AGEC 217 Module 4

The Wall Street Journal described monetary policy in 1979 as "a world turned upside-down." They wrote this because

. the President's administration wanted interest rates higher than the Federal Reserve wanted them.

The economy was near potential output in 1965. Starting in that year, the Johnson administration increased spending on social programs and escalated the Vietnam War, while maintaining the Kennedy tax cuts. In 1968 the Congress passed an income tax surcharge to try to bring down consumer spending. Which of the above goods market graphs best represents the results of the Johnson administration policies (a) and the intended effects of the tax surcharge (b)?

A

Suppose the Federal Reserve responds to an oil shock with expansionary monetary policy. Which pair of graphs best represents this option?

A and C

The Volcker Fed allowed interest rates to rise to very high levels in the early 1980's, in order to bring down inflation. Which of the above pairs of goods market and money market graphs best represents this policy and its results?

A and D

Which pair of graphs describes the response of exchange markets to the Plaza Accord?

A and D

In 1979 high inflation caused an increase in money demand, and Paul Volcker's Federal Reserve used the quantity of money as its policy target. Which of the above graphs shows what happened to interest rates as a result?

A

Suppose the Federal Reserve responds to a supply shock with an increase in the money supply. Which of the above graphs best represents this shock and policy response?

A

The 1990-91 recession was caused by interest rate increases, a credit crunch, and the uncertainty created by the Gulf War. By 1991 the unemployment rate was nearly 7%. Which of the above graphs best describes this recession?

A

The Johnson administration pledged to raise taxes in early 1967, but the income tax surcharge was not passed until mid-1968. Meanwhile, the Federal Reserve agreed to reverse its contractionary policies in 1967. Which pair of the above graphs represents the policies of 1967?

B and C

Which of the following is not a reason why housing demand increased so much during the 1998-2006 housing bubble

Baby boomers came of age, so household formation increased

In the mid 1990's Alan Greenspan thought productivity growth had increased potential output. Lawrence Meyer thought that potential output had not increased. This meant that

Greenspan thought interest rates could remain low without the threat of inflation, while Meyer thought interest rates had to be raised to prevent inflation.

Consider the Plaza Accord of 1985: The Ministers and Governors agreed that exchange rates should play a role in adjusting external imbalances. In order to do this, exchange rates should better reflect fundamental economic conditions than has been the case. They believe that agreed policy actions must be implemented and reinforced to improve the fundamentals. Some further orderly appreciation of the main non-dollar currencies against the dollar is desirable. They stand ready to cooperate more closely to encourage this when to do so would be helpful. What role did the ministers and governors mean by "appreciation of the main non-dollar currencies against the dollar"?

Currencies such as the British pound, German mark and French franc should rise in value relative to the dollar, which means that the dollar would fall in value

Suppose the Federal Reserve responds to a supply shock with no change in policy, depending instead on a recession to reduce input costs over the long run. Which of the above graphs best represents this shock and policy response?

D

How did the inflation of the 1970's help cause the Savings and Loan crisis of the 1980's?

Inflation caused interest rates Savings and Loans paid on deposits to rise above the interest rates they earned on their long-term loans

Why did investors in Japan want to lend money for U.S. home mortgages in the 2000's?

Japan's central bank responded to its long recession by reducing interest rates, so investors could earn more by lending in the U.S. housing market

Consider the Plaza Accord of 1985: The Ministers and Governors agreed that exchange rates should play a role in adjusting external imbalances. In order to do this, exchange rates should better reflect fundamental economic conditions than has been the case. They believe that agreed policy actions must be implemented and reinforced to improve the fundamentals. Some further orderly appreciation of the main non-dollar currencies against the dollar is desirable. They stand ready to cooperate more closely to encourage this when to do so would be helpful. What message did the Plaza Accord send to currency speculators?

That governments were going to sell dollars, causing its value to fall, so speculators should sell dollars

Which of the following was not a cause of the Great Inflation of the 1960's and 1970's?

The 1968 income tax surcharge

The above macro model graphs represent the events of 2008-09. Which of the following stories is correct?

The fall in home values reduces the value of mortgage-backed securities. Financial markets panic and lenders increase reserves. The reduction in the money multiplier reduces the money supply. International investors move money to U.S. Treasury bonds, increasing the demand for the dollar and the exchange value of the dollar. Higher real interest rates reduce investment spending, and a higher exchange value of the dollar reduce exports. Aggregate demand falls, output and inflation decline, and unemployment increases

Which of the following best describes the Federal Reserve's policy for bringing down inflation in the early 1980's?

Reduce the money supply to increase interest rates, reducing aggregate demand. Hold output below potential long enough to reduce inflationary expectations, eventually increasing aggregate supply

Consider these data for the United States economy, 1966-1970. What would be the appropriate counter-cyclical policies for the years 1969-1970?

Since both unemployment and inflation are rising, the appropriate counter-cyclical policies are unclear

After Federal budget surpluses at the end of the 1990's, structural budget deficits returned in the 2000's. Why?

The Bush administration tax cuts, the boom in housing prices which increased mortgage interest deductions, and the brief six-year expansion.

