MOdules 34-36

monetary policy rule

- a formula that determines the central bank's actions - slow, steady growth of money supply

new classical macroeconomics

- an approach to the business cycle that returns to the classical view that shifts in the aggregate demand curve affect only the aggregate price level, not aggregate output. 2 steps 1. rational expectations 2. real business cycle theory

flaws of monetarism

- became clear that steady growth of the money supply does not lead to steady growth in the economy - velocity was not that stable figure 35.3 pg. 350 - we dont use monetarism very much anymore BUT it is widely accepted that discretionary monetary policy can destabilize the economy

real business cycle theory

- claims that fluctuations in the rate of growth of total factor productivity cause the business cycle - business cycles are caused by shifts in the supply curve (assuming its vertical) - a recession occurs when a slowdown in productivity growth shifts the aggregate supply curve leftward - recovery is when productivity growth shifts the aggregate supply curve rightward

quantity theory of money

- emphasized the positive relationship between the price level and the money supply. It relies on the velocity equation ( M *V= P *Y) M is money supply V is velocity P is aggregate price level Y is real GDP

Rational expectations

- individuals and firms make decisions optimally, using all available information.

macroeconomic policy activism

- is the use of monetary and fiscal policy to smooth out the business cycle

New Keynesian economics

- market imperfections can lead to price stickiness for the economy as a whole

classical economics

- no clear theory on the business cycle - GD was so bad for so long because classical economists could not agree on how to fight a recession - GD showed that we shouldn't ignore the short run

classical model of the price level

- prices are flexible: aggregate supply curve vertical even in the short-run - increase in money supply leads to a rise in aggregate price level and not effect on aggregate output - emphasized role of changes in the money supply in shifting the aggregate demand curve - confidence has no effect on price level or output - increases in the money supply lead to inflation - didn't actually believe that SR in vertical, but they only cared about the long run

political business cycle

- results when politicians use macroeconomic policy to serve political ends - pump up economy in election year, so they get re-elected, but face consequence of high inflation/ high unemployment - expansionary fiscal and monetary policy - to avoid this: monetary policy is hands of central bank

Keynesian Economics

- short run: shift in aggregate demand have an effect on aggregate output, employment and aggregate prices - SRAS slopes upward - business confidence has an effect on business cycles - macroeconomic policy activism - monetary policy would not be very effective in depression conditions

natural rate hypothesis

- to avoid accelerating inflation over time, the unemployment rate must be high enough that the actual inflation rate equals the expected inflation rate

Monetarism

-asserts that GDP will grow steadily if the money supply grows steadily - central bank should have target rate of growth of the money supply - similar to Keynesian ( use of expansionary policy and SRAD) - discretionary monetary policy faces problems of lags (same as fiscal, but to a lesser extent) - argues that if money supply stays fixed and the gov. has expansionary fiscal policy, crowding out will limit fiscal policy effects of aggregate demand. (35.2 pg. 349) - monetary policy rule

If a lenders charges 10% nominal interest rate, and the actual rate of inflation is 10% what is the lenders real return

0%

If a lender charges a 10% nominal interest rate, and the actual rate of inflation is 5% what is the lenders real return?

5%

Modern Consensus on recessarionary gap

Both monetary and fiscal policies can reduce a recessionary gap, although if a liquidity trap exists, it will reduce or eliminate the effectiveness of monetary policy. Discretionary monetary policy is generally preferred over discretionary fiscal policy.

The modern consensus about macroeconomic policy is that: A. Only monetary policy works against recessions but fiscal policy is effective only in the long run. B. Both expansionary monetary and fiscal policies can reduce unemployment in the long run. C. Both expansionary monetary and fiscal policies are effective in the short run but not in the long run. D. Discretionary monetary and fiscal policies are effective in the short run and in the long run. E. Discretionary monetary and fiscal policies are effective in the long run, but not in the short run.

C

Phillips curves show the relationship between the A) nominal interest rate and the real interest rate. B) expected rate of inflation and the nominal interest rate. C) real interest rate and the unemployment rate. D) unemployment rate and the inflation rate.

