ECON330 (Money & Banking) - Exam 5

- The underlying theory explaining shifts in AD suggests that the decline in aggregate demand shown in this Figure (see Imgur) occurred because the real interest rate increase engineered by Paul Volcker - Once the U.S. economy moved from the​ pre-Volcker equilibrium at point 1 to point 2 in this Figure (see Imgur), the U.S. economy experienced a negative ... gap. - According to the theory explaining shifts in aggregate​ supply, the fact that output fell below potential output meant that the labor market was experiencing - According to this Figure (see Imgur), ​Volcker's policy had the​ effect, over the​ 1980-1986 period, of curtailing inflation by approximately ... , while unemployment ...

- A and C only. (increased borrowing costs for consumers and raised the return to​ saving, causing a decline in consumption spending. ; raised the cost of financing investment​ projects, thereby reducing investment expenditure.) - output - considerable slack and downward pressure on​ wages, enabling firms to raise prices at a slower rate. - 86% ; remained virtually unchanged.

- In the short​ run, which of the following is likely to happen if there is a decrease in​ taxes? - In the long​ run, which of the following is likely to happen if there is a decrease in​ taxes?

- A decrease in taxes will lead to a rightward shift of the aggregate demand curve.​ Therefore, there will be an increase in inflation and output. - The economy will reach a new​ long-run equilibrium, with potential level of output and inflation permanently higher.

Classify the following situation as a supply or demand​ shock: - Favorable weather produces a record crop of wheat and corn in the Midwest. Determine the effects on inflation and output in the short run and the long run using ​AD/AS graph analysis. - In the short​ run, output ... and inflation ... . In the long run, output ... to potential and inflation ... . - Which of the following graphs illustrates your previous answer? (See Imgur) Classify the following situation as a supply or demand​ shock: - Households and firms become more optimistic about the economy. Determine the effects on inflation and output in the short run and the long run using ​AD/AS graph analysis. - In the short​ run, output ... and inflation ... . In the long run, output ... to potential and inflation ... . - Which of the following graphs illustrates your previous answer? (See Imgur) Classify the following situation as a supply or demand​ shock: - Steel workers go on strike for 4 weeks. Determine the effects on inflation and output in the short run and the long run using ​AD/AS graph analysis. - In the short​ run, output ... and inflation ... . In the long run, output ... to potential and inflation ... . - Which of the following graphs illustrates your previous answer? (See Imgur) Classify the following situation as a supply or demand​ shock: - Financial frictions increase. Determine the effects on inflation and output in the short run and the long run using ​AD/AS graph analysis. - In the short​ run, output ... and inflation ... . In the long run, output ... to potential and inflation ... . - Which of the following graphs illustrates your previous answer? (See Imgur)

- A positive (temporary) supply shock. - increases ; decreases ; falls ; increases to its original level. - Graph C. - A positive demand shock. - increases ; increases ; falls ; rises - Graph B. - A negative (temporary) supply shock. - decreases ; increases ; rises ; decreases to its original level. - Graph D. - A negative demand shock. - decreases ; decreases ; rises ; falls - Graph A.

- Draw the aggregated demand curve (AD), the aggregate supply curve (AS). Locate the short-run equilibrium (E). - The​ short-run equilibrium will move as long as

- AD is negatively sloping and AS is positively sloping. E is at the intersection. - output differs from its potential level.

Suppose the current administration decides to decrease government expenditures as a means to cut the existing government budget deficit. The aggregate economy is depicted in the graph to the right. - Draw the curve that will shift as a result of this policy move. Locate the new equilibrium point. - If the Federal Reserve decides to stabilize the inflation​ rate, it will ... the real interest rate at every inflation rate. - As a result of this policy​ change, in the long​ run, the inflation rate will move ... its target level, output will be ... potential output, and the real interest rate will be at a ... level compared to the previous​ long-run equilibrium.

- AD, 2 shifts left/downward ; Point shifts left/downward (located where AD, 2 and SRAS, 1 intersect). - decrease - closer to ; at ; permanently lower

The chairman of the Federal Reserve Board announces that over the next​ year, the rate of money growth will be reduced from its current rate of​ 10% to a rate of​ 2%. Assume that the new classical view of the economy is correct. The chairman is believed by the public but the Fed actually reduces the rate of money growth to​ 5%. - Show what happens to the price level and output in the short run. Identify the new short-run equilibrium.

- AS, 2 shifts left/upward. ; AD, 2 shifts right/upward. ; E,2 shifts right/upward (at the intersection of AS, 2 and AD, 2).

- Show the effect of increased oil prices on the​ short-run aggregate supply curve. - The primary factor that shifts the​ short-run aggregate supply curve is changes​ in:

- AS, 2 will shift left/up. - production costs.

- Show how the economy will self-correct. - When aggregate output is below the natural​ rate, what will happen to the inflation rate over time if the aggregate demand curve remains​ unchanged?

- AS, 2 will shift right/down. - The inflation rate will fall because the slackness of the labor market will eventually cause wages to fall.

- According to the​ expectations-augmented Phillips​ curve, which of the following factors determines the rate of​ inflation? - The inflation rate tends to​ increase, ceteris paribus​, as expected inflation ... - The inflation rate tends to​ increase, ceteris paribus​, as the unemployment gap ... - The inflation rate tends to​ increase, ceteris paribus​, as the actual unemployment rate ... - The inflation rate tends to​ increase, ceteris paribus​, as the natural rate of unemployment ...

- All of the above are correct. (The degree of tightness in the labor market. ; The difference between the unemployment rate and the natural rate of unemployment. ; Expected inflation.) - increases - decreases - decreases - increases

Use the following graph(see Imgur) of aggregate demand and supply to demonstrate how lags in the policy process can result in undesirable fluctuations in output and inflation. Point ... : Due to a policy lag, the self-correcting mechanism has already returned the economy to full employment. Point ... : Activist policy kicks in and output is above natural level Point ... : The economy is currently in recession, and activist policymakers wish to stabilize output.

