Week 2
If the nominal interest rate is 20% per year, how much money can an individual borrow today if she wants to repay $100 in one year?
$83.33
The Phillips curve is given by πt=πet+(m + z)− α ut. Rewrite this relation as a relation between the deviation of the unemployment rate from the natural rate, inflation, and expected inflation.
(u(t)-u(n)) = -pi(t)-pi(et)/alpha
If you look mainly at what the long−run trends have been for inflation when trying to predict what inflation will be this year, then you believe that θ is near
0
If you look mainly at what the inflation rate was last year when trying to predict what inflation will be this year, then you believe that θ is near_______
1
The real wage implied by the price-setting behavior of firms having some market power is given by _______
1/(1+m)
Suppose that the Phillips curve is given by πt=πet+(m + z)−α ut and expected inflation is given by πet= (1 −θ) π + θπt−1. If θ = 1, m = 0.02, z = 0.08, and α = 2.5, what would be the natural rate of unemployment? The natural rate of unemployment would be _______
4.00%
If the nominal interest rate 8% and expected inflation 3%, the expected real interest rate in year t is approximately:
5%
If the nominal policy interest rate is 8% and the expected rate of inflation is 3%, the value for the vertical intercept of the LM curve is ______
5%
Consider an economy where the nominal interest rate is 6.6% and the real interest rate is −1.2%. The expected inflation rate is ____
7.8%
Use the information provided below to answer the following questions. The non−institutional civilian population is 250 million, of which 100 million are employed and 10 million are unemployed. Based on the information above, the unemployment rate is
9.1 percent
Why is it so important when the nominal policy interest rate is at the Zero Lower Bound to maintain a positive expected rate of inflation?
A low or negative expected rate of inflation results in an increase in real borrowing costs when the risk premium goes up. AND A positive expected rate of inflation allows the central bank to keep real borrowing costs relatively low when the risk premium rises. AND A positive expected rate of inflation enables the central bank to significantly offset any increase in the risk premium. D. ALL OF THE ABOVE
Consider the job of a delivery person and a computer network administrator. In which of these jobs does a worker have more bargaining power?
A network administrator would have more bargaining power because the job is more skilled.
Why is it so important when the nominal policy interest rate is at the Zero Lower Bound to maintain a positive expected rate of inflation?
A positive expected rate of inflation enables the central bank to significantly offset any increase in the risk premium. AND A positive expected rate of inflation allows the central bank to keep real borrowing costs relatively low when the risk premium rises. AND A low or negative expected rate of inflation results in an increase in real borrowing costs when the risk premium goes up. ALL OF THE ABOVE
What is the effect of wage indexation on the relation between π and u?
As indexation rises, inflation becomes more sensitive to the gap between the unemployment rate and natural rate.
Which of the following statements are true?
A bank's balance sheet shows that total assets equal total liabilities plus equity capital.
Which of the following are implications of the equation you identified above? (Check all that apply.)
Because expected inflation is typically positive, the real interest rate is typically lower than the nominal interest rate. Your answer is correct. B. When expected inflation equals zero, the nominal interest rate and the real interest rate are equal. The expected rate of inflation can be discerned by examining the difference between the nominal interest rate and the real interest rate.
The two factors in bond markets that lead to a positive risk premium are (Check only two.)
Bondholders' degree of risk aversion. and The probability of default.
Which of the following factors determines the risk premium that bond holders require to hold bonds? (Check all that apply.)
Bond holders' degree of risk aversion. and Borrowers' probability of default.
Given the answers above and the material in the text, why might recapitalization be a better policy than buying the troubled assets?
Buying trouble assets will at best provide a bank liquidity but not necessarily positive capital. AND Unless the government is willing to buy assets at above market prices, buying assets does not mean bank capital will remain positive. AND The direct infusion of capital improves the solvency of the bank. ALL OF THE ABOVE
Identify how m and z may explain variations in the natural rate of unemployment across countries and across time.
Differences in both m and z can explain variation across countries and across time.
Nominal and real interest rates around the world There are a few episodesLOADING... of negative nominal interest rates around the world. Some may or may not be in play as you read this book. The Swiss nominal policy rate, the Swiss equivalent of the federal funds rate, was negative from 2014 and 2018. If so, why not hold cash instead of bonds?
Even with negative yields, bonds allow investors to achieve some degree of portfolio diversification. AND Bonds with negative yields will still be profitable to hold if bond yields are expected to decrease even further. AND Foreign investors, particularly those from struggling emerging market economies, may be willing to "pay for safety." ALL OF THE ABOVE
Consider the following statement: The Phillips curve implies that when unemployment is high, inflation is low, and vice versa. Therefore, we may experience either high inflation or high unemployment, but we will never experience both together. Is this statement true, false, or uncertain? Choose the answer that best explains.
