sufficiently; in the basic model, expansionary policy would be used when demand falls. The dynamic model assumes that potential GDP is constantly growing while the basic model assumes that it is static. If the economy is below full employment, expansionary monetary policy will cause an increase in the price level in both models All of the above are correct statements about the two models.

According to the quantity theory of money, if velocity does not change, when the money supply of a country increases, what will occur?

nominal GDP will increase

Briefly explain whether each of the following is an example of (1) a discretionary fiscal policy, (2) an automatic stabilizer, or (3) not a fiscal policy. The federal government increases spending on rebuilding the New Jersey shore following a hurricane. This is an example of

not a fiscal policy.

The Federal Reserve sells Treasury securities. This is an example of

not a fiscal policy.

The federal government changes the required gasoline mileage for new cars. This is an example of

not a fiscal policy.

Even though the federal government earned a profit on its investment in AIG, economists and policymakers who opposed the bailout were

not necessarily wrong, because it was an expensive and risky solution.

Defense spending is increased. This is

not part of fiscal policy

Families are allowed to deduct all their expenses for daycare from their federal income taxes. This is

not part of fiscal policy

The Federal Reserve lowers the target for the federal funds rate. This is

not part of fiscal policy

Which one of the following is not a reason why businesses accept paper currency knowing that, unlike a gold coin, the paper the currency is printed on is worth very little? Paper currency is a good medium of exchange because it is

not valuable

Economists and policymakers might disagree over the best rule to guide monetary policy because

of differing views about the significance of inflation and unemployment.

What is "labor market slack"? The degree of slack in the economy is measured by the difference

of the unemployment rate from its equilibrium level.

Economists use the term fiscal policy to refer to changes in taxing and spending policies

only by the federal government.

An article in BusinessWeek in 2013 reported that Fed Chairman Ben Bernanke testified to Congress that: "If we see continued improvement and we have confidence that that is going to be sustained, then we couldlong dash—in the next few meetingslong dash—we could take a step down in our pace of purchases." According to the article, Bernanke also told Congress that "'premature tightening' could 'carry a substantial risk of slowing or ending the economic recovery.'" Source: Nick Summers, "Confusion about the Fed Slowing Its $85 Billion in Monthly Bond Buying Is Roiling the Markets," Bloomberg BusinessWeek, June 10-16, 2013. The purchases Fed Chairman Bernanke is referring to are

open market purchases of government securities.

(i) part of an expansionary fiscal policy, (ii) part of a contractionary fiscal policy, or (iii) not part of fiscal policy. a. The corporate income tax rate is increased. This is

part of a contractionary fiscal policy

The individual income tax rate is decreased. This is

part of an expansionary fiscal policy

Money serves as a standard of deferred payment when

payments agreed to today but made in the future are in terms of money.

When the article refers to "credit availability," it means the ability of

people to obtain credit.

Difficulty in estimating the "long-run stock of capital and labour" creates difficulty in estimating the value of potential GDP in real time because

potential GDP is determined by the availability of resources, especially capital and labor.

Given that the Phillips curve is derived from the aggregate demand and aggregate supply model, why use the Phillips curve? The answer is that while the aggregate demand and aggregate supply model shows the_____, the Phillips curve explicitly shows the _____ the aggregate demand and aggregate supply model explicitly shows changes in the_____, while the Phillips curve explicitly shows the ______

price level inflation rate level of real GDP unemployment rate

Money serves as a unit of account when

prices of goods and services are stated in terms of money.

A baseball fan with a Mike Trout baseball card wants to trade it for a Miguel Cabrera baseball card, but everyone the fan knows who has a Cabrera card doesn't want a Trout card. Economists characterize this problem as a failure of the

principle of a double coincidence of wants.