- B ; C ; A

In what ways can nonconventional monetary policy affect the real interest rate for investments when the economy reaches the zero lower​ bound? How are credit spreads​ affected?

- By purchasing private​ assets, the central bank reduces financial frictions in specific asset​ classes, and therefore the real interest rate for investments in those markets. Credit spreads are reduced directly as financial frictions are reduced. ; By purchasing government​ securities, the central bank directly lowers the safe policy real interest rate at any given level of financial frictions. Credit spreads are not affected directly. ; By providing forward​ guidance, the central banks acts to reduce financial frictions for any given current safe policy​ rate, thereby lowering the real interest rate for investments. Credit spreads are reduced directly as financial frictions are reduced. ; By providing liquidity to key credit​ markets, the central bank can directly reduce financial​ frictions, which lowers the real interest rate for investments at any given safe policy interest rate. Credit spreads are reduced directly as financial frictions are reduced.

- How is constrained discretion different from discretion in monetary​ policy? - How are the outcomes likely to be​ different? Under constrained​ discretion, policymakers are likely to have ... credibility through commitment and transparency.​ Thus, inflation and inflation expectations are likely to be ... than under pure​ discretion, ... much flexibility to address changes in the real economy.

- Constrained discretion is a type of discretion that is less flexible with monetary policy. - more ; lower ; without giving up

Suppose country A has a central bank with full​ credibility, and country B has a central bank with no credibility. Determine which country is most likely affected by each of the following​ situations: - The public is less likely to believe announcements about future policy changes. - Aggregate supply adjusts more quickly to policy announcements when compared to another country. - Output is less stable when compared to another country.

- Country B - Country A - Country B

How can establishing an​ exchange-rate target bring credibility to a country with a poor record of inflation​ stabilization?

- Credible exchange-rate targets can reduce the time-inconsistency problem by limiting discretionary policy.

Suppose the financial frictions, denoted by f, are determined by two factors: financial panic and asset purchases. - Of the four figures shown​ above, the one that shows how a sufficiently large financial panic can pull the economy below the zero lower bound into a destabilizing deflationary spiral is - Use the multipoint curve drawing tool in the accompanying figure to show how a sufficient amount of asset purchases can reverse the effects of the financial panic depicted above.

- Figure B - AD, 2 shifts right, with the top line intersecting where LRAS and AS meet.

- The top portion of the following table lists a variety of factors that shift some component of the aggregate demand and supply model. - Of the factors identified above that shift the​ short-run aggregate supply​ curve, the only factor that possibly also shifts the​ long-run aggregate supply curve is ... but only if this factor is ...

- Firms alter their plans for investment expenditures. : X - Households and businesses come to expect an acceleration in inflation. : S - A negative price shock occurs in the form of higher oil prices. : S - An autonomous easing of monetary policy is implemented by the Federal Reserve. : X - Output remains persistently high relative to potential output (Y>Y^P). : S - Consumer and business pessimism spread as the media reports disappointing news about the economy. : X - Consumer and business optimism spread as the media reports encouraging news about the economy. : X - price shocks ; permanent.

- What basic relationship does the​ short-run Phillips curve​ describe? - What​ trade-offs does this relationship seem to offer​ policymakers?

- It describes the negative relationship between unemployment and inflation. - Policymakers can increase inflation to decrease unemployment.

- Proposals have come before Congress that advocate the implementation of a national sales tax. Which of the following is true if such a tax is​ implemented? - Which of the following best explains why aggregate supply would decrease in the short run due to the implementation of a national sales​ tax? - The graph to the right depicts aggregate supply and demand in​ long-run equilibrium. Show the effect of the implementation of a national sales tax. - We can see from the graph that in the short run if a national sales tax is​ implemented, the equilibrium inflation rate will ... and the equilibrium level of aggregate output will ...

- It would cause a decrease in aggregate supply in the short run and no change in the long run. - The cost of goods sold would​ increase, making production more expensive. - AS, 2 shifts left, upward - increase ; decrease

Many of the resources devoted to the January 2009 U.S. stimulus package encouraged investment in research and development of new technologies​ (e.g., more​ fuel-efficient cars and wind and solar​ power). - Assume this policy results in positive technological change for the U.S. economy and​ "takes hold" at a time when the economy has been restored to a position of​ long-run equilibrium as depicted by point 1 in the figure to the right. Shift the LRAS curve in the appropriate direction. Shift one of the remaining curves such that a new short-run equilibrium is achieved that is not also a long-run equilibrium. Identify the new short-run equilibrium. - Compared to its original​ state, the economy in the​ short-run equilibrium at point 2 has output that is ... and inflation that is ... - However, a negative output gap now exists since ... , consequently the short-run aggregate supply curve (AS, 2) will shift ... - The shifts in the​ short-run aggregate supply curve continue​ until:

- LRAS, 2 shifts right ; AS, 2 shifts right/downward ; 2 shifts right/downward (where AD, 1 and AS, 2 intersect) - higher ; lower - (Y* < Y^P) ; down and to the right - All of the above are correct. (a new​ long-run equilibrium is attained. ; the AS curve intersects AD, 1 and LRAS, 2. ; the output gap falls to zero.)

In the United​ States, inflation increased significantly in the 1960s and 1970s.​ However, unemployment behaved very differently in the two decades. - Which of the following is true of the behavior of unemployment in the​ 1960s? - Which of the following is true of the behavior of unemployment in the​ 1970s?

- Much of the inflationary pressures were generated from​ demand-pull inflation policies due to highly expansionary fiscal and monetary policy pushing the aggregate demand curve far to the right. This helped to reduce unemployment to low levels. - Most of the inflation came from​ cost-push sources, such as adverse price​ shocks, declines in​ productivity, and sharp increases in inflation expectations. This resulted in substantial shifts of the​ short-run aggregate supply curve​ upward, and triggering spiraling inflation and higher unemployment.

