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Macro Final - multiple choice

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To stabilize a $3 trillion debt with a 2% interest rate, the government must ____________ the deficit, _____________ the tax rate, run a primary surplus of $60 billion _____________.

eliminate, increase, indefinitely

"A deficit during a war can be a good thing. First, the deficit is temporary, so after the war is over, the government can go right back to its old level of spending and taxes. Second, given that the evidence supports the Ricardian equivalence proposition, the deficit will stimulate the economy during wartime, helping to keep the unemployment rate low." Which of the following parts of the statement are NOT correct?

"First...taxes" and "Second...low"

Consider each of the following statements: 1. "Under Ricardian equivalence, government spending has no effect on output." 2. "Under Ricardian equivalence, changes in taxes have no effect on output." What is true?

1 is false, 2 is true

If a home costs $400,000 and the maximum loan-to-value ratio is 70% as in Denmark, then the minimum down payment is ___________. If the maximum loan-to-value is increased, then, with all else constant, the demand for homes will ________________.

120,000, increase

Suppose you have a mortgage of $50,000. The expected inflation rate is equal to 0% and the nominal interest rate on the mortgage is 7%. The real interest rate is ____________.

The real money stock of a developing country is 0.95. The rate of nominal money growth (rounded to the nearest tenth) necessary to fund a deficit that is 8% of GDP through seignorage is: A. 8.4% B. 7.95% C. 8.05% D. 7.6% If governments fund government deficits with seignorage for an extended period of time, the real money balances that people want to hold ____________.

8.4% (A), decreases

Some countries have chosen to allow the central bank to control both monetary policy and macroprudential tools. Which of the following is a case for such action? A. Being able to raise interest rates on higher loan to value mortgages in a low interest rate environment. B. Allowing fiscal policy more control over the free market system of pricing. C. Being able to raise interest rates on lower loan to value mortgages in a high interest rate environment. D. Allowing the central bank more control over the free market system of pricing.

The advantage of the Taylor Rule is that it tries to achieve the Fed's target inflation rate by A. simply adjusting the nominal interest rate. B. adjusting the natural rate of unemployment. C. adjusting the expected future interest rate. D. simply adjusting the nominal money growth.

With respect to the choice between indexed or non-indexed bonds, an investor's preference will A. depend on his degree of risk aversion. B. always be in favor of the indexed bond. C. not be relevant to the decision. D. always be in favor of the non-indexed bond.

When people have trouble distinguishing between nominal and real values, they are A. incurring shoe-leather costs. B. suffering from money illusion. C. experiencing tax distortion. D. incurring menu costs.

Under flexible inflation targeting, with a coefficient of 0.50.5 and an inflation rate 22% lower than expected inflation, output would: A. fall by 4%. B. rise by 4%. C. fall by more than 4%. D. rise by less than 4%. Going forward, the above scenario would most likely result in an interest rate __________.

C, decrease

Economists that support a 0% inflation rate claim: A. it eliminates the scope for money illusion. B. it can reduce the time consistency problem faced by central banks. C. it corresponds to price stability. D. all of the above.

In the medium run, which of the following will occur in response to a decrease in the demand for money? A. Price levels (P) will adjust. B. There will be a period of inflation. C. Real money (M) will decrease. D. All of the above.

The Federal Reserve Board bought long-term Treasury bonds to A. prevent the U.S. Treasury from defaulting on its debt. B. reduce the term premium on government bonds. C. increase the private sector's willingness to borrow for new investments. D. all of the above. E. B and C only.

T or F of uncertain: When the ratio of debt to GDP is high, the best policy is a fiscal consolidation.

Uncertain

Yes - the first sentence. A deficit during a war can be a good thing.

