Macro Test 3
If inflation is generally undesirable, why do policymakers choose inflation targets that are greater than zero?
If prices are generally rising, real wages can fall without a reduction in nominal wages.
The 'paradox of thrift' refers to the fact that:
If we all save more, aggregate income will fall.
This unit discusses the lessons for economists from each of the three epochs explored. Which of the following is not one of the conclusions drawn in the text?
Risk increases in recessions and falls in booms
The leverage ratio is defined as total assets/equity. Assume that a household's sole asset is a house worth $190,000, which it has bought with a mortgage loan of $180,000. What is the value of the leverage ratio, and what happens to the ratio if the house value falls to $185,000?
19; 37.
At the end of 2015 the UK consumer price index was 258; at the end of 2016 it was 267. According to this information, the annual rate of inflation during 2016 was approximately:
3.3 per cent
Assume that the level of consumption in an economy is given by the expression 1000 + 0.7Y, when Y = 50,000, consumption will be:
36,000
According to the revised version of the Phillips curve, as shown in the figure, if the rate of inflation last year was 3 per cent and the bargaining gap this year and next year is 2 per cent, then inflation this year and next will be:
5 per cent then 7 per cent
Assume that the central bank has an inflation target of 2% per year but inflation is currently running at 4%. The nominal policy (interest) rate is currently 5%. The central bank needs to create a negative bargaining gap and estimates that the real policy rate required to achieve this is 3%. Consequently it needs to set the nominal policy rate at:
7%
(The Economy Question 17.7) Figure 17.16 is a graph of the unemployment rate and consumer price inflation in advanced economies between 1960 and 2013. Based on this information, which of the following statements is correct?
Stagflation was caused by the shifting up of the Phillips curve, propelled by higher inflation expectations.
In an economy with unutilised resources, the government stimulates aggregate demand by increasing its spending. The effect on output and employment will be greater if:
Its trading partners undertake a similar policy.
Which of the following best describes the operation of 'automatic stabilisers'?
Some components of government spending inevitably increase when output falls.
Which term can be defined as "an unexpected change in the economy, such as a rise or fall in autonomous consumption, investment, or exports"?
demand shock
Which term can be defined as "the fact that the nominal interest rate cannot be negative, thus setting a floor on the nominal interest rate that can be set by the central bank"?
zero lower bound
Which term can be defined as "the opinion that wage- and price-setters form about the growth rate of the general price level in the next period"?
expected inflation
Which term can be defined as "changes in taxes or government spending in order to stabilize the economy"?
fiscal policy
Which term can be defined as "The system of fixed exchange rates, abandoned in the Great Depression, by which the value of a currency was defined in terms of gold, for which the currency could be exchanged"?
gold standard
Which term can be defined as "The period during the 1930s in which there was a sharp fall in output and employment, experienced in many countries"?
great depression
Which term can be defined as "The prolonged recession that followed the global financial crisis of 2008"?
great recession
Which term can be defined as "Financing used by firms to fulfil contractual payment obligations using cashflow"?
hedge finance
Assume that a bargaining gap remains constant at 1 per cent. The rate of inflation in future years will:
Accelerate by 1 per cent per year.
Assume that a bargaining gap remains constant at 1 per cent. The rate of inflation in future years will:
Accelerate by 1 per cent per year.
(The Economy Question 15.4, modified) The following diagram depicts the model of the labour market: Suppose there is an increase in workers' bargaining power that causes inflation. Which of the following statements are correct?
After the initial increase in the workers' bargaining power, the firms adjust the wages and prices, creating inflation. Neither the wage nor the price-setting curve shifts.
(The Economy Question 15.3, modified) The following diagram depicts the model of the labour market: Suppose now that the government adopts policies that make it difficult for foreign firms to enter its markets. Assume that the level of employment and the labour supply remain constant. Which of the following statements regarding mechanisms by which inflation is created are correct?
After the price rise, if the workers are able to continue demanding the initial real wage as the minimum level required to motivate them to work, the wage rises again, increasing the real wage to the level on the wage-setting curve.
Following the collapse of Lehman Brothers in September 2008, some of its managers blamed the US government for putting pressure on banks to lend to subprime borrowers. What effect do you think this had on the household leverage ratios and on the financial risks faced by subprime borrowers?
