SR Fluctuations and Policy
What market forces might cause the labor demand curve to shift back to the right?
Technological advances encourage firms to expand their activities excess inventory has been sold off The banking system recuperates and businesses are again able to use credit to finance their activities
How do expansionary policies differ from contractionary policies?
Expansionary policies seek to reduce the severity of recessions, while contractionary policies seek to slow down the economy when it grows too fast. Expansionary policies seek to increase economic growth and increase employment, while contractionary policies seek to reduce the risk of excessive price inflation. Expansionary policies seek to shift the labor demand curve to the right, while contractionary policies seek to shift it to the left. All of the above
If an economic shock decreases labor demand, equilibrium employment _______ and real GDP ______.
Falls, Falls
If wages were flexible, employment would have been _______ employment with rigid wages.
Higher than
In Moricana, unemployment is likely to be classified as ____________.
Involuntary
Which of the following statements correctly describes the events that took place during the Great Depression?
Its start coincided with a crash in the U.S. stock market.
____________ used the concepts of animal spirits and sentiment to explain economic fluctuations. According to his theory of animal spirits and sentiment, changes in sentiment cause economic fluctuations through ____________.
John Maynard Keynes changes in household consumption and firm investment.
Contractionary monetary policy can lead to an economy-wide recession through ____________.
an increase in the real interest rate, leading to an increase in production costs and therefore lower demand for labor. a reduction in the price level, leading to a reduction in employment because of downward wage rigidity. What are the important
If an economic shock increases labor demand, equilibrium employment _____ and real GDP _____. If wages are flexible, the increase in employment and real GDP will be _____ the increase if wages are rigid. When workers are laid off, what happens to physical capital?
rises; rises smaller than Physical capital becomes less productive, leading firms to reduce capacity utilization.
Economic fluctuations are ____________. Recessions are periods in which the economy _____, while economic expansions are defined as the periods _____. An economic expansion begins ____________. In the United States, recessions are usually defined as _____.
short-run changes in the growth of GDP. contracts; between recessions. at the end of a recession two consecutive quarters of negative growth in real GDP.
According to real business cycle theory, the economic impact of changing input prices is similar to the economic impact from ____________. If oil, which is a major input to most production processes, abruptly falls in price, the impact on the economy would be similar to ____________.
technology changes. a productivity increase, with a resultant increase in real GDP.
Quantitative easing is ____________.
the central bank's purchase of long-term bonds in the open market. an attempt by the central bank to more directly impact long-term interest rates. a variation on the central bank's traditional manner of conducting open market operations. All of the above
One major difference between modeling economic busts and booms is that ____________. While economic booms are generally positive, they also have a dark side. This is because ____________.
there is no issue of rigid nominal wages when modeling booms. if the economy is close to full employment and full capacity utilization before the beginning of the boom, the economy might eventually experience a leftward shift in labor demand, causing a recession rather than a gentle fall to pre-boom levels.
The Troubled Asset Relief Program (TARP) is considered to be an example of a countercyclical policy that represents a mix of fiscal and monetary effects because it ____________
was a congressionally authorized expenditure by the U.S. Treasury that sought, in part, to provide financial resources to elements of the banking system.
The core ingredients of expansionary monetary policy are shown below. These events impact the real economy and occur as shown by the sequence on the right. For each of the events described below, insert the number (1−4) to give each event its correct position in the sequence.
1. Short-term investment rates fall and access to credit expands. 2. Long-term investment rates fall. 3. Demand for goods and services increase. 4. Labor demand shifts right. Suppose the Fed conducts an open market sale.
How does the zero lower bound on interest rates affect the working of monetary policy?
It complicates the formulation of expansionary monetary policy because it forces the central bank to rely on nontraditional and less familiar tools such as quantitative easing. It reduces the effectiveness of monetary policy by impairing the ability of the public (including investors) to understand the central bank's actions and signals. It makes the implementation of expansionary monetary policy more difficult since it effectively blocks the central bank's use of its primary tool. All of the above
According to the Taylor rule, should the Fed raise or lower the federal funds rate when the output gap is positive?
It should raise the federal funds rate
What are the automatic and discretionary components of fiscal policy?