An article in the Economist described the difference between the rate of inflation in Zimbabwe before and after the government abandoned its own currency and made the U.S. dollar its official currency in 2009: Zimbabwe's dollar had been too liberally printed: a swollen stock of local banknotes was chasing a diminished supply of goods. Now the American banknotes the economy relies on have to be begged, borrowed or earned. Even so, the monetary system works surprisingly well. A scarcity of greenbacks keeps inflation in the low single digits. Source: "In Dollars They Trust," Economist, April 27, 2013. Zimbabwe's recent hyper-inflation can be explained by what theory?

quantity theory of money

Robert Lucas said: "In practice, it is much more painful to put a modern economy through a deflation than the monetary theory we have would lead us to expect. I take this to mean that we have 'price stickiness."' Source: Paul A. Samuelson and William A. Barnett, eds., Inside the Economist's Mind: Conversations with Eminent Economists, Malden, MA: Blackwell Publishing, 2007, p. 63. When Lucas made the comment about "the monetary theory we have," he meant the

rational expectations theory.

This chapter argues that if the price level increases, over time, the average wage should increase by the same amount. This is true because workers and firms are most concerned with the___ wage

real

Models that use factors, such as technology shocks, to explain fluctuations in real GDP instead of changes in the money supply are called

real business cycle models.

The sequester could create a headwind for the economic recovery because government spending cuts resulting from the sequester could

reduce aggregate demand.

An article in the Wall Street Journal in mid-2013 on Parker Hannifin noted: "The company's revenue has been falling in recent quarters amid softer international business conditions...." Source: Billy Crosby, "Parker Hannifin 4th-Quarter Net Falls on Weaker Volumes," Wall Street Journal, August 6, 2013. A large international firm like Parker Hannifan might pay more attention to the Federal Reserve raising or lowering interest rates than a local restaurant because it

relies on international sales which are impacted by the value of the dollar for a portion of its revenue.

Economists during the early 1960s thought of the Phillips curve as a "policy menu" because they thought that the Phillips curve

represented a structural relationship in the economy that would not change as a result of policy changes.

An article on Bloomberg.com reported in 2012 that the People's Bank of China "cut the amount of cash that banks must set aside as reserves for the third time in six months, pumping money into the financial system to support lending after data showed a slowdown in growth is deepening." Source: "China Lowers Banks' Reserve Requirements to Support Growth," Bloomberg.com, May 12, 2012. When the People's Bank of China "cut the amount of cash that banks must set aside as reserves," the monetary policy tool they used was a change in the

required reserve ratio.

Suppose that the Federal Reserve makes a $10 million discount loan to First National Bank (FNB) by increasing FNB's account at the Fed. Complete the following T-account to show the impact of this transaction. First National Bank Assets Liabilities

reserves $10 million discount loan $10 million

Due to the American Recovery and Reinvestment Act of 2009long —the stimulus package long —the effect on federal government

revenue and expenditures was highest in 2010 but both effects declined in 2011.

According to Milton Friedman, differences between the actual and expected inflation rates could lead the actual unemployment rate to

rise above or fall below the natural rate.

The unemployment rate

rose from 6% to 10% during the period of the Volcker disinflation.

The process of ________ involves creating a secondary market in which loans that have been bundled together can be bought and sold in financial markets.

securitization

The recessions accompanied by a financial crisis are more severe than recessions that do not involve bank crises because

severe financial crises collapse asset markets, lower real housing prices and cause a significant fall in GDP and employment.

If unemployment continues to be above the natural rate, the short-run Phillips curve will

shift downward as inflationary expectations adjust downward.

As the public starts expecting a higher inflation rate, the short-run Phillips curve will

shift up and to the right

An increase in interest rates affects aggregate demand by

shifting the aggregate demand curve to the left, reducing real GDP and lowering the price level.