D

Classical view on recessionary gap

Do nothing. The recessionary gap will exist only in the short run, and the only focus for policy makers is the long run.

if AD decreases (Negaitve demand shock)

Down along the SRPC

Which of the following is an example of an opinion on which economists have reached a broad consensus? I. The natural rate hypothesis holds true. II. Discretionary fiscal policy is usually counterproductive. III. Monetary policy is effective, especially in a liquidity trap.

I and II

The following recommendation is consistent with which view of the macroeconomy? "A decrease in taxes will alleviate a recessionary gap." Classical Keynesian Monetarist Modern consensus Rational expectations

Keynesian

A decrease in the expected rate of inflation will change the short run phillips cuve

LEFT

An increase in the expected rate of inflation will change AS to

LEFT

The following recommendation is consistent with which view of the macroeconomy? "Use monetary policy to stabilize the economy and use fiscal policy only when monetary policy is ineffective." Classical Keynesian Monetarist Modern consensus Rational expectations Modern consensus

Modern consensus

The following recommendation is consistent with which view of the macroeconomy? "The government should avoid deficit spending because of the crowding-out effect on investment spending." Classical Keynesian Monetarist Modern consensus Rational expectations

Monetarist

Zero bound

On the nominal interest rate (it can't go below zero).

Most economists believe that discretionary fiscal policy should be used sparingly because of the risk of: Budget deficits. Political business cycles. Budget surpluses. Sacrificing equity in order to achieve efficiency. Lower interest rates.

Political business cycles.

A decrease in the expected rate of inflation will change AS

RIGHT

An increase in the expected rate of inflation will change Short Run phillips curve to

RIGHT

Stagflation is when

SRAS shifts left higher prices lower output higher unemployment

if AS increases (POsitive supply shcok

SRPC to LEFT

If AS decreases (Negative SUPPLY shock)

SRPC to right

Long-run Phillips curve

Shows the relationship between unemployment and inflation after expectations of inflation have had time to adjust to experience

Liquidity trap

Situation in which conventional monetary policy is ineffective because nominal interest rates are up against the zero bound

What economic theory holds that reducing tax rates will increase the incentive to work and invest, and will ensure a high growth rate of the potential output

Supply Side Theory

Keynesian view on recessionary gap

The best policies to alleviate the recessionary gap are fiscal policies. Although expansionary monetary policies can be effective in promoting economic growth, they will not be very effective when the economy is in a deep recession or depression, when the economy may face a liquidity trap.

Real business cycle view on recessionary gap

The government should engage in policies that increase total factor productivity. Changes in monetary or fiscal policy that simply stimulate demand will have no effect on the economy because the aggregate supply curve is vertical.

Monetaris view on recessionary gap

The government should not engage in discretionary fiscal or monetary policies because such policies can worsen economic fluctuations. GDP will grow steadily without inflationary pressure if the money supply grows steadily.

Short-run Phillips Curve

The negative short-run relationship between the unemployment rate and inflation rate

Debt deflation

The reduction in aggregate demand arising from the increase in the real burden of outstanding debt caused by deflation

Non accelerating inflation rate of unemployment (NAIRU)

Unemployment rate at which inflation does not change over time

IF AD increases (IE positive demand shock)

Up along the SRPC

At each meeting of the Federal Open Market Committee, the Federal Reserve sets a target for which of the following? I. the federal funds rate II. the prime interest rate III. the market interest rate a. I only b. II only c. III only d. I and III only e. I, II, and III

a

Contractionary monetary policy attempts to ____________ aggregate demand by __________ interest rates. a. decrease increasing b. increase decreasing c. decrease decreasing d. increase increasing e. increase maintaining

a

Revenue generated by the government's right to print money is known as a. seignorage b. an inflation tax c. hyperinflation d. fiat money e. monetary funds

a

The Fed's main concerns are a. inflation and unemployment. b. inflation and asset prices. c. inflation, asset prices, and unemployment. d. asset prices and unemployment. e. inflation and the value of the dollar

a

The main difference between the classical model of the price level and Keynesian economics is that a. the classical model assumes a vertical short-run aggregate supply curve. b. Keynesian economics assumes a vertical short-run aggregate supply curve. c. the classical model assumes an upward sloping long-run aggregate supply curve. d. Keynesian economics assumes a vertical long-run aggregate supply curve. e. the classical model assumes aggregate demand can not change in the long run.

