ECON 405: FINAL EXAM

The rational-expectations point of view, in the most extreme case, holds that if policymakers are credibly committed to reducing inflation, and rational people understand that commitment and quickly lower their inflation expectations, then the sacrifice ratio will be approximately: 5. 2.8. 1. 0.

0.

If the government debt, D, equals $5 trillion, the nominal interest rate is 7 percent, and the real interest rate is 3 percent, then nominal budget deficit overstates the real deficit by $ ___ trillion. 0.15 0.20 0.35 0.07

0.20

Assume that the sacrifice ratio for an economy is 4. If the central bank wishes to reduce inflation from 10 percent to 5 percent, this will cost the economy ______ percent of one year's GDP. 40 4 5 20

20

Taylor Rule

FFR = Actual Inflation + long term interest rate +(0.5) (actual infltion - inflation target) + (0.5) (GDP gap: Actual GDP- Target/ target x 100)

Phiilips Curve

Inflation = Expected Inflation - B (U-Unat) + v

One item that is considered part of the federal debt is: Treasury bills. student loans, which may go into default. future Social Security benefits. potential liabilities of savings and loan associations.

Treasury bills.

SRAS formula

Y = Ybar + (P - EP)

To force politicians to judge whether government spending is worth the costs, some economists have argued for: a constant money-growth rule for monetary policy. avoiding the assumption of any contingent liabilities. a balanced-budget rule for fiscal policy. the application of Ricardian equivalence.

a balanced-budget rule for fiscal policy.

If the equation for a country's Phillips curve is π = 0.02 - 0.8(u - 0.05), where π is the rate of inflation and u is the unemployment rate, what is the short-run inflation rate when unemployment is 4 percent (0.04)? below 2 percent (0.02) 2 percent (0.02) -2 percent (-0.02) above 2 percent (0.02)

above 2 percent (0.02)

Inflation inertia is represented in the aggregate supply-aggregate demand model by continuing upward shifts in the: aggregate demand and short-run aggregate supply curves. aggregate demand curve. long-run aggregate supply curve. short-run aggregate supply curve.

aggregate demand and short-run aggregate supply curves.

Which of the following is an example of a fiscal policy that has no inside lag? a reduction in the age at which people become eligible for retirement benefits a decrease in income tax rates an increase in government spending for job training an ongoing unemployment insurance program

an ongoing unemployment insurance program

Policy is conducted by rule if policymakers: manipulate policy to ensure both low inflation and unemployment on election day. announce in advance how policy will respond to various situations and commit themselves to following through on this announcement. set policy according to election results, i.e., set policy by rule of the ballot box. are free to size up the situation case by case and choose whatever policy seems appropriate at the time.

announce in advance how policy will respond to various situations and commit themselves to following through on this announcement.

Because monetary and fiscal lags are long and variable: attempts to stabilize the economy are often destabilizing. policy must be completely passive. successful stabilization policy is completely impossible. stronger policies must be used.

attempts to stabilize the economy are often destabilizing.

Policies that stimulate or depress the economy without any deliberate policy change are called: time-inconsistent policies. automatic stabilizers. rational expectations policies. leading indicators.

automatic stabilizers.

The assumption of adaptive expectations for inflation means that people will form their expectations of inflation by: basing their opinions on recently observed inflation. flipping a coin. asking the opinions of experts. taking all information into account using the best economic model available.

basing their opinions on recently observed inflation.

In the sticky-price model, if no firms have flexible prices, the short-run aggregate supply schedule will: be steeper than it would be if some firms had flexible prices. slope upward to the right. be vertical. be horizontal.

be horizontal.

Assume that a government has a balanced budget when the economy is at full employment. If the economy then enters a recession, with no change in tax or spending laws, then the budget of the government is most likely to: be in surplus. remain balanced. be in deficit. be in either deficit or surplus, depending on the severity of the recession.

be in deficit.

The outside lag is the time: between a shock to the economy and the policy action responding to the shock. between a policy action and its influence on the economy. when automatic stabilizers are not effective. before automatic stabilizers respond to economic activity.

between a policy action and its influence on the economy.

Holding other factors constant, the ratio of government debt to GDP can decrease as a result of any of the following changes except: decreases in tax revenues. decreases in government spending. decreases in transfer payments. increases in GDP.

decreases in tax revenues.

The amount by which government spending exceeds government revenues is called the ______, and the accumulation of past government borrowing is called the ______. deflation; devaluation debt; deficit devaluation; deflation deficit; debt

deficit; debt

According to the imperfect-information model, when the price level rises by the amount the producer expected it to rise, the producer: increases production. decreases production. does not change production. hires more workers.

does not change production.

