Macro Exam 3

The intersection of the IS curve and the Fed Rule gives the equilibrium values of output and interest rate for given values of _______, _______, and _______.

- Government Spending (G) - the price level (P) - and the factors in Z

As the interest rate rises (falls), ___ Falls, thus total planned spending ________ as well.

- I - rises (falls)

A decreases in ___ lowers Equilibrium output (Y) by a multiple of the initial decrease in ___

-AE -I

When dealing with a cost shock, the increase in P leads the Fed to raise r, which lowers __ and thus __

-I -Y

Examples of events that can shift the AS curve

-New discoveries of oil -Problems in the production of energy -Increase in wage rates (causes an increase in prices, examples of cost shock)

2 main inputs into the Fed's interest rate decision

-Output (Y) -Inflation (P)

Long-Run Aggregate Supply Curve

-When the AD curve shifts from AD0 to AD1, the equilibrium price level initially rises from P0 to P1 and output rises from Y0 to Y1. -Wages respond in the longer run, shifting the AS curve from AS0 to AS1. -If wages fully adjust, output will be back to Y0. -Y0 is sometimes called potential GDP.

In the short run, a supply shock as a result of an unexpected decrease in oil prices will _______ the price level but ________ real GDP

-decrease -increase

Fluctuations in total spending in the economy may affect both ___________ and _________ in the short run

-employment -production

Along the IS curve, output _____ as the interest rate ________ because...

-falls -increases -planned investment depends negatively on the interest rate

When interest rates_______________ , aggregate expenditure ____________ , ceteris paribus.

-increase -falls

When an expansionary fiscal policy works well, there is an ___________ in output with little increase in the ___________.

-increase -price level

With a higher price level, the Fed ____________ the interest rate (r), and in this case, there is almost complete crowding out of __________

-increases -planned investment

In a binding situation, the _________________ does not change, thus the AD curve is __________

-interest rate -vertical

An increase in the money supply lowers _____________ and increases _____________________, which causes the aggregate demand curve to shift rightward.

-interest rates -investment and consumer spending

When a is small relative to b; when the Fed sees a price increase, it responds with a ______ increase in the ___________

-large -interest rate

An increase in future price expectations may shift the AS curve to the ____ and thus act like a ________

-left -cost shock

When dealing with a cost shock, the shift of the AS curve to the left leads to ________ output at a ______ price level

-lower -higher

In the goods market (IS Curve), there is a _______ relationship between output and the interest rate because...

-negative -planned investment depends negatively on the interest rate

In the Fed Rule, the Fed raises the interest rate as ________ increases

-output

An increase in the money supply can be depicted by a _______ in the ___ curve

-shift -AD

If wages adjust fully to match higher prices, then the long-run AS curve is __________, and so fiscal policy will have ____ effect on output

-vertical -no

When the economy is on the flat part of the AS curve, there is _____________________ crowding out of planned investment

-very little -output expands to meet the increased demand

When an expansionary fiscal policy does not work well, the output multiplier is close to _______. Output is initially close to capacity, and attempts to increase it further mostly lead to a ___________________

-zero -higher price level

Cost Shock (Supply Shock)

A change in costs that shifts the short-run AS curve

Aggregate Supply (AS) curve aka "price/output response" curve

A curve that traces out the price decisions and output decisions of all firms in the economy under different levels of aggregate demand

Aggregate supply (AS) curve

A graph that shoes the relationship between the aggregate quantity of output supplied by all firms in an economy and the overall price level

When the interest rate (r) is fixed, an increase in government spending (G) increases...

AE, and thus Y in equilibrium

The intersection of the AS and AD curves determines..

Aggregate output and the aggregate price level

AE =

C + I + G

Fed Rule

Equation that shows how the Fed's interest rate decision depends on the state of the economy

Aggregate Demand curve (AD)

Falls when P increases because the higher P leads the Fed to raise r, which decreases I and thus Y

an increase in P shifts the Fed Rule _____

Left

an increase in Z shifts the Fed Rule _____

Left

As the economy approaches capacity, the short-run AS curve becomes....

Nearly vertical

A decrease in net taxes and an increase in government spending increase ____________

Output (Y) -both result in a shift of the AD curve to the right

The AD curve reflects the negative relationship between...

P and Y

IS Curve

Relationship between aggregate output and the interest rate in the goods market

Binding situation

State of the economy in which the Fed rule calls for a negative interest rate

Real Wealth Effect

The change in consumption brought about by a change in real wealth that results from a change in the price level

The vertical part of the short-run AS curve represents...

