Econ Final Chapters 20-22, 24 & 25
If taxes increaseincrease and autonomous consumption expenditure increaseincrease, the IS curve; During financial crises, financial frictions __________, leading to a __________ shift of the IS curve.
...may shift right, left, or not shift at all. increase; leftward
Suppose that a new Fed chair is appointed, and his or her approach to monetary policy can be summarized by the following statement: "I care only about increasing employment; inflation has been at very low levels for quite some time; my priority is to ease monetary policy to promote employment." 1. How would you expect the monetary policy curve to be affected, if at all? 2. What would be the effect on the aggregate demand curve?
1. The MP curve will shift downward because decreasing unemployment results in a loosening of monetary policy. 2. The AD curve will shift to the right.
Which of the following does not shift the IS curve?
A fall in the interest rate.
What causes the IS curve to shift?
A shift in the IS curve occurs when equilibrium output changes at each given real interest rate. The factors of shifting are autonomous consumption, autonomous investment, autonomous net exports, taxes, and government purchases.
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: A. The public is moremore likely to believe announcements about future policy changes. B. Aggregate supply adjusts lessless quickly to policy announcements when compared to another country. C. Output is moremore stable when compared to another country.
A. Country A B. Country B C. Country A
Why is it necessary for the MP curve to have an upward slope?
An upward-sloping MP curve keeps inflation from spinning out of control.
Which of the following is not one of the three basic approaches to establishing credibility?
By using time-inconsistency arguments
When the Federal Reserve reduces its policy interest rate, how, if at all, is the IS curve affected?
Changes in interest rates represent a movement along the IS curve, and so the IS curve does not shift.
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.
The Federal Reserve steadily raised interest rates during 2004 and 2005. Higher interest rates cause the value of the dollar to increase, which causes net exports to decrease, and thus output would be expected to decrease. This is an example of which of the following monetary transmission mechanisms?
Exchange rate effects.
Which of the following is a correct transmission channel that shows how monetary policy can affect investment, without relating investment to interest rates?
Expansionary monetary policy can increase the value of stocks, raising Tobin's q, and thus increasing investment.
Consider the following statement: "The cost of financing investment is related only to interest rates; therefore, the only way that monetary policy can affect investment spending is through its effects on interest rates."
FALSE
In the 2007-2009 recession, the value of common stocks in real terms fell by nearly 50%. Which of the following shows a transmission mechanism through which the decline in the stock market might have affected aggregate demand and thus contributed to the severity of the recession?
Falling stock prices lead to a fall in financial wealth, and thus consumption spending falls, reducing aggregate demand.
Contractionary monetary policy reduces stock prices, which reduce the value of financial assets and increase the probability of household financial distress. Households with less access to liquid assets spend less on consumption and residential investment. This statement describes which of the following monetary transmission channels?
Household liquidity effects.
When r increases, this causes a movement along the________ curve, and shifts the _________ curve.
IS; AD
Any factor that shifts the __________ curve shifts the __________ curve in the __________ direction.
IS; AD; same
What happens to inflation and output in the short run and the long run when government spending increases?
If government spending increases, the aggregate demand curve shifts rightward. In the short run, inflation increases and output increases. This leads to tightness in the labor market, which raises inflation expectations and shifts the short-run aggregate supply curve up. When this occurs, the economy moves to a new long-run equilibrium, output falls back to potential, and inflation increases.
How can the interest-rate channel still function when short-term nominal interest rates are at the zero-lower bound?
If the central bank commits to a higher inflation policy, it can raise inflation expectations, thereby lowering real interest rates, even when the nominal interest rate is zero.
Observe a positive demand shock in the graph to the right.
In the short run, "both inflation and output rise." In the long run, "inflation rises, but output does not change."
Which of the following represents a movement along a given AD curve?
Inflation decreases, the real interest rate decreases, and aggregate output increases.
What relationship does the aggregate supply curve describe?
It describes the relationship between the total quantity of output supplied and the inflation rate.
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.
________ flexible wages and prices imply that the shortminus−run aggregate supply curve is ________.
More; steeper
Which of the following is not a part of this monetary policy strategy to achieve these goals?
Public announcement of the procedural details of using all inflation-related policy variables.
Which of the following best describes the adjustment to long-run equilibrium if an economy's short-run equilibrium output is belowbelow potential output?
Since unemployment is greater than its natural rate, there will be excess slack in the labor market and, consequently, pressure on firms to raise their prices at a less rapid rate. This deceleration of inflation shifts the short-run aggregate supply curve down, pushing the economy's output up toward potential output.
Describe how (if at all) the IS curve, MP curve, and AD curve are affected in the following situation: The new Federal Reserve chair begins to care more about fighting inflation.
The IS curve is not affected, the MP curve becomes steeper, and the slope of the AD curve becomes flatter.