Banks felt obliged to accept lower levels of collateral, so households began with smaller housing equity and higher leverage ratios. This made them more vulnerable to a fall in house prices.
The advantage of a negative feedback mechanism is that it:
Contributes to stability.
Which term can be defined as "a decrease in the general price level in the economy"?
Deflation
Imagine that the rate of inflation has been 10 per cent per year for a number of years. The central bank then introduces a 'tight' monetary policy and the rate of inflation comes down to 5 per cent per year. This reduction is an example of:
Disinflation
(The Economy Question 15.9, modified) The following is a table of the British pound (GBP) exchange rate against the dollar (USD) and euro (Source: Bank of England): 24 Nov 201423 Nov 2015USD/GBP1.56981.5131euro/GBP1.26221.4256 In this table, the exchange rates are defined as the number of USD or euro per GBP. Based on this information, which of the following statements are correct?
Exports of British goods were cheaper in the US in November 2015 than a year before.
Imagine that at the end of 2014 your monthly income in money terms was £2000 per month while the index of retail prices was 100. At the end of 2015, your monthly income was £2100 while the index of retail prices was 110. During 2015, your real income had:
Fallen by 5 per cent
(The Economy Question 15.6) Figure 15.6 is a scatter plot of the inflation rate and the unemployment rate for the US for each year between 1960 and 2014. Based on this information, which of the following statements is correct?
In the 1960s, the Phillips curve suggests a trade-off of a 2% fall in the unemployment rate and a 2-3% rise in the inflation rate.
(The Economy Question 15.8) Which of the following statements is correct regarding monetary policy?
When interest rates go down, asset prices go up.
A household owns a house valued at $190,000, which it has bought with a loan of $180,000. It also has financial savings of $10,000. Which of the following shows its net worth at the outset, the minimum amount the value of the house has to fall in order to put the household into negative equity (on the house), and the minimum amount the value of the house has to fall to make the household insolvent?
$20,000; $10,001; $20,001.
In an economy where the MPC is 0.7, the proportional tax rate is 0.25 and the marginal propensity to import is 0.2, the multiplier (from the full model including government and net exports) will be:
1.48
Which of the following is a positive feedback mechanism?
A fall in the price level (deflation) causes consumers to expect further falls. This causes them to postpone spending and the reduction in demand causes prices to fall further.
In the figure shown, the distance between the price-setting curve and the wage-setting curve at C indicates:
A negative bargaining gap.
Imagine that at the end of 2014 your monthly income in money terms was £2000 per month while the index of retail prices was 100. At the end of 2015, your monthly income was £2100 while the index of retail prices was 110. During 2015, your real income had:
Fallen by 5 per cent.
(The Economy Question 14.8, modified) Which of the following statements is correct regarding the multiplier?
If firms anticipate that the government's fiscal policy will be effective, then the multiplier will be higher.
Which of the following statements regarding the multiplier is correct?
Taxation and imports are 'leakages' from the circular flow of income, which reduce the size of the multiplier.
(The Economy Question 15.7) Figure 15.9 depicts the diagrams of the labour market model and the Phillips curve that incorporates inflation expectations. Based on this information, which of the following statements is correct?
Upward shifts of the Phillips curve represent a rising inflation rate for a given unemployment rate.
Suppose that the economy enters a recession. Unemployment rises, which reduces workers' negotiating power. In terms of our wage-setting/price-setting labor market model:
We move along the wage-setting curve, to the left.
The figure shows that central banks reduced interest rates more sharply and kept them lower after the 2008 crisis than they did in the 1930s. But the figure shows nominal interest rates. Bearing in mind that inflation was negative in the early 1930s and approximately zero from 2009, which of the following statements could be true about monetary policy after 1929 and after 2008?
When we consider real interest rates, monetary policy was even tighter in the 1930s compared with 2008 onwards.
