Macro Quiz 6

To contract aggregate demand can be described as ___ or ___.

**To contract aggregate demand → can be described as decreasing money supply or raising interest rate**

To expand aggregate demand can be described as ___ or ___.

**To expand aggregate demand → can be described as increasing money supply or as lowering interest rate**

What is the effect of the Fed decreasing money supply (selling bonds) on interest rate, quantity of goods and services demanded for any given price level, and the aggregate-demand curve shift?

**when the Fed decreases money supply (sells bonds)→ increases interest rate → decreases quantity of g&s demanded for any given price level → shifts aggregate-demand curve left**

What is the effect of the Fed increasing money supply (buying bonds) on interest rate, quantity of goods and services demanded for any given price level, and the aggregate-demand curve shift?

**when the Fed increases money supply (buys bonds) → lowers interest rate → increases quantity of g&s demanded for any given price level → shifts aggregate-demand curve right**

What is the effect of a higher price level on money demanded, interest rates, and quantity of goods and services demanded?

*higher price level → increase in money demanded → higher interest rates → fall in quantity of g&s demanded*

What is the effect of a lower price level on money demanded, interest rates, and quantity of goods and services demanded?

*lower price level → decrease in money demanded → lower interest rates → increase in quantity of g&s demanded*

"Inflation does not in itself (or by itself) reduce people's real purchasing power." Agree, Disagree, Uncertain? Explain.

-Agree - when prices rise, buyers pay more for what they buy, but sellers get more for what they sell -Nominal incomes tend to keep pace with the rising prices

Distinguish between deflation and disinflation , and give an example of each.

-Deflation - a decrease in general price levels --> would lower nominal interest rate → would reduce the cost of holding money --> Ex. Friedman's rule -Disinflation - transition from high inflation to low inflation, inflation rate still remains positive --> Ex. Volcker distribution

"Testimony by Greenspan lifts Treasury Bond Prices." So read a newspaper headline in the early part of this century after Fed chairman Alan Greenspan delivered some remarks to the Senate Banking Committee. What must he have said? Why?

-He must have said that they expected a slowdown/recession so the Fed would be engaging in expansionary policy -If bond prices were increasing, that would mean that the Fed had started buying bonds and decreasing the supply of them so that the money supply would increase

What explains the shape of the short-run Phillips curve? Why is it called the "Phillips curve"? Explain the history of the concept. Explain the logic behind the Phillips curve - what it is really based on, the policy implications, and the differences between how we regard it in the short run v. the long run.

-Inverse relationship between inflation and unemployment → illustrates the trade-off -Low unemployment is associated with high-aggregate demand → which puts upward pressure on wages and prices throughout the economy -Long run → money growth does not affect real variables, so the two are not related, and the long-run Phillips curve is vertical --> In the long run, people come to expect whatever inflation rate the Fed choose to produce → nominal wages will adjust to keep pace with inflation -Short-run - monetary changes lead to unexpected fluctuations in output, prices, unemployment, and inflation --> The Fed's ability to create unexpected inflation by increasing money supply only exists in the short run

If Jerome Powell wanted Donald Trump to be re-elected in 2020, what would he do-and when?

-It would help Trump if GDP were growing and unemployment was lower at election time so Powell could conduct expansionary monetary policy (by buying bonds and decreasing interest rates) -However, there would be a lag to monetary policy, so he would probably have to do it a few months before the election

People hold money primarily . . . Complete that sentence and explain. What if one had substituted "drug traffickers" for "people"?

-People hold money primarily as a medium of exchange and storage of value -Drug traffickers hold money in order to avoid paying taxes and evasion when it comes to conducting illegal transactions

When then Fed chair Ben Bernanke appeared before a U.S. House Budget Committee back in 2009, at one point in the hearing a Congressman inquired about the government's budget deficit, increases to the public debt, and balancing the budget. Then he asked: "Will the Fed monetize this debt?" Bernanke responded: "The Federal Reserve will not monetize the debt." Explain what they exchange was all about and why it's important.

-The Fed can choose to let the govt/treasury sell bonds in the market, which will cause interest rates to rise, OR go into the market and buy bonds, which would be monetizing the debt to keep it steady -So the question is asking is the Fed increasing the money supply (monetizing the debt) or not

Explain what is meant by an "inflation tax."