a

Which of the following actions can the Fed take to decrease the equilibrium interest rate? a. increase the money supply b. increase money demand c. decrease the money supply d. decrease money demand e. both (a) and (d)

a

do nearly all economist agree that central banks should be independent

avoid politics

An increase in expected inflation will shift a. the short-run Phillips curve downward. b. the short-run Phillips curve upward. c. the long-run Phillips curve upward. d. the long-run Phillips curve downward. e. neither the short-run nor the long-run Phillips curve.

b

If government spending exceeds tax revenues, which of the following is necessarily true? There is a I. positive budget balance II. budget deficit III. recession a. I only b. II only c. III only d. I and II only e. I, II, and III

b

In the classical model of the price level a. only the short-run aggregate supply curve is vertical b. both the short-run and long-run aggregate supply curves are vertical c. only the long-run aggregate supply curve is vertical d. both the short-run aggregate demand and supply curves are vertical e. both the long-run aggregate demand and supply curves are vertical

b

The classical model of the price level is most applicable in a. the United States b. periods of high inflation c. periods of low inflation d. recessions e. depressions

b

The long-run Phillips curve is I. the same as the short-run Phillips curve. II. vertical. III. the short-run Phillips curve plus expected inflation. a. I only b. II only c. III only d. I and II only e. I, II, and III

b

The natural rate hypothesis says that the unemployment rate should be a. below the NAIRU. b. high enough that the actual rate of inflation equals the expected rate. c. as close to zero as possible. d. 5%. e. left wherever the economy sets it.

b

A 10% decrease in the money supply will change the aggregate price level in the long run by a. zero b. less than 10% c. 10% d. 20% e. more than 20%

c

An inflation tax is a. imposed by governments to offset price increases b. paid directly as a percentage of the sale price on purchases c. the result of a decrease in the value of money held by the public d. generally levied by states rather than the federal government e. higher during periods of low inflation

c

In the first FYI box of this module (p. 357) you learned about supply-side economics. Which of the following is stressed by supply siders? a. Taxes should be increased. b. Lower taxes will lead to lower tax revenues. c. It is important to increase incentives to work, save, and invest. d. The economy operates on the upward-sloping section of the Laffer curve. e. Supply side views are widely supported by empirical evidence

c

Monetary neutrality means that, in the long run, changes in the money supply a. can not happen b. have no effect on the economy c. have no real effect on the economy d. increase real GDP e. change real interest rates

c

The "clean little secret of macroeconomics" is that a. microeconomics is even more contentious than macroeconomics. b. debate among macroeconomists has ended. c. economists have reached a significant consensus. d. macroeconomics has progressed much more than microeconomics in the past 70 years. e. economists have identified how to prevent future business cycles.

c

The cyclically adjusted budget deficit is an estimate of what the budget balance would be if real GDP were a. greater than potential output b. equal to nominal GDP c. equal to potential output d. falling e. calculated during a recession

c

The short-run Phillips curve shows a relationship between . a. negative the aggregate price level and aggregate output b. positive the aggregate price level and aggregate output c. negative unemployment and inflation d. positive unemployment and aggregate output e. positive unemployment and the aggregate price level

c

Which of the following is a goal of monetary policy? a. zero inflation b. deflation c. price stability d. increased potential output e. decreased actual real GDP

c

in the long run, changes in the quantity of money affect which of the following? I. real aggregate output II. interest rates III. the aggregate price level a. I only b. II only c. III only d. I and II only e. I, II, and III

c

An increase in the money supply will lead to which of the following in the short run? a. higher interest rates b. decreased investment spending c. decreased consumer spending d. increased aggregate demand e. lower real GDP

d

During a recession in the United States, what happens automatically to tax revenues and government spending? a. tax revenues- increase government spending- increases b. tax revenues- decrease government spending- decreases c. tax revenues- increase government spending- decreases d. tax revenues- decrease government spending- increases e. tax revenues- decrease government spending- does not change

d

That fluctuations in total factor productivity growth cause the business cycle is the main tenet of which theory? a. Keynesian b. classical c. rational expectations d. real business cycle e. natural rate