You are given the following information about the short-term nominal interest rate and the rate of inflation over a period of 8 years labeled Y1 to Y8. In which year was the real rate of interest at its maximum? a)Y8 b)Y4 c)Y5 d)Y1
Y4
Which term can be defined as "the difference between the real wage that firms wish to offer in order to provide workers with incentives to work, and the real wage that allows firms the markup that maximizes profits given the degree of competition"?
bargaining gap
Which term can be defined as "a measure of the extent to which an economy is producing as much as the stock of its capital goods and current knowledge would allow"?
capacity utilization rate
Which term can be defined as "The process by which many (but far from all) economies in the world close the gap between the world leader and their own economy"?
catch-up growth
Which term can be defined as "a monetary policy regime where the central bank changes interest rates to influence aggregate demand in order to keep the inflation rate close to an specific value"?
inflation targeting
Which term can be defined as "The risk that an asset cannot be exchanged for cash rapidly enough to prevent a financial loss"?
liquidity risk
Which term indicates that only technology and the economy's institutions are exogenous in a model
long run
Which term can be defined as "the change in total imports associated with a change in total income"?
marginal propensity to import
Which term can be defined as "central bank actions aimed at influencing economic activity through changing interest rates or the prices of financial assets"?
monetary policy
Which term can be defined as "the interest rate uncorrected for inflation"?
nominal interest rate
Which term can be defined as "the interest rate set by the central bank which applies to banks that borrow base money from the central bank"?
policy rate
Which term can be defined as "An informal agreement among employers, governments, and trade unions that created the conditions for rapid economic growth in advanced economies from the late 1940s to the early 1970s"?
postwar accord
Which term can be defined as "the interest rate corrected for inflation"?
real interest rate
Which term indicates that prices, wages, the capital stock, technology, and institutions are all exogenous in a model?
short run
Suppose that in an economy with no taxation and no external trade, the marginal propensity to consume is 0.7. The size of the multiplier (rounded to 2 decimal places) will be?
3.33
The rate of interest that you are paying on a mortgage loan is 6.5 per cent per year. Inflation is running at 3 per cent per year. The real rate of interest that you are paying is therefore:
3.5 per cent.
(The Economy Question 17.3) Franklin Roosevelt became the US President in 1933. In the period after he became the president: The federal government deficit increased to 5.6% of GNP in 1934. The short-term nominal interest rate fell from 1.7% in 1933 to 0.75% in 1935. The CPI fell by 5.2% in 1933 and rose by 3.5% in 1934. The US left the gold standard in April 1933. The New Deal was launched in 1933 and included proposals to increase federal government spending in a wide range of programs and reforms to the banking system. Which of the following statements is correct regarding the years immediately after Roosevelt became the US president?
A change in the expectations of consumers of their future earnings, as a result of the New Deal, would have contributed to an expansion in the economy's aggregate demand.
(The Economy Question 14.6) The aggregate demand of an open economy is given by the after-tax domestic consumption C, the investment I (which depends on the interest rate r), the government spending G and net exports X − M: AD=C+I+G+X−M=c0+c1(1−t)Y+I(r)+G+X−mY c₀ is autonomous consumption, c₁ is the marginal propensity to consume, and m is the marginal propensity to import. In the economy's equilibrium this equals its output: AD = Y. Solving for Y yields: Y=(11−c1(1−t)+m)(c0+I(r)+G+X) Given this equation, which of the following increases the multiplier?
A fall in the marginal propensity to import.
(The Economy Question 14.7) Which of the following statements is correct?
A fiscal stimulus can be implemented by raising spending to directly increase demand, or by cutting taxes to increase private sector demand.
(The Economy Question 14.5) Figure 14.10c depicts the aggregate investment function of an economy. Based on this information, which of the following statements is correct?
A forecast of a permanent demand increase shifts the investment line outwards.
(The Economy Question 17.12, modified) Which of the following statements are correct regarding fire sales in the housing market?
A household is underwater when the value of the house it owns is less than the value of the mortgage on the house.
(The Economy Question 17.9, modified) Figure 17.21 is the graph of leverage of banks in the UK and the US between 1960 and 2014. The leverage ratio is defined as the ratio of the banks' total assets to their equity. Which of the following statements are correct?
A leverage ratio of 25 means that a fall of 4% in the asset value would make a bank insolvent.
An overseas bank announces that it is introducing a new type of savings account that pays a 3% fixed rate of interest for deposits of a one year duration. This 3% is:
A nominal rate of interest.