By the end of the 1990's budget deficits had turned to surpluses. Which of the following is not a reason for these surpluses?

The Clinton administration's big tax cuts in the early 1990's

Consider these data for the United States economy, 1966-1970. For the years 1967-1969, what would be an appropriate monetary policy?

The Fed should sell Treasury bonds.

Consider the Plaza Accord of 1985: The Ministers and Governors agreed that exchange rates should play a role in adjusting external imbalances. In order to do this, exchange rates should better reflect fundamental economic conditions than has been the case. They believe that agreed policy actions must be implemented and reinforced to improve the fundamentals. Some further orderly appreciation of the main non-dollar currencies against the dollar is desirable. They stand ready to cooperate more closely to encourage this when to do so would be helpful. What role did the ministers and governors mean by "exchange rates should play in adjusting external imbalances"?

The dollar should fall in value to reduce the U.S. trade deficit

Which of the following was a pro-cyclical fiscal policy response to the slow recovery from the Great Recession

The government spending sequester

Which of the following was not a possible reason why productivity declined in the 1970's and 1980's?

The rising value of the dollar caused businesses to import high-technology machinery, rather than developing it themselves.

Why did China lend so much money for U.S. home mortgages in the 2000's

To encourage their exports, China bought dollars to keep the value of the yuan low. They invested some of these dollars in the secondary mortgage market

The sudden rise in oil prices in 1973 caused

a decrease in aggregate supply.

The supply shock caused by the sudden rise in oil prices in 1973 resulted in

a recession and higher inflation

The large hay crop during the Nixon price controls increased farmer demand for steel wire for hay bales. As a result

a shortage of wire developed, much hay went unharvested, and the beef supply was smaller than it could have been

The 1985 Plaza Accord was

an agreement among the major economic powers to sell dollars in exchange markets, to bring down the value of the dollar

The Laffer Curve shows the relationship

between tax rates and tax revenues

The 1980's saw "crowding out" of investment spending. This occurred because

big budget deficits combined with tight monetary policy increased interest rates, which reduced investment spending

The Federal Reserve maintained a strong anti-inflation policy during the 1980's. The big Federal budget deficits then caused a

crowding out of investment.

In response to the financial panic in 2008 and the 2007-09 Great Recession, the Federal Reserve

cut the federal funds rate to near zero and invested new ways to flood financial markets with money

When the unemployment rate is below the natural rate,

equilibrium output is more than potential output

President Johnson's policy of expanding the social safety net with the Great Society programs, escalating the Vietnam War, and maintaining the Kennedy tax cut, caused

equilibrium output to expand beyond potential output.

If unemployment is cyclical,

expansionary fiscal or monetary policy can reduce it.

The Gulf War of 1990-91

helped cause the recession of 1990-91

The A.I.G. insurance company failed in 2008 because

it had not reserved enough money to pay on credit default swaps when asset values fell

Both the 1987 stock market crash and the 1997-98 Asian crisis could have caused U.S. recessions, because

lender pessimism could have increased reserves and reduced the money multiplier

In response to the stock market crash of 1987, the Federal Reserve

pledged to act as the lender of last resort

If Federal budget deficits crowd out investment, in the long run

potential output will grow more slowly, because there will be a smaller stock of buildings and equipment

The 1968 income tax surcharge was intended to

reduce aggregate demand growth and bring down the inflation rate

On this Laffer Curve, if the tax rate falls from point 2 to point 1,

revenue decreases

If the tax rate is to the left of the peak of the Laffer Curve

tax cuts will decrease tax revenue

Among the causes of the "Great Moderation" of the 1980's, 1990's and 2000's were

the absence of big wars or supply shocks, improved inventory control by businesses, and counter-cyclical monetary policy by the Federal Reserve.

Wars have usually been associated with economic booms and inflation. The Gulf War of 1990-91 corresponded with a recession, because

the added government spending for the war was small, and the economic uncertainty resulting from the war caused consumer and business spending to drop.

Johnson administration economists had hoped to "go down that [Phillips] curve just as you went up that curve." This proved impossible because

the high inflation rates at the end of the 1960's caused an increase in inflationary expectations

In the equation of exchange, if real GDP rises by 5% per year, Monetarism recommends that

the money supply be increased by 5% per year, to keep inflation at zero if velocity doesn't change.

The "Great Moderation" refers to

the period from the mid-1980s to 2007 when the U.S. economy experienced two long expansion, two short recessions, low inflation and falling interest rates

A 2011 survey found that consumers spent only 36% of the added disposable income they kept as a result of the 2009 tax cuts. An explanation for this small added spending is

the permanent income hypothesis. People increase their spending less when they think the added income is temporary

The Phillips Curve shows

the relationship between the unemployment rate and the inflation rate.

In the secondary mortgage market

the rights to receive mortgage payments are bundled and sold as securities to investors

As a result of the Great Recession of 1981-82,

the unemployment rate rose above 10%, but the inflation rate fell below 5%.

If the money market is in a liquidity trap, increases in aggregate demand

will not cause an increase in interest rates