The automatic components do not require deliberate action on the part of the government, while the discretionary components do.
Which of the following statements describing relationships between inflation expectations and monetary policy are correct?
The long-term expected real interest rate will decline if long-term expectations of the inflation rate rise and the nominal interest rate doesn't rise one-for-one with inflation. The Fed's effort to influence today's expectations about future monetary policy is referred to as forward guidance.
Which of the following is true regarding the natural rate of unemployment?
The natural rate is calculated by averaging the unemployment rate over an extended time period. The natural rate of unemployment does not include cyclical unemployment. The natural rate includes both frictional and structural unemployment.
Which of the following is not true regarding the natural rate of unemployment?
The natural rate of unemployment is 0 percent when the U.S. economy is not in a recession.
What does it mean to say that an economic fluctuation involves the co-movement of many aggregate macroeconomic variables?
These variables grow or contract together during booms and recessions.
An old saying goes: "Nothing succeeds like success." How could this saying relate to Keynes's animal spirits view of economic fluctuations?
When people succeed, they become confident and optimistic, which can lead to actions that stimulate further success.
The concept of multipliers was one of the key elements of John Maynard Keyne's theory of fluctuations. A multiplier is ____________.
an economic mechanism that causes an initial shock to be amplified by follow-up effects
During an economic downturn of any duration, _____________.
consumption, investment, and GDP decrease while unemployment increases.
Real business cycle theory _____________.
emphasizes the role of changing productivity and technology in causing economic fluctuations
Which of the following key factors can help explain the Great Recession of 2007-2009?
An increase in mortgage defaults, negatively impacting banks. A reduction in new home construction, leading to a decrease in labor demand. A fall in housing prices. A reduction in consumer wealth, curtailing spending.
What are the similarities and the differences between monetary and fiscal policies? The manner (or ways) in which they work. The aspect of the labor market they impact. The result their implementation seeks to achieve. The entities (or authorities) that oversee them.
D S S D
Suppose country X suffers from a recession. Determine how the central bank can use the following tools to conduct countercyclical monetary policy in this scenario. Reserve requirement. Interest rate paid on reserves deposited at the central bank. Lending from the discount window. Long-term bonds.
Decrease Decrease Increase Purchase
Suppose traditional monetary and fiscal policy has had only limited success in promoting higher employment. Governments sometimes seek to directly stimulate hiring by the private sector by engineering a shift in the labor ______ curve. According to your graph, the targeted increase in employment can be achieved with the payment of a subsidy to employers of ______ per worker.
Demand Demand curve shifts right $2
Countercyclical monetary and fiscal policies both work by shifting the labor ________ curve. Which of the following is not a reason why policymakers might implement growth-reducing contractionary policies during a boom?
Demand Graph shifts D3 in between D1 and D2 To bring the unemployment rate down to the target level.
he University of Michigan runs monthly surveys of households around the United States. Some of the questions gauge consumer optimism by asking how households feel about their own financial situation, as well as the economy more broadly. These responses are used to generate a monthly measure of Consumer Sentiment. During recessions, there is a(n) ______ in consumer sentiment. Based on the information given in the chart, which of the following is likely to be true according to Keynes' animal spirits view of economic fluctuations? Does the chart 'University of Michigan: Consumer Sentiment' prove that Keynes' theory is correct? Which of the following inferences can be made from the chart? Which of the following is true of the relationship between consumer sentiment and a recession?
Dip The decline in consumer sentiment will likely lead to the deepening of recessions. No The direction of causality between recessions and consumer sentiment is indeterminate. Both directions of causality between consumer sentiment and recession are present in an economy.
Suppose the Fed conducts an open market sale. Such an action would be called for if the economy faced the possibility of_______. The Fed's open market sale impacts the federal funds market shown on the right by shifting the _______ reserves. Following the Fed's successful open market sale, the process that ensues is given by ____________.
Inflation Supply of Supply shifts left on graph Short-term interest rates rise→Long-term interest rates rise→Demand for goods and services decreases→Labor demand shifts left
Suppose the central bank carries out a contractionary monetary policy to prevent inflation from rising above its target level. Which of the following will not be an effect of such a policy?
Interest rates would fall.
