MACRO Ch. 22.3

John, who has an inflation adjusted wage, would like to borrow a loan from the Bank of Titon. Suppose the inflation rate is predicted to be 8%. In order for the loan payments to be more favorable to John, the interest rate should be:

6% When the rate of inflation is greater than the cost of capital (the interest rate), this tends to penalize suppliers of financial capital, who receive repayment in dollars that are worth less because of inflation. Therefore, John as the borrower, would benefit if the interest rate was less than the inflation rate (6% <8%).

Hyperinflation often occurs when economies shift from a(n) ________________ economy to a ___________________ economy.

controlled; market-oriented Hyperinflation is an outburst of high inflation that often occurs (although not exclusively) when economies shift from a controlled economy to a market-oriented economy. In the early 2000s, the problem of inflation appears to have diminished for most countries, at least in comparison to the worst times of recent decades.

Deflation is a time when the buying power of money in terms of goods and services _____________.

increases Because inflation is a time when the buying power of money in terms of goods and services is reduced, deflation is a time when the buying power of money in terms of goods and services increases.

If prices are considered the messengers in a market economy because they convey information about supply and demand conditions, what can blur price messages about the economy?

inflation Prices are the messengers in a market economy, conveying information about conditions of demand and supply. Inflation blurs those price messages. Inflation means that we perceive price signals more vaguely.

Tony negotiated for a cost-of-living adjustment (COLA) in his wage contract. Suppose the inflation rate is predicted to be 5% . This means Tony's nominal wage will go up by _________.

5% Cost-of-living adjustments (COLAs) are meant to guarantee that wages would keep up with inflation, thus the inflation rate would go up by 5%.

All of the following statements are true, except: a. A firm can make money from inflation by paying bills and wages as late as possible so that it can pay in inflated dollars, while collecting revenues as soon as possible. b. If a firm is currently holding a lot of assets in cash, it would benefit from inflation c. An economy with high inflation rewards businesses that have found clever ways of profiting from inflation. d. In the short term, low or moderate levels of inflation may not pose an overwhelming difficulty for business planning.

If a firm is currently holding a lot of assets in cash, it would benefit from inflation If inflation declines more than anticipated, the purchasing power of cash increases. Therefore, in this case, the firm would benefit from increases in purchasing power.

Which of the following statements is true?

If the price level (as measured by the CPI) increases, a borrower with an adjustable rate mortgage (ARM) will receive a higher interest rate. Loans often have built-in inflation adjustments so that if the inflation rate rises by two percentage points, then the interest rate that a financial institution charges on the loan rises by two percentage points as well. An adjustable-rate mortgage (ARM) is a type of loan that one can use to purchase a home in which the interest rate varies with the rate of inflation. Often, a borrower will be able receive a lower interest rate if borrowing with an ARM, compared to a fixed-rate loan. The reason is that with an ARM, the lender is protected against the risk that higher inflation will reduce the real loan payments, and so the risk premium part of the interest rate can be correspondingly lower. Hence, if the inflation rate increases, the interest rate on the ARM increases as well.

All of the following statements are true, except: a. If inflation varies substantially over the short or medium term, then it may make sense for businesses to stick to shorter-term strategies. b. In recent decades in the U.S., rising inflation rates have at times been closely followed by lower inflation rates. c. In recent decades in the U.S, rising inflation rates have always corresponded to increasing productivity rates. d. There is some evidence that if inflation can be held to moderate levels, it doesn't prevent a nation's real economy from growing at a healthy pace.

In recent decades in the U.S, rising inflation rates have always corresponded to increasing productivity rates. Over the last several decades in the United States, there have been times when rising inflation rates have been closely followed by lower productivity rates and lower inflation rates have corresponded to increasing productivity rates. As the graph shows, however, this correlation does not always exist.

Which of the following statements is true about inflation?