Consider the long-run Phillips curve and the short-run Phillips curve in the graph at right. A movement from point A to point B could be caused by

short run effects of contractionary monetary policy.

is considered the most relevant interest rate when conducting monetary policy.

short-term nominal interest rate

The formula for the simple deposit multiplier is

simple deposit multiplier=1/RR

Suppose that the tax increase only affected aggregate demand. Compared to the above, the effect on real GDP would be___ and the effect on the price level would be____

smaller larger

The multiplier effect implies that if government wants to cause an increase in aggregate demand of $500 million, it can do so by increasing government spending by an amount

smaller than $500 million

In macroeconomics courses in the 1960s and early 1970s, some economists argued that one of the U.S. political parties was willing to have higher unemployment in order to achieve lower inflation and that the other major political party was willing to have higher inflation in order to achieve lower unemployment. Such views of the trade-off between inflation and unemployment might have existed in the 1960s because the Phillips curve was widely viewed as

stable

A former Federal Reserve official argued that at the Fed, "the objectives of price stability and low long-term interest rates are essentially the same objective." Source:William Poole, "Understanding the Fed," Federal Reserve Bank of St. Louis Review, Vol. 89,No. 1, January/February 2007, p. 4. This is true because

stable prices make it easier to plan for the future, so expectations can be stable, which makes it less costly to make loans.

In a discussion of monetary policy in the United Kingdom, an article in the Economist magazine, quoted a publication of the British Institute for Economic Affairs as arguing that: "To try to use monetary policy to reduce unemployment when inflation is already above target is playing with fire and could lead us down the road that we followed in the 1970s." Source: "Mixed Reaction," Economist, August 7, 2013. When the author refers to "the road that we followed in the 1970s," he means the period when there was

stagflation

The table below contains real data of the number of farms F in thousands during year x. x 1999 2001 2003 2005 F 95 94 90 89 Identify the line graph on the right that accurately displays the data.

straight with slight down

Policy that is specifically designed to affect aggregate supply and increase incentives to work, save, and start a business, by reducing the tax wedge is called

supply-side economics.

In February 2013, the Congressional Budget Office (CBO) forecast that the federal budget deficit for fiscal year 2013 would be approximately $850 billion. In May 2013, the CBO revised down its forecast of the budget deficit to $642 billion. The CBO stated that a major reason for the downward revision was "factors related mainly to the strengthening economy." Source: Susan Davis, "CBO Drops 2013 Deficit Estimate to $642 Billion," usatoday.com, May 15, 2013. a. A "strengthening economy" could lead to a downward revision of the projected budget deficit because as GDP increases,

tax revenues increase and government spending decreases, lowering the deficit.

There may be some truth in the columnist's argument, but an economist might argue that

taxpayers in one year should not have to pay for a project that will benefit other taxpayers well into the future.

An article in the Wall Street Journal discussed the views of William Poole, who was then the president of the Federal Reserve Bank of St. Louis. According to the article, Poole argued that the expected inflation rate and the output gap affected the current inflation rate. The article quoted Poole as stating that it could take a long time before the output gap would "offset what's going on with inflation expectations." Source: Greg Ip, "Fed Policy Maker Warns of Rising Inflation," Wall Street Journal, June 6, 2006. a. Consider the short-run and long-run Phillips curves diagram to the right. In saying that "both inflation expectations and the output gap affect the current inflation rate," Poole meant all of the following except

that increases in inflation expectations shift the long-run Phillips curve down along a downward-sloping long-run Phillips curve.

Do all economists agree with Lucas's main conclusions about the effectiveness of monetary policy? Briefly explain. Many economists have remained skeptical of all the following, except

that there is a short-run trade-off between unemployment and inflation.

In Congressional testimony, Federal Reserve Chairman Ben Bernanke said: "Another significant factor influencing medium-term trends in inflation is the public's expectations of inflation. These expectations have an important bearing on whether transitory influences on prices, such as changes in energy costs, become embedded in wage and price decisions and so leave a lasting imprint on the rate of inflation." Source: "Testimony of Chairman Ben S. Bernanke before the Joint Economic Committee,U.S.Congress," March 28, 2007. When Federal Reserve Chairman Ben Bernanke said that the public's expectations of inflation could "become embedded in wage and price decisions," he meant

that workers, firms, consumers, and the government will all take the inflation rate into account when making decisions.

Congress broadened the Fed's responsibility since

the 1930s as a result of the Great Depression.