A government has a primary deficit of zero. The real interest rate is 3.5% and the growth rate of output is 5%. The change in the ratio of debt to GDP is

a DECREASE of 1.5%

A central bank's credibility about the inflation target is useful since A. expected inflation will equal the target rate. B. expected inflation will be anchored. C. adjustments to the target will be relatively easy. D. all of the above. E. B and C only.

all of the above (D)

Under the Ricardian equivalence proposition, a long sequence of deficits and the associated increase in government debt lead to: A. a decrease in capital stock. B. a change in investment. C. an increase in private saving equivalent to the decrease in public saving. D. an increase in consumer spending.

an increase in private saving equivalent to the decrease in public saving (C)

The benchmark against which to judge the direction of fiscal policy:

full-employment, mid-cycle, standardized employment, structural, cyclically adjusted deficits

If Ricardian equivalence did not hold, output would increase by _____, all other things equal.

In an economy with a higher average inflation rate, the central bank has ______ room to use monetary policy to fight a recession.

To control inflation through decreased spending, the __________________ interest rate must be _________________ the actual inflation rate.

nominal, more than

Ricardian equivalence proposition:

once the government budget constraint is accounted for, neither debt nor deficit impact economic activity

All of the following are future concerns for the U.S. in trying to maintain a manageable debt-to-income ratio except: A. increasing cost of health care. B. projected interest rate decreases. C. government pensions. D. a larger percent of retirees.

projected interest rate decreases (B)

Consider an economy in which Ricardian equivalence does hold. Suppose the government starts with a balanced budget. Then, there is an increase in government spending, but there is no change in taxes. Consumers will ____________, and thus output will __________.

save more, increase by only the amount of the change in G

T or F: In the crisis, central banks provided liquidity to financial institutions they did not regulate.

T or F: One consequence of the crisis was higher capital requirements and a more extensive regulatory regime for banks.

T or F: Quantitative easing refers to central bank purchases of assets with the intention of directly affecting the yield on these assets.

T or F: Tax smoothing and deficit finance help spread the burden of war across generations.

T or F: The higher the inflation rate, the higher the effective tax rate on capital gains.

The money demand relationship in Chapter 4 is used implicitly in Figure 23-1. That relation is M/P = YL(i). The central bank in conjunction with the political authorities chooses an inflation target π*. In a medium-run equilibrium, with r representing the real interest rate and π* the target rate of inflation, the target nominal interest rate, i*, is given by _____________.

B!!! (r sub n + π*)

T or F: Fighting inflation should be the Fed's only purpose.

T or F: Hyperinflations may distort prices, but they have no effect on real output.

T or F: Inflation and money growth moved together from 1970 to 2009.

T or F: Most central banks around the world have an inflation target of 4%.

T or F: The United States has experienced negligible fluctuations in the ratio of debt to GDP in the past century.

T or F: The cyclically adjusted deficit is always smaller than the actual deficit.

T or F: A haircut reduces the value of government debt outstanding.

T or F: A hyperinflation is an inflation rate greater than 30% per month.

T or F: Because most people have much trouble distinguishing between nominal and real values, inflation likely distorts decision making.

A country has a rate of growth (g) of 0.50%, a debt-to-income ratio of 85% and a primary deficit of 0.8%of output. In response to a stimulus package, the debt-to-income ratio rises to 95% which causes an increase in the interest rate from 2.9% to 7.9%. The impact to the change in the debt ratio over time is __________%. In response to the above situation, the government decides to increase taxes enough to stabilize the debt. This will most likely result in a ______________ in output

-4.99, decrease

The Federal Reserve Board bought mortgage-backed securities to A. offset some of the heightened risk premium on these securities. B. make mortgages less expensive. C. stimulate the purchase of new houses. D. all of the above. E. A and C only.

Consider an economy characterized by the following facts. 1. The official budget deficit is 4% of GDP. 2. The debt-to-GDP ratio is 100%. 3. The nominal interest rate is 10%. 4. The inflation rate is 7%. Thus the primary surplus-to-GDP ratio is 6% and the inflation-adjusted surplus-to-GDP ratio is 3%. Suppose that the output is 2% below its natural level. The cyclically adjusted, inflation-adjusted deficit/surplus ratio to GDP is ______%. Suppose instead that the output begins at its natural level and that output growth remains constant at the natural rate of 2%. How will the debt-to-GDP ratio change over time?

