Econ 102
As a result of the supply shock, the rate of inflation has
increased
NAIRU is the
nonaccelerating inflation rate of unemployment.
Cross-country evidence supports that the more independent a country's central bank,
the lower its inflation rate.
We can tell whether a monetary policy has worked by
the state of the economy.
When Lucas made the comment about "the monetary theory we have," he meant the
rational expectations theory.
Models that use factors, such as technology shocks, to explain fluctuations in real GDP instead of changes in the money supply are called
real business cycle models.
Which of the following will not have an effect on the long−run Phillips curve?
Changes in monetary policy.
This statement in Goodyear's annual report illustrates the concern that many businesses had regarding the Federal Reserve's policy to
raise interest rates because the inflation rate was below the target rate.
The short−run Phillips curve is:
Downward Sloping
When Taylor refers to a "rules-based policy," he means
a formulaic strategy for targeting the money supply and the federal funds rate.
Higher interest rates would have
decreased investment spending by firms and home purchases.
Milton Friedman argued that the Phillips curve did not represent a permanent trade-off between unemployment and inflation, since
the long-run Phillips curve is vertical, there is no trade-off between unemployment and inflation in the long run.
Therefore, during the 1970s, there
was not a trade-off between unemployment and inflation.
The short-run Phillips curve exhibits a trade-off between inflation and unemployment
whereas the long-run Phillips curve shows no trade-off between inflation and unemployment
If workers ignore inflation in forming their expectations of the real wage rate, what is the effect of an expansionary monetary policy?
A move up along the short-run Phillips curve.
What effect does expansionary monetary policy have on equilibrium if consumers have rational expectations
A movement from point A to point C.
Which of the following statements concerning the Phillips curve is correct?
Many economists and policymakers in the 1960s viewed the Phillips curve as a structural relationship.
Given that the Phillips curve is derived from the aggregate demand and aggregate supply model, why use the Phillips curve?
The answer is that while the aggregate demand and aggregate supply model shows the price level, the Phillips curve explicitly shows the inflation rate. Further, the aggregate demand and aggregate supply model explicitly shows changes in the level of real GDP, while the Phillips curve explicitly shows the unemployment rate .
Which of the following can most likely be inferred from the information given above?
The economy is currently on the long-run Phillips curve.
When Burns refers to "the current environment," he means the 1970s, a period in which
both inflation and unemployment worsened.
In this case,
firms will hire fewer workers than they had planned to hire and employment will fall.
If this evaluation of the economic situation is correct, the Fed should consider
increasing its federal funds rate target.
According to the real business cycle models,
inflation can change due to movements in the money supply, however, fluctuations in real GDP are mainly explained by changes in the level of technology.
Prior to the U.S. dollar strengthening, Fed policy had been attempting to reach a point on the short-run Phillips curve representing
lower unemployment and higher inflation because the inflation rate had been below the Fed's target of 2 percent for more than three years.
The effect is
more likely if inflation is unanticipated because workers would not seek higher nominal wages.
The unemployment rate
rose from 6% to 10% during the period of the Volcker disinflation.
As the public starts expecting a higher inflation rate, the short-run Phillips curve will
shift up and to the right
Consider the long-run Phillips curve and the short-run Phillips curve in the graph at right. A movement from point A to point B could be caused by
short run effects of contractionary monetary policy.
In macroeconomics courses in the 1960s and early 1970s, some economists argued that one of the U.S. political parties was willing to have higher unemployment in order to achieve lower inflation and that the other major political party was willing to have higher inflation in order to achieve lower unemployment. Such views of the trade-off between inflation and unemployment might have existed in the 1960s because the Phillips curve was widely viewed as
stable.
Do all economists agree with Lucas's main conclusions about the effectiveness of monetary policy? Briefly explain. Many economists have remained skeptical of all the following, except
that there is a short-run trade-off between unemployment and inflation.