False. If inflation expectations are high, it is possible to have high inflation and high unemployment simultaneously.
Consider the following statement: As long as we do not mind having high inflation, we can achieve as low a level of unemployment as we want. All we have to do is increase the demand for goods and services by using, for example, expansionary fiscal policy. Is this statement true, false, or uncertain? Choose the answer that best explains.
False. This would require not merely high inflation but ever-increasing inflation because expectations adjust.
Why is the natural rate of unemployment also called the nonaccelerating inflation rate of unemployment (NAIRU)?
If the central bank tries to hold unemployment below the natural rate, it will cause inflation to increase.
Which of the following best explains why the increase in the markup causes the natural rate of unemployment to rise?
It shifts the price-setting relation downward, decreasing the real wage.
The text proposes the following model of expected inflation πet = (1 − θ) π + θ πt−1 What do we know about your process of the formation of expected inflation when θ = 1?
Last year's inflation rate will be the only input for you to revise your estimates for this year's expected rate regardless of what the long-run average inflation rate is.
What do we know about your process of the formation of expected inflation when θ= 1?
Last year's inflation rate will be the only input for you to revise your estimates for this year's expected rate regardless of what the long-run average inflation rate is.
Which of the following is considered out of the labor force?
NOT: The unemployed, Those individuals who have started searching for employment for the first time, Those who worked full time, but in a family business, Those temporarily laid off who will soon be recalled. Answer is: none of the above.
Now suppose the government's enforcement of existing antitrust legislation becomes less stringent. In this case, the______ shifts _______ and the natural rate of unemployment ________
PS; down; rises
The text proposes the following model of expected inflation πet = (1 − θ) π + θ πt−1 What do we know about your process of the formation of expected inflation when θ = 0?
Regardless of what inflation was last year, you would expect it to be at the long-run average inflation rate this year.
What do we know about your process of the formation of expected inflation when θ= 0?
Regardless of what inflation was last year, you would expect it to be at the long-run average inflation rate this year.
In response to the financial crisis, policymakers enacted an assortment of corrective measures. Which of the following were among these?
Stimulation of demand via fiscal policy. AND Efforts to strengthen the financial system via financial policies. AND Attempts to reduce borrowing costs for consumers and firms.
he formula assumes that payment upon default is zero. In fact, it is often positive. How would you change the formula in this case?
The final term would become p "times" some fraction of (1+i+x).
What happens to inflation when θ = 1 and unemployment is kept at the natural rate of unemployment?
The inflation rate stays constant from one year to the next.
In the previous chapter, we derived the natural rate of unemployment. What condition on the price level and the expected price level was imposed in that derivation?
The natural rate is the unemployment rate at which the actual price level is equal to the expected price level.
The two factors in bond markets that lead to a positive risk premium are (Check only two.)
The probability of default and Bondholders' degree of risk aversion.
In the mid-1980s, a famous supermodel once said that she would not get out of bed for less than $10,000 (presumably per day). Which of the following statements about the reservation wage is correct?
The wage that you were paid for your first job most likely was greater than your reservation wage.
What happens to inflation when θ = 1 and unemployment is kept below the natural rate of unemployment?
There will be an increasing inflation rate.
How does the natural rate of unemployment vary with the markup?
When the markup increases, the natural rate of unemployment will increase.
Which of the following is true regarding the natural rate of unemployment? (Check all that apply.)
When unemployment is at the natural rate, the inflation rate is constant. This is the correct answer. B. It is the unemployment rate at which the actual price level is equal to the expected price level. This is the correct answer. C. It is the unemployment rate at which the actual inflation rate is equal to the expected inflation rate.
Recall that in the previous chapter the equation for wage determination took the form: W = Pe F(u, z) and that the equation for price determination took the form: P = (1 + m) W Given these equations, what do you know about the relationship between the expected price and the price? A decrease in the expected price will result in _________
a decrease
Which of the following would not lead to a decrease in the actual inflation rate?
a decrease in the unemployment rate
If investors become less risk averse and/or less concerned about the health of the financial system, consumers and firms are likely to see _______ in the rate they pay to obtain funds.
a fall
Suppose we wish to examine the determinants of the equilibrium real wage and equilibrium level of employment (N). In a graph with the real wage on the vertical axis, and the level of employment on the horizontal axis, the price−setting relation will now be
a horizontal line.