The economy's maximum (capacity) output

Zero interest rate bound

The interest rate cannot go below zero

Potential Output (Potential GDP)

The level of aggregate output that can be sustained in the long run without inflation (Y0)

The aggregate demand curve shows the relationship between...

The price level and the quantity of real GDP demanded

Stagflation

The simultaneous increase in unemployment and inflation

Aggregate Supply

The total supply of all goods and services in an economy

The short-run AS curve has an upward slope because...

Wages are a large fraction of total costs, and wage changes lag behind prices.

Inflation targeting

When a monetary authority chooses its interest rate values with the aim of keeping the inflation rate within some specified band over some specified horizon

Some economists believe the wages can be "stuck" and not adjust downward during recessions. These economists advocate:

active fiscal stimulus to move the economy back to full employment

The AD curve in a binding situation

always vertical

Example of demand-pull inflation

an improvement in Keynes's animal spirits, such as a rise in consumer confidence

The AD curve is shifted to the right by..

an increase in aggregate demand (income) (higher government spending)

If prices have been rising and if people's expectations are adaptive (i.e., forming expectations on the basis of past pricing behavior), firms may...

continue raising prices even if demand is slowing or contracting

In a binding situation, changes in P and Z ________ shift the r=0 line

do not

When the price level increases very little, the Fed __________ raise the interest rate much, and so there is little change in planned investent

does not

Z in the Fed Rule equation

economic factors other than Y (Output) and P (inflation) that lie outside our model and are likely to vary from period to period in ways that are hard to predict

Government policies that increase aggregate demand are called __________.

expansionary policies

At low levels of aggregate output, the short-run AS curve is.....

fairly flat

When the Fed cares more about the price level than output, the AD curve is relatively _____, as the Fed is willing to accept large changes in Y to keep P stable

flat

Which of these actions is the government likely to take if the economy is operating above the potential GDP?

increase taxes

Cost-push (supply-side) inflation

inflation caused by an increase in costs

Demand-Pull inflation

inflation that is initiated by an increase in aggregate demand

Any point on the IS curve is an equilibrium in the goods market for the given ______________

interest rate (r)

The IS curve represents the relationship between...

interest rates and aggregate output in the goods market

If the shift in the AD curve is caused by a decrease in net taxes ____________________________________________, that causes the crowding out of investment

it is consumption, not government spending

A rapid increase in the price of oil can shift the short-run aggregate supply to the...

left

An increase in Z, such as an increase in consumer confidence, shifts the AD curve to the ______, due to a tightening of monetary policy

left

The economy is in long-run equilibrium when the short-run aggregate supply and the aggregate demand curve intersect at a point on the...

long-run aggregate supply curve

The federal reserve will _________________ when the economy is operating below the potential GDP

lower interest rates

Planned investment depends ___________ on the interest rate

negatively

Looking at recent Fed policy it appears the Fed has..

not engaged in inflation targeting

John Maynard Keynes referred to animal spirits which are...

optimistic views of investors that propel economic growth

A high interest rate (r) discourages... so...

planned investment (I), so planned aggregate expenditure (AE) at every level of income falls.

In the short run, the aggregate supply curve (the price/output response curve) has a ___________ slope

positive

A shift in AD must be caused by something other than a change in the _______________

price level

When the economy is producing on the nearly flat portion of the AS curve, firms are...

producing well below capacity, and they will respond to an increase in demand by increasing output much more than they increase prices.

Any price increase that results from a demand-side shock is also considered demand-______ inflation

pull

Lower interest rates shift the AD curve to the ______

right

an increase in G shifts the IS curve _____

right

The aggregate demand and aggregate supply model explains...

short-run fluctuations in real GDP and the price level

The tax multiplier is _____________ in absolute value than is the government spending multiplier

smaller

In reference to the Fed rule, if a is small relative to b, the Fed has a ______ preference for stable prices relative to output

strong

The AD curve slopes down because...

the Fed raises the interest rate (r) when P increases and because I depends negatively on r -also a real wealth effect on consumption

Potential GDP

the level of aggregate output that can be sustained in the long run without spurring inflation

In the long-run, the level of output that can be sustained without inflation is...

the potential GDP

Monetary policy in the form of changes in Z has _________ issues as does fiscal policy in the form of changes in G and T.

the same

The vertical portion of the short-run AS curve exists because....

there are physical limits to the amount that an economy can produce in any given period

Since 1991 there have been ______ economic recessions.

two; 2001, 2008

Expansionary fiscal policy works well when the economy is operating....

well below the full employment level of output