When Federal Reserve Chairman Ben Bernanke said that the public's expectations of inflation could "become embedded in wage and price decisions," he meant
that workers, firms, consumers, and the government will all take the inflation rate into account when making decisions.
If, in the long run, real GDP returns to its potential level, then in the long run,
the Phillips curve is vertical.
Robert Lucas and Thomas Sargent argued that
there might not be a trade-off between unemployment and inflation in the short run, and the short-run Phillips curve would be vertical.
Most economists in 1968 would not have agreed with him because
they believed in the stable trade-off relation manifested in the Phillips curve.
In referring to the "increasing strength of the U.S. dollar," the company meant that
the dollar/foreign currency exchange rate had risen.
Friedman defined the "natural rate of unemployment" as the
unemployment rate that exists when the economy produces potential GDP.
If the Fed fails to act, it is likely that the short-run Phillips curve will shift
up over time as inflation occurs, and workers and firms adjust to the higher inflation rate.
If workers and firms have rational expectations, they will
use all available information when forming their expectations of future inflation; thus, the actual inflation rate will be equal to the expected inflation rate.
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
use expansionary monetary policy.
If the unemployment rate is below the natural rate, the inflation rate tends to ___________, and eventually, the short-run Phillips curve will shift _______.
increase; up
Point E on the Phillips curve graph represents the same economic situation as point B on the aggregate demand and aggregate supply graph.
Point D on the Phillips curve graph represents the same economic situation as point C on the aggregate demand and aggregate supply graph.
Roasia is a developing economy with a large population. Its public healthcare and transportation infrastructure is very poor, which creates a bottleneck for industrial development. Leading industry experts have been claiming that investment in infrastructure so far has not been sufficient. According to them, there is a pressing need to step up government expenditure on public infrastructure. With the debate heating up, the government proposed a 30 percent increase in infrastructure investment this year. This is also expected to reduce unemployment considerably from the current level of 6 percent. Which of the following conclusions can most reasonably be drawn from the information given above
With increased government expenditure, the economy will move up along the short-run Phillips curve.
Indicate the two main objections to the idea that the short-run Phillips curve is vertical.
Workers and firms might not have rational expectations. Contracts with workers keep wages sticky.
If the board had kept its estimate fixed at 5.5 percent during a period when the actual NAIRU was higher, monetary policy would have been too
expansionary in an effort to decrease the unemployment rate.
Such views are rare today because
in the long run there is no tradeoff between inflation and unemployment.
In referring to an "unfavorable foreign currency translation," the company meant that
it was more expensive for businesses around the world to purchase U.S. goods because of changes in the exchange rate.
A movement from point A to point C could be caused by
long run effects of contractionary monetary policy.
In 2010, Congress passed the Wall Street Reform and Consumer Protection Act (Dodd-Frank Act) which
made it much more difficult for the Fed to use a too-big-to-fail policy.
Economists during the early 1960s thought of the Phillips curve as a "policy menu" because they thought that the Phillips curve
represented a structural relationship in the economy that would not change as a result of policy changes.
According to Milton Friedman, differences between the actual and expected inflation rates could lead the actual unemployment rate to
rise above or fall below the natural rate.
The short-run trade-off between the rate of inflation and the unemployment rate is best represented by:
the Phillips curve.
If workers and firms have rational expectations and wages and prices adjust quickly, then if the Fed announces a credible expansionary monetary policy,
the inflation rate will increase, but the unemployment rate will be unchanged.
If actual inflation is higher than expected inflation, the
actual real wage is less than the expected real wage: unemployment falls.
The concept of a nonaccelerating inflation rate of unemployment (NAIRU) helps us to understand why in the long run, the Federal Reserve
can affect the inflation rate but not the unemployment rate.
If the long-run aggregate supply curve is vertical, then the Phillips curve
cannot be downward sloping in the long run.