2 (I think it's just the same as the percentage below its natural level). The debt-to-GDP ratio will fall by 2% a year.

1. The official budget deficit is 4% of GDP. 2. The debt-to-GDP ratio is 100%. 3. The nominal interest rate is 10%. 4. The inflation rate is 7%. The primary deficit/surplus ratio to GDP is _______%. The inflation-adjusted deficit/surplus ratio to GDP is _______%.

6% (nominal interest rate - budget deficit), 3% (10% - 7% * 100%, inflation-adjusted surplus = 6% - 3% = 3%)

One specific problem faced by the central bank is that the natural rate of unemployment is not known with certainty. Suppose the natural rate of unemployment, u sub n, changes frequently. This will A. make it more difficult for the Fed to hit its inflation target because it will be harder to distinguish between changes in the actual rate of unemployment from changes in the natural rate of unemployment. B. help the Fed to hit its inflation target every time because the natural rate of unemployment will be zero. C. make it less difficult for the Fed to hit its inflation target because the actual rate of unemployment will always be equal to the natural rate of unemployment. D. make it easier for the Fed to hit its inflation target because it will be easier to distinguish between changes in the actual rate of unemployment from changes in the natural rate of unemployment.

Suppose the expected rate of inflation is anchored (does not move) and equal to the target rate of inflation, that is, pi bar = π*. In this situation, the central bank's task is easier because A. output gaps only generate higher or lower levels of inflation rather than increases or decreases in inflation. B. deviations from the inflation target only require that the policy rate be restored to r sub n, the natural rate of interest. C. the adjustment of output to its natural level is instantaneous. D. all of the above. E. A and B only.

A and B only (E)

Which of the following will generate a larger increase in the ratio of debt to GDP?

A higher ratio of the primary deficit to GDP

Inflation has been averaging 2% a year for 7 years. A vacation home that was purchased 77 years ago for $100,000 was sold for $116,000. The sale was subject to a 33% capital gains tax. The effective tax rate based on the nominal value is: A. 4.27%. B. 33%. C. 5.28%. D. 19.00%. If inflation were lower than expected, investors would be better off having invested in ___________ bonds.

A, nominal

Consider a central bank that has an inflation target, π*. Is it realistic to expect that the central bank can always hit its target? A. Yes, central banks use sophisticated forecasting tools to anticipate shocks and can make preemptive adjustments to the policy rate. B. No, ever-present shocks produce deviations of actual inflation from the target rate, and uncertainty about the effects of the interest rate necessitate slow adjustments back to the target.

Consider the following statements. All of the following are true except A. the Fed chair is the most powerful economic policymaker in the United States. B. Congress has imposed an explicit Taylor rule on the Fed by choosing the target inflation rate and the relative weight on the inflation and unemployment targets. C. the record of U.S. monetary policy under the past two Fed chairmen, Alan Greenspan and Ben Bernanke, has been outstanding. D. the Fed has been very successful in keeping inflation low during the past twenty years.

Due to the quantitative easing policy's of the Fed, if the policy rate were to increase, this would: A. help the Fed as this would lower the demand for bonds. B. hurt the Fed as it would have to pay interest on much higher reserves. C. help banks as the opportunity cost of holding money would fall. D. help the Fed as it would have to pay interest on much lower reserves.

Suppose the mortgage interest is deductible from income. Which of the following statements is correct? A. Inflation has no effect on mortgage payments. B. Inflation is beneficial for homeowners in the United States. C. Inflation is harmful for homeowners in the United States. D. Inflation has nothing to do with income tax deductions.

The ability of the central bank to alter the equilibrium rate of interest is as we have seen, a powerful tool to affect the macro economy. All of the following are reasons the Fed held for not using the interest rate to affect industry bubbles except: A. price increases aren't always reflected proportionately in price indexes. B. decreasing leverage is better than increasing credit. C. interest rate changes affect all industries. D. they could decrease the interest rate after the bubble burst.