The concerns of economists who favor passive over active policy are most closely associated with their: view that policy made by rules is superior to policy made by discretion. preference for using monetary policy rather than fiscal policy for stabilization. belief that shocks to modern economies are not large enough to require any policy response. doubt that the correct policy will be implemented at the correct time.

doubt that the correct policy will be implemented at the correct time.

The tradeoff between inflation and unemployment does not exist in the long run because people will adjust their expectations so that expected inflation: exceeds the inflation rate. equals the inflation rate. is below the inflation rate. equals the inflation rate of the previous year.

equals the inflation rate.

According to the Phillips curve, other things being equal, inflation depends positively on: the rate of technological change. expected inflation. the unemployment rate. the quantities of capital and labor.

expected inflation.

The short-run aggregate supply curve is drawn for a given: price level. expected price level. output level. level of aggregate demand.

expected price level

Both models of aggregate supply discussed in Chapter 14 imply that if the price level is lower than expected, then output ______ natural rate of output. falls below the equals the moves to a different exceeds the

falls below the

An argument in favor of allowing discretionary macroeconomic policy is that: giving policymakers flexibility will allow them to respond to changing conditions. policymakers may make erratic shifts in policy in response to changing political situations. the objectives of policymakers may be in conflict with the well-being of the public. uninformed policymakers may choose incorrect policies.

giving policymakers flexibility will allow them to respond to changing conditions.

An increase in the elderly population of a country affects fiscal policy most directly because: the elderly generally are not required to pay taxes. governments spend more on education as the proportion of the elderly increases. governments provide pensions and health care for the elderly. the elderly favor high interest rates on their savings.

governments provide pensions and health care for the elderly.

According to the sticky-price model, other things being equal, the greater the proportion, s, of firms that follow the sticky-price rule, the ______ the ______ in output in response to an unexpected price increase. smaller; increase smaller; decrease greater; decrease greater; increase

greater; increase

Automatic stabilizers: have no outside lag. require congressional action before each time that they are put into effect. have no inside lag. have long and variable inside lags.

have no inside lag.

According to the traditional view of government debt, if taxes are cut without cutting government spending, then the short-run effects will be: no change in output or unemployment. higher output and higher unemployment. higher output and lower unemployment. no change in output and higher unemployment.

higher output and lower unemployment.

According to the Lucas critique, when economists evaluate alternative policies they must take into consideration: the stage of the political business cycle in which the policy is to be implemented. the length of the inside lags associated with the policies. whether the policy will offset the impact of automatic stabilizers. how the policies will affect expectations and behavior.

how the policies will affect expectations and behavior.

According to the natural-rate hypothesis, output will be at the natural rate: if inflation exceeds expected inflation. if aggregate demand affects output in the long run. if inflation falls below expected inflation. in the long run.

in the long run.

Government tax policy can affect aggregate supply as well as aggregate demand, because changes in taxes change the: incentives to work and invest. tradeoff between inflation and unemployment. length of the inside lag of fiscal policy. supply of money in the economy.

incentives to work and invest.

A debt-financed tax cut will ______ current consumption in the traditional view and ______ current consumption in the view of Ricardian equivalence. increase; increase increase; not change increase; decrease decrease; decrease

increase; not change

When the federal government incurs additional debt to acquire an asset, under current budgeting procedures the deficit ______, while under capital budgeting procedures the deficit ______. does not change; increases decreases; does not change increases; does not change does not change; decreases

increases; does not change

If the velocity of money varies a great deal, steady growth of the money supply is a(n): ineffective way to stabilize aggregate demand. automatic stabilizer. active policy rule. example of discretionary monetary policy.

ineffective way to stabilize aggregate demand

According to the traditional view of government debt, if taxes are cut without cutting government spending, then the international effect initially will be a capital ______ and a trade ______. outflow; deficit inflow; deficit outflow; surplus inflow; surplus

inflow; deficit

What are two types of tools that economists use to forecast future economic developments? leading indicators and computer models visual assessment and global positioning monetary instruments and fiscal instruments direct imputations and indirect attributions

leading indicators and computer models

Along an aggregate supply curve, if the level of output is less than the natural level of output, then the price level is: stuck at the existing price level. equal to the natural price level. less than the expected price level. greater than the expected price level.

less than the expected price level.

Advocates of the rational-expectations approach predict that a credible policy to lower inflation will ______ the sacrifice ratio. lower sometimes raise and sometimes lower raise not change

lower

The political business cycle refers to the: manipulation of the economy to win elections. cycle of electing U.S. representatives every two years, the U.S. president every four years, and U.S. senators every six years. pattern of recession and expansion that follows every election. pattern of holding primaries, conventions, and general elections every four years.

manipulation of the economy to win elections.