In the Phillips curve equation, which of the following will cause an increase in the current inflation rate?
a reduction in the unemployment rate, an increase in the expected inflation rate, an increase in the expected inflation rate ALL OF THE ABOVE
U.S. data covering the 1996-2014 period show that the proportion of unemployed workers finding jobs has
a strong inverse relationship with the unemployment rate.
U.S. data covering the 1996-2014 period show that the separation rate has
a strong positive relationship with the unemployment rate.
An increase in the expected price will result in _________ in prices
an increase
If we view wages as being determined by worker−employer bargaining, then lower unemployment strengthens workers' bargaining power. This indicates that a decrease in unemployment leads to _________ in the nominal wage.
an increase
In equilibrium, the effect of an increase in worker bargaining power is _________ in the natural rate of unemployment and _________ in the real wage
an increase; no change
Suppose we wish to examine the determinants of the equilibrium real wage and equilibrium level of employment (N). In a graph with the real wage on the vertical axis, and the level of employment on the horizontal axis, the wage−setting relation will now be
an upward sloping line.
he leverage ratio is the ratio of a bank's
assets divided by capital.
Suppose the probability that a particular bond issuer (firm) will default becomes lower. If at the same time, the risk aversion of bond holders falls, the risk premium on the issuer's bonds _______
becomes smaller
The capital ratio is the ratio of a bank's
capital divided by its assets.
If the central bank wants to maintain the economy's output at its initial level, the change cited above will require _________monetary policy.
contractionary
If the central bank wants to keep the borrowing rate at some target value, and the risk premium rises, then the real policy rate must be
decreased
The bargaining power possessed by workers decreases as the skill level of their jobs _______ and as the overall unemployment rate ________
decreases; increases
The real wage ________ on this level of employment.
does not depend
In the figure on the right, demonstrate the wage-setting relation graphically. 1.) Using the 3-point curved line tool, draw the wage-setting relation. Label your curve 'WS'.
downward sloping curve
The real rate of interest is frequently negative → LOADING.... A negative value for the real interest rate arises when the rate of price inflation
exceeds the nominal rate of interest
Nominal interest rates differ from real interest rates in that real interest rates are expressed in terms of ________
goods
If the probability of bankruptcy is zero, the rate of interest on the risky bond is
i
One of the factors in z, the catch-all variable, is unemployment insurance, the payment of benefits to workers who lose their jobs. An increase in this factor will be expected to __________ the nominal wage.
increase
Part of the policy response to the crisis-induced recession in 2009 was to extend the length of time workers could receive unemployment benefits. If this change were made permanent, it would be expected that reservation wages would ________
increase
Suppose the nominal policy interest rate is 8%.If expected inflation increases from 3% to 4%, in order to keep the LM curve from shifting, the central bank must ______ the nominal policy rate of interest to
increase; 9%
A negative real interest rate will, all else constant, ______ borrowing and ______ lending
increase; decrease
How does the natural rate of unemployment vary with the catchall term z? As the catchall term z increases, the natural rate of unemployment _______
increases
Theta might increase in this way because
inflation expectations adapt to persistently positive inflation.
This expectations structure is probably not realistic because it implies that
inflation expectations are always wrong.
Which of the following is a true statement about the Phillips curve relationship? The original Phillips curve
is the negative relation between unemployment and inflation first observed in the United Kingdom.
Using the graph, if α were to increase, then the line would
keep the same y-intercept and rotate down, becoming steeper.
The high degree of securitization in the US financial system
led to partcipants having a greater degree of leverage. AND encouraged additional risk taking behavior in the economy. AND amplified the negative effects from the mortgage crisis. ALL OF THE ABOVE
Given that the actual inflation rate for May 2020 was 0.24%, it can be concluded that, in terms of the cost of borrowing for that month,_______ were better off than expected, and ___________ were worse off than expected
lenders; borrowers
Assume that expected inflation is based on the following: πet = θπt−1. If θ= 1, we know that:
low rates of unemployment will cause steadily increasing rates of inflation
The monetary policy options that can prevent an increase in the risk premium on risky bonds from decreasing the level of output include (Check all that apply.)
lower reserve requirements and open market purchases
The fiscal policy options that can prevent an increase in the risk premium on risky bonds from decreasing the level of output include (Check all that apply.)
lower taxes and higher government expenditures
The real interest rate is equal to the nominal interest rate
minus the inflation rate.
Efficiency wage theory would predict that relative to the wage of your first job, the job you will have in 10 years will pay ___
more, because firms will want to pay more to increase morale and productivity and reduce turnover.
