chapter 17 homework

discretion strategy

Allows the Fed to adjust its policies based on changes in the economy.

rational expectations

Expectations formed by using all available information about an economic variable.

As of​ 1993, the Fed sets targets for which of the following in order to achieve price stability and high​ employment? A. Federal funds rate B. M1 definition of the money supply C. M2 definition of the money supply D. Discount rate

A. Federal funds rate In​ 1987, the Fed​ (under Volcker) announced that it would no longer set M1 money supply targets. In​ 1993, the Fed​ (under Greenspan) announced that it would no longer set M2 money supply targets. That​ is, by​ 1993, the Fed relied on setting targets for the federal funds​ rate, rather than the money​ supply, in order to achieve its goals of price stability and high employment.

Economists who believed that the Phillips curve represented a structural relationshipbelieved that the curve represented A. a permanent​ trade-off between unemployment and inflation. B. a temporary​ trade-off between unemployment and inflation. C. a cyclical​ trade-off between unemployment and inflation. D. no​ trade-off between unemployment and inflation.

A. a permanent​ trade-off between unemployment and inflation. Structural relationship A relationship that depends on the basic behavior of consumers and firms and remains unchanged over long periods. With respect to the Phillips​ curve, economists who believe the curve represents a structural relationship believe that it represents a permanent​ trade-off between unemployment and inflation. As long as​ policy-makers were willing to accept a permanently higher inflation​ rate, they would be able to keep unemployment lower.

Alan Greenspan A. agreed with Paul Volcker about the importance of keeping inflation low. B. disagreed with Paul Volcker about the importance of keeping inflation low. C. used fiscal policy to keep inflation low. D. None of the above.

A. agreed with Paul Volcker about the importance of keeping inflation low. In​ 1987, President Ronald Reagan appointed Alan Greenspan as the chairman of the Board of Governors of the Federal Reserve. Greenspan was also determined to keep inflation low. The greater capacity of the economy to produce goods and services at every price level contributed to the very low rates of inflation in the U.S. during the late 1990s and the early 2000s.

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? A. Positive relationship B. Inverse relationship C. No relationship D. Direct relationship

B. Inverse relationship Phillips Curve A curve showing the​ short-run relationship between the unemployment rate and the inflation rate. ​Specifically, when aggregate demand​ increases, unemployment falls and inflations rises. When aggregate demand​ decreases, unemployment increases and inflation falls. This inverse relationship exists in the short​ run, but disappears in the long run. Each point on the Phillips curve shows a possible combination of unemployment and inflation that prevails in a given year. When inflation is​ high, unemployment tends to be low. When inflation is​ low, unemployment tends to be high.

Indicate the two main objections to the idea that the​ short-run Phillips curve is vertical. A. Wages tend to adjust quickly. B. Workers and firms might not have rational expectations. C. Contracts with workers keep wages sticky. D. Any wage rising more quickly than the rate of inflation is actually falling.

B. Workers and firms might not have rational expectations. C. Contracts with workers keep wages sticky. Some economists have argued that a monetary policy that was announced ahead of time would not cause a change in unemployment. That​ is, some argue that the​ short-run Phillips curve is vertical.​ However, there are two main criticisms of this​ argument: 1. Workers and firms might not actually have rational expectations. If workers and firms do not know the impact of an expansionary monetary​ policy, the actual real wage may end up being lower than the expected real wage. 2. The rapid wage and price adjustments needed for a vertical​ short-run Phillips curve will not occur.​ Specifically, firms have contracts with workers and suppliers that keep prices from adjusting quickly. Some economists have argued that a monetary policy that was announced ahead of time would not cause a change in unemployment. That​ is, some argue that the​ short-run Phillips curve is vertical.​ However, there are two main criticisms of this​ argument: 1. Workers and firms might not actually have rational expectations. If workers and firms do not know the impact of an expansionary monetary​ policy, the actual real wage may end up being lower than the expected real wage. 2. The rapid wage and price adjustments needed for a vertical​ short-run Phillips curve will not occur.​ Specifically, firms have contracts with workers and suppliers that keep prices from adjusting quickly.