In 2013, Japan's government debt was approaching 250 percent of GDP, more than twice as high as in the United States. An article in the Economist noted that "the sheer size of the debt weighs ever more heavily." Source: "Don't Mention the Debt," Economist, May 4, 2013. Government debt weighs heavily on

the Japanese economy because of the taxes required to service the debt.

the MPC is multiplied by (1 minus− t).

the MPC is multiplied by (1 − t).

From an understanding of the multiplier process, explain why an increase in the tax rate would decrease the size of the government purchases multiplier. The value of the government purchases multiplier would decrease because in the formula for the multiplier Similarly, explain why a decrease in the marginal propensity to import would increase the size of the government purchases multiplier. The value of the government purchases multiplier would decrease because in the formula for the multiplier the denominator is

the MPC is multiplied by (1− t). 1-[MPC *(1-t)-MPI]

If, in the long run, real GDP returns to its potential level, then in the long run,

the Phillips curve is vertical.

The event that may have led him to conclude that it is more painful to reduce the inflation rate than theory would predict was

the Volcker disinflation.

When the Federal Reserve sells Treasury securities in the open market,

the buyers of these securities pay for them with checks and bank reserves fall.

In addition, budget deficits can cause inflation if

the central bank buys the bonds used to finance the deficits.

Which of the following events was an important cause of the 2007dash-2009 recession?

the collapse of a housing bubble

Crowding out refers to

the decline in private expenditures that result from an increase in government purchases.

"20 or 30 years ago, local financial institutions were the only option for some borrowers. Today, borrowers have access to national (and even international) sources of mortgage finance." Source: Daniel J.McDonald and Daniel L. Thornton, "A Primer on the Mortgage Market and Mortgage Finance," Federal Reserve Bank of St. Louis Review, January/February 2008. What caused this change in the sources of mortgage finance? What would be the likely consequence of this change for the interest rates borrowers have to pay on mortgages? The primary reason for this change in the sources of mortgage finance was _____; the consequence of this change was also _____ in mortgage rates.

the development of a secondary mortgage market; a decrease

A newspaper article in the fall of 2007 reported stated that: "The luxury-home builder Hovnanian Enterprises reported its fourth consecutive quarterly loss on Thursday, citing continuing problems of credit availability and high inventory." Source: "New Loss for Home Builder," Associated Press, September 7, 2007. Hovnanian was suffering losses because

the economy was slowing down and about to head into a severe recession.

Quantitative easing policy hurts pension funds because

the eventual rise of interest rates when QE ends will lower the value of pension funds' fixed income portfolios.

A double coincidence of wants refers to

the fact that for a barter trade to take place between two people, each person must want what the other one has.

When we say that the Federal Reserve has lowered the interest rate, we mean that it has lowered its target for

the federal funds rate

Which of the following accurately defines the government purchases multiplier and the tax multiplier?

the government purchases multiplier= delta in equilibrium real GDP/delta in government purchases tax multiplier delta in equilibrium real GDP/ delta in taxes

If workers and firms have rational expectations and wages and prices adjust quickly, then if the Fed announces a credible expansionary monetary policy,

the inflation rate will increase, but the unemployment rate will be unchanged.

The federal funds rate is

the interest rate that banks charge each other for overnight loans.

A spokesperson for the California state agency in charge of the project mentioned that the Caldecott tunnel project would have a "ripple effect" on employment. The ripple effect meant that

the job creation would spread to other industries and eventually to the whole economy due to the consumption of the construction workers.

Cross-country evidence supports that the more independent a country's central bank,

the lower its inflation rate.

We saw that in calculating the stimulus package's effect on real GDP, economists in the Obama administration estimated that the government purchases multiplier has a value of 1.57. John F. Cogan, Tobias Cwik, John B. Taylor, and Volker Wieland, in a research paper written in early 2009, argue that the value is only 0.61. Source: John F. Cogan, Tobias Cwik, John B. Taylor, and Volker Wieland, "New Keynesian versus Old Keynesian Government Spending Multipliers," National Bureau of Economic Research Working Paper No. 14782, March 2009. a. The government purchases multiplier can have a value greater than zero and less than 1 if

the marginal propensity to consume is negative.