Consider an aggregate demand (or multiplier) model in which the domestic economy begins again at a full-employment level of output and in goods market equilibrium. An increase in aggregate demand in these circumstances will most likely cause:
A rise in the general level of prices.
A flatter aggregate consumption function, if plotted on a graph with output on the horizontal axis and aggregate consumption on the vertical axis, would indicate which of the following:
A smaller marginal propensity to consume and a smaller multiplier.
The original Phillips curve shown in the figure suggested that the policymaker could choose:
A stable combination of inflation and unemployment.
Cuts in public expenditure are unlikely to reduce the government's deficit by the full amount of the cuts because:
Aggregate demand will fall, reducing government revenue.
(The Economy Question 14.4) Figure 14.9 depicts possible investment projects for Firms A and B.
An expected rise in energy prices leads to a fall in the expected profit rates, resulting in fewer projects being profitable at a given interest rate. This results in reduced investment.
Consider an aggregate demand (or multiplier) model in which the domestic economy begins again at a full-employment level of output and in goods market equilibrium. Now suppose a fall in output is caused by a reduction in investment. Which of the following would help restore output to its original level?
An increase in actual wealth.
Which of the following is likely to lead to a fall in the level of investment spending?
An official forecast of a downturn in the economy.
Which term can be defined as "An international monetary system of fixed but adjustable exchange rates, established at the end of the Second World War"?
Bretton Woods system
(The Economy Question 15.10) Figure 15.21 depicts the Phillips curve and the indifference curves of an economy. This economy has an independent central bank with an inflation target of 2%. Based on this information, which of the following statements is correct?
Consider an aggregate demand shock that increases unemployment. Without monetary or fiscal policy to counter the negative bargaining gap, the Phillips curve would shift down.
Herbert Hoover was the US President between 1929 and 1933. During this time: (1) President Hoover advocated a balanced budget which remained within the range of -0.6% to +0.8% of GNP in 1929-31, (2) Output was 20% below the full employment level in 1931, (3) The short-term nominal interest rate fell from 5.8% in 1929 to 1.7% in 1933, (4) The CPI decreased from -2.7% in 1930 to -10.3% in 1932 and (5) The US remained on the gold standard while the UK abandoned the regime in 1931. Which of the following statements regarding this period is correct?
Despite the cut in the nominal interest rate, monetary policy was contractionary during this period.
The roaring twenties and the great moderation were similar in that both ended with a stock market crash, but the figure shown indicates that productivity growth fell much more at the beginning of the Great Depression than it did at the beginning of the Great Recession. What could explain this difference?
Governments had learned from the earlier period that to reduce the damage of a recession they needed to operate much looser monetary and fiscal policy.
The crisis that marked the end of the golden age is sometimes described as a supply-side phenomenon in contrast to the crisis of the 1930s, which was caused by inadequate demand. Which of the following did not cause greater problems on the supply side in the 1970s?
High levels of employment.
The diagram depicts a consumption function of an economy, where C is the aggregate consumption spending, Y is the current income of the economy, and c_0 is the fixed (or autonomous) consumption such that c_0 > 0. Assume that households that are not credit-constrained would completely smooth their consumption. Which of the following statements is correct?
If all households were not credit-constrained, and all income changes were perceived to be temporary, then the aggregate consumption line would be horizontal.
Why does a fixed exchange rate regime (like the gold standard) restrict the conduct of monetary policy?
In a fixed exchange rate regime, the central bank guarantees a fixed price for its domestic currency (or gold) against other currencies. To ensure this, it may have to manipulate the demand for the domestic currency (raising or depressing it) to keep the price stable. The quickest way to do this is through the interest rate, which they cannot use simultaneously to influence aggregate demand.
(The Economy Question 15.5) See Figure 15.4d for diagrams of the labour market model, the Phillips curve, and the multiplier model of aggregate demand. The unemployment rates and the bargaining gaps at different states of the economy are shown. Based on this information, which of the following statements is correct?
In the boom shown, the upward shift in the aggregate demand curve reduces the unemployment rate, which in turn creates a bargaining gap of 1%.