​If, in the long​ run, real GDP returns to its potential​ level, then in the long​ run, A. the Phillips curve represents a structural relationship. B. the Phillips curve is vertical. C. the Phillips curve is upward sloping. D. the Phillips curve disappears.

B. the Phillips curve is vertical. Natural rate of unemployment The unemployment rate that exists when the economy is at potential GDP. Milton Friedman and Edmund Phelps argued that there is no​ trade-off between unemployment and inflation in the long run. If real GDP automatically returns to its potential level in the long​ run, the unemployment rate must return to the natural rate of unemployment in the long run.​ Therefore, the​ long-run Phillips curve must be vertical.

What effect does expansionary monetary policy have on equilibrium if consumers have rational expectations​? A. A movement from point C to point A. B. A movement from point B to point C. C. A movement from point A to point C. D. A movement from point A to point B.

C. A movement from point A to point C. Rational expectations Expectations formed by using all available information about an economic variable. If workers and firms ignore inflation or if they have adaptive​ expectations, an expansionary monetary policy will cause the​ short-run equilibrium to move from point A on the Phillips curve to point​ B; inflation rises and unemployment falls. If workers have rational​ expectations, an expansionary monetary policy will cause the​ short-run equilibrium to move up the​ long-run Phillips curve from point A to point C. Inflation will still​ rise, but unemployment will not change.

In the​ figure, 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​? A. Point A B. Point B C. Point C D. None of the above

C. Point C The moral of the vertical​ long-run inflation rate is that in the long​ run, there is no​ trade-off between the unemployment rate and the inflation rate. The inflation rate is stable only if the unemployment rate equals the natural rate of unemployment​ (point C). It is often called the nonaccelerating inflation rate of unemployment​: the unemployment rate at which the inflation rate has no tendency to increase or decrease. If the unemployment rate is below the natural rate​ (point A), the inflation rate​ increases, and,​ eventually, the Phillips curve shifts up. If the unemployment rate is above the natural rate​ (point B), the inflation rate​ decreases, and,​ eventually, the Phillips curve shifts down.

If actual inflation is higher than expected​ inflation, the A. actual real wage is greater than the expected real​ wage: unemployment rises. B. actual real wage is less than the expected real​ wage: unemployment rises. C. actual real wage is less than the expected real​ wage: unemployment falls. D. actual real wage is greater than the expected real​ wage: unemployment falls.

C. 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. If actual inflation is less than expected​ inflation, actual real wages in the economy will be higher than expected real wages. As a​ result, many firms will hire fewer workers than they had planned. Unemployment rises.

Models that use​ factors, such as technology​ shocks, to explain fluctuations in real GDP instead of changes in the money supply are called A. real monetary models. B. real technology models. C. real business cycle models. D. monetary business cycle models.

C. real business cycle models. Models that focus on real rather than monetary explanations of fluctuations in real GDP.

Paul Volcker is credited largely with which of the​ following? A. Fighting inflation by reducing the growth of the money supply. B. The​ "Volcker disinflation." C. Driving up the unemployment rate. D. A and B only.

D. A and B only. In​ 1979, President Jimmy Carter appointed Paul Volcker as the Fed chairman. The​ Fed, under​ Volcker, began fighting inflation by reducing the annual rate of growth of the money​ supply, thereby raising interest rates. Under​ Volcker's leadership, the Fed reduced inflation from more than 10 percent to less than 5​ percent, sometimes called​ "disinflation" or the​ "Volcker disinflation."​ However, the disinflation came at a high price. Unemployment increased to more than 10 percent between 1982 and 1983.​ However, as workers and firms lowered their expectations of future​ inflation, the Fed switched to an expansionary​ policy, which brought the economy back to the natural rate of unemployment​ (4%) by 1987. pg 626

What is the Fed doing to increase the credibility of its​ policies? A. Announcing the federal funds target rate. B. Whenever a change in policy is​ announced, the change actually takes place. C. Conducting more open market purchases of government securities. D. A and B only.

