Macroeconomics Chp. 10, 11, 12

Changes in monetary policy shift the

LM curve.

In the Keynesian-cross model, fiscal policy has a multiplied effect on income because fiscal policy

changes income, which changes consumption, which further changes income.

In the IS-LM model, changes in taxes initially affect planned expenditures through

consumption.

An unexpected deflation can change demand by redistributing wealth from

debtors to creditors, thus lowering consumption.

According to the IS-LM model, if Congress raises taxes but the Fed wants to hold the interest rate constant, then the Fed must ______ the money supply

decrease

If a liquidity trap does exist, then ______ policy will not be effective in increasing income when interest rates reach very ______ levels

monetary; low

When drawn on a graph with income along the horizontal axis and the interest rate along the vertical axis, the IS curve generally

slopes downward and to the right.

Using the IS-LM analysis, if the LM curve is not horizontal, the multiplier for an increase in government spending is ______ for an increase in government purchases using the Keynesian-cross analysis

smaller than the multiplier

Equilibrium levels of income and interest rates are ______ related in the goods and services market, and equilibrium levels of income and interest rates are ______ related in the market for real money balances

negatively; positively

The IS-LM model is generally used

only in the short run.

A short-run aggregate supply curve shows fixed ______, and a long-run aggregate supply curve shows fixed ______

prices; output

According to the theory of liquidity preference, if the supply of real money balances exceeds the demand for real money balances, individuals will

purchase interest-earning assets in order to reduce holdings of non-interest-bearing money.

If expected inflation equals 3 percent and monetary policymakers push the nominal interest rate to 1 percent, the real interest rate equals ______ percent

-2

(Exhibit: Short Run to Long Run) Based on the graph, if the economy starts from a short-term equilibrium at A, then the long-run equilibrium will be at ____ with a _____ price level

B; lower

An increase in income raises money ______ and ______ the equilibrium interest rate

demand; raises

The short run refers to a period

during which prices are sticky and unemployment may occur.

If the Fed reduces the money supply by 5 percent and the quantity theory of money is true, then

every point on the aggregate demand curve moves 5 percent to the left.

(Exhibit: Keynesian Cross) In this graph, if firms are producing at level Y1, then inventories will ______, inducing firms to ______ production

fall; increase

According to the quantity theory of money, if output is higher, ______ real balances are required, and for fixed M this means ______ P

higher; lower

Most economists believe that the classical dichotomy

holds approximately in the long run but not at all in the short run.

A 5 percent reduction in the money supply will, according to most economists, reduce prices 5 percent of what but

in the long run but lead to unemployment in the short run.

An explanation for the slope of the LM curve is that as

income rises, money demand rises, and a higher interest rate is required.

The version of Okun's law studied in Chapter 10 assumes that with no change in unemployment, real GDP normally grows by 3 percent over a year. If the unemployment rate fell by 1 percentage point over a year, Okun's law predicts that real GDP would

increase by 5 percent.

In the IS-LM model under the usual conditions in a closed economy, an increase in government spending increases the interest rate and crowds out

investment.

The monetary transmission mechanism works through the effects of changes in the money supply on

investment.

According to the theory of liquidity preference, the supply of real money balances

is fixed.

If the Fed accommodates an adverse supply shock, output falls ______ and prices rise ______

less; more

If Congress passed a tax increase at the request of the president to reduce the budget deficit, but the Fed held the money supply constant, then the two policies together would generally lead to ______ income and a ______ interest rate

lower; lower

The IS curve plots the relationship between the interest rate and ______ that arises in the market for ______

national income; goods and services

The aggregate demand curve is the ______ relationship between the quantity of output demanded and the ______

negative; price level

Okun's law is the ______ relationship between real GDP and the ______

negative; unemployment rate

If the short-run aggregate supply curve is horizontal and the Fed increases the money supply, then

output and employment will increase in the short run.

Starting from long-run equilibrium, if the velocity of money increases (due to, for example, the invention of automatic teller machines) and no action is taken by the government

output will rise in the short run and prices will rise in the long run.

(Exhibit: IS-LM Fiscal Policy) Based on the graph, starting from equilibrium at interest rate r1 and income Y1, a tax cut would generate the new equilibrium combination of interest rate and income

r2, Y3

(Exhibit: IS-LM Fiscal Policy) Based on the graph, starting from equilibrium at interest rate r1 and income Y1, a decrease in government spending would generate the new equilibrium combination of interest rate and income:

r3, Y2

An adverse supply shock ______ the short-run aggregate supply curve ______ the natural level of output

raises; and may also lower

Monetary neutrality, the irrelevance of the money supply in determining values of _____ variables, is generally thought to be a property of the economy in the long run

real

An increase in the interest rate

reduces planned investment, because the interest rate is the cost of borrowing to finance investment projects.

Stabilization policy refers to policy actions aimed at

reducing the severity of short-run economic fluctuations.

When bond traders for the Federal Reserve seek to increase interest rates, they ______ bonds, which shifts the ______ curve to the left

sell; LM

Long-run growth in real GDP is determined primarily by ______, while short-run movements in real GDP are associated with ______

technological progress; variations in labor-market utilization

A supply shock does not occur when

the Fed increases the money supply.

Possible explanations put forth for the Great Depression do not include

the Pigou effect.

The interaction of the IS curve and the LM curve together determine

the equilibrium level of the interest rate and output.

The natural level of output is

the level of output at which the unemployment rate is at its natural level.

The vertical long-run aggregate supply curve satisfies the classical dichotomy because the natural rate of output does not depend on

the money supply.