In recent​ years, central banks have dramatically increased the amount of communication with market participants and the​ public, and at the same time in many of these​ countries, average inflation has declined and become less volatile. - Is this a coincidence that an increase in communication has led to a decline in average​ inflation? - Which of the following is likely to explain the connection between central bank communication and​ inflation?

- No - Increased communication has led to greater transparency and greater credibility of central banks and thus reduced inflation.

In recent​ years, central banks have dramatically increased the amount of communication with market participants and the​ public, and at the same time in many of these​ countries, average inflation has declined and become less volatile. - Is this a coincidence that an increase in communication has led to a decline in average​ inflation? - Which of the following is likely to explain the connection between central bank communication and​ inflation?

- No - Increased communication has led to greater transparency and greater credibility of central banks and thus reduced inflation.

During​ 2017, some Fed officials discussed the possibility of increasing interest rates as a way of fighting potential increases in expected inflation. - If the public came to expect higher inflation rates in the​ future, what would be the effect on the​ short-run aggregate supply​ curve? Show the effect of higher inflation expectations on the​ short-run aggregate supply curve. Show the new equilibrium.

- SRAS, 2 shifts left/upward ; e,2 shifts left/upward.

In​ Japan, the government and central bank have enacted policies recently to raise inflation permanently from persistently low​ levels, however inflation continues to remain near zero. - ​How, if at​ all, might credibility of the central bank explain the low inflation​ persistence?

- Since inflation has been near zero for many years in​ Japan, it has created a mindset among market participants and the public in Japan that even if the central bank or government​ acts, it likely will not be successful in raising inflation.

- During the global financial​ crisis, how was the Fed able to help offset the sharp increase in financial​ frictions, without the ability to lower interest rates​ further? - Did the​ Fed's policy​ work?

- The Fed engaged in asset purchases and liquidity​ provision, lowering interest rates and increasing aggregate demand. - No. The aggregate demand shock from the global financial crisis was so large that the​ Fed's policies were insufficient to fully stabilize economic activity and shift output back to potential.

An​ economy's aggregate demand is shown graphically as a​ downward-sloping curve. The position of this curve relative to the vertical axis is impacted by six basic factors.

- The Federal Reserve autonomously loosens monetary policy. : R - The Federal Reserve autonomously tightens monetary policy. : L - The government adopts ​ill-advised regulations that diminish the​ economy's overall efficiency. : X - The government rescinds ​ill-advised regulations that hamper the​ economy's overall efficiency. : X - The government allows previously enacted tax cuts to​ expire, resulting in much higher taxes for households. : L - The prospect of worsening inflation induces the Federal Reserve to tighten monetary policy. : X - Consumer pessimism spreads as the media reports disappointing news about the economy. : L - Consumer optimism spreads as the media reports encouraging news about the economy. : R - Actual output rises above potential​ output, creating ​"tightness" in resource markets. : X - Actual output falls below potential​ output, eliminating ​"tightness" in resource markets. : X - Foreign economies crash​, producing a substantial drop in net exports. : L - Foreign economies rebound​, producing a substantial rise in net exports. : R - Optimism within the business community induces a surge in planned business expenditures. : R - War breaks​ out, forcing the government to substantially enhance defense expenditures. : R - Peace breaks​ out, enabling the government to substantially curtail defense expenditures. : L

In the early​ 1970s, an unexpected productivity slowdown in the United States led most economists to believe that potential output was larger than it actually was. - How are policymakers likely to respond under this​ situation, and what do you expect to be the​ outcome?

- The economy is likely to experience high inflation as production will be higher than the sustainable level of production. ; Policymakers are likely to adopt overly expansionary policies that increase output above potential.

Suppose an econometric model based on past data predicts a small decrease in domestic investment when the Federal Reserve increases the federal funds rate. Assume that the Federal Reserve is considering an increase in the federal funds rate target to fight inflation and promote a low inflation environment that promotes investment and economic growth. - Which of the following is not an implication of the econometric​ model's predictions if individuals interpret the increase in the federal funds rate target as a sign that the Fed will keep inflation at low levels in the long run. - What would be​ Lucas's critique of this​ model?

- The increase in the federal funds rate implies an increase in real interest rates in the short run and long run.​ Therefore, the user cost of capital increases and investment decreases. - ​Lucas's critique will point out the fact that the model was most probably constructed by using past data in which domestic investment decreased after interest rates increased and that individuals might revise their expectations quite quickly and decide to alter the way in which they respond to changes in the interest rate.

In the United​ States, many observers have commented in recent years on the​ "political gridlock in Washington​ D.C." and referred to Congress as a​ "Do Nothing​ Congress". - Which of the following types of lag is referred to in the above​ statement?

- The legislative lag.

​"The appreciation of the dollar from 2012 to 2017 had a negative effect on aggregate demand in the United​ States." - Is this statement​ true, false, or​ uncertain?

- The statement is true. An appreciation of the U.S. dollar decreases net exports and according to aggregate demand and supply​ analysis, the aggregate demand curve shifts downward and to the​ left, thus reducing output.

- Many developing countries suffer from graft and endemic corruption. How does this help explain why these economies have typically high inflation and economic​ stagnation? - When these conditions​ occur, the level of potential output is ... and inflation is ... , thus creating the same effect as ... shock

- These conditions result in inefficiencies in​ markets, which reduce the​ long-run productive capacity of the​ economy, and thus act like a permanent negative supply shock. - reduced ; higher ; a permanent negative supply

In many countries around the​ world, the population is aging and large segments of the population are retiring or close to retirement. - What effect would this have on a​ country's long-run aggregate supply​ curve? What will happen to aggregate output as a​ result?

- The​ long-run aggregate supply curve of these countries is likely to shift to the left because of the reduction in the productive capacity of these countries. Aggregate output will decline as a result.