The same U.S. data indicate that from periods of low unemployment to periods of high unemployment, the probability that employed workers will lose their jobs ______
nearly doubles
Which of the following variables is most directly determined in the labor market?
nominal wages
The inflation equation: π = πe + (m + z) − αu is derived from the price equation: P = Pe (1 + m) (1 − αu + z) Given what you found above, you can see that expected inflation can impact actual inflation through its effects on _______.
nominal wages, W
Policymakers can exploit the inflation-unemployment trade-off
only temporarily, because expectations adapt to higher levels of inflation.
Given the information above, which of the following best describes the equation for the change in the inflation rate? Recall that πt − πet = −α ut − un.
pi(t) - pi(et) = -2.5 (u(t)-u(n))
Which of the following represents the new equation for the Phillips curve?
pi(t) = pi(e,t) - 4(u(t)-.05)
In the IS-LM framework, the ________ interest rate directly reflects central bank actions, while the ________ rate is taken as the relevant rate for consumers and firms.
policy; borrowing
Which of the following expressions captures the approximate relationship between the nominal interest rate (it), the real interest rate (rt), and the expected rate of inflation (πet+1)?
r(t) =(approx) I(t) = pi (e, t+1)
An increase in the expected price level leads to an increase in the nominal wage since both workers and firms care about _______ wages.
real
The interest rate relevant to consumers and firms, known as the real borrowing rate, is determined by combining the
real policy rate and the risk premium.
If the expected rate of inflation were to increase from 3% to 4%, the IS curve ________
remains stationary
The immediate effects of the financial crisis on the macroeconomy included (Check all that apply.)
sharply higher borrowing rates for consumers and firms. Your answer is correct. C. limited access to credit for many borrowers, especially small firms. Your answer is correct. D. a dramatic decline in confidence.
If the risk premium on risky bonds increases from 5% to 6%, the LM curve
shifts down if the central bank acts to offset.
If the risk premium on risky bonds increases from 5% to 6%, the LM curve
shifts down if the central bank acts to offset.
If the expected rate of inflation were to increase from 3% to 4%, the LM curve
shifts down unless the central bank acts to offset.
If the risk premium on risky bonds increases from 5% to 6%, the IS curve
shifts left
If the risk premium on risky bonds increases from 5% to 6%, the IS curve ______
shifts left
If the expected rate of inflation were to decrease from 2% to 1%, the LM curve
shifts up unless the central bank acts to offset.
According to the wage-setting relation, a decrease in the unemployment rate ______ the workers' bargaining power and consequently _______ the real wage.
strengthens; raises
An increase in a firm's leverage ratio
tends to increase the expected profit per unit of capital and increase the amount of risk associated with the firm.
Assume that expected inflation is based on the following: πet = θπt−1. If θ= 0, we know that:
the Phillips curve illustrates the relationship between the level of inflation rate and the level of the unemployment rate
The situation with the highest risk premium is
the lowest nominal policy rate value
If the central bank wants to reduce the real policy rate, the minimum value it can take is
the negative of inflation
Suppose the Phillips curve is represented by the following equation: πt−πt−1= 20 −2ut. Given this information, which of the following is most likely to occur if the actual unemployment in any period is equal to 6%?
the rate of inflation will tend to increase
The decline in U.S. housing prices starting in 2006 was amplified into a major financial crisis as a result of several contributory factors. These included (Check all that apply.)
the spread of securitization. Your answer is correct. D. the increased reliance by banks on wholesale funding. Your answer is correct. E. banks becoming highly leveraged.
The nominal interest rate is
the type of interest rate typically reported in the financial pages of newspapers.
Given what we know about the actual price level and the expected price level at the natural rate of unemployment, the equation πt=πet+(m + z)− α ut can be transformed to show the natural rate of unemployment as
u(n) = (m+z)/alpha
In the wage−setting relation, the nominal wage tends to decrease when
unemployment benefits decrease.
To assess labor market conditions, it would be best to look at the ___________ when this rate is high, workers will have _________ bargaining power.
unemployment rate; less
Now suppose that unemployment benefits become more generous. In this case, the wage-setting relation shown in the graph will shift _______
upward
The situation(s) that correspond to a liquidity trapLOADING... is(are)
when nominal policy interest rate equals 0
The situation(s) that correspond to the case where the nominal policy interest rate is at the Zero Lower Bound is(are)
when nominal policy interest rate equals 0
Workers are typically paid more than the wage that would make them indifferent between working and being unemployed because
workers possess some bargaining power. AND employers want to raise worker productivity.