Suppose that taxes are decreased and the central bank conducts an autonomous easing of monetary policy. What will be the result?
The IS curve shifts right, the MP curve shifts down, and the AD curve shifts right.
How do changes in planned expenditures affect the aggregate demand curve?
The aggregate demand curve shifts to the right if autonomous consumption, autonomous investment, autonomous net exports, or government purchases increase, or if taxes decrease.
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
How can use of macroeconometric models that do not assume expectations are rational be problematic for policy analysis?
They are unreliable for evaluating policy options.
"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.
How does an autonomous tightening or easing of monetary policy by the Fed affect the MP curve?
When the Fed decides to raise the real interest rate at any given inflation rate, the MP curve shifts upward. Monetary policy easing, a decision to lower the real interest rate at any given inflation rate, shifts the MP curve downward.
How is an autonomous tightening or easing of monetary policy different than a change in the real interest rate due to a change in the current inflation rate?
With a tightening or easing of monetary policy, some projected changes in monetary policy independent of the current inflation rate may occur.
If adverse selection and moral hazard increase, how does this affect the ability of monetary policy to address economic downturns?
With increased adverse selection, monetary policy must be more powerful to offset the contractionary effects of adverse selection and moral hazard
The short-run aggregate supply curve has:
a positive slope because as the inflation rate increases, so does the quantity of output supplied.
Which of the following is a benefit of having a credible nominal anchor?
a. It helps to solve the time-inconsistency problem. b. It helps control inflation expectations, leading to smaller fluctuations in inflation and output. c. It enables policy makers to achieve price stability. ^^ ALL OF THE ABOVE
A credible nominal anchor
a. can help overcome the time−inconsistency problem by providing an expected constraint on discretionary policy. b. can help to anchor inflation expectations, which leads to smaller fluctuations in inflation. ^^ BOTH A & B
Arguments for discretionary policies include
a. discretion avoids the straightjacket that would lock in the wrong policy if the model that was used to derive the policy rule proved to be incorrect. b. policy rules do not easily incorporate the use of judgment. c. discretion enables policy makers to change policy settings when an economy undergoes structural changes. d. policy rules can be too rigid because they cannot foresee every contingency. ^^ ALL OF THE ABOVE
Arguments for adopting a policy rule include
a. discretionary policies pursue overly expansionary monetary policies to boost employment in the short run but generate higher inflation in the long run. b. the time−inconsistency problem can lead to poor economic outcomes. c. policy makers and politicians cannot be trusted. ^^ ALL OF THE ABOVE
Everything else held constant, when output is ________ the natural rate level, wages will begin to ________, decreasing short−run aggregate supply.
above; rise
Everything else held constant, an increase in government spending will cause ________.
aggregate demand to increase
A negative supply shock that raises production costs will cause the
aggregate supply curve to shift up.
Which of the following causes the MP curve to shift down?
an autonomous easing of monetary policy
Suppose the U.S. economy is producing at the natural rate of output. A depreciation 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 depreciation causes no effects in the supply side of the economy.)
an increase; an increase
Suppose the economy is producing at the natural rate of output and the government passes legislation that severely restricts a company's ability to reduce production costs via outsourcing. Everything else held constant, this policy action will cause ________ in the unemployment rate in the short run and ________ in inflation in the short run.
an increase; an increase
Suppose the economy is producing at the natural rate of output. An increase in consumer and business confidence will cause ________ in real GDP in the short run and ________ in inflation in the short run, everything else held constant.
an increase; an increase
Lucas argues that when policies change, expectations will change thereby
changing the relationships in econometric models.
The Lucas critique is an attack on the usefulness of
conventional econometric models as indicators of the potential impacts on the economy of particular policies.
The short-run aggregate supply curve slopes upward because an increase in output relative to potential output:
creates tight labor and product markets that cause inflation to rise
A negative demand shock will ________ inflation and _______ aggregate output in the long run.
decrease; not change
Everything else held constant, an increase in the cost of production ________ aggregate ________.
decreases; supply
With an autonomous easingeasing of monetary policy, the cost of capital __________, and investment __________.
decreases; increases
An expansionary monetary policy lowers the real interest rate, causing the domestic currency to ________, thereby ________ net exports.
depreciate; raising
Under a negative supply shock with a fully credible monetary policy, the AD curve __________ and the AS curve __________ in the short run.
does not shift; shifts up, but by less than under a noncredible monetary policy
The Lucas critique indicates that
expectations are important in determining the outcome of a discretionary policy.
When interest rates fall in the United States (with the price level fixed), the value of the dollar ________, domestic goods become ________ expensive, and net exports ________.
falls; less; rise
According to the household liquidity effect, higher stock prices lead to increased consumption expenditures because consumers
feel more secure about their financial position.
A "conservative" central banker:
has a strong aversion to inflation.
The Taylor principle:
holds when lambda greater than λ>0. MP curve is upward sloping because of Taylor principle.