- How does a credible nominal anchor help improve the economic outcomes that result from a positive aggregate demand​ shock? - How does a credible nominal anchor help if a negative aggregate supply shock​ occurs?

- With a credible nominal​ anchor, inflation is more stable following the demand shock. - The decrease in output and the increase in inflation are less than under the absence of a credible nominal anchor.

To promote an economic expansion and an exit from the deflationary environment that the Japanese had been experiencing for the past fifteen​ years, the​ "Abenomics" aims at

- all of the above. (purchasing long-term bonds. ; increasing inflation target. ; increasing inflation expectations.)

Nonactivist policymakers believe that

- all of the above. (the​ self-correcting mechanism is very rapid. ; wages and prices are very flexible. ; government action is unnecessary.)

- A temporary negative supply shock would tend to result in ... inflation. This type of inflation is associated with the unemployment rate being ... its natural rate. - Increasing aggregate demand to reach an output target above potential output would tend to result in ... inflation. This type of inflation is associated with the unemployment rate being ... its natural rate.

- cost-push ; greater than - demand-pull ; less than

Implementing stabilization policy is made more difficult by the presence of various time lags. - The time it takes to collect and process the data that indicate how well the economy is faring is known as the - The time that policymakers may wait for data that support their initial impression of the current state of the economy is known as the - The time required for policymakers to put a policy into action once approved is known as the - The time to decide on the appropriate policy for the current economic situation is known as the - The time it takes for a policy to have an effect on the economy is known as the

- data lag - recognition lag - implementation lag - legislative lag - effectiveness lag

- A temporary positive supply shock will ... inflation and will ... aggregate output in the short run. - temporary positive supply shock will ... inflation and will ... aggregate output in the long run.

- decrease ; increase - not change ; not change

- Suppose the economy is starting from a situation of​ long-run equilibrium. In this​ case, we know that its equilibrium output ​(Y*) is ... its potential output (Y^P​). - Starting from its​ long-run equilibrium at point 1 in the figure to the​ right, suppose the economy experiences a temporary positive supply shock. Shift a single curve to show the initial short-run effect. Identify the new short-run equilibrium. - Compared to its original​ state, the economy in the​ short-run equilibrium at point 2 has output that is ... and inflation that is ... . - In this​ short-run equilibrium at point​ 2, labor markets would likely see increasing ... and corresponding stronger pressure on wages and costs that force firms to raise their ... at a more rapid rate. - Graphically, this chain reaction from wages to costs to prices produces shifts in the​ short-run aggregate supply curve ​(AS, 2​) that are ... - These shifts in the​ short-run aggregate supply curve result in output gaps that are ... and the economy is evolving toward an eventual new​ long-run equilibrium at which inflation and output​ are, compared to their original​ values, ... - Starting from its​ long-run equilibrium at point 1 in the figure to the​ right, suppose the economy experiences a temporary negative supply shock. Shift a single curve to show the initial short-run effect. Identify the new short-run equilibrium. - Compared to its original​ state, the economy in the​ short-run equilibrium at point 2 has output that is ... and inflation that is ... . - In this​ short-run equilibrium at point​ 2, labor markets would likely see increasing ... and corresponding stronger pressure on wages and costs that force firms to raise their ... at a more rapid rate. - Graphically, this chain reaction from wages to costs to prices produces shifts in the​ short-run aggregate supply curve ​(AS, 2​) that are ... - These shifts in the​ short-run aggregate supply curve result in output gaps that are ... and the economy is evolving toward an eventual new​ long-run equilibrium at which inflation and output​ are, compared to their original​ values, ...

- equal to - AS, 2 shifts right/downward ; 2 shifts right/downward. - higher ; lower - tightness ; prices - up and to the left - narrowing ; unchanged - AS, 2 shifts left/upward ; 2 shifts left/upward. - lower ; higher - slack ; prices - down and to the right - narrowing ; unchanged

- Suppose the economy is starting from a situation of​ long-run equilibrium. In this​ case, we know that its equilibrium output ​(Y*) is ... its potential output (Y^P​). - Starting from its​ long-run equilibrium at point 1 in the figure to the​ right, suppose the economy experiences a permanent positive supply shock. Shift the LRAS curve. Shift one of the remaining curves such that a new short-run equilibrium is achieved that is not also a long-run equilibrium. Identify the new short-run equilibrium. - Compared to its original​ state, the economy in the​ short-run equilibrium at point 2 has output that is ... and inflation that is ... - At the new​ short-run equilibrium, the output gap (Y*−Y^P) is ... - The negative output gap means that the aggregate supply curve (AS, 2​) will shift ... - The shifts in the​ short-run aggregate supply curve continue​ until: - Suppose the economy is starting from a situation of​ long-run equilibrium. In this​ case, we know that its equilibrium output ​(Y*) is ... its potential output (Y^P​). - Starting from its​ long-run equilibrium at point 1 in the figure to the​ right, suppose the economy experiences a permanent negative supply shock. Shift the LRAS curve. Shift one of the remaining curves such that a new short-run equilibrium is achieved that is not also a long-run equilibrium. Identify the new short-run equilibrium. - Compared to its original​ state, the economy in the​ short-run equilibrium at point 2 has output that is ... and inflation that is ... - At the new​ short-run equilibrium, the output gap (Y*−Y^P) is ... - The positive output gap means that the aggregate supply curve (AS, 2​) will shift ... - The shifts in the​ short-run aggregate supply curve continue​ until:

- equal to - LRAS, 2 shifts right ; AS, 2 shifts right/downward ; 2 shifts right/downward (intersection between AD, 1 and AS, 2) - higher ; lower - negative - down and to the right - All of the above are correct. (a new​ long-run equilibrium is attained. ; the AS curve intersects AD, 1 and LRAS, 2. ; the output gap falls to zero.) - equal to - LRAS, 2 shifts left ; AS, 2 shifts left/upward ; 2 shifts left/upward (intersection between AD, 1 and AS, 2) - lower ; higher - positive - up and to the left - All of the above are correct. (a new​ long-run equilibrium is attained. ; the AS curve intersects AD, 1 and LRAS, 2. ; the output gap falls to zero.)