Given the equilibrium condition for real money supply and real money demand, in the short run, with a constant price level (P), a decrease in the demand for money will result in: A. a decrease in output (Y). B. a decrease in liquidity (L). C. a decrease in the interest rate (i). D. an increase in money (M).

If inflation is higher than the target, the Taylor Rule states that: A. the central bank should increase the nominal interest rate above the target nominal interest rate, which will lead to a decrease in unemployment and a decrease in inflation. B. the central bank should decrease the nominal interest rate below the target nominal interest rate, which will lead to an increase in unemployment and a decrease in inflation. C. the central bank should increase the nominal interest rate above the target nominal interest rate, which will lead to an increase in unemployment and a decrease in inflation. D. the central bank should decrease the nominal interest rate below the target nominal interest rate, which will lead to a decrease in unemployment and a decrease in inflation.

The Federal Reserve's mandate is to achieve A. low inflation in the short run and low unemployment in the long run. B. full employment in both the short and the long run. C. low inflation in the medium and long run and stabilize the economic activity in the short run. D. zero inflation in the medium run and zero unemployment in the long run.

The disadvantage of the Taylor Rule is that it A. tends to increase the natural rate of unemployment. B. increases the inflation rate. C. cannot handle sudden shocks. D. must always be exactly followed.

The divine coincidence implies that in response to achieving a constant rate of inflation in line with inflation expectations: A. employment exceeds its natural rate and output exceeds potential. B. unemployment exceeds its natural rate and output exceeds potential. C. employment equals its natural rate and output exceeds potential. D. employment equals its natural rate and output equals potential.

The first Quantitative Easing (QE1) program undertaken by the Fed, the purchase of mortgage-based securities, was relatively effective because: A. the premiums on these securities were very low. B. the Fed's intervention helped increase premiums. C. the demand for these securities was too high. D. the market for these securities was dysfunctional.

While realizing they must be proactive in preventing industry bubbles, the Fed also recognizes that affecting the entire economy unnecessarily is equally dangerous. For the financial system in particular, all of the following are examples of macroprudential tools that can help limit bubbles except: A. lowering the percentage of a home loan to its assessed value. B. lowering taxes on foreign direct investment. C. limiting mortgages to loans in the domestic currency. D. lowering fees on higher capital to asset investments.

T or F: The deficit is the difference between real government spending and taxes net of transfers.

T or F: The government should always take immediate action to eliminate a cyclically adjusted budget deficit.

T or F: The most important argument in favor of a positive rate of inflation in OECD countries is seignorage.

T or F: The ratio of debt to GDP cannot exceed 100%.

T or F: The zero lower bound on the nominal policy rate was expected to be a regular feature of monetary policy when inflation targeting began.

T or F: The inflation-adjusted deficit is always smaller than the actual deficit.

Which of the following results from a government relying on deficit financing of wars? A. Government spending (G) increases, interest rates increase, and investment (I) increases. B. Government spending (G) increases, interest rates increase, and investment (I) decreases. C. Government spending (G) increases, interest rates decrease, and investment (I) decreases. D. Government spending (G) increases, interest rates decrease, and investment (I) increases.

Government spending (G) increases, interest rates increase, and investment (I) decreases (B)

T or F: If Ricardian equivalence holds, then an increase in income taxes will affect neither consumption nor saving.

T or F: The Taylor rule describes how central banks adjust the policy interest rate policy interest rate across recessions and booms

T or F: The primary deficit is the difference between real government spending and taxes net of transfers.