d

The real quantity of money is I. equal to M/P II. the money supply adjusted for inflation III. higher in the long run when the Fed buys government securities a. I only b. II only c. III only d. I and II only e. I, II, and III

d

When implementing monetary policy, the Federal Reserve attempts to achieve a. an explicit target inflation rate b. zero inflation c. a low rat elf deflation d. a low, but positive inflation rate e. 4-5% inflation

d

Which of the following fiscal policies is expansionary? a. taxes- increase by $100 million government spending- increases by $100 million b. taxes- decrease by $100 million government spending- decreases by $100 million c. taxes- increase by $100 million government spending- decreases by $100 million d. decrease by $100 million government spending- increases by $100 million e. both (a) and (d)

d

Which of the following is a central point of monetarism? a. Business cycles are associated with fluctuations in money demand. b. Activist monetary policy is the best way to address business cycles. c. Discretionary monetary policy is effective while discretionary fiscal policy is not. d. The Fed should follow a monetary policy rule. e. All of the above.

d

Disinflation is when

decrease in the rate of inflation Slower pace of inflation

According to Keynesians, expansionary policies have what effect in the long run

does not change output or employment

A graph of percentage increases in the money supply and average annual increases in the price level for various countries provides evidence that a. changes in the two variables are exactly equal b. the money supply and aggregate price level are unrelated c. money neutrality holds only in wealthy countries d. monetary policy is ineffective e. money is neutral in the long run

e

Bringing down inflation that has become embedded in expectations is called a. deflation. b. negative inflation. c. anti-inflation. d. unexpected inflation. e. disinflation.

e

Debt deflation is a. the effect of deflation in decreasing aggregate demand. b. an idea proposed by Irving Fisher. c. a contributing factor in causing the Great Depression. d. due to differences in how borrowers/lenders respond to inflation losses/gains. e. all of the above.

e

Which of the following is a reason to be concerned about persistent budget deficits? a. crowding out b. government default c. the opportunity cost of future interest payments d. higher interest rates leading to decreased long-run growth e. all of the above

e

Which of the following is true regarding central bank targets? a. The Fed has an explicit inflation target. b. All central banks have explicit inflation targets. c. No central banks have explicit inflation targets. d. The Fed clearly does not have an implicit inflation target. e. Economists are split regarding the need for explicit inflation targets.

e

Which of the following was an important point emphasized in Keynes's influential work? I. In the short run, shifts in aggregate demand affect aggregate output. II. Animal spirits are an important determinant of business cycles. III. In the long run we're all dead.

e

According to Keynesians, expansionary policies have what effect in the short run?

higher output, higher price level, higher employment

according to classical theory, exampsionary policies will result in?

higher price level, but not change to output or employment

according to macroeconomic consensus, if the current rate of unemployment is higher than the NRU. what should be done to the money supply

increase

most economist agree that increasing government spending will have what impact on AD

increase

most economist agree that increasing the money supply will have what impact on the AD

increase

what do modern macroeconmist believe about the ability to use discretionary policy to affect long run level of unemployment

ineffective in the long run

what is the modern concensus view of the effectiveness of monetary policy

it works

whose views argues " use monetary policy to stabslize the economy and use fiscal policy only when monetary policy is ineffective?

modern consensus

what is the classical view of the utility of monetary and fiscal policies in changing output and unemployment

monetary and discal policies are ineffective and often counter productive

What is a liquidity trap?

monetary policy does not work if interest rates are near 0

What is the monetarist view of the money supply

money supply is important but should be used sparingly

how does thie affect their view of the aggregate supply curve?

output stays the same

monetary rule

steady money supply

what do some economist warn against using discretionary fiscal polcies

take a long time

Short run phillips curve shows

the downward slope and inverse relationship

velocity of money

the ratio of nominal GDP to the money supply. It is a measure of the number of times the average dollar bill is spent per year monetarism: believed that velocity of money is stable in the short run, and changes slowly in the long-run. *Therefore steady growth in the money supply by the central bank would ensure steady growth in spending, and therefore GDP*

what is the Keynesian and modern concensus view of the impact of tax cuts and spending increases

they work

Describe the long run phillips curve

vertical line at NRU

How do classical economist view prices and wages

wages are flexible