If the price level decreases,

the money demand curve shifts to the left.

If real GDP increases,

the money demand curve shifts to the right.

Which of these variables are the main monetary policy targets of the Fed?

the money supply and the interest rate

If the FOMC orders the trading desk to sell Treasury securities,

the money supply curve will shift to the left, and the equilibrium interest rate will rise.

Economists believe that the smaller the tax wedge for any economic activity, such as working, saving, investing, or starting a business,

the more of that economic activity that will occur

As the tax rate increases,

the multiplier effect decreases.

The economic concept that part of each additional dollar earned will be spent, and that this spending will provide additional income of which part will again be spent, is known as

the multiplier principle

The central bank of a country controls the money supply, which equals the currency held by

the public plus their checking acount balances.

Suppose that the inflation rate is increasing each year for a number of years, then

the rational expectations hypothesis is likely to give more accurate forecasts because if workers or firms have rational expectations, then they will use all the available information to forecast future inflation.

An article in a publication of the Federal Reserve Bank of San Francisco described the change in the natural rate of unemployment in 2011: Recent labor markets developments, including mismatches in the skills of workers and jobs, extended unemployment benefits, and very high rates of long-term joblessness, may be impeding the return to "normal" unemployment rates of around 5%. An examination of alternative measures of labor market conditions suggests that the "normal" unemployment rate may have risen as much as 1.7 percentage points to about 6.7%, although much of this increase is likely to prove temporary. Source: Justin Weidner and John C. Williams, "What Is the New Normal Unemployment Rate?" FRBSF Economic Letter, February 14, 2011. The natural rate of unemployment has increased because of all the following, except

the recent downturn in the labor market.

The Fed gave up targeting the money supply because

the relationship between monetary aggregates and other economic variables was becoming unreliable.

The Phillips curve exhibits

the relationship between the unemployment and the inflation rates.

Which of the following refers to the minimum fraction of deposits banks that are required by law to keep as reserves?

the required reserve ratio

Notice that the graph only shows the shifts in aggregate demand (AD) and long-run aggregate supply (LRAS); for purposes of this exercise we ignore short-run aggregate supply. Now suppose that there is an increase in marginal tax rates on individual income that affects both aggregate demand and long-run aggregate supply. Compared to the dynamic changes shown in the graph, the result of the increase in the marginal tax rate will be that

the rightward shift in aggregate demand will be smaller and the rightward shift in long-run aggregate supply will be smaller.

On the other hand, if Greenspan had accepted the view and wanted to target a lower inflation rate, monetary policy during the late 1990s might have been ____

the same as it was

When the Federal Reserve purchases Treasury securities in the open market,

the sellers of such securities deposit the funds in their banks and bank reserves increase.

We saw in the chapter opener that during 2013, Congress and President Obama were unable to reach an agreement to avoid the sequester, which involved a series of automatic cuts in federal government purchases. In testifying before Congress, then Federal Reserve Chairman Ben Bernanke said that the sequester "could create a significant headwind for the economic recovery." Source: Binyamin Appelbaum, 'Austerity Kills Government Jobs as Cuts to Budgets Loom," New York Times, February 26, 2013. When Bernanke said "headwind," he meant that

the sequester could slow down the economic recovery

It would seem that both households and businesses would benefit if the federal income tax were simpler and tax forms were easier to fill out. However, tax laws have become increasingly complicated because

the tax laws are used to encourage certain activities and discourage others.

The national debt is best measured as

the total value of U.S. Treasury securities outstanding.

The Caldecott tunnel in northern California and similar construction projects elsewhere in the country would be expected to help the economy in the short run, because

the use of discretionary fiscal policy would create a multiplied increase in real GDP and employment.

Robert Lucas and Thomas Sargent argued that

there might not be a trade-off between unemployment and inflation in the short run, and the short-run Phillips curve would be vertical.