(The Economy Question 17.11) Figure 17.26 depicts the US aggregate demand between 2006 Q2 and 2010 Q4. Based on this information, which of the following statements is correct?
In the recession, not only did households stop purchasing new houses and other consumption goods, but also firms stopped investing.
(The Economy Question 17.2, modified) The following figure shows the income share of the top 1% richest households in the US between 1914 and 2013. Based on this information, which of the following statements are correct?
Inequality can either rise or fall during recessions.
An increase in the policy rate reduces aggregate demand because:
It depresses asset prices and makes people feel less wealthy.
Consider a scenario where the Bank of England views the UK economy to be overheating and is attempting to slow the economy down using monetary policy. Which of the following statements regarding the effects of an interest rate rise is correct
It leads to higher demand for GBP, which results in an appreciation of the GBP.
Consider a scenario where the Bank of England views the UK economy to be overheating and is attempting to slow the economy down using monetary policy. Which of the following statements regarding the effects of an interest rate rise is correct?
It leads to higher demand for GBP, which results in an appreciation of the GBP.
Deflation refers to a situation where prices are generally falling. Why is deflation generally undesirable?
It might lead to a cumulative reduction in aggregate demand as firms and households wait for prices to fall further.
The central bank announces a rise in the official interest rate to reduce the rate of inflation. Looking at the figure shown, ceteris paribus, what is likely to happen to the aggregate investment function (i.e. the entire curve) in these circumstances?
It will remain unchanged.
In an economy with unutilized resources, the government stimulates aggregate demand by increasing its spending. The effect on output and employment will be greater if:
Its trading partners undertake a similar policy.
(The Economy Question 15.2, modified) The following table shows the nominal interest rate and the annual inflation rate (the GDP deflator) of Japan in the period 1996-2015 (Source: World Bank). 1996-2000 2001-2005 2006-2010 2011-2015Interest rate1.5% 1.4% 1.3% 1.2% Inflation rate-1.9% -0.9% -0.5% 1.6% Based on this information, which of the following statements are correct?
Japan's real interest rate turned from being positive to negative during the period.
(The Economy Question 15.1) The following table shows the annual inflation rate (the GDP deflator) of Japan, the UK, China and Nauru in the period 2010-2013 (Source, World Bank): 2010201120122013Japan−1.9%−1.7%−0.8%−0.3%UK1.6%2.0%1.6%1.9%China6.9%8.2%2.4%2.2%Nauru−18.2%18.1%24.1%−21.7% Based on this information, which of the following statements is correct?
Nauru's price level at the end of 2013 is lower than it was at the start of 2010.
(The Economy Question 17.10, modified) Figure 17.24 shows some S-shaped price dynamics curves for the housing market. Based on the figure, which of the following statements is true?
Optimism about housing prices would shift the PDC upwards.
Which of the following statements are essential features of a 'goods market equilibrium'?
Output is equal to aggregate demand.
Imagine that you are responsible for policymaking in an economy that is experiencing a deep recession. You and your colleagues announce a number of measures (like those in Roosevelt's 'New Deal') that you tell everyone will boost demand and output. Why does it matter whether the public believes your announcement?
People will feel more confident about the future and increase their spending, which will reinforce the actions of government.
In the figure shown, when employment is at level C, the real wage lies below the price-setting curve. Assume inflation is zero. In a competitive system, firms will begin to prices and this will start a process of .
Reduce; deflation
Section 17.5 describes innovation and its effects in the US (and some other economies) during the golden age as a 'virtuous circle'. Which of the following did not contribute to that process?
Strong trade unions that were able to seize most of the benefits of increased output for their members.
(The Economy Question 17.8) Figure 17.19 shows the household debt-to-income ratio and the house prices in the US between 1950 and 2014. Based on this information, which of the following statements is correct?
Subprime mortgages partly explain the rise in debt in the US prior to the financial crisis.
In the multiplier model, we assume the following:
That the capital stock and the state of technology are both fixed.
(The Economy Question 14.9, modified) Figure 14.16 shows the effects of France's increased government spending and tax cuts in 1982 on the economies of France and Germany. Based on this information, which of the following statements are correct?
The German economy benefitted from the spillover effect of higher French imports of German goods.