When Robert Shiller asked a sample of the general public what they thought caused inflation, the most frequent answer he received was "greed." Most economists would argue that inflation is caused by
changes in both aggregate demand and aggregate supply.
Robert Shiller asked a sample of the general public and a sample of economists the following question: "Do you agree that preventing high inflation is an important national priority, as important as preventing drug abuse or preventing the deterioration in the quality of our schools?" Fifty-two percent of the general public, but only 18 percent of economists, fully agreed. The general public believes that inflation is a bigger problem than economists do because the general public believes that real wages
fall until a full inflation correction takes place .
Workers, firms, banks, and investors in financial markets care about the future rate of inflation because
if actual inflation turns out to be different from the expected inflation, real wages, profits, and interest will be different from their expected values.
The board would change its estimate of the NAIRU over time when
the natural rate of unemployment changes as a result of demographic changes or changes in labor market institutions.
Assuming people have rational expectations,
when the Fed uses monetary policy, people quickly realize the impact that will be created by the policy, adjust wages and prices, and inflation will adjust to the new expectations which means the policy will not affect real GDP.
If expected inflation is higher than actual inflation, actual real wages in the economy will turn out to be _________ than expected real wages; consequently, firms will hire _________ workers than they had planned.
higher; fewer
If inflation increases beyond expectations of inflation,
the real wage paid by employers and received by workers will decrease.
The Phillips curve exhibits
the relationship between the unemployment and the inflation rates.
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. (Both A and B)
According to many economists and policymakers, what other options does the Fed have to improve its credibility with workers, firms, and investors?
All of the above A.Following a discretion strategy. B.Following a rules strategy. C.Following the Taylor rule.
Which of the following statements is correct?
All of the above. A.In the long run, the Phillips curve is a vertical line at the natural rate of unemployment. B.In the long run, a higher or lower inflation rate has no effect on the unemployment rate. C.In the long run, a higher or lower price level has no effect on real GDP.
In the figure to the right, expected inflation is initially at 1.5%. When expected inflation increases to 4.5%, which of the following will occur?
All of the above. A.To have 3.5% unemployment rate, inflation would be 7.5%. B.At the natural rate of unemployment, inflation is 4.5%. C.Unemployment reaches the natural rate of 5%.
This approach works by
offering information about the policy outlook and expectations for the future path of the federal funds rate.
What economic framework did economists change as the result of Lucas's arguments?
Economists changed the theory of "adaptive expectations" where people assume that future rates of inflation will follow the past rates of inflation.
As of 1993, the Fed sets targets for which of the following in order to achieve price stability and high employment?
Federal funds rate
The Taylor rule is:
Federal funds target rate = Current inflation rate + Equilibrium real federal funds rate + (0.5 × Inflation gap) + (0.50 × Output gap).
Why doesn't the Phillips curve represent a permanent trade-off between unemployment and inflation in the long run?
In the long run, aggregate supply is vertical.
General Juan Peron, the former dictator of Argentina, once said of the labor market in his country, "Prices have gone up the elevator, and wages have had to use the stairs."
In this situation, real wages in Argentina were falling Unemployment was likely to have been relatively low
Why do most economists believe that it is important for a country's central bank to be independent of the rest of the country's central government?
Independent central banks are more effective at fighting inflation.
The Phillips curve was developed by A.W. Phillips in 1957 and shows the relationship between unemployment and inflation. The curve, shown at the right, indicates what type of relationship between the two variables?
Inverse relationship
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)?
It shifts up such that a given level of unemployment occurs at a higher price level.
The country of Tarragon is a developing economy which has been experiencing a very high level of inflation for the last one year. Shira Kapoor, a prominent academician, is of the opinion that the central bank should intervene and attempt to bring inflation down from the current level of eight percent to an acceptable level between three to five percent. Jack Dorian, who heads the Industries Federation of Tarragon (IFT), however believes that this will adversely affect the economy. The decline in the prices of goods and services as a result of this intervention will reduce overall production in the country. Which of the following statements is most supported by the information given above?