- Chinese exports collapsed in late 2008 most likely because - Had the Chinese government elected to rely solely on the​ economy's self-correcting​ mechanism, how, aside from​ timing, would the​ long-run outcome have differed from that which the policy stimulus produced​ (which was the restoration of equilibrium at point 1 in this Figure, see Imgur)? - Given the relative size of the Chinese fiscal stimulus and its acknowledged success in restoring strong growth to the Chinese​ economy, one might cautiously​ conclude, with the U.S. economy still languishing well into​ 2010, that the comparable U.S. effort was ...

- incomes fell in its key export markets. - Only inflation would be lower. - inadequate

Suppose​ Okun's law can be expressed according to the following​ formula: U - U,n = -0.75 * (Y - Y^P) Assuming potential output grows at a steady rate of 2.5​% and that the natural rate of unemployment remains​ unchanged: - Unemployment will ... by ...% when real GDP decreases by one percentage point. - Real GDP will ... by ...% when unemployment decreases by two percentage points.

- increase ; 0.75 - increase ; 2.66 (%deltaU = -0.75 * (%deltaY - 2.5) %deltaY = -1.33%deltaU + 2.5 1% decrease in unemployment => 1.33% ; 2% => 2.66%)

- According to modern Phillips curve​ analysis, an increase in expected inflation​ would: - According to modern Phillips curve​ analysis, a price shock - like a significant increase in oil prices - would: - According to modern Phillips curve​ analysis, an increase in the unemployment gap​ would:

- increase the inflation rate by shifting the Phillips curve upward. - increase the inflation rate by shifting the Phillips curve upward. - decrease the inflation rate by moving downward and to the right along the Phillips curve.

- In the absence of the negative demand shock​ (precipitated by the Lehman Brothers bankruptcy) and the reversal of the oil price​ increase, the U.K. economy would likely have evolved back toward full employment via ... . - Even after the aggregate supply curve shifted rightward after July​ 2008, the severity of the negative demand shock hitting after the Lehman Brothers bankruptcy caused the U.K. economy to move ... potential output. - Once the U.K. economy sank to the​ short-run equilibrium at point 3 in this Figure (see Imgur), the restoration of equilibrium at full employment could come from the combined effects of aggressive expansionary macro policies and the​ economy's self-correcting mechanism. In terms of the ​AD-AS​ analysis, this restoration works itself out as

- its self-correcting mechanism. - farther from - both AD and AS shifting rightward.

- Inflation targeting can be used​ to: - Which of the following is not a part of this monetary policy strategy to achieve these​ goals?

- keep inflation under control and increase the credibility of monetary​ policymakers' commitment to price stability. - Public announcement of the procedural details of using all​ inflation-related policy variables.

If consumers reduce autonomous consumption​, describe how monetary policymakers would respond​ (if at​ all) to stabilize economic activity. Assume the economy starts at a​ long-run equilibrium. - A reduction in autonomous consumption ... aggregate demand, so monetary policymakers would pursue an autonomous ... of monetary policy to stabilize economic activity.

- reduces ; easing

Suppose the central bank is following a constant money growth​ rule, and the economy is hit with a severe economic downturn. Use aggregate supply and demand analysis to explain what the possible effect would be. - A severe economic downturn shifts the aggregate demand curve ... . If the central bank maintains a constant money growth rule​, this would ... - How does this reflect on the credibility of the central bank if it maintains a constant money growth rule? This ... the central​ bank's credibility because the central​ bank:

- sharply to the left ; be inadequate to fully stabilize output - reduces ; may be viewed by the public as not doing its job.

- Demand shocks are exogenous events that cause ... the aggregate demand curve. - Demand shocks that are negative are events that induce planned spending at any given inflation rate to ... ​, thus pushing the AD curve ... - Compared to negative demand​ shocks, positive demand shocks have ... effect on aggregate demand. - The top portion of the following table lists several demand shocks along with several exogenous events that do not affect the position of the aggregate demand curve.

- shifts in. - fall ; leftward. - the opposite. - The Federal Reserve autonomously tightens monetary policy. : N - The government adopts ​ill-advised regulations that diminish the​ economy's overall efficiency. : X - The government imposes much higher taxes on households. : N - A temporary disruption in oil production​ occurs, pushing oil prices higher. : X - Consumer optimism surges as the media reports encouraging news about the economy. : P - The​ nation's labor unions push forcefully for higher wages and expanded benefits. : X - Foreign economies rebound​, producing a substantial rise in net exports. : P - Sudden optimism within the business community induces a big jump in planned business expenditures. : P - Peace breaks​ out, enabling the government to substantially curtail defense expenditures. : N

- Supply shocks are exogenous events that cause ... the aggregate supply curve. - Supply shocks that are positive are events that induce, at any given inflation rate, ... in supply ​, thus shifting the AS curve ... - Compared to positive supply​ shocks, negative supply shocks have ... effect on aggregate supply. - Whether positive or​ negative, supply shocks that ultimately leave output and inflation unchanged are ... . - The top portion of the following table lists several supply shocks along with several exogenous events that do not affect the position of the aggregate supply curve.

