Chapter 17: Inflation, Unemployment, and Federal Reserve Policy

Phillips Curve

A graph showing the short-run relationship between the unemployment rate and the inflation rate.

Too-Big-To-Fail Policy

A policy under which the federal government does not allow large financial firms to fail, for fear of damaging the financial system.

Structural Relationship

A relationship that depends on the basic behavior of consumers and firms and that remains unchanged over long periods.

Disinflation

A significant reduction in the inflation rate.

Paul Volcker is credited largely with which of the​ following?

A. Fighting inflation by reducing the growth of the money supply. B. The​ "Volcker disinflation." C. Driving up the unemployment rate. *A and B only.*

D. All of the above.

According to many economists and​ policymakers, what other options does the Fed have to improve its credibility with​ workers, firms, and​ investors? A. Following a discretion strategy. B. Following the Taylor rule. C. Following a rules strategy. D. All of the above.

Increase

An increase in inflation expectations will cause the inflation rate to __________ (decrease/increase) at all levels of unemployment.

D. Federal funds rate

As of​ 1993, the Fed sets targets for which of the following in order to achieve price stability and high​ employment? A. Discount rate B. M1 definition of the money supply C. M2 definition of the money supply D. Federal funds rate

D. All of the above.

Consider the graph on the​ right, where both the​ short-run and​ long-run Phillips curves are vertical. An expansionary monetary policy will increase the inflation rate continuously but will have no effect on the unemployment rate because of which of the following? A. Wages and prices will adjust very rapidly as inflation increases as a response to the​ Fed's policy. B. Workers and firms who have rational expectations will consider the​ Fed's policy before revising their expectations about inflation upward. C. The unemployment rate will not fall below the natural rate. D. All of the above.

Permanent Trade-Off

Economists who believed that the Phillips curve represented a structural relationship believed that the curve represented a __________ between unemployment and inflation.

Rational Expectations

Expectations formed by using all available information about an economic variable.

Natural Rate of Unemployment

Friedman defined the __________​ as the unemployment rate that exists when the economy produces potential GDP.

Less Than and Falls

If actual inflation is higher than expected​ inflation, the actual real wage is __________ (greater than/less than/ equal to) the expected real​ wage: unemployment __________ (falls/rises).

B. use expansionary monetary policy.

If the Fed wants to move from a point on the​ short-run Phillips curve representing high unemployment and low inflation to a point representing lower unemployment and higher​ inflation, then it should A. use expansionary fiscal policy. B. use expansionary monetary policy. C. use a combination of expansionary monetary and fiscal policies. D. use contractionary monetary policy.

Ignore Inflation and Adaptive Expectations

If workers and firms __________, or if they have __________, an expansionary monetary policy will cause short-run equilibrium to move from point A on the short-run Phillips curve to point B; inflation will rise and unemployment will fall.

Rational Expectations

If workers and firms have __________, an expansionary monetary policy will cause short-run equilibrium to move up the long-run Phillips curve from point A to Point C. Inflation will still rise, but there will be no change in unemployment.

C. Point C

In the figure to the​ right, at what point is the inflation rate​ stable? That​ is, at what point can we refer to the inflation rate as the nonaccelerating inflation rate of unemployment? A. Point A B. Point B C. Point C D. None of the above

D. All of the above.

In the figure to the​ right, expected inflation is initially at​ 1.5%. When expected inflation increases to​ 4.5%, which of the following will​ occur? A. To have​ 3.5% unemployment​ rate, inflation would be​ 7.5%. B. At the natural rate of​ unemployment, inflation is​ 4.5%. C. Unemployment reaches the natural rate of​ 5%. D. All of the above.

When SRAS 1 shifts to SRAS 2​, the price level increases and the level of real GDP falls. What happens to the​ short-run Phillips curve when the​ short-run aggregate supply curve shifts​ (a supply​ shock)?

It shifts up such that a given level of unemployment occurs at a higher price level.

Vertical and Trade-Off

Milton Friedman argued that the Phillips curve did not represent a permanent​ trade-off between unemployment and​ inflation, since the​ long-run Phillips curve is​ __________, there is no​ __________ between unemployment and inflation in the long run.

Real Business Cycle Models

Models that focus on real rather than monetary explanations of fluctuations in real GDP.

D. real business cycle models.

Models that use​ factors, such as technology​ shocks, to explain fluctuations in real GDP instead of changes in the money supply are called A. monetary business cycle models. B. real monetary models. C. real technology models. D. real business cycle models.

Lower and Higher

The AD-AS model indicates that rapid growth in aggregate demand leads to both __________ (higher/lower) unemployment and __________ (higher/lower) inflation.

Higher and Lower

The AD-AS model indicates that slow growth in aggregate demand leads to both __________ (higher/lower) unemployment and __________ (higher/lower) inflation.

B. Inverse relationship

The Phillips curve was developed by A.W. Phillips in 1957 and shows the relationship between unemployment and inflation. The​ curve, shown at the​ right, indicates what type of relationship between the two​ variables? A. Direct relationship B. Inverse relationship C. No relationship D. Positive relationship

Long-Run Phillips Curve

The __________ is a vertical line at the natural rate of unemployment. It signifies that no trade-offs exist between unemployment and inflation in the long-run.

Short-Run Trade-Off

The inverse relationship between unemployment and inflation which the Phillips curve shows explains why there there is a __________.

Nonaccelerating Inflation Rate of Unemployment (NAIRU)

The unemployment rate at which the inflation rate has no tendency to increase or decrease.

Natural Rate of Unemployment

The unemployment rate that exists when the economy is at potential GDP.

A and C

What effect does expansionary monetary policy have on equilibrium if consumers have rational expectations? A movement from point __________ to point __________.

D. A and B only

What is the Fed doing to increase the credibility of its​ policies? A. Announcing the federal funds target rate. B. Whenever a change in policy is​ announced, the change actually takes place. C. Conducting more open market purchases of government securities. *D. A and B only.*

Up and Higher

When SRAS1 shifts to SRAS2​, the price level increases and the level of real GDP falls. What happens to the​ short-run Phillips curve when the​ short-run aggregate supply curve shifts​ (a supply​ shock)? It shifts __________ (down/up) such that a given level of unemployment occurs at a __________ (higher/lower) price level.

A. In the long​ run, aggregate supply is vertical.

Why​ doesn't the Phillips curve represent a permanent​ trade-off between unemployment and inflation in the long​ run? A. In the long​ run, aggregate supply is vertical. B. In the long​ run, aggregate demand sets the price level. C. In the long​ run, aggregate supply is upward sloping. D. ​"In the long​ run, we're all​ dead."

Indicate the two main objections to the idea that the​ short-run Phillips curve is vertical.

Workers and firms might not have rational expectations. Contracts with workers keep wages sticky.

If the Federal Reserve chooses to fight high inflation with contractionary monetary policy and firms and consumers expect this policy to reduce​ inflation, which of the following would you expect to​ see?

a downward shift of the short-run Phillips curve

Alan Greenspan

agreed with Paul Volcker about the importance of keeping inflation low.

B. the Phillips curve is vertical.

​If, in the long​ run, real GDP returns to its potential​ level, then in the long​ run, A. the Phillips curve represents a structural relationship. B. the Phillips curve is vertical. C. the Phillips curve disappears. D. the Phillips curve is upward sloping.