Jack is confusing disinflation with deflation.
How can the Fed fight a combination of rising unemployment and rising inflation?
Not easily; neither expansionary nor contractionary monetary policy can solve both problems simultaneously.
In the figure to the right, at what point is the inflation rate stable? That is, at what point can we refer to the inflation rate as the nonaccelerating inflation rate of unemployment
Point C
When the central bank of Tarragon reduced the money supply, inflation was expected to decline to five percent. However, inflation actually increased further from eight to 10 percent in the following months. Which of the following, if true, can explain this outcome?
Recent sanctions on two major oil-producing nations caused a shortage of oil globally.
As expectations of inflation increase, the short-run Phillips curve will
Shift to the right
In 1968, Herbert Stein, who would later serve on President Nixon's Council of Economic Advisors, wrote, "Some who would opt for avoiding inflation would say that in the long run such a policy would cost little, if any, additional unemployment.
Stein's statement was correct
Which of the following statements is true about the Fed under the leadership of Chairman Alan Greenspan between 1987 and 2006?
The Fed attempted to enhance its credibility by announcing its monetary policy action at the conclusion of each FOMC meeting.
The average price level in Outlandia, a developing country, increased by 5 percent this year compared to last year. Graeme Border, a member of the Department of Commerce, suggested that the central bank should use contractionary policies to curb inflation. According to him reducing inflation would help in improving general welfare. His friend Abraham Scott, a business analyst, disagrees. Abraham feels that, given the state of affairs in the economy, a contractionary monetary policy will not be a suitable measure. Economists in Roasia were expecting the increased investment in infrastructure to lower unemployment by 1.5 percent this year. However, unemployment only declined by 0.5 percent. Which of the following, if true, can explain this outcome?
The Roasian central bank's recent open market sale of bonds was unanticipated.
West Paragon, a developed economy, has been experiencing stable and low inflation for the last two years. There is consensus that the current unemployment rate of 4 percent is also its natural rate of unemployment. However, the country's GDP growth is stagnating and the government of West Paragon is worried about a possible slowdown. Given the situation, members of the government believe that the central bank should increase money supply in order to stimulate growth. Analysts at a leading economic research institute however believe that increasing money supply will only raise inflation and will not have any positive impact on unemployment. Which of the following can most likely be inferred from the information given above?
The economy is currently on the long-run Phillips curve.
Paul Volcker is credited largely with which of the following?
The "Volcker disinflation." And Fighting inflation by reducing the growth of the money supply
Which of the following decisions does the textbook discuss as an action by the Fed during Chairman Alan Greenspan's term that possibly contributed to the financial crisis of 2007-2009?
The Fed's decision to keep the target for the federal funds rate at 1 percent for more than 18 months after the end of the 2001 recession.
Suppose that the expected inflation rate increases from 4 percent to 6 percent. What will happen to the short-run Phillips curve?
The short-run trade-off between uemployment and inflation will be worse than before as the economy moves to a higher short-run Phillips curve.
An article in the Economist observes that "a sudden unanticipated spurt of inflation could lead to rapid economic growth."
This statement implies that there is a positive relationship between inflation and economic growth.
Suppose the inflation rate has been 15 percent for the past four years. The unemployment rate is currently at the natural rate of unemployment of 5 percent. The Federal Reserve decides that it wants to permanently reduce the inflation rate to 5 percent. To do this, the Fed would use
a contractionary policy.
According to Lucas and Sargent, workers and firms have rational expectations, and therefore if the Fed pursues an expansionary monetary policy:
agents will immediately adjust their expectations of inflation
Alan Greenspan
agreed with Paul Volcker about the importance of keeping inflation low.
As a result of this policy, the unemployment rate will be greater than the natural rate of 5 percent
and the inflation rate will be edging down slowly.