- shifts in. - increase ; rightward. - the opposite. - temporary. - The Federal Reserve autonomously loosens monetary policy. : X - The government rescinds ​ill-advised regulations that hamper the​ economy's overall efficiency. : P - The U.S. dollar sharply depreciates​, suddenly raising the prices of imported inputs. : N - Foreign economies crash​, producing a substantial drop in net exports. : X - Phenomenally poor weather leads to dismal harvests of most grains. : N - The​ nation's labor unions passively accept lower wages and reduced benefits. : P - Startling advances in nanotechnology dramatically raise productivity across the economy. : P - Sudden optimism among firms induces a big jump in planned business expenditures. : X - Hurricanes blast the U.S. Gulf​ Coast, seriously damaging refining facilities. : N

Suppose three economies are hit with the same negative supply shock. In country​ A, inflation initially rises and output​ falls; then inflation rises more and output increases. In country​ B, inflation initially rises and output​ falls; then both inflation and output fall. In country​ C, inflation initially rises and output​ falls; then inflation falls and output eventually increases. What type of stabilization approach did country A take? - In country A, policymakers chose a policy to: - In country B, policymakers chose a policy to: - In country C, policymakers chose a policy to:

- stabilize output - stabilize inflation. - leave autonomous monetary policy unchanged. ; not respond

- Since the combination of the negative demand shocks and the​ pre-July 2008 negative supply shocks produced a sharply higher inflation rate​ (from 2.5% for 2006 to​ 5.0% in​ June, 2008), it can be deduced that the stronger shocks came from the ... side. - Had the Lehman Brothers bankruptcy and its severe aftershocks not​ occurred, the decline in oil prices after July 2008 would likely have ... the output decline sustained up to that point. - Since the​ short-run aggregate supply curve was moving rightward after July​ 2008, the consequences for output and employment from the sharp decline in aggregate demand following the Lehman Brothers bankruptcy were ... severe than they otherwise might have been. With the economy positioned in a​ short-run equilibrium far below potential output​ (point 3 in this Figure, see Imgur), the restoration of full employment could occur as a result of

- supply - partly reversed - less - all of the above. (an autonomous easing of monetary policy. ; the​ economy's self-correcting mechanism. ; an increase in government expenditures​ and/or a cut in taxes.)

- The aggregate demand curve slopes downward because a rise in inflation​ leads: - The​ short-run aggregate supply curve slopes upward because an increase in output relative to potential​ output:

- the monetary policy authorities to raise real interest rates. - creates tight labor and product markets that cause inflation to rise.

In what way is a permanent negative supply shock worse than a temporary negative supply​ shock? - Permanent negative supply shock is worse than a temporary negative supply shock because

- the​ long-run adverse effects of a permanent negative supply shock are permanent.

​"The more credible the policymakers who pursue an​ anti-inflation policy, the more successful that policy will​ be." - This statement is ...

- true

- If huge budget deficits cause the public to think that there will be higher inflation in the​ future, what will happen to the position of the​ short-run aggregate supply​ curve? - If huge budget deficits cause the public to think that there will be higher inflation in the future but have no effect on business or consumer​ optimism, what will happen to the position of the aggregate demand​ curve?

- ​Short-run aggregate supply will shift leftward. - Aggregate demand will not change.

In 2003 as the economy finally seemed poised to exit the prior​ recession, the Fed began worrying about a​ 'soft patch' in the​ economy, and in particular were worried about the possibility of deflation occurring. As a​ result, they proactively lowered the federal funds rate from​ 1.75% in late 2002 to​ 1% by​ mid-2003, the lowest the federal funds rate had been at the time. In​ addition, the Fed committed to keeping the federal funds rate at this level for a considerable period of time. This was considered a highly expansionary​ policy, and one that was seen by some as potentially inflationary and unnecessary. - Given the​ Fed's worry of a​ 'soft patch' in the economy and the possibility of​ deflation, fears of a zero lower bound likely raised concerns that the policy rate could become​ ... as a means of​ ... . - Show the initial condition of the economy in 2003. Show the impact of the Fed's federal funds rate policies. - On the assumption that the policy​ rate's zero lower bound was not​ encountered, the result of the​ Fed's policy would be to

- ​ineffective; increasing aggregate demand - MP, 2 shifts right/downward ; AS, 2 would not move/shift at all. - push AD​ rightward, increasing both output and inflation.

Which of the following would cause the​ short-run aggregate supply curve to shift upward and to the​ left?

A negative price shock.

What type of negative​ shock, if​ any, can pose a dilemma for​ policymakers?

A temporary negative supply shock.

What factors led to a decrease in both the unemployment rate and the inflation rate in the​ 1990s?

An increased proliferation of computer technology. ; Changes in the health care industry, which greatly reduced medical care costs relative to other goods and services.

What does it mean for the inflation gap to be negative?

An inflation gap is negative when the current inflation rate is less than the inflation target.

Which of the followings is NOT true about the word​ "autonomous" that economists​ use?

Changes in autonomous components are associated with movements along a curve.

What does the Lucas critique say about the limitations of our current understanding of the way the economy​ works?

Econometric models that do not incorporate rational expectations ignore any effects of changing​ expectations, and thus are unreliable for evaluating policy options.

The fact that it takes a long time for firms to bring new plant and equipment on line is an illustration of the concept related to what policy​ problem?

Effectiveness lag.

​"If prices and wages are perfectly​ flexible, then γ = 0 and changes in aggregate demand have a smaller effect on​ output." Is this statement​ true, false, or​ uncertain? Explain your answer.

False. As prices and wages become more​ flexible, γ becomes larger, and thus for a given aggregate demand​ shock, the effects on output are smaller.

​"If autonomous spending​ falls, the central bank should lower its inflation target in order to stabilize​ inflation." Is this statement​ true, false, or​ uncertain? Explain your answer.

False. If the central bank pursues stabilization​ policy, it can stabilize both inflation and output simultaneously with an autonomous easing of policy.

Which of the following is a correct statement about the effect of budget deficits when the central bank is pursuing an​ anti-inflation policy?

If the government decreases budget deficits while the central bank is pursuing an​ anti-inflation policy, the public is likely to find central bank policies more​ credible, and thus the loss of output required to reduce inflation may be less.

How would an unexpected change in the equilibrium real fed funds rate be an argument against using a Taylor rule for monetary policy​ implementation?

It is difficult to measure the change in equilibrium real fed funds rate and using Taylor rule might be too rigid. Taylor rule does not easily incorporate the tool of judgment as more information is received.

