Chapter 21 HW:

Given that a steep downturn ensued following the financial crisis despite the​ Fed's autonomous​ easing, it may be concluded that the A. Fed was insufficiently aggressive. B. negative shock to the economy was overwhelmingly severe. C. Fed acted too late to stem the downturn. D. all of the above are plausible conclusions.

D. all of the above are plausible conclusions.

What is the aggregate demand​ curve?

It is the relationship between the inflation rate and aggregate output when the goods market is in equilibrium.

if λ = 0, what does this imply about the relationship between the nominal interest rate and the inflation rate?

The implication is that as inflation increases, the nominal interest rate will increase by exactly the same as the inflation rate, so that the real interest rate stays constant.

If the Fed continued a movement up along the MP curve as inflation​ rose, its actions would be described as

automatic

A movement to the right along a given MP curve means

inflation is increasing

The MP curve gives the relationship between the

real interest rate and inflation rate

Why does the aggregate demand curve slope​ downward?

A rise in inflation works through the increase in real interest rates to reduce the equilibrium quantity of aggregate output.

Suppose government spending is increased at the same time that an autonomous monetary policy tightening occurs. Which of the following are likely to be true of the aggregate demand​ curve? ​(Select all that​ apply.) A. An autonomous monetary policy tightening is likely to shift the aggregate demand curve to the left. B. An increase in government spending is likely to cause a downward movement along the aggregate demand curve. C. An autonomous monetary policy tightening is likely to cause an upward movement along the aggregate demand curve. D. An increase in government spending is likely to shift the aggregate demand curve to the right.

A. An autonomous monetary policy tightening is likely to shift the aggregate demand curve to the left. D. An increase in government spending is likely to shift the aggregate demand curve to the right.

What is the real interest​ rate? A. The nominal interest rate minus expected inflation. B. Expected inflation. C. The nominal interest rate plus expected inflation. D. The nominal interest rate.

A. The nominal interest rate minus expected inflation.

Taylor Principle A. holds when λ>0. B. implies the IS curve is downward sloping. C. leads to higher real interest rates when inflation decreases. D. leads a raise of the nominal interest rate equal to the rise in inflation.

A. holds when λ>0. monetary authorities should raise nominal interest rates by more than the increase in the inflation rate

Describe how​ (if at​ all) the IS​ curve, MP​ curve, and AD curve are affected in the following ​situation: There is an increase in taxes, and an autonomous easing of monetary policy. A. The IS curve shifts to the right, the MP curve shifts to the left and there is a movement along it, and the AD curve does not shift. B. The IS curve shifts to the left and the economy moves along the IS curve, the MP curve shifts down, and the net effect on the AD curve cannot be definitely determined. C. There is a movement along the MP and IS curves, and the AD curve does not shift. D. The IS curve shifts to the right, the AD curve is not affected, and the slope of the MP curve becomes flatter. E. The IS curve shifts to the left, and