If the Fed's policy is successful, the inflation rate will be 5 percent
and the unemployment rate will be 5 percent.
If the Federal Reserve keeps monetary policy unchanged, eventually the unemployment rate will be:
back to the 5% natural rate of unemployment.
As a central bank has greater independence from the government, the economy's inflation rate tends to
be reduced
During the 1980s and 1990s, the relationship between growth in M2 and inflation
broke down, and the Fed announced that it would no longer set targets for M2.
If the Fed had raised interest rates earlier than it did, Schwab would have expected
consumer spending to have increased.
A country would want to grant its central bank more independence than it grants, say, its department of agriculture or department of education, because the central bank
controls the money supply, and the more independent the central bank, the lower is the likelihood of inflation.
Which of the following terms best describes the situation during 1933?
deflation
In a speech in September 1975, then Fed chairman Arthur Burns said the following: "There is no longer a meaningful trade-off between unemployment and inflation. In the current environment, a rapidly rising level of consumer prices will not lead to the creation of new jobs...Highly expansionary monetary and fiscal policies might, for a short time, provide some additional thrust to economic activity. But inflation would inevitably accelerate- a development that would create even more difficult economic problems than we have encountered over the past year." Burns's views in this speech are
different than the views at the Fed in the late 1960s.
A significant reduction in the inflation rate is called
disinflation.
The Phillips curve is a
downward sloping straight line
The Fed's "target policy rate" refers to the
federal funds rate.
An attempt to shape expectations about future policy decisions is what the Fed refers to a
forward guidance.
Disinflation might have been a good thing in the 1980s, but worrisome in 2015, because
inflation was persistently high and the Fed was not credible in the 1980s, but inflation was persistently low and the Fed was more credible in 2015.
The Fed appears to believe that the more "potent multiplier effect" is associated with
investment spending because it is more sensitive to lower interest rates.
A central bank's ability to maintain credibility on a policy to keep inflation low
is important because maintaining credibility allows a central bank to keep inflation expectations lower.
Many Fed officials have been opposed to adopting a rules-based policy because
it would reduce the ability of the Fed to respond rapidly to a financial crisis.
In order to improve credibility the Fed has enacted all of the following policies, except:
the Fed no longer makes it's future intentions clear.
The event that may have led him to conclude that it is more painful to reduce the inflation rate than theory would predict was
the Volcker disinflation.
In the United States, the Fed is held accountable to the nation's elected leadership through
the nomination and confirmation process, and the requirement to submit semiannual reports on monetary policy and the economy to Congress.
As expectations of inflation increase, firms and workers increase wages and prices,
therefore inflation increases
He concluded that the U.S. economy apparently had "price stickiness," because
wages and prices declined very slowly during the disinflation process.
A serious inconsistency exists between a vertical long-run aggregate supply curve and a downward-sloping long-run Phillips curve because
when the long-run aggregate supply curve is vertical at potential real GDP, the long-run Phillips curve is vertical at the natural rate of unemployment.
Members of the Federal Open Market Committee might have believed that the natural rate of unemployment was lower in 2015 than it had been several years earlier because
while unemployment had persisted for more than four years after the end of the 2007-2009 recession, it then began to decline.
Economists have remained skeptical of the argument that the short-run Phillips curve is vertical for all of the following reasons except:
workers and firms may adjust prices and wages quickly.
Consider the graph on the right, where both the short-run and long-run Phillips curves are vertical. An expansionary monetary policy will increase the inflation rate continuously but will have no effect on the unemployment rate because of all the following except
workers and firms who have adaptive expectations will not consider the Fed's policy before forming their expectations about inflation.