In the aftermath of the​ 2007-2008 financial crisis in the United​ States, labor mobility has decreased significantly. - ​How, if at​ all, might this affect the natural rate of​ unemployment?

It is likely to increase because structural unemployment will increase.

In some​ countries, the president chooses the head of the central bank. The same president can fire the head of the central bank and replace him or her with another director at any time. What is the implication of such a situation for the conduct of monetary​ policy? Do you think the central bank will follow a monetary policy​ rule, or engage in discretionary​ policy?

It is quite plausible that the conduct of monetary policy would be discretionary.

What is the significance of the Lucas critique of econometric policy​ evaluation?

It points out an econometric model based on past data may prove to be unreliable for evaluating policy options.

Central banks that engage in inflation targeting usually announce the inflation target and time period for which that target will be relevant. In​ addition, central bank officials are held accountable for their actions​ (e.g., they could be fired if the target is not​ reached), which is also public information. Why is transparency such a fundamental ingredient of inflation​ targeting?

It provides an extra incentive for central banks to attain their goals and makes their policy more credible.

... flexible wages and prices imply that the short−run aggregate supply curve is ... .

More ; steeper.

If stagflation is bad​ (high inflation and high​ unemployment), does this necessarily mean that very low inflation and very low unemployment is​ good?

No. Having too low of an inflation rate could mean that an adverse shock could result in a deflationary episode which can be particularly damaging. ; No. If unemployment is too low relative to the natural rate of​ unemployment, future inflation risk could build even if the current inflation rate remains relatively low.

If the​ economy's self-correcting mechanism works​ slowly, should the government necessarily pursue discretionary policy to eliminate​ unemployment?

Not necessarily. It is still possible that activist policy to eliminate unemployment will cause​ demand-pull and​ cost-push inflation.

What will happen if policymakers erroneously believe that the natural rate of unemployment is​ 7%, when it is actually​ 5%, and pursue stabilization​ policy?

Policymakers will likely pursue contractionary​ policy, which could lead to deflation and a severe economic downturn.

Which of the following is not an argument either for or against​ rules?

Rules can be flexible so policymakers will still have the same flexibility as in discretionary policy.

Why did China fare much better than the United States and the United Kingdom during the​ 2007-2009 financial​ crisis?

The Chinese economy is less closely tied to the functioning of financial markets than the economies of the United States and the United Kingdom. ; China pursued an autonomous easing of monetary policy.

As part of its response to the global financial​ crisis, the Fed lowered the federal funds rate target to nearly zero by December 2008 and nearly tripled the monetary base between 2008 and​ 2011, a considerable easing of monetary policy.​ However, survey-based measures of​ five- to​ ten-year inflation expectations remained low through most of this period. - Which of the following statements on the​ Fed's credibility to fight inflation is​ correct?

The Fed has a high level of credibility.

As the labor force becomes more productive over​ time, how does that affect the​ long-run aggregate supply​ curve?

The LRAS curve shifts to the right because the existing labor​ force, along with a given amount of capital and other​ resources, can produce more output.

In what ways is the Volcker disinflation considered a​ success? What are the negative aspects of​ it?

The Volcker disinflation was successful in bringing inflation down with contractionary​ policies; however, these policies resulted in two recessions and a significant increase in unemployment.

Suppose that the public believes that a newly announced​ anti-inflation program will work and so lowers its expectations of future inflation. What will happen to aggregate output and the inflation rate in the short​ run?

The inflation rate will fall and aggregate output will rise.

In​ general, how does a Central​ Bank's lack of credibility as an inflation fighter affect the aggregate supply​ curve?

The public will have higher inflation​ expectations, which will shift the aggregate supply curve up and to the​ left; thus, reducing output.

​If, in a surprise​ victory, a new administration is elected to office that the public believes will pursue inflationary​ policy, predict what might happen to the level of output and​ inflation, according to the traditional model​, even before the new administration comes into power.

There will be no predicted change in inflation or output.

Why did the oil price shocks of the 1970s affect the economy differently than the oil price shocks in​ 2007?

The​ Fed's credibility that it would keep inflation under control was stronger in 2007 than during the 1970s.

Why does the​ self-correcting mechanism stop working when the policy rate hits the zero lower​ bound?

The​ self-correcting mechanism stops working because the falling inflation produced by a negative output gap produces higher rather than lower real interest rates when the policy rate hits the zero lower​ bound, and this increase depresses planned spending and further widens the output gap.

Assume a majority of governors are reluctant to increase interest rates to fight inflation for fear of causing too much unemployment in the short run. How is this situation most likely to affect the​ Fed's credibility?

This could be troublesome for the​ Fed's credibility, as it might require​ more-than-necessary increases in interest rates to show the public that the Fed still focuses on fighting inflation.

​"The more credible the policymakers who pursue an​ anti-inflation policy, the more successful that policy will​ be." Is this statement​ true, false, or​ uncertain? Explain your answer.

True. If expectations affect the​ wage- and​ price-setting process, a credible​ anti-inflation policy will reduce inflation faster and at lower costs.

​"The Lucas critique by itself casts doubt on the ability of discretionary stabilization policy to be​ beneficial." Is this statement​ true, false, or​ uncertain? Explain your answer.

True. The Lucas critique indicates that the effect of policy on inflation and output depends on​ expectations, making it harder to create a beneficial policy.

​"Policymakers would never respond by stabilizing a temporary positive supply​ shock." Is this statement​ true, false, or​ uncertain? Explain your answer.

Uncertain. If the shock is large​ enough, it could reduce inflation​ and/or increase output such that it could create more variability and uncertainty in​ inflation, which could be destabilizing to an economy.

How can​ demand-pull inflation lead to​ cost-push inflation?

When a​ demand-pull inflation produces higher inflation​ rates, it could prompt workers to demand higher wages in anticipation of future higher​ inflation, creating​ cost-push inflation.

Why are central banks so concerned about inflation​ expectations?

