Chapter 17 Monetary Policy ECON 2301

The table above gives a nation's government outlays and tax revenues for 2012 through 2016. 18) During which years did the country have a budget surplus? A) 2012 and 2013 B) 2016 only C) 2015 only D) 2014 and 2016 E) all except 2015

A) 2012 and 2013

The crowding out effect refers to the ________ from ________ in the government's budget deficit. A) decrease in investment; an increase B) decrease in employment; an increase C) decrease in consumption; a decrease D) increase in consumption; an increase E) increase in investment; an increase

A) decrease in investment; an increase

The Fed fights inflation by _______. A. lowering the federal funds rate, which lowers interest rates and decreases aggregate demand B. raising the federal funds rate, which raises interest rates and decreases aggregate demand C. decreasing the monetary base, which raises the interest rate and increases saving D. lowering the long-term real interest rate, which increases investment and spurs economic growth

B) By raising the federal funds rate, the Fed ultimately decreases aggregate demand, which slows the inflation rate.

The Fed's monetary policy instrument is the ________. A. inflation rate B. federal funds rate C. long-term interest rate D. monetary base

B) The Fed uses the federal funds rate as its monetary policy instrument.

Ignoring any supply-side effects, suppose the government is considering cutting taxes by $100 billion or increasing government expenditures on goods and services by $100 billion. Then A) both policies would increase aggregate demand by the same amount. B) both policies would increase aggregate demand but the tax cut has a smaller effect. C) both policies would increase aggregate demand but the increase in government expenditure has a smaller effect. D) the tax cut would decrease aggregate demand and the increase in government expenditure would increase aggregate demand. E) the tax cut would increase aggregate demand and the increase in government expenditure would decrease aggregate demand.

B) both policies would increase aggregate demand but the tax cut has a smaller effect.

In 2010, the U.S. government had tax revenues of $2,703 billion and outlays were $3,973 billion. The budget A) surplus was $1,270 billion. B) deficit was $1,270 billion. C) surplus was $2,703 billion. D) deficit was $3,973 billion. E) was balanced because every dollar the government spends it must raise.

B) deficit was $1,270 billion.

To eliminate a recessionary gap, the government can ________ government expenditures on goods and services or ________ taxes. A) increase; increase B) increase; decrease C) decrease; increase D) decrease; decrease E) increase; not change

B) increase; decrease

During which years did the country have a balanced budget? A) 2012 and 2013 B) 2016 only C) 2015 only D) 2014 and 2016 E) all except 2015

C) 2015 only

) If the income tax rate is 20 percent and the tax rate on consumption expenditure is 15 percent, then the tax wedge is A) 2 percent. B) 5 percent. C) 35 percent. D) 300 percent. E) None of the above answers is correct.

C) 35 percent.

The above table gives the government outlays and tax revenues from 2012 through 2016 for two countries. In 2015 country A had a ________ and country B had a ________. A) budget deficit; budget deficit B) balanced budget; budget surplus C) balanced budget; budget deficit D) budget surplus; budget surplus E) budget surplus; balanced budget

C) balanced budget; budget deficit

During which years did the country have a budget deficit? A) 2012 and 2013 B) 2016 only C) 2015 only D) 2014 and 2016 E) all except 2015

D) 2014 and 2016

A fiscal stimulus works to close a recessionary gap by shifting the A) AD curve leftward. B) AS curve leftward. C) AD curve leftward and AS curve leftward. D) AD curve rightward. E) potential GDP line leftward.

D) AD curve rightward.

If an economy is at the short-run equilibrium illustrated by the figure above, a discretionary FISCAL policy to adjust the economy to full employment is to A) decrease taxes. B) decrease the quantity of money. C) increase government spending. D) increase taxes and decrease government spending simultaneously. E) increase the quantity of money.

D) increase taxes and decrease government spending simultaneously.

What is financial stability? What actions has the Fed taken since 2007 in pursuit of financial stability? Use a graph to illustrate the effects of the Fed's actions.

