Macro CH 31: Inflation, Disinflation, and Deflation

According to current estimates of Okun's law, if the output gap is 3%, the natural rate of unemployment is 5%, and the expected rate of inflation is 5%, the unemployment rate will be _____%.

3.5

The nominal interest rate on a one-year loan for $1,000 is 8%. The lender expected inflation of 2% during the year; however, deflation of 3% occurred. The lender of this loan expected a real interest rate of _____%.

6

accelerating inflation

An attempt to reduce unemployment leads to this

_____ is MOST likely to lead to decreases in output.

Deflation

real quantity of money

M/P (M=nominal money supply) (P=price level)

Okun's Law

There is a predictable negative relationship between the output gap and the unemployment rate. Modern estimates find that a rise in the output gap of 1% reduces the unemployment rate by about 0.5%

deflation

a falling aggregate price level

A negative output gap implies an unemployment rate that is:

above the natural rate.

Disinflation in an economy:

entails a loss in employment and a decrease in real gross domestic product (GDP).

A liquidity trap is NOT associated with:

fiscal policy becoming ineffective.

If the natural rate of unemployment is 5%, and the actual rate of unemployment is 4%:

inflation will increase.

The unemployment rate will fall if the growth of potential output is:

lower than the growth of actual output.

If the economy is in a liquidity trap, then:

monetary policy is ineffective, but fiscal policy is effective.

liquidity trap

the inability to use monetary policy because nominal interest rates are too low and cannot fall below the zero bound

short-run Phillips curve

the negative short-run relationship between the unemployment rate and the inflation rate

Governments use seigniorage as a revenue source when they are _____ to raise taxes and _____ to reduce government spending.

unwilling; unwilling

Suppose the expected and actual inflation rate is currently 2% and the NAIRU (nonaccelerating inflation rate of unemployment) is 6%. The actions of policy makers drive inflation up to 4% and unemployment down to 4%. Which is most likely to occur if no further action is taken?

Eventually, the public will come to expect an inflation rate of 4% and the economy will shift back to 6% unemployment.

Debt deflation refers to a(n):

reduction in aggregate demand caused by the increase in a borrower's real burden of outstanding debt caused by deflation.

The nominal interest rate on a one-year loan for $5,000 is 10%. The lender expected inflation of 2% during the year; however, inflation of 3% occurred. The lender of this loan expected a real interest rate of _____%.

8

the inflation tax

the reduction in the real value of money held by the public caused by inflation

How to avoid accelerating inflation over time?

the unemployment rate must be high enough that the actual rate of inflation matches the expected rate of inflation

If money held by the public is $300 billion, and the inflation rate is 5%, then the inflation tax that year is:

$15 billion.

The nominal interest rate on a one-year loan for $1,000 is 8%. The lender expected inflation of 2% during the year; however, deflation of 3% occurred. After one year, the borrower of this loan must repay $_____.

1,080

If the money supply is $200 billion and inflation is 5%, then the inflation tax is $_____ billion.

10

The nominal interest rate on a one-year loan for $1,000 is 8%. The lender expected inflation of 2% during the year; however, deflation of 3% occurred. The lender of this loan actually received a real interest rate of _____%.

11

If the NAIRU (nonaccelerating inflation rate of unemployment) is 6%, then an unemployment rate of _____% will cause accelerating inflation.

2

If the NAIRU (nonaccelerating inflation rate of unemployment) is 6%, then an unemployment rate of _____% will cause decelerating inflation.

7

The nominal interest rate on a one-year loan for $5,000 is 10%. The lender expected inflation of 2% during the year; however, inflation of 3% occurred. The lender of this loan actually received a real interest rate of _____%.

7

How does the Federal Reserve monetize debt?

by buying it back from the public through open-market purchases of Treasury bills

How does the US government raise revenue?

by printing money

What happens in countries with high inflation?

changes in money supply are quickly translated into changes in inflation

The core inflation rate is considered a better indicator of inflationary trends than the overall consumer price index because the:

consumer price index includes energy prices.

A supply shock caused by an increase in the price of gasoline causes a(n) _____ in output and a(n) _____ in prices.

decrease; increase

During periods of _____, people will be more eager to hold large sums of money.

deflation

A government with a large deficit will also produce high inflation in the economy if it:

finances the deficit via seigniorage.

An economy will experience a liquidity trap when the Federal Reserve:

finds that it cannot reduce nominal interest rates, even if it engages in open-market purchases of Treasury bills.

Seigniorage refers to the:

government's right to print money.

In the long run, an increase in aggregate demand from a position of full employment leads to:

higher prices and the same output.

According to the text, in the long run, an increase in the inflation rate will lead to:

no change in the unemployment rate.

real seignorage

= rate of growth of the money supply × real money supply

_____ is often a result of a government financing its spending through the inflation tax.

Hyperinflation

Which is true regarding the zero bound?