-The central bank uses money creation to pay for government spending (when there is high spending, inadequate tax revenue, and a limited ability to borrow -The Inflation tax is the revenue the government raises by creating money -It's like a tax on everyone who holds money, because everyone's dollars become less valuable

The Quantity Theory of Money is the proposition that . . . ." complete the sentence and explain its significance.

-The quantity of money available determines the price level ad the growth rate in the quantity of money available determines the inflation rate -If V is fairly constant, P is ~2% and Y is ~3%, then equation says that the economy will grow nominally 5% a year → SO, money supply should increase at 5% a year, which represents a move away from discretionary monetary policy

What do the Quantity Theory of Money, a gold standard and the Taylor Rule have in common? (2 points)

-These are all methods of rule-based monetary policy -The quantity theory of money -Gold standard would also eliminate discretionary monetary policy because the Fed would not be able to change money supply -Similarly, the taylor Rule produces a target rate that the Fed should proceed with

An increase in the money supply will decrease bond prices. True, false, or uncertain? Explain.

-True → there is an inverse relationship between bond prices and money supply → as money supply increases, interest rates go up, so bond prices will go down -However, because of the difference between nominal and real interest rates - a big increase in the money supply could cause inflation, so it could be false or uncertain in a nominal sense

What do we mean by "inflation targeting" and what is its significance in terms of (countercyclical) public policy?

-Would leave the central bank with some discretion, but would constrain how that discretion is used -Would give a range that increases the transparency and accountability of monetary policy

If the stereotypical University of Chicago macroeconomist were named to be head of the Federal Reserve System, what would he/she advocate for in terms of monetary policy in 2019? Why?

Chicago economists have conservative ideas about how monetary policy should (it shouldn't) affect the economy, so a UChicago economists would probably not engage in much monetary policy

Mr. Trump could have nominated Stanford economist John Taylor to be head of the Fed. Why didn't he?

Doesn't rules-based monetary policy

In the beginning (early 2008) of the "great recession", a Chicago Tribune headline read: "Rising prices put Fed on hot seat". Interpret that sentence and explain the "backstory." Under equivalent circumstances, would you have expected to see the same headline - in French or German, respectively - in a newspaper in Paris or Berlin? Why or why not?

During a recession, the Fed might want to decrease interest rates in order to stimulate the economy → but in doing so, they might cause inflation → the Fed has a dual mandate, so they would have to decide which to address The same headline would not be a problem/issue in Europe because the European Central Bank only has one mandate - no inflation

Are fiscal and monetary policies interdependent or independent (of each other)? Explain.

Fiscal policy can affect monetary policy

Discuss/Explain the "rules v. discretion" debate.

Look at ch. 36

All U.S. paper dollars (or money or Federal Reserve Notes) contains this statement: "This note is legal tender for all debts, public and private." What does that mean or imply or assume or characterize or reveal?

Our currency is fiat currency, as opposed to commodity money → it is valuable/acceptable only because the government says it is and depends on the faith of the government

What is the current sacrifice ratio in the U.S.? Explain. (2 points)

Sacrifice ratio = The number of percentage points of annual output lost in the process of reducing inflation by 1 percentage point

Explain and discuss the following comment, observation, or assertion: "Central bankers may be independent of their governments; they are not independent of each other."

The Fed may want to engage in expansionary monetary policy, but maybe the Central European Bank or the Bank of England is pursuing contractionary policies at the same time which could make it more difficult for the Fed to run their agenda → in the end, there is only one, worldwide financial market

Bennett McCallum, Carnegie Mellon economist, argued that during the 1970s the Fed was "acting under the influence of 1960s academic ideas that posited the existence of a long-run and exploitable Phillips-type tradeoff." What would he have meant by "exploitable," and what would have been the consequences?

Why shouldn't policymakers look at Phillips curve as a menu of options? → because they face only a temporary trade-off between inflation and unemployment. In the long-run, expanding aggregate demand more rapidly will yield higher inflation without any reduction in unemployment

Explain what one would mean by "the political business cycle" and how it could occur.

central bankers are sometimes tempted to use monetary policy to affect the outcome of elections → a banker sympathetic to the incumbent president might be tempted to pursue expansionary policies just before the election to stimulate production and employment, knowing the resulting inflation will not show up until after the election → leads to economic fluctuations that reflect the electoral calendar