Inflation redistributes purchasing power in the economy. Inflation can cause redistributions of purchasing power that hurt some and help others. For example, people who are hurt by inflation include those who are holding considerable cash, while wages tend to creep up with inflation over time.

All of the following statements are true, except: a.Uncertainty about future inflation makes it hard to predict the value of some financial assets in the future. b. Moderate or high Inflation rarely poses substantial long-term planning problems for businesses. c. When saving for retirement, people need to consider what their money will really buy several decades in the future. d. It's very hard to predict the rate of future inflation.

Moderate or high Inflation rarely poses substantial long-term planning problems for businesses. It is hard to predict what money (for example, retirement monies) will really buy several decades in the future without knowing the rate of future inflation (that is, how inflation will affect purchasing power in the future). Inflation, especially at moderate or high levels, will pose substantial planning problems for businesses.

All of the following statements are true, except:

The incentives in the economy to adjust in response to changes in prices are stronger in periods of high and variable inflation than in periods of low inflation. High and variable inflation means that the incentives in the economy to adjust in response to changes in prices are weaker. Markets will adjust toward their equilibrium prices and quantities more erratically and slowly, and many individual markets will experience a greater chance of surpluses and shortages.

Some economists argue that during an inflationary period, the erosion of real wages could help reduce the rate of inflation.

True Inflation would contribute to a decline in real wages which in turn reduces the purchasing power of households. If households respond to a reduction in a purchasing power by reducing their expenditure, this could have an effect of slowing down the inflation rate for prices levels could decline due a decrease in demand.

Consider an individual who borrowed $10,000 to purchase a used car at a fixed interest rate of 7%. If inflation increases from 2% to 5%, how will this impact the real interest rate the individual will be paying?

the car loan must be repaid at a real interest rate of 2% Ordinary people can sometimes benefit from the unintended redistributions of inflation. Consider someone who borrows $10,000 to buy a car at a fixed interest rate of 7%. If inflation is 5% at the time the loan is made, then he or she must repay the loan at a real interest rate of 2%. (7%−5%=2%) The lesson is that when interest rates are fixed, rises in the rate of inflation tend to penalize suppliers of financial capital, who receive repayment in dollars that are worth less because of inflation, while demanders of financial capital end up better off, because they can repay their loans in dollars that are worth less than originally expected.

In defined contribution plans, who contributes to the employee's retirement account?

the employee the employer In defined contribution plans, the employer and the employee both contribute a fixed amount to the employee's retirement account on a regular basis.

Consider a family buys a new home with a home loan of $125,000 at a fixed interest rate of 7%. If inflation increases from 5% to 7%, how will this impact the real interest rate the individual will be paying?

the home loan must be repaid at a real interest rate of zero The home loan's fixed interest rate of 7% will subtract the new inflation rate of 7% and the loan must be repaid at a real interest rate of zero. (7%−7%=0%) Ordinary people can sometimes benefit from the unintended redistributions of inflation. Consider someone who borrows $125,000 to buy a new home at a fixed interest rate of 7%. If inflation rises to 7%, then the real interest rate on the loan is zero. In this case, the borrower's benefit from inflation is the lender's loss. A borrower paying a fixed interest rate, who benefits from inflation, is just the flip side of an investor receiving a fixed interest rate, who suffers from inflation. The lesson is that when interest rates are fixed, rises in the rate of inflation tend to penalize suppliers of financial capital, who receive repayment in dollars that are worth less because of inflation, while demanders of financial capital end up better off, because they can repay their loans in dollars that are worth less than originally expected.

Which of the following best describes the real interest rate?

the rate of interest after allowing for inflation The real interest rate isolates the effect of inflation. The real interest rate is the nominal interest rate minus the inflation rate and considered to be the rate of interest after allowing for inflation.

Which of the following best defines indexing?

when prices, wages, or the interest rate is adjusted automatically with inflation By definition, indexing is when a price, wage, or interest rate is adjusted automatically with inflation.