Financial stability is the situation in which the nation's financial markets and institutions are working normally to allocate capital and risk. With the crisis in the nation's financial markets, in 2007 banks faced significantly more risk than normal and responded by drastically increasing their demand for (safe) reserves. The demand curve for reserves shifted right from RD0 to RD1. In the absence of Fed action, the federal funds rate would have skyrocketed from 5 percent to 9 percent. But the Fed engaged in quantitative easing by increasing the supply of reserves from RS0 to RS1. The Fed's actions drove the federal funds rate to 0 percent and helped maintain financial stability

What is the problem that might arise if the Fed keeps the interest rate too low for too long?

If the Fed waits too long to raise the interest rate, the Fed's decision will lead to higher inflation.

What happens in Freezone if the central bank conducts an open market sale of securities? How will the interest rate change? Do you recommend that the central bank conduct an open market sale of securities? Why?

If the central bank conducts an open market sale of securities, the federal funds interest rate rises. With the rise in the federal funds rate, aggregate demand decreases. The price level falls. Real GDP decreases and moves closer to potential GDP. Because real GDP moves closer to potential GDP, it is reasonable to recommend that the central bank conduct an open market sale of securities.

Suppose that a drought decreases potential GDP in Artica to $250 billion. Explain what happens if the central bank lowers the federal funds rate.

If the central bank lowers the federal funds rate, aggregate demand increases. The price level rises. Real GDP increases and moves closer to potential GDP.

What happens in Freezone if the central bank lowers the federal funds rate?

If the central bank lowers the federal funds rate, aggregate demand increases. The price level rises. Real GDP increases and moves farther away from potential GDP. Lowering the interest rate moves real GDP farther away from potential GDP and so is an incorrect policy to pursue.

What do you predict will happen if the central bank takes no monetary policy actions? What monetary policy action would you advise the central bank to take and what do you predict will be the effect of that action?

If the central bank takes no action, then in the long run the money wage rate falls. Aggregate supply increases so that the AS curve shifts rightward. In the long run, the economy returns to potential GDP of $300 billion and the price level falls to 120. If the central bank undertakes a policy action, the central bank should lower the federal funds interest rate and thereby increase aggregate demand. If the central bank did so and was totally accurate, then real GDP would return to potential GDP of $300 billion and the price level would rise to 140.

What do you predict will happen in Freezone if the central bank takes no monetary policy actions? What monetary policy action would you advise the central bank to take and what do you predict will be the effect of that action?

If the central bank takes no action, then in the long run the money wage rate rises. Aggregate supply decreases so that the AS curve shifts leftward. In the long run, the economy returns to potential GDP of $300 billion and the price level rises to 120. If the central bank undertakes a policy action, the central bank should raise the federal funds rate and thereby decrease aggregate demand. If the central bank did so and was totally accurate, then real GDP would return to potential GDP of $300 billion and the price level would fall to 100.

What is the Fed's "dual mandate" for the conduct of monetary policy?

The Fed has two goals for its monetary policy. These two goals—the Fed's dual mandate—are to achieve a stable price level, that is, keep the inflation rate low and predictable, and to achieve maximum employment, that is, keep real GDP close to potential GDP.

The above table gives a country's government outlays and tax revenue for 2012 through 2016. During which years did the country have a balanced budget, budget surplus, and budget deficit?

The country had a balanced budget in 2015 because in that year government outlays equaled tax revenues. The country had a budget surplus in 2012 and 2011 because in those years tax revenues exceeded government outlays. The country had a budget deficit in 2014 and 2015 because in those years government outlays exceeded tax revenues.

Use the following information to work the following Problems. Figure 17.3 shows the aggregate demand curve, AD, and the shortrun aggregate supply curve, AS, in the economy of Freezone. Potential GDP is $300 billion. What are the price level and real GDP? Does Freezone have an unemployment problem or an inflation problem? Why?

The price level is 110 and real GDP is $400 billion. Freezone has an inflation problem because real GDP exceeds potential GDP.

Figure 17.2 shows the aggregate demand curve, AD, and the short-run aggregate supply curve, AS, in the economy of Artica. Potential GDP is $300 billion. What are the price level and real GDP? Does Artica have an unemployment problem or an inflation problem? Why?

The price level is 130 and real GDP is $200 billion. Artica has an unemployment problem because real GDP is less than potential GDP.