A temporary negative supply shock will ______ inflation and will ______ aggregate output in the short run.
increase; decrease
A positive demand shock will ________ inflation and _______ aggregate output in the short run.
increase; increase
The wealth effect and household liquidity effect are similar because:
increases in real interest rates lead to lower asset prices, which lead to lower spending on housing and consumption.
Approaches to establishing central bank credibility include
inflation targeting. central bank independence. appointment of a more conservative central banker. exchange rate targeting.
If autonomous consumption increasesincreases, and there is a sharp increase in energy prices, you would expect
inflation to increase, and output to have an ambiguous effect.
The IS curve shows combinations of:
interest rates and income that bring equilibrium in the market for goods and services.
The IS curve slopes downward because higher ______________ lead to lower ___________ and ___________.
interest rates; investment spending; net exports
Inflation targeting can be used to:
keep inflation under control and increase the credibility of monetary policymakers' commitment to price stability.
Everything else held constant, a decrease in autonomous consumer spending will cause the IS curve to shift to the ________ and aggregate demand will ________.
left; decrease
Everything else held constant, an appreciation of the domestic currency will cause the IS curve to shift to the ________ and aggregate demand will ________.
left; decrease
Everything else held constant, if aggregate output is to the ________ of the IS curve, then there is an excess demand of goods which will cause aggregate output to ________.
left; rise
According to Tobin's q theory, when q is ________, firms will not purchase new investment goods because the market value of firms is ________ relative to the cost of capital.
low; low
The self-correcting mechanism describes how the economy eventually returns to the _______ regardless of where output is initially.
natural rate level of output
A decrease in the availability of raw materials that increases the price level is called a ________ shock
negative supply
A temporary positive supply shock will ______ inflation and will ______ aggregate output in the long run.
not change; not change
A rise in stock prices ________ the net worth of firms and so leads to ________ investment spending because of the reduction in moral hazard.
raises; higher
A contractionary monetary policy decreases net exports by ________ interest rates and ________ the value of the dollar.
raising real; increasing
The MP curve gives the relationship between the; A movement to the right along a given MP curve means;
real interest rate and the inflation rate. inflation is increasing.
Economic theory suggests that ________ interest rates are ________ important than ________ interest rates in explaining investment behavior.
real; more; nominal
If the interest rate falls, other things being equal, investment spending will ________.
rise
Because of the presence of asymmetric information problems in credit markets, an expansionary monetary policy causes a ________ in net worth, which ________ the adverse selection problem, thereby ________ increased lending to finance investment spending.
rise; reduces; encouraging
If workers demand and receive higher real wages (a successful wage push), the cost of production ________ and the short−run aggregate supply curve shifts ________.
rises; leftward
Under a positivepositive demand shock with a fully credible monetary policy, the AD curve __________ and the AS curve __________ in the short run.
shifts right; does not shift
If autonomous consumption declinesdeclines, then the AD curve
shifts to the left.
Everything else held constant, if workers expect an increase in the price level, ________ aggregate supply ________.
short−run; decreases
Tobin's q theory suggests that monetary policy may affect investment spending through its impact on
stock prices.
Everything else held constant, if aggregate output is to the right of the IS curve, then there is an excess ________ of goods which will cause aggregate output to ________.
supply; fall
The argument that econometric policy evaluation is likely to be misleading if policymakers assume stable economic relationships is known as
the Lucas critique.
Inflation expectations and realized inflation are likely to be more stable with
the appointment of a "conservative" central banker.
An expansionary monetary policy may cause asset prices to rise, thereby reducing the likelihood of financial distress and causing consumer durable and housing expenditures to rise. This monetary transmission mechanism is referred to as
the household liquidity effect.
An upward shift in aggregate supply ultimately causes
the inflation rate to remain unchanged and output to remain unchanged.
An upward shift in aggregate supply initially causes
the inflation rate to rise and output to fall.
The aggregate demand curve slopes downward because a rise in inflation leads:
the monetary policy authorities to raise real interest rates.
When the financial crisis started in August 2007, inflation was rising and the Fed began an aggressive easing lowering of the federal funds rate, which indicated that;
the monetary policy curve shifted downward.
Suppose that there is a positive aggregate demand shock and the central bank commits to an inflation rate target. But if the commitment is not credible, then
the short−run aggregate supply curve will rise.
The rational expectations hypothesis implies that when macroeconomic policy changes,
the way expectations are formed will change.
At points to the leftleft of the IS curve,
there is an excess demand for goods which leads to an unplanned decrease in inventories.
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.
When inflation and inflation expectations adjust to move output to potential, this is an example of
the self-correcting mechanism.
The long-run aggregate supply curve is:
vertical because changes in labor, capital, and technology (not the inflation rate) change the output an economy can produce over the long run.
According to Lucas, the public's expectations about a policy
will influence the response to that policy.