Using the multi-point curve drawing tool, show the impact of introducing a wage subsidy (s) on this economy by shifting the appropriate curve, and label the new curve accordingly. Which of the following statements are correct in describing the efficiency of new public expenditures? Identify whether the following expenditure-based policies would be affected by policy waste and policy lags or not. Federal transfers to state governments to reduce layoffs of teachers and police officers. Infrastructure spending on building a school which hasn't passed a rigorous cost-benefit analysis.
Labor demand shifts right The urgency of spending huge sums of new government expenditures makes it harder to identify and efficiently implement the projects that are socially beneficial. Expenditure-based policies often face a huge lag inimplementation, which reduces their effectiveness. Many of the projects with the highest social return have been funded already, raising the chance that a new project won't be socially desirable. Not affected Affected
Suppose that the mythical country Moricana has a very high minimum wage. Labor market laws are trade union-friendly and allow unions a high degree of bargaining power. Moricana is in a recession—capacity utilization in the economy is at an all-time low, surveys show that firms do not expect economic conditions to improve in the coming year. Firms in the country are cutting back on capital spending and investment. In Moricana, wages are likely to be ____________.
Rigid
When wages exhibit downward flexibility and a recession occurs, the decline in employment will be ____________.
Smaller when the supply of labor is relatively inelastic Softened because some of the decline in labor demand is absorbed by a fall in wages. Smaller than what would occur if wages were rigid. All of the above
In his book The Optimum Quantity of Money, Milton Friedman talks about a helicopter dropping $2,000 over a community. The cash dropped by the helicopter gives the people in this community more money to spend. A tax cut also has the same effect: it increases disposable income. Suppose tax cuts, analogous to the helicopter drop, were proposed as a method to shift the labor demand curve to the right following a recession. How effective do you think this policy would be?
Somewhat effective, but only to the extent that most of the tax cut is concurrently spent on domestic output, that multiplier effects occur, and crowding out is small.
The graph on the right shows actual and projected estimates of potential GDP and GDP. Potential GDP is also a measure of trend GDP. When is the output gap, defined as the percent difference between GDP and potential GDP, positive?
When the economy's capacity to produce is exceeded by its actual production. When actual real GDP rises above potential GDP. When the economy experiences an inflationary boom. All of the above
An example of a multiplier is when __________
an increase in business confidence causes firms to increase production and hire employees, leading to an increase in household spending, causing firms to further increase production and employment a drop in consumer confidence reduces household spending, causing firms to cut production and lay off employees, leading to a greater reduction in household spending.
During recessions, firms typically prefer to achieve a reduction in employment by _______. But, if this is not sufficient for reducing employment quickly, they would have to ________. Which of the following statements correctly describes features / implications of real business cycle (RBC) theory?
cutting back new hiring, engage in mass layoffs It suggests that technological progress is an important determinant of long-term fluctuations in growth.
What are the important mechanisms that reverse the effects of a recession in a modern economy?
labor demand increases due to market forces Labor demand increases due to expansionary government policies
How do wage flexibility and downward wage rigidity affect the extent of unemployment in the economy when the demand for labor falls? When the demand for labor falls, the fall in employment is ________ when real wages are flexible and ________ when wages are downwardly rigid.
limited; amplified
Contractionary monetary policy shifts the labor demand curve to the left by____________.
pushing long-term interest rates up, thereby causing reduced private expenditures and inducing firms to want to hire fewer workers.
According to Keynes's view on animal spirits, ____________. Keynes's theory of multipliers involved an element of the self-fulfilling prophecy.Which of the following illustrates the concept of a self-fulfilling prophecy?
the economy could fluctuate beyond the level that could be explained by the underlying economic fundamentals. Firms expect an increase in demand in the future and so hire additional workers now, which leads to an increase in consumption demand.
Central banks undertake quantitative easing programs to ____________.
work around the problems when short-term nominal interest rates approach zero. more forcefully and directly impact the interest rates relevant for investment decisions.
How can expansionary expenditure-based fiscal policy lead to crowding out in the economy?
Expenditure-based fiscal policy leads to more government borrowing, absorbing funds that would have otherwise been borrowed and expended by the private sector.