An article on how the Zimbabwean economy had recovered after the end of the hyperinflation notes the following fact as being important: "Bank deposits increased by 31% last year, to $4.4 billion." Source: "In Dollars They Trust," Economist, April 27, 2013. Bank deposits are important to the Zimbabwean economy because

these funds enable banks to make loans.

How can investment banks be subject to liquidity problems? Investment banks can be subject to liquidity problems because

they often borrow short term, sometimes as short as overnight, and invest the funds in longer-term investments.

Support for a monetary rule of the kind advocated by Friedman declined since 1980 because

the Fed's performance since 1980 has been excellent even without a formal inflation target.

What is "Operation Twist"? "Operation Twist" refers to

the Fed's program to purchase $400 billion in long-term Treasury securities while selling an equal amount of shorter-term Treasury securities.

The simple deposit multiplier equals

the inverse, or reciprocal, of the required reserve ratio. the ratio of the amount of deposits created by banks to the amount of new reserves. the formula used to calculate the total increase in checking account deposits from an increase in bank reserves. All of the above.

Milton Friedman argued that the Phillips curve did not represent a permanent trade-off between unemployment and inflation, since

the long-run Phillips curve is vertical, there is no trade-off between unemployment and inflation in the long run.

In 2012, the ratio of imports to GDP was 14 percent in Japan and 83 percent in Belgium. On the basis of this information, you can conclude that

the open-economy multiplier in Belgium would be less than the the open-economy multiplier in Japan.

The Chinese government has refused to print currency in denominations higher than the 100-renminbi note, which is the equivalent of about $16. The United States prints $100 bills and all other countries print currency in denominations that are at least that high. The Chinese government might be reluctant to print currency in high denominations

to discourage corruption.

The quantity theory of money is better able

to explain the inflation rate in the long run.

The goal of expansionary fiscal policy is

to increase aggregate demand.

When Congress established the Federal Reserve in 1913, its main responsibility was

to make discount loans to banks suffering from large withdrawals by depositors.

Congress initially decided to make the Fed independent of the rest of the federal government

to prevent an incumbent administration from exploiting Fed policy to remain in power. to avoid the inflation that might arise if the Fed buys government bonds that were floated for debt-financing.

Which of the following are categories of federal government expenditures?

transfer payments grants to state and local governments interest on the national debt All of the above.

The largest and fastest-growing category of federal expenditures is

transfer payments.

Central banks try to maintain price stability. This is typically assumed to refer to inflation. However, if prices are falling, this is undesirable as well because deflation also impacts price stability.

true

Countries with a higher marginal propensity to import (MPI) will have smaller multipliers than countries with a lower marginal propensity to import.

true

During the German hyperinflation of the 1920s, many households and firms in Germany were hurt economically; however, people with debt actually benefited some from the hyperinflation.

true

Few economists believe the federal government should attempt to balance its budget every year.

true

If some of the Roman coins had been taken to Germania, then the coins could have been a medium of exchange in Germania if people began to consider it safe and would have accepted it for payments. If coins could have been easily used to purchase goods and services in other areas, the coins would also have some intrinsic value.

true

It would be possible to decide whether these factors or a bubble was the cause of rising housing prices by looking at the number of new home units sold. If the number of new home units sold rose noticeably over time, then the evidence supports the bubble argument.

true

Stabilizing asset prices should not be added to the list of the Fed's policy goals because they are more specific and deal mainly with individuals and firms. Each of these carry risk associated with them and the Fed should not be in the business of trying to make profit for individuals.

true

The actual change in real GDP resulting from an increase in government purchases or a cut in taxes will be less than the simple multiplier effect indicates.

true

The balanced budget multiplier is always equal to 1.

true

Two government-sponsored enterprises that stand between investors and banks that grant mortgages are the Federal National Mortgage Association and the Federal Home Loan Mortgage Corporation.

true

We can say that loans are funded by deposits because deposits give banks financial capital, which can be loaned out so banks can make a profit.

true

Friedman defined the "natural rate of unemployment" as the

unemployment rate that exists when the economy produces potential GDP.