A government has a primary deficit of zero. The real interest rate is 3.5% and the growth rate of output is 5%. The change in the ratio of debt to GDP is:

a decrease of 1.5%

A cyclically adjusted budget deficit is: A. a deficit that exists when the economy is in a recession. B. a deficit that cannot be eliminated with tax increases. C. a deficit that exists when the economy is in a boom. D. a deficit that would exist if the economy is at full employment.

a deficit that would exist if the economy is at full employment (D)

What will generate a larger increase in the ratio of debt to GDP?

a higher ratio of the primary deficit to GDP

Suppose the expected rate of inflation is last period's rate of inflation rather than the target rate of inflation. This makes the central bank's task more difficult since A. deviations from the inflation target require policy rate changes above or below r sub n, the natural rate of interest. B. output gaps generate increases or decreases in inflation rather than simply higher or lower levels of inflation. C. compensatory swings in economic activity must occur given initial booms (or recessions). D. all of the above. E. A and C only.

all of the above (D)

Debt restructuring can often be a better option than default. This is because a default can cause all of the following except: A. heavy financial losses by those on pensions. B. banks to become more solvent. C. a more credible debt. D. a deteriorating relationship with foreign investors.

banks to become more solvent (B)

In order for a central bank to alleviate the fear of default or devaluation due to a high debt burden and its effect on interest rates, it must be ready to: A. buy bonds, increase the yield, return to good equilibrium. B. sell more bonds, increase the yield, return to good equilibrium. C. buy bonds, reduce the yield, return to good equilibrium. D. sell more bonds, reduce the yield, return to good equilibrium.

buy bonds, reduce the yield, return to good equilibrium (C)

If a government finances a war through an increase in taxes, then: A. consumption will increase, interest rates will increase, and investment will decrease. B. consumption will increase, interest rates will decrease, and investment will decrease. C. consumption will decrease, interest rates will decrease, and investment will decrease. D. consumption will decrease, interest rates will increase, and investment will decrease.

consumption will decrease, interest rates will increase, and investment will decrease (D)

In either version, in principle, the central bank is able to keep the actual rate of inflation in period t equal to the target rate of inflation π* in every period. The central bank carries out this task by A. fixing the growth rate of the money supply. B. setting the policy rate equal to π* C. continual manipulation of the policy rate. D. fixing the policy rate at r sub n, the natural rate of interest.

continual manipulation of the policy rate (C)

If the Ricardian equivalence proposition holds, an increase in income taxes would A. increase current saving and decrease current consumption. B. decrease current saving but not change current consumption. C. decrease current saving and current consumption. D. increase current saving and current consumption.

decrease current saving but not change current consumption (B)

Assuming government spending remains constant, the larger the debt the ____________ future tax rates must be. To offset this, the real interest rate would have to __________.

higher, fall

Suppose the Federal Reserve Board sells 0.5 trillion in mortgage-backed securities and buys 0.5 trillion in Treasury securities with less than one year to maturity. The consequence of this operation would be an ________ in long-term bond yields. Alternatively, suppose the Federal Reserve sells 0.5 trillion in Treasury securities with maturity longer than one-year and buys 0.5 trillion in Treasury securities with less than one year to maturity. In this case, interest rates on mortgage-backed securities would __________.

increase, rise

The two versions of the Phillips curve differ in the way A. the natural rate of unemployment is formulated. B. inflation expectations are formed. C. inflation reacts to deviations from the natural rate of unemployment. D. the economy adjusts to output gaps.

inflation expectations are formed (B)

save more, increase by only the amount of the change in G, MORE

Consider an economy in which Ricardian equivalence does hold. Suppose the government starts with a balanced budget. Then, there is an increase in government spending accompanied by an equivalent increase in taxes. Consumers will ____________, and thus output will __________. If Ricardian equivalence did not hold, output would increase by _____, all other things equal.

save more; increase by only the amount of the change in G, THE SAME AMOUNT

To stabilize the debt, the government must eliminate the deficit. To do so, the government must run a primary ____________ equal to the _________________________ on the existing debt. This requires higher taxes forever.

surplus, interest payments

The United States limits the debt-to-GDP ratio to A. 37% of GDP. B. There is no limit on the debt-to-GDP ratio. C. 100% of GDP. D. 50% of GDP.

there is no limit on the debt-to-GDP ratio (B)

If due to recession, the cyclically adjusted deficit is positive, a return to potential output __________ stabilize the debt. If current output is 3% below potential, automatic stabilizers will ____________ the deficit to GDP ratio by _________%.

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