The aggregate demand curve generally slopes downward and to the right because, for any given money supply M a higher price level P causes a ______ real money supply M/P, which ______ the interest rate and ______ spending

lower; raises; reduces

A movement along an aggregate demand curve corresponds to a change in income in the IS-LM model ______, while a shift in an aggregate demand curve corresponds to a change in income in the IS-LM model ______

resulting from a change in the price level; at a given price level

The relationship between the quantity of goods and services supplied and the price level is called

aggregate supply.

An increase in investment demand for any given level of income and interest rates—due, for example, to more optimistic "animal spirits"—will, within the IS-LM framework, ______ output and ______ interest rates

increase; raise

The IS and LM curves together generally determine

both income and the interest rate.

Business cycles are

irregular and unpredictable.

(Exhibit: IS-LM to Aggregate Demand) Based on the graph, if LM1 shifts to LM2 because the price level decreases from P1 to P2 then, holding other factors constant:

this represents a movement down the aggregate demand curve.

The debt-deflation theory of the Great Depression suggests that an ______ deflation redistributes wealth in such a way as to ______ spending on goods and services

unexpected; reduce

In the Keynesian-cross model, actual expenditures differ from planned expenditures by the amount of

unplanned inventory investment.

In the Keynesian-cross model, if the MPC equals 0.75, then a $1 billion increase in government spending increases planned expenditures by ______ and increases the equilibrium level of income by ______

$1 billion; more than $1 billion

If MPC = 0.75 (and there are no income taxes) when G increases by 100, then the IS curve for any given interest rate shifts to the right by

400.

Analysis of the short and long runs indicates that the ______ assumptions are most appropriate in ______

Keynesian; the short run, whereas the classical assumptions are most appropriate in the long run.

An increase in the money supply shifts the ______ curve to the right, and the aggregate demand curve ______

LM: shifts to the right

Exhibit: Supply Shock) Assume that the economy is at point B. With no further shocks or policy moves, the economy in the long run will be at point:

A.

(Exhibit: Supply Shock) In this graph, assume that the economy starts at point A and there is a favorable supply shock that does not last forever. In this situation, point ______ represents short-run equilibrium and point ______ represents long-run equilibrium:

E; A

Changes in fiscal policy shift the

IS curve.

One policy response to the U.S. economic slowdown of 2001 was tax cuts. This policy response can be represented in the IS-LM model by shifting the ______ curve to the ______

IS; right

A tax cut shifts the ______ to the right, and the aggregate demand curve ______

IS; shifts to the right

(Exhibit:Shift in Aggregate Demand) In this graph, initially the economy is at point E, with price P0 and output Y. Aggregate demand is given by curve AD0, and SRAS and LRAS represent, respectively, short-run and long-run aggregate supply. Now assume that the aggregate demand curve shifts so that it is represented by AD1. The economy moves first to point ______ and then, in the long run, to point ______:

C; B

An increase in consumer saving for any given level of income will shift the

IS curve downward and to the left.

According to classical theory, national income depends on ______, while Keynes proposed that ______ determined the level of national income

aggregate supply; aggregate demand

The price level decreases and output increases in the transition from the short run to the long run when the short-run equilibrium is _____ the natural rate of output in the short run

below

When planned expenditure is drawn on a graph as a function of income, the slope of the line is

between zero and one.

If Central Bank A cares only about keeping the price level stable and Central Bank B cares only about keeping output at its natural level, then in response to an exogenous decrease in the velocity of money

both Central Bank A and Central Bank B should increase the quantity of money.

(Exhibit: Market for Real Money Balances) Based on the graph, if the interest rate is r1, then people will ______ bonds and the interest rate will ______

buy; fall

(Exhibit: Policy Interaction) Based on the graph, starting from equilibrium at interest rate r3, income Y2, IS1, and LM1, if there is an increase in government spending that shifts the IS curve to IS2, then in order to keep the interest rate constant, the Federal Reserve should _____ the money supply shifting to _____

increase; LM2

According to the theory of liquidity preference, tightening the money supply will ______ nominal interest rates in the short run, and, according to the Fisher effect, tightening the money supply will ______ nominal interest rates in the long run

increase; decrease

If a short-run equilibrium occurs at a level of output above the natural rate, then in the transition to the long run prices will ______ and output will ______

increase; decrease

A variable that links the market for goods and services and the market for real money balances in the IS-LM model is the

interest rate.

A liquidity trap occurs when

interest rates fall so low that monetary policy is no longer effective.

If taxes are raised, but the Fed prevents income from falling by raising the money supply, then

investment rises but consumption falls.

Over the business cycle, investment spending ______ consumption spending

is more volatile than

When firms experience unplanned inventory accumulation, they typically

lay off workers and reduce production.

The spending hypothesis suggests that the Great Depression was caused by a

leftward shift in the IS curve.

John Maynard Keynes wrote that responsibility for low income and high unemployment in economic downturns should be placed on

low aggregate demand.

The theory of liquidity preference implies that, other things being equal, an increase in the real money supply will

lower the interest rate.

When the Federal Reserve reduces the money supply, at a given price level the amount of output demanded is ______ and the aggregate demand curve shifts ______

lower; inward

Assume that the economy begins in long-run equilibrium. Then the Fed reduces the money supply. In the short run ______, whereas in the long run prices ______ and output returns to its original level

output decreases and prices are unchanged; fall

A decrease in the real money supply, other things being equal, will shift the LM curve

upward and to the left.