Ch. 17 Macroeconomics

But this turned out not to be true: allowing more inflation doesn't lead to

permanently lower unemployment

Since any rate of unemployment other than the natural rate results in the rate of inflation increasing or decreasing, the natural rate of unemployment is sometimes referred to as the

non-accelerating inflation rate of unemployment

•A macroeconomic model that focus on real rather than monetary explanations of the fluctuations in real G D P.

real business cycle model

a relationship that depends on the basic behavior of consumers and firms and that remains unchanged over long periods.

structural relationship

By the late 1960s, most economists agreed that the long-run aggregate supply curve was

vertical

With hindsight, two Fed actions during Greenspan's tenure appear to have worsened the 2007-2009 recession:

1.Saving hedge fund Long-Term Capital Management (L T C M) 2.Keeping the federal funds rate at 1 percent from June 2003 to June 2004

Indicate the two main objections to the idea that the​ short-run Phillips curve is vertical. A. Workers and firms might not have rational expectations. B. Any wage rising more quickly than the rate of inflation is actually falling. C. Contracts with workers keep wages sticky. D. Wages tend to adjust quickly.

A and C

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 A. use expansionary fiscal policy. B. use expansionary monetary policy. C. use a combination of expansionary monetary and fiscal policies. D. use contractionary monetary policy.

B

A graph showing the short-run relationship between the unemployment rate and the inflation rate.

Philips curve

expecting inflation to be the same as it was last period, then expansionary monetary policy can increase employment.

adaptive expectations

A significant reduction in the inflation rate.

disinflation

if actual inflation is greater than expected inflation, then the actual real wage is _____ than the expected real wage, and the unemployment rate ________

less, falls

These models assume rational expectations and quickly-adjusting prices, as did Lucas and Sargent; collectively, these two approaches are known as

the new classical macroeconomics.

Moderate but stable inflation

•quick adjustment, stable but noticeable inflation is easily incorporated into expectations

If Lucas and Sargent were​ right, A. an expansionary monetary policy would work better if people had rational​ expectations, since they will not use all available information especially knowledge of the effects of the​ Fed's fiscal policy. B. 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. C. a contractionary monetary policy would work better if people had rational​ expectations, since they will use all available information including knowledge of the effects of the​ Fed's monetary policy. D. an expansionary fiscal policy would be more suitable if people had adaptive​ expectations, since they will use all available information including knowledge of the effects of the​ Fed's fiscal policy.

B

If workers and firms have rational​ expectations, they will A. ignore the inflation rate since their real wages never keep up with inflation anyway. B. use all available information when forming their expectations of future​ inflation; thus, the actual inflation rate will be equal to the expected inflation rate. C. behave as if they expected the actual inflation rate during one year to continue into the next​ year; thus, they forecast future rates of inflation based on past rates of inflation. D. depend on rational information about wages and prices and thus often fail to realize that as prices​ rise, inflation will not increase the average wage in the economy.

B

Models that use​ factors, such as technology​ shocks, to explain fluctuations in real GDP instead of changes in the money supply are called A. real monetary models. B. real business cycle models. C. monetary business cycle models. D. real technology models.

B

According to many economists and​ policymakers, what other options does the Fed have to improve its credibility with​ workers, firms, and​ investors? A. Following a rules strategy. B. Following the Taylor rule. C. Following a discretion strategy. D. All of the above.

D

According to many economists and​ policymakers, what other options does the Fed have to improve its credibility with​ workers, firms, and​ investors? A. Following the Taylor rule. B. Following a rules strategy. C. Following a discretion strategy. D. All of the above.

D

As of​ 1993, the Fed sets targets for which of the following in order to achieve price stability and high​ employment? A. Discount rate B. M1 definition of the money supply C. M2 definition of the money supply D. Federal funds rate

D

If actual inflation is higher than expected​ inflation, the A. actual real wage is less than the expected real​ wage: unemployment rises. B. actual real wage is greater than the expected real​ wage: unemployment rises. C. actual real wage is greater than the expected real​ wage: unemployment falls. D. actual real wage is less than the expected real​ wage: unemployment falls.

D

If workers and firms have rational​ expectations, they will A. behave as if they expected the actual inflation rate during one year to continue into the next​ year; thus, they forecast future rates of inflation based on past rates of inflation. B. ignore the inflation rate since their real wages never keep up with inflation anyway. C. depend on rational information about wages and prices and thus often fail to realize that as prices​ rise, inflation will not increase the average wage in the economy. D. use all available information when forming their expectations of future​ inflation; thus, the actual inflation rate will be equal to the expected inflation rate.

D

Models that use​ factors, such as technology​ shocks, to explain fluctuations in real GDP instead of changes in the money supply are called A. real monetary models. B. real technology models. C. monetary business cycle models. D. real business cycle models.

D

Paul Volcker is credited largely with which of the​ following? A. The​ "Volcker disinflation." B. Fighting inflation by reducing the growth of the money supply. C. Driving up the unemployment rate. D. A and B only.

D

Robert Lucas and Thomas Sargent argued that A. there would always be a​ trade-off between unemployment and inflation in the short​ run, and the​ short-run Phillips curve would be downward sloping. B. there would always be a direct relationship between unemployment and inflation in the short​ run, and the​ short-run Phillips curve would be upward rising. C. there would always be a​ trade-off between unemployment and inflation in both the short​ run, and the​ long-run and the Phillips curve in both the short and long run would be downward sloping. D. there might not be a​ trade-off between unemployment and inflation in the short​ run, and the​ short-run Phillips curve would be vertical.

D

What is the Fed doing to increase the credibility of its​ policies? A. Whenever a change in policy is​ announced, the change actually takes place. B. Announcing the federal funds target rate. C. Conducting more open market purchases of government securities. D. A and B only.