D. A and B only. ​Workers, firms, and investors in stock and bond markets have to view Fed announcements as credible if monetary policy is to be effective. Over the past two​ decades, the Fed has taken important steps to ensure the credibility of its policies. ​First, changes in Fed policy have already occurred by the time the change is announced.​ Also, the Fed now makes public its federal funds target rate. pg630

In the​ figure, expected inflation is initially at​ 1.5%. When expected inflation increases to​ 4.5%, which of the following will​ occur? A. At the natural rate of​ unemployment, inflation is​ 4.5%. B. To have​ 3.5% unemployment​ rate, inflation would be​ 7.5%. C. Unemployment reaches the natural rate of​ 5%. D. All of the above.

D. All of the above. A​ new, higher expected inflation rate​ (4.5%) can become embedded in the economy such that​ workers, firms,​ consumers, and government all consider the inflation rate when making decisions. The​ short-run trade-off between unemployment and inflation now occurs at a higher level. 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%.

According to many economists and​ policymakers, what other options does the Fed have to improve its credibility with​ workers, firms, and​ investors? A. Following a discretion strategy. B. Following a rules strategy. C. Following the Taylor rule. D. All of the above.

D. All of the above. In order to increase the​ Fed's credibility, some policymakers believe that the Fed should adopt and follow rules. Rules​ strategy: Following specific and publicly announced guidelines for​ policy, regardless of the state of the economy. Discretion​ strategy: Allows the Fed to adjust its policies based on changes in the economy. Taylor​ rule: The Fed sets a target federal funds rate following an equation that includes the inflation​ rate, the real equilibrium federal funds​ rate, the​ "inflation gap," and the​ "output gap." Rules are not​ foolproof, but they reduce central bank flexibility and give​ workers, firms, and investors the confidence that the Fed will do what it says.

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)? A. It shifts up such that a given level of unemployment occurs at a lower price level. B. It shifts down such that a given level of unemployment occurs at a lower price level. C. It shifts down such that a given level of unemployment occurs at a higher price level. D. It shifts up such that a given level of unemployment occurs at a higher price level.

D. It shifts up such that a given level of unemployment occurs at a higher price level. When a supply shock shifts the short run aggregate supply curve from SRAS1 to SRAS2​, the price level increases and the level of real GDP falls​ (Panel A). In​ addition, the​ short-run Phillips curve shifts up​ (Panel B). pg 625

rules strategy

Following specific and publicly announced guidelines for​ policy, regardless of the state of the economy.

real business cycle models

Models that focus on real rather than monetary explanations of fluctuations in real GDP.

Taylor rule

The Fed sets a target federal funds rate following an equation that includes the inflation​ rate, the real equilibrium federal funds​ rate, the​ "inflation gap," and the​ "output gap." Rules are not​ foolproof, but they reduce central bank flexibility and give​ workers, firms, and investors the confidence that the Fed will do what it says.

non accelerating inflation rate of unemployment (NAIRU)

The unemployment rate at which the inflation rate has no tendency to increase or decrease.

Why​ doesn't the Phillips curve represent a permanent​ trade-off between unemployment and inflation in the long​ run? A. In the long​ run, aggregate supply is vertical. B. In the long​ run, aggregate demand sets the price level. C. In the long​ run, aggregate supply is upward sloping. D. ​"In the long​ run, we're all​ dead."

A. In the long​ run, aggregate supply is vertical. Opposition to idea that the Phillips curve represented a structural relationship suggested that the Phillips curve did not represent a permanent​ trade-off between unemployment and inflation. Since economists had come to agree that the aggregate supply curve was vertical in the long​ run, the Phillips curve could not be downward sloping in the long run. In​ essence, there is no​ trade-off between unemployment and inflation in the long run.

natural rate of unemployment

The unemployment rate that exists when the economy is at potential GDP.

phillips curve

A curve showing the​ short-run relationship between the unemployment rate and the inflation rate.

structural relationship

A relationship that depends on the basic behavior of consumers and firms and remains unchanged over long periods.