When inflation expectations​ rise, the​ short-run aggregate supply curve shifts​ up, leading to higher actual inflation in the short run.

As monetary policymakers care more about inflation​ stabilization, the slope of the aggregate demand curve becomes flatter. How does the resulting change in the slope of the aggregate demand curve help stabilize inflation when the economy is hit with a temporary negative supply​ shock? How does this affect​ output?

When the aggregate demand curve becomes​ flatter, then for a given negative supply​ shock, it implies that the increase in inflation is smaller and the reduction in output is larger.

How does the policy rate hitting a floor of zero lead to an upward sloping aggregate demand​ curve?

When the policy rate hits a floor of the​ zero, the positive relationship between inflation and the real interest rate embodied by the MP curve becomes​ negative, and this reversal results in lower inflation producing a higher real interest​ rate, and hence lower planned​ spending, i.e., an upward sloping AD curve.

Is stabilization policy more likely to be conducted with monetary policy or fiscal​ policy? Why?

With monetary policy - as fiscal policy takes longer to deliberate and enact.

The​ short-run aggregate supply curve​ has:

a positive slope because as the inflation rate​ increases, so does the quantity of output supplied.

A theory of aggregate economic fluctuations called real business cycle theory holds that

aggregate supply shocks do affect the natural rate of output.

Assuming the economy is starting at the natural rate of output and everything else held​ constant, the effect of​ ... in aggregate​ ... is a rise in both inflation and output in the short-run, but in the long-run the only effect is a rise in inflation.

an​ increase; demand

Suppose the U.S. economy is producing at the natural rate of output. An appreciation of the U.S. dollar will cause​ ... in real GDP in the short run and​ ... in inflation in the short​ run, everything else held constant.​ (Assume the appreciation causes no effects in the supply side of the​ economy.)

a​ decrease; a decrease

Suppose the inflation rate remains relatively​ constant, and output decreases and the unemployment rate increases. This is possible​ if:

both the aggregate supply and demand curves shift horizontally to the left by the same amount.

The financial crisis that began in August 2007 in the United​ States:

caused a collapse of​ China's exports and the Chinese government used a fiscal stimulus package to restore economic activity.

One way to derive aggregate demand is by looking at its four component​ parts, which​ are:

consumer​ expenditures, planned investment​ spending, government​ spending, and net exports.

Because policies in the United States were too expansionary from 1965 through​ 1973, the U.S. suffered

demand-pull inflation.

The aggregate demand curve is the total quantity of an​ economy's

final goods and services demanded at different inflation rates.

The following graphs (see Imgur) describe two different​ short-run aggregate supply curves. In which situation is the case for nonactivist policy​ stronger? Explain why.

graph ​(a) because in that graph prices and wages are more​ flexible, necessitating bigger changes in policy for the same change in output.

A​ "conservative" central​ banker:

has a strong aversion to inflation.

An advantage of monetary policy over fiscal policy is that monetary policy has​ shorter:

implementation and legislative lags.

Cost-push inflation is considered to be a monetary phenomenon​because:

it cannot occur unless the monetary authorities accommodate by increasing the rate of monetary growth.

Aggregate​ demand-aggregate supply analysis suggests that if the Federal Reserve wants to increase its inflation rate target in the long​ run:

it should cause the monetary policy curve to shift downward.

The Federal Reserve pursued inherently recessionary policies in the early 1980s​ to:

lower the inflation​ rate, which had spun out of control.

The divine coincidence occurs​ when:

monetary policies accomplish the dual objectives of stabilizing inflation and economic activity.

When the economy suffers a permanent negative supply shock and the central bank does not respond by changing the autonomous component of monetary​ policy, then

output will be lower.

Lucas argued that when policies change or new policies are​ implemented, public expectations are likely to change. The implication of this argument is​ that:

relationships established using econometric models also change.

A positive supply shock causes​ ... to​ ... .

short-run aggregate​ supply; increase

When the unemployment rate is above the natural rate of​ unemployment, there is ... in the labor market and output is ... potential. This causes the short-run aggregate supply curve to ... . Hence inflation ... and output ... over time, until the economy reaches a ... equilibrium.

slack ; below ; shift downward ; decreases ; increases ; long-run

When Milton Friedman said that​ "inflation is always and everywhere a monetary​ phenomenon," he meant​ that:

sustained increases in the price level are always the result of money supply growth.

Policy makers cannot achieve both price stability and economic activity stability when facing

temporary supply shocks.

The time it takes for policy makers to obtain data indicating what is happening in the economy is called

the data lag.

The time it takes for policy makers to change policy instruments once they have decided on the new policy is called

the implementation lag.

Greater central bank independence can make the​ time-inconsistency problem worse​ because:

there is less formal accountability by central banks to pursue stable inflation policies.

In the long​ run:

there is no conflict between stabilizing inflation and economic activity in response to shocks.

​"Because government policymakers do not consider inflation​ desirable, their policies cannot be the source of​ inflation." Is this statement​ true, false, or​ uncertain? Explain your answer.

​False, because budget deficits or government policy goals such as high employment can create inflation.

If the public expects the Fed to pursue a policy that is likely to raise​ short-term interest rates permanently to​ 12%, but the Fed does not go through with this policy​ change, what will happen to​ long-term interest​ rates?

​Long-term interest rates will fall.

​"If the data and recognition lags could be​ reduced, discretionary policy would more likely be beneficial to the​ economy." Is this statement​ true, false, or​ uncertain? Explain your answer.

​True, because without such​ lags, discretionary policy could more quickly change aggregate​ demand, avoiding overshooting and excessive variability in the price level.

Many economists are worried that a high level of budget deficits may lead to inflationary monetary policies in the future. Could these budget deficits have an effect on the current rate of​ inflation?

​Yes, if these policies are fully​ anticipated, it could lead to a shift in​ short-run aggregate supply.

In the period 1965 through the 1970s, policymakers pursued ... policies in order to achieve ... .

​expansionary; high employment