(The Economy Question 14.1) Figure 14.2 depicts a consumption function of an economy, where C is the aggregate consumption spending and Y is the current income of the economy. Based on this information, which of the following statements is correct?
The MPC is normally less than 1 as some households are able to smooth their consumption.
(The Economy Question 17.1) The following figure shows the unemployment rate (left-hand axis) and productivity growth (right-hand axis) in the US between 1914 and 2015. Based on this information, which of the following statements is correct?
The US economy's performance in 1979-2008 was less strong than during the other two boom periods, with a higher average unemployment rate and lower average productivity growth.
Your monthly real wage is:
The amount you earn each month, divided by the average price of goods and services that you buy.
Alan Greenspan admitted that his 'model' of the economy contained a 'flaw'. What exactly was that flaw?
The assumption that self-interested economic agents, including firms (and banks especially), would avoid taking excessive risks.
Consider the simple multiplier model with no government spending or trade, so that the goods market equilibrium is given by the equation Y = [1/(1 - c_1)] (c_0 + I). Given this equation, which of the following statements is correct?
The boost in the economy's output is the same, regardless of whether the aggregate demand shock comes from an increase in investment or in autonomous consumption c_0.
(The Economy Question 17.6) Figure 17.15 describes the movements in employment, profits, and wages in the 1950s to 1970s using the labour market model. Which of the following statements is correct regarding this period?
The collapse of postwar accords in the late 1960s/early 70s led to workers demanding higher wages, leading to an upward shift in the wage-setting curve.
According to the original Phillips curve (Unit 15), higher inflation is associated with lower unemployment. The term 'stagflation' was coined to describe the unusual situation in the 1970s where unemployment and inflation both rose together. Which of the following best summarizes the underlying causes?
The lower growth of productivity meant a slower growth in the real wage and in the upward movement of the price-setting curve. In addition, the succession of oil price shocks caused a rise in prices that firms could only partially pass on. This also ate into profits, reducing further the upward movement of the price-setting curve. It also led people, workers especially, to expect inflation and therefore to build it into wage settlements.
In the expression for aggregate consumption C = C_0 + C_1Y, C_1 is known as:
The marginal propensity to consume.
In a severe recession, with falling prices, the economy may need a negative real interest rate in order to give sufficient stimulus to aggregate demand. What particular problem for conventional monetary policy do negative real interest rates pose?
The policy rate needs to be more negative than the rate of deflation but nominal rates cannot go below zero.
(The Economy Question 17.5) Figure 17.14 is a graph of days on strike per 1,000 industrial workers (left-hand axis) and the average wages relative to share prices (right-hand axis) in advanced economies between 1950 and 2002. Based on this information, which of the following statements is correct?
The postwar accord of cooperation between employers and employees broke down in the late 1960s.
The great moderation masked three changes that would create the environment for the global financial crisis, including all of the options below except for which one?
The power of workers
(The Economy Question 14.10) The following are the labour market and the multiplier diagrams, representing the medium-run supply side and the short-run demand side of the aggregate economy, respectively: Assume that the economy's production function is given by Y = N, where Y is the output and N is the employment. Based on this information, which of the following statements is correct?
The shifts in the aggregate demand cause short-run cyclical fluctuations in unemployment around the medium-run level shown in the labour market diagram.
(The Economy Question 14.3) Which of the following statements is correct regarding household wealth?
The total broad wealth equals material wealth plus expected future earnings.
A household's net worth (or equity) is best described as:
The total value of assets minus the total value of its liabilities.
Suppose that the bargaining power of workers rises relative to that of employers because government legislation improves the security of employment. In terms of our wage-setting/price- setting labor market model:
The wage-setting curve moves up.
Suppose that the bargaining power of workers rises relative to that of employers because government legislation improves the security of employment. In terms of our wage-setting/price-setting labor market model:
The wage-setting curve moves up.
Which term can be defined as "the effect of an increase in government spending in reducing private spending"?
crowding out
Which term can be defined as "an unexpected change in the economy, such as a rise or fall in oil prices or an improvement in technology"?
supply shock
Which term can be defined as "an effect that occurs if an initial increase in wages in the economy is followed by an increase in the price level, which is followed by an increase in wages and so on"?
wage-price spiral