In testifying before Congress, Alan Greenspan remarked, "The challenge of monetary policy is to interpret data on the economy and financial markets with an eye to anticipating future inflationary forces and to countering them by taking action in advance." Source: Nicoletta Batini and Andrew G. Haldane, "Forward-Looking Rules for Monetary Policy," in John B. Taylor, ed., Monetary Policy Rules, Chicago: University of Chicago Press, 1999, p. 157. Why should the Fed take action in anticipation of inflation? Why not just wait until the increase in the inflation rate has occurred? The answer is that the Fed does not want a higher inflation rate to persist because, if it does, the short-run Phillips curve may shift

If the Fed believes the inflation rate is about to increase, it should

use a contractionary monetary policy to increase the interest rate and shift AD to the left.

If workers and firms have rational expectations, they will

use all available information when forming their expectations of future inflation; thus, the actual inflation rate will be equal to the expected inflation rate.

If the Fed believes the economy is about to fall into recession, it should

use an expansionary monetary policy to lower the interest rate and shift AD to the right.

If the Fed wants to move from a point on the short-run Phillips curve representing high unemployment and low inflation to a point representing lower unemployment and higher inflation, then it should

use expansionary monetary policy.

According to an article in the Economist magazine, Senator Charles Schumer of New York claimed that Bitcoin is "just what drug dealers have been waiting for." Source: "Bits and Bob," Economist, June 13, 2013. Drug dealers might find using a virtual currency like Bitcoin to be appealing because it can be

used to make anonymous transactions.

Velocity is defined as

v=(P*Y)/M

Additionally, the federal funds rate is

very important for the Fed's monetary policy because the Fed uses the federal funds rate as a monetary policy target since it can control the rate through open market operations.

He concluded that the U.S. economy apparently had "price stickiness," because

wages and prices declined very slowly during the disinflation process.

Therefore, during the 1970s, there____ a trade-off between unemployment and inflation.

was not

they____to think of the Phillips curve as a "policy menu."

were not correct

Since 2008, the Fed has used forward guidance as a monetary policy tool. Forward guidance refers to central banks telling the public

what future monetary policy will be in order to shape expectations today.

Governments sometimes allow hyperinflation to occur because

when governments want to spend more than they collect in taxes, central banks increase the money supply at a rate higher than GDP growth, often resulting in hyperinflation.

The federal funds rate is the interest rate charged

when one bank lends money to another bank

A serious inconsistency exists between a vertical long-run aggregate supply curve and a downward-sloping long-run Phillips curve because

when the long-run aggregate supply curve is vertical at potential real GDP, the long-run Phillips curve is vertical at the natural rate of unemployment.

c. Inflation expectations are slow to respond to the output gap because

workers and firms may not have rational expectations when predicting the future inflation rate and wage-price stickiness exists.

Consider the graph on the right, where both the short-run and long-run Phillips curves are vertical. An expansionary monetary policy will increase the inflation rate continuously but will have no effect on the unemployment rate because of all the following except

workers and firms who have adaptive expectations will not consider the Fed's policy before forming their expectations about inflation.

Most economists in 1968_____ have agreed with him because they ___

would not believed in the stable trade-off relation manifested in the Phillips curve.

What is the disadvantage of holding money?

Money, in the form of currency or checking account deposits, earns either no interest or a very low rate of interest.

What is meant by supply-side economics?

Supply-side economics refers to the use of taxes to increase incentives to work, save, invest, and start a business in order to increase long-run aggregate supply.

Is it possible for Congress and the president to carry out an expansionary fiscal policy if the money supply does not increase?

Yes, because fiscal policy and monetary policy are separate things.

In 2009, Congress and the president enacted "cash for clunkers" legislation that paid people buying new cars up to $4,500 if they traded in an older, low gas-mileage car. Source: Justin Lahart, Trade-In Program Tunes Up Economic Engine," Wall Street Journal, August 4, 2009. Was this piece of legislation an example of fiscal policy?

