Macroeconomics Chapter 17
In the figure, expected inflation is initially at 1.5%. When expected inflation increases to 4.5%, which of the following will occur?
1) To have 3.5% unemployment rate, inflation wold be 7.5% 2) Unemployment reaches the natural rate of 5% 3) At the natural rate of unemployment, inflation is 4.5%ANSWER: All of the Above At this higher expected inflation rate, the real wage rose, causing some workers to lose their jobs. The economy's equilibrium returned to the natural rate of unemployment at 5%, but now with an inflation rate of 4.5% instead of 1.5%.
Assume that inflation expectations increase. What will happen to the short-run Phillips curve? Use the line drawing tool to show the impact of an increase of inflation expectations on the Phillips curve. Carefully follow the instructions above, and only draw the required objects. An increase in inflation expectations will cause the inflation rate to ___________ at all levels of unemployment.
1. Draw a SRPC to the right of the original and label it "SR Phillips Curve" -Increase in inflation --> SRPC shifts right 2. Increase
Point _____ on the Phillips curve graph represents the same economic situation as point B on the aggregate demand and aggregate supply graph.
1. e 2. d
Real Business Cycle Theory
A macroeconomic model that focuses on real, rather than monetary, causes of the business cycle.
In the real business cycle model, which of these best explains an increase in real GDP above the full-employment level?
A positive technology shock
Which of these factors can cause the natural rate of unemployment to change?
Demographic Changes Since younger lower skilled workers have higher rates of unemployment a shift in the age structure of the labor force can cause the natural rate of unemployment to change.
Rational expectations
Expectations formed by using all available information about an economic variable.
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.
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
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.
The short-run trade-off between the rate of inflation and the unemployment rate is best represented by:
Phillips curve
According to real business cycle theory, a major source of fluctuations in economic activity is __________.
Shocks to technology
Such views of the trade-off between inflation and unemployment might have existed in the 1960s because the Phillips curve was widely viewed as Such views are rare today because
Stable in the long run there is no tradeoff between inflation and unemployment.
Rational Expectations Theory
The hypothesis that business firms and househlds expect monetary and fiscal policies to have certain effects on the economy and take, in pursuit of their own self interests, actions which make these policies ineffective at changing real output.
Natural Rate of Employment
The normal rate of unemployment, consisting of frictional unemployment and structural unemployment.
Nonaccelerating inflation rate of unemployment (NAIRU)
The unemployment rate at which the inflation rate has no tendency to increase or decrease.
How can the Fed fight a combination of rising unemployment and rising inflation?
These goals are conflicting and cannot be addressed simultaneously.
Disinflation
a reduction in the rate of inflation
Which of the following statements is correct?
a. In the long run, a higher or lower price level has no effect on real GDP. b. In the long run, a higher or lower inflation rate has no effect on the unemployment rate. c. In the long run, the Phillips curve is a vertical line at the natural rate of unemployment (CORRECT ANSWER: All of the above)
If actual inflation is higher than expected inflation, the
actual real wage is less than the expected real wage: unemployment falls. If actual inflation is higher than expected inflation, actual real wages in the economy will be lower than expected real wages. As a result, many firms will hire more workers than they had planned. Unemployment falls.
The short−run Phillips curve is:
downward sloping
The labor market may take a long time to adjust to economic growth due to __________.
excess capacity in production
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
When aggregate demand increases, unemployment will usually __________ and inflation will __________.
fal, rise
According to rational expectations theory, any announced policy change will:
have no impact on output
According to real business cycle theory, shifts in aggregate demand:
have no impact on real GDP
What four tools can the Fed use to achieve its monetary policy goals?
he discount rate, reserve requirements, open market operations, and interest on reserves. The fed CANNOT control the inflation rate
It is inconsistent to believe that the long-run aggregate supply curve is vertical and the long-run Phillips curve is downward sloping because
in order for the long-run Phillips curve to be downward sloping, changes in the price level (inflation) would have to affect the unemployment rate in the long run, which does not happen with a vertical long-run aggregate supply curve.
If the unemployment rate is below the natural rate, the inflation rate tends to ___________, and eventually, the short-run Phillips curve will shift _______. The concept of a nonaccelerating inflation rate of unemployment (NAIRU) helps us to understand why in the long run, the Federal Reserve
increase; up can affect the inflation rate but not the unemployment rate.
The long-run Phillips curve __________.
is vertical at the natural rate of unemployment
Consider the long-run Phillips curve and the short-run Phillips curve in the graph at right. A movement from point A to point C could be caused by
long-run effects of contractionary monetary policy. If the Federal Reserve used contractionary policy to push short-run equilibrium to a point such as B, where the unemployment rate is above the natural rate, the inflation rate would decrease. If short-run equilibrium remained above the natural rate long enough, the short-run Phillips curve would shift down as workers and firms adjusted to the new, lower inflation rate. Only at a point such as C, where the unemployment rate is equal to the natural rate, will the inflation rate be stable. We can conclude that in the long run, the Federal Reserve can affect the inflation rate but not the unemployment rate.
Countries that grant their central banks higher degrees of independence from the political process are more likely to have:
lower inflation
If high unemployment continues to be a problem for several years it is possible that the:
natural rate of unemployment may increase. Workers who remain unemployed for years lose skill sets and marketability and become increasingly more unlikely to find work.
If workers and firms have rational expectations and wages and prices adjust quickly, an expansionary monetary policy will result in higher inflation and
no change in the unemployment rate
Monetary stimulus designed to increase aggregate demand would have __________ on real output according to real business cycle theory.
no impact Changes in economic activity are only attributable to real changes in technology or productivity and not changes in the money supply.
The output gap is the difference between __________.
potential GDP and actual GDP
The theory that workers will use all available information to form forecasts of the future expected inflation is known as:
rational expectations.
Economists during the early 1960s thought of the Phillips curve as a "policy menu" because they thought that the Phillips curve They __________ to think of the Phillips curve as a "policy menu."
represented a structural relationship in the economy that would not change as a result of policy changes. were not correct
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
As expectations of inflation increase, the short-run Phillips curve will ___________ .If inflation increases beyond expectations of inflation,
shift to the rights the real wage paid by employers and received by workers will decrease.
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. If the Federal Reserve were to attempt to use contractionary monetary policy to push short-run equilibrium to a point such as B, where the unemployment rate is above the natural rate, the result would be a movement down the short-run Phillips curve with decreasing inflation.
A Phillips curve is a curve showing the __________.
short-run relationship between the unemployment rate and the inflation rate
A relationship based on consumer and firm behavior that remains consistent for long periods of time is known as a:
structural relationship
Friedman's assumptions
the LRAS and the LRPC are both vertical. Inflation doesn't impact Unemployment
If, in the long run, real GDP returns to its potential level, then in the long run,
the Phillips curve is vertical. Natural rate of unemployment The unemployment rate that exists when the economy is at potential GDP.
Milton Friedman argued that the Phillips curve did not represent a permanent trade-off between unemployment and inflation, since Friedman defined the "natural rate of unemployment" as the
the long-run Phillips curve is vertical, there is no trade-off between unemployment and inflation in the long run. the unemployment rate that exists when the economy produces potential GDP.
The natural rate of unemployment is the __________.
unemployment rate that results when the economy produces the potential level of real GDP
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 expansionary monetary policy deals with recessions (high unemployment + low inflation = recession)
Most economists agree that in the long run there is no tradeoff between inflation and unemployment which means the long-run Phillips curve is:
vertical