D

What will happen to the​ short-run Phillips​ curve? A. The​ short-run trade-off between unemployment and inflation will be better than before as the economy moves to a lower​ short-run Phillips curve. B. The real wage will​ fall, unemployment will fall and the economy will go back to equilibrium with an even higher inflation rate. C. The economy will go back to equilibrium with a lower inflation rate and a higher unemployment. D. The​ short-run trade-off between unemployment and inflation will be worse than before as the economy moves to a higher​ short-run Phillips curve.

D

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? A. During periods of low​ inflation, workers,​ firms, banks, and investors tend to ignore changes in prices. B. During periods of high​ inflation, people should use all available information including the​ Fed's policy announcement when forming their expectations of future inflation. C. During periods of moderate​ inflation, people usually expect the inflation rate during one year to continue into the following year. D. During periods of high​ inflation, people do not take any particular action until the Fed has controlled the inflation rate.

D

​If, in the long​ run, real GDP returns to its potential​ level, then in the long​ run, A. the Phillips curve is upward sloping. B. the Phillips curve represents a structural relationship. C. the Phillips curve disappears. D. the Phillips curve is vertical.

D

quick adjustment again, but for a different reason: forming rational expectations about inflation becomes very important, so workers and firms pay a lot of attention to forecasting inflation.

High and unstable inflation

A policy under which the federal government does not allow large financial firms to fail, for fear of damaging the financial system.

Too-big-to-fail policy

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

The two great macroeconomic problems that the Fed deals with (in the short run) are

employment and inflation

if actual inflation is less than expected inflation, the actual real wage is ______ than the expected real wage, and the unemployment rate ________.

greater, rises

the long-run Phillips curve was also vertical because

in the long run, employment is determined by output, which in the long run does not depend on the price level.

•Unemployment, in the long run, goes to the ______________, when the output returns to potential G D P.

natural rate of unemployment

Expectations formed by using all available information about an economic variable.

rational expectations

The short-run trade-off appears to exist because

workers and firms sometimes expect the inflation rate to be either higher or lower than it turns out to be.

Low inflation

• slow adjustment, since workers and firms seem to ignore inflation

Should the Fed Be Independent of Congress and the President? Arguments "For"

1.In a democracy, elected officials should make public policy; while monetary policy is complicated and requires a long view, the same is true of other tasks assigned to Congress and the president, like national security and foreign policy. 2.Reducing Fed independence would ease coordination of monetary policy with fiscal policy.

Should the Fed Be Independent of Congress and the President? Arguments "Against"

1.Political pressure to improve short-run outcomes would result in too "easy" money, resulting in high inflation. 2.A government controlling its central bank could use that control to further its internal political interests.

If actual inflation is higher than expected​ inflation, the A. actual real wage is less than the expected real​ wage: unemployment falls. B. actual real wage is greater than the expected real​ wage: unemployment rises. C. actual real wage is less than the expected real​ wage: unemployment rises. D. actual real wage is greater than the expected real​ wage: unemployment falls.

A

When SRAS1 shifts to SRAS2​, 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)? A. It shifts up such that a given level of unemployment occurs at a higher price level. B. It shifts down such that a given level of unemployment occurs at a lower price level. C. It shifts up such that a given level of unemployment occurs at a lower price level. D. It shifts down such that a given level of unemployment occurs at a higher price level.

A

Economists during the early 1960s thought of the Phillips curve as a​ "policy menu" because they thought that the Phillips curve A. represented a structural relationship in the economy that would not change as a result of policy changes. B. represented a relationship that did not depend on consumers and firms and could change over time. C. represented a direct relationship between unemployment and inflation in the short run. D. presented policymakers with a reliable menu of combinations of unemployment and inflation. They were or were not correct to think of the Phillips curve as a​ "policy menu."

A, were not

Economists who believed that the Phillips curve represented a structural relationship believed that the curve represented A. a temporary​ trade-off between unemployment and inflation. B. no​ trade-off between unemployment and inflation. C. a permanent​ trade-off between unemployment and inflation. D. a cyclical​ trade-off between unemployment and inflation.

C

It is inconsistent to believe that the​ long-run aggregate supply curve is vertical and the​ long-run Phillips curve is downward sloping because A. in order for the​ long-run aggregate supply curve to be​ vertical, changes in the price level​ (inflation) would have to affect the unemployment rate in the long​ run, which does not happen with a​ downward-sloping long-run Phillips curve. B. in order for the​ long-run Phillips curve to be downward​ sloping, changes in the interest rate would have to affect the unemployment rate in the long​ run, which does not happen with a vertical​ long-run aggregate supply curve. C. in order for the​ long-run Phillips curve to be downward​ sloping, changes in the price level​ (inflation) would have to affect the unemployment rate in the long​ run, which does not happen with a vertical​ long-run aggregate supply curve. D. None of the above—believing that the​ long-run aggregate supply curve is vertical and the​ long-run Phillips curve is downward sloping is not inconsistent.

C

The Phillips curve exhibits A. the inverse relationship between the actual and the natural rate of unemployment. B. the relationship between the unemployment and the inflation rates. C. the direct relationship between the unemployment and the inflation rates. D. the situation where cyclical unemployment becomes zero.

C

​Workers, firms,​ banks, and investors in financial markets care about the future rate of inflation because A. actual inflation is always the same as the expected​ inflation, and there is no difference between actual real​ wages, profits, and interest and their respective expected values. B. if actual inflation turns out to be lower than the expected​ inflation, real​ wages, profits, and interest will be lower than their expected values. C. if actual inflation turns out to be different from the expected​ inflation, real​ wages, profits, and interest will be different from their expected values. D. if actual inflation turns out to be higher than the expected​ inflation, real​ wages, profits, and interest will be higher than their expected values.

C