Yes, because the primary goal of the spending program was to stimulate the national economy.

Does government spending ever reduce private spending?

Yes, due to crowding out.

As the interest rate increases,

consumption, investment, and net exports decrease; aggregate demand decreases.

A "premature tightening" of the "pace of purchases" would slow down the economic recovery because this action would be

contractionary, reducing lending and economic activity.

An attempt to reduce inflation requires _____________ fiscal policy, which causes real GDP to _________ and the price level to __________.

contractionary; fall; fall

As the price of a single good rises, the quantity demanded of that good tends to _______________. As overall prices (the price level) rise, the quantity demanded of output tends to _________________.

decrease, decreas

There is a different short-run Phillips curve for every level of the ___________ inflation rate. The inflation rate at which the short-run Phillips curve intersects the long-run Phillips curve equals the ___________ inflation rate.

expected; expected

If expected inflation is higher than actual inflation, actual real wages in the economy will turn out to be _________ than expected real wages; consequently, firms will hire _________ workers than they had planned.

higher; fewer

According to the crowding-out effect, if the federal government increases spending, the demand for money and the equilibrium interest rate will ___________, which will cause consumption, investment, and net exports to ___________.

increase; decrease

Budget deficits automatically __________ during recessions and __________ during expansions.

increase; decrease

With an expansionary monetary policy, investment, consumption, and net exports all ________, which results in the aggregate demand curve shifting to the ________, increasing real GDP and the price level.

increase; right

If the unemployment rate is below the natural rate, the inflation rate tends to ___________, and eventually, the short-run Phillips curve will shift _______.

increase; up

In an opinion column in the Wall Street Journal, Martin Feldstein of Harvard University argued with respect to quantitative easing that, "low interest rates are generating excessive risk-taking by banks and other financial investors." He also warned that the risks could have serious negative effects on the value of pension funds. Source: Martin Feldstein, "The Fed Should Start to Taper Now," Wall Street Journal, July 1, 2013. Under quantitative easing policy, the Fed purchased

long-term Treasury securities and mortgage-backed securities to reduce long-term interest rates.

When interest rates on Treasury bills and other financial assets are low, the opportunity cost of holding money is _________, so the quantity of money demanded will be _________.

low; high

In 2013, John Taylor wrote: "I realize that there are differences of opinion about what is the best rule to guide policy and that some at the Fed (including Janet Yellen) now prefer a rule with a higher coefficient [on the output gap]." Source: John Taylor, "Cross Checking 'Checking in on the Taylor Rule'," www.economicsone.com, July 16, 2013. If the Taylor rule was changed to have a higher coefficient on the output gap, then during a recession the federal funds rate would be

lower, because more weight would be given to the output gap.

After Fed Chairman Paul Volcker began fighting inflation in 1979, workers and firms eventually ____________ their expectations of future inflation, and the short-run Phillips curve shifted ___________.

lowered; down

As interest rates decline, stocks become a __________ attractive investment relative to bonds, which causes the demand for stocks and their prices to __________.

more; rise

Expansionary fiscal policy has a ________ multiplier effect on equilibrium real GDP, and contractionary fiscal policy has a ________ multiplier effect on equilibrium real GDP.

positive; negative

Suppose that when the Fed decreases the money supply, households and firms initially hold less money than they want to, relative to other financial assets. As a result, households and firms will _________ Treasury bills and other financial assets, thereby _________ their prices, and _________ their interest rates.

sell; decreasing; increasing

When the Fed conducts monetary policy, the most relevant interest rate is the

short-term nominal interest rate.

Policy that is specifically designed to affect aggregate supply and increase incentives to work, save, and start a business, by reducing the tax wedge is called

supply-side economics.

Since World War II, the federal government's share of total government expenditures has been between

two-thirds and three-quarters.

About ________ of the American Recovery and Reinvestment Act stimulus package took the form of increases in government expenditures, and about ________ took the form of tax cuts.

two-thirds; one-third

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