Assume that there is a short-run tradeoff between inflation and unemployment, that the central bank desires both low inflation and low unemployment, and that the central bank uses discretion in conducting monetary policy. Initially, households and firms expect high inflation. Following an announcement by the central bank of a low-inflation policy, households and firms will ______ the central bank's announcement and ______ their expectations of inflation. believe; lower not believe; not change believe; not change not believe; lower

not believe; not change

The time between when government spending increases and when aggregate demand starts to increase is an example of an: outside lag of fiscal policy. inside lag of monetary policy. inside lag of fiscal policy. outside lag of monetary policy.

outside lag of fiscal policy.

Price formula for sticky + flexible firms

p= EP + (1-s/s) a (y-Ybar)

The Lucas critique argues that because the way people form expectations is based ______ on government policies, economists ______ predict the effect of a change in policy without taking changing expectations into account. in no way; cannot partly; cannot only partly; can in no way; can

partly; cannot

If policymakers are free to analyze events as they occur and choose whatever policy seems appropriate at the time, then this is: monetary policy. policy by discretion. fiscal policy. policy by rule.

policy by discretion.

The time-inconsistency problem in discretionary policymaking about unemployment and inflation can be effectively avoided when the: policymaker has and is known to have an extremely strong preference for very low inflation. policymaker has more information than do the private agents in the economy. policymaker does not care about the rate of inflation and simply sets policy to avoid unemployment. private agents in the economy are not "rational."

policymaker has and is known to have an extremely strong preference for very low inflation.

Financing a budget deficit by ______ leads to inflation, and inflation ______ the real value of government debt. issuing debt; increases printing money; decreases issuing debt; decreases printing money; increases

printing money; decreases

According to the traditional viewpoint of government debt, a tax cut without a cut in government spending: lowers consumption in the short run but raises it in the long run. raises consumption in both the short run and the long run. lowers consumption in both the short run and the long run. raises consumption in the short run but lowers it in the long run.

raises consumption in the short run but lowers it in the long run.

A deficit adjusted for inflation should include only government spending used to make _____ interest payments. nominal real foreign domestic

real

Cyclically adjusted budgets are useful because they: systematically account for changes in government assets and liabilities. account for tax burdens on different generations of taxpayers. reflect policy changes, but not current economic conditions. correctly account for the impact of inflation on government indebtedness

reflect policy changes, but not current economic conditions.

The percentage of a year's real GDP that must be foregone to reduce inflation by 1 percentage point is called the: sacrifice ratio. Okun's law. NAIRU. short-run Phillips curve.

sacrifice ratio.

Given a reduction in income tax withheld, but no change in income tax owed, households that act according to Ricardian equivalence would ______ the extra take-home pay, while those facing binding borrowing constraints would ______ the extra-take home pay. spend; save spend; spend save; save save; spend

save; spend

Government debt equals the: M1 money supply. difference between current government purchases and taxes. sum of past budget deficits and surpluses. difference between saving and investment

sum of past budget deficits and surpluses.

Central-bank independence refers to: the degree of separation between central-bank decision making and political influence. whether central banks pursue monetary policy by rules or discretion. the situation that occurs when the inside lag of monetary policy is not related to the outside lag. the extent to which automatic stabilizers are relied on to cushion economic volatility.

the degree of separation between central-bank decision making and political influence.

If government debt is not changing, then: capital per worker is constant. the government's budget must be balanced. the economy is at long-run equilibrium. GDP must equal the natural rate of output.

the government's budget must be balanced

In the case of demand-pull inflation, other things being equal: both the inflation rate and the unemployment rate fall. the inflation rate rises but the unemployment rate falls. the unemployment rate rises but the inflation rate falls. both the inflation rate and the unemployment rate rise at the same time.

the inflation rate rises but the unemployment rate falls.

Inflation targeting is a monetary policy rule that requires the central bank to adjust _____ in order to attain the desired inflation rate. the money supply the velocity of money a price index nominal GDP

the money supply

Based on the Phillips curve, unexpected movements in inflation are related to ______, and based on the short-run aggregate supply curve, unexpected movements in the price level are related to ______. sticky prices; sticky wages sticky wages; sticky prices unemployment; output output; unemployment

unemployment; output

Ricardian equivalence refers to the same impact of financing government: whether by printing money or raising taxes. in an open economy as in a closed economy. in the long run as in the short run. whether by debt or taxes.

whether by debt or taxes.

Countries with greater central-bank independence can achieve lower rates of inflation: at the cost of higher levels of unemployment. at the cost of greater volatility of real GDP. at the cost of slower growth rates of real GDP. with no apparent real economic costs.

with no apparent real economic costs.