Nominal interest rates have a zero bound; real interest rates do not have a zero bound.

Who issues debt?

Treasury

When the output gap is negative, the unemployment rate is:

above the natural rate.

The economy would move down a fixed short-run Phillips curve to a higher unemployment rate and a lower inflation rate if the:

aggregate demand curve shifts to the left.

The short-run Phillips curve shows:

an inverse relationship between unemployment and inflation.

When there is a positive output gap, the unemployment rate is:

below the natural rate.

According to the short-run Phillips curve, when actual output is _____ potential output, the price level _____, and the unemployment rate rises.

below; decreases

Who loses from unexpected deflation?

borrowers

During periods of deflation, _____ are hurt, and _____ are helped.

borrowers; lenders

As people try to avoid the inflation tax, the government must _____ the rate of growth of the money supply to _____.

increase; raise the same revenue from seigniorage

If nominal wages are slow to adjust to changes in the price level, then an increase in the money supply:

increases real GDP only in the short run and raises the price level in the long run

If the economy is in a liquidity trap, monetary policy is _____, and fiscal policy is _____.

ineffective; effective

Any unemployment rate below the nonaccelerating inflation rate of unemployment leads to:

inflation

If potential output is $16 trillion and actual output is $18 trillion, then the actual unemployment rate MOST likely:

is less than the natural rate.

the natural rate of unemployment

is the part of the unemployment rate unaffected by the swings of the business cycle

disinflation

is the process of bringing down inflation that is embedded in expectations

the nonaccelerating inflation rate of unemployment (NAIRU)

is the unemployment rate at which inflation does not change over time

All of the following are true regarding moderate inflation EXCEPT that:

it may be caused by a shift of the aggregate supply curve to the right.

Policies that contract the economy tend to:

lead to higher unemployment.

An economy is in equilibrium at the natural rate of unemployment, and government spending increases. In the long run, the natural rate of unemployment most likely will:

not change.

Disinflation:

policies may plunge the economy into a recession.

When the output gap is _____, reflecting an inflationary gap, the unemployment rate is _____ the natural rate of unemployment.

positive; below

If an administration pursues expansionary policy before an election to bring down the unemployment rate, it can:

produce inflation if the targeted rate of unemployment is too low.

Expectations of a lower inflation rate shift the short-run aggregate supply curve to the _____, changing the trade-off between inflation and unemployment. As a result, the short-run Phillips curve shifts _____.

right; downward

If an economy has just had a serious recession, but real GDP is expanding once again, we can expect the unemployment rate to:

rise if previously discouraged workers enter the work force but do not find jobs immediately.

In the United States, if there is a decrease in the expected inflation rate of 2%, then the short-run Phillips curve will _____ and the actual inflation rate will _____.

shift downward; decrease by 2%

If the short-run aggregate supply curve shifts to the left, then the short-run Phillips curve will:

shift upward.

How does a negative supply shock affect the Phillips curve?

shifts SRPC up as the inflation rate increases for every level of the unemployment rate

How does a positive supply shock affect the Phillips curve?

shifts it down as the inflation rate falls for every level of the unemployment rate

The negative relationship between the inflation rate and the unemployment rate is known as the _____curve.

short-run Phillips

when actual aggregate output is equal to potential output

the actual unemployment rate is equal to the natural rate of unemployment

output gap

the percentage difference between the actual level of real GDP and potential output

In order for governments to collect seigniorage:

the price level must increase.

Compared with borrowers, lenders gain under deflation because:

the real burden of borrowers' payments increases.

classical model of the price level

the real quantity of money is always at its long-run equilibrium level

debt deflation

the reduction in aggregate demand arising from the increase in the real burden of outstanding debt caused by deflation

the natural rate hypothesis

the relationship between accelerating inflation and the unemployment rate

As a result of a downturn in the economy, a firm reduces workers' hours but does not fire workers. Following Okun's law, this is one reason:

the relationship between the output gap and the unemployment is negative and less than one-to-one.

long-run Phillips Curve

the relationship between unemployment and inflation after expectations of inflation have had time to adjust to experience

seignorage

the revenue generated by a government's right to print money (usually less than 1% of the U.S. government's budget)

when the output gap is negative (recessionary gap)

the unemployment rate is above the natural rate

when the output gap is positive (inflationary gap)

the unemployment rate is below the natural rate

When the economy faces an inflationary gap:

the unemployment rate is less than the natural rate of unemployment.

If there is an increase in the expected inflation rate of 4%, then the short-run Phillips curve will shift _____ and the actual inflation rate will _____.

upward; increase by 4%

When can a liquidity trap occur?

whenever there is a sharp reduction in demand for loanable funds