There is a different short-run Phillips curve for every level of the ___________ inflation rate. The inflation rate at which the short-run Phillips curve intersects the long-run Phillips curve equals the ___________ inflation rate.
expected; expected
A negative supply shock, such as the OPEC oil price increases of the early 1970s, can be illustrated by a shift to the ______________ of the short-run aggregate supply curve and a shift _________________ of the short-run Phillips curve.
left; up
After Fed Chairman Paul Volcker began fighting inflation in 1979, workers and firms eventually ____________ their expectations of future inflation, and the short-run Phillips curve shifted ___________.
lowered; down
If inflation turns out to be lower than households and firms had previously expected, the actual real wage will end up being
higher than the expected real wage.
They were to think of the Phillips curve as a "policy menu."
not correct
A lower estimate of the natural rate of unemployment would lead the Fed to lower its target policy rate because the
output gap would increase.
In claiming that an expansionary monetary policy will only increase inflation and have no impact on unemployment, the analysts are assuming that:
people accurately interpret all available information to form reliable forecasts.
Suppose that the inflation rate is increasing each year for a number of years, then
the rational expectations hypothesis is likely to give more accurate forecasts because if workers or firms have rational expectations, then they will use all the available information to forecast future inflation.
Slow growth in aggregate demand leads to
higher unemployment and lower inflation.
An increase in inflation expectations will cause the inflation rate to
increase at all levels of unemployment.
The natural rate of unemployment is the unemployment rate at which the inflation rate has no tendency to increase or decrease. However, the natural rate of unemployment is not fixed. What causes changes in the natural rate of unemployment? Which of the following will not cause the natural rate of unemployment to change?
Changes in the money supply resulting from monetary policy.
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?
During periods of high inflation, people do not take any particular action until the Fed has controlled the inflation rate.
Roasia is a developing economy with a large population. Its public healthcare and transportation infrastructure is very poor, which creates a bottleneck for industrial development. Leading industry experts have been claiming that investment in infrastructure so far has not been sufficient. According to them, there is a pressing need to step up government expenditure on public infrastructure. With the debate heating up, the government proposed a 30 percent increase in infrastructure investment this year. This is also expected to reduce unemployment considerably from the current level of 6 percent. With a 30 percent increase in investment, industry experts predicted that unemployment would decline from 6 to 4 percent in two years' time. However, the unemployment level at the end of two years was even lower at 3 percent. Which of the following, if true, can explain this outcome?
Following the investment in infrastructure, Roasia saw an unprecedented increase in foreign direct investment.
West Paragon, a developed economy, has been experiencing stable and low inflation for the last two years. There is consensus that the current unemployment rate of 4 percent is also its natural rate of unemployment. However, the country's GDP growth is stagnating and the government of West Paragon is worried about a possible slowdown. Given the situation, members of the government believe that the central bank should increase money supply in order to stimulate growth. Analysts at a leading economic research institute however believe that increasing money supply will only raise inflation and will not have any positive impact on unemployment. Which of the following, if true, will weaken the claim of the analysts at the research institute?
People of West Paragon tend to underestimate monetary policy impacts.
Economists who believed that the Phillips curve represented a structural relationship believed that the curve represented
a permanent trade-off between unemployment and inflation.
In a real business cycle model, which of the following best explains an increase in real GDP above the full-employment level?
a positive technology shock
The "Volcker disinflation" was
a significant reduction in the inflation rate between 1979 and 1989, under the leadership of Fed Chairman Paul Volcker.
If Ford and the United Auto Workers (UAW) union fail to accurately forecast the inflation rate, the real wage will be different than the company and the union had expected. The company and the union sign long-term contracts rather than negotiate a new contract each year because each party believes that the
actual inflation rate will be equal to their expected inflation rate in the long term.
According to Lucas and Sargent, workers and firms have rational expectations, and therefore if the Fed pursues a contractionary monetary policy:
agents will immediately adjust their expectations of inflation down.
If Lucas and Sargent were right,
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.
When Gregory says that the "policy ... is unlikely to have a stimulative effect because it will be easily anticipated," he indicates his belief that households and businesses have
rational expectations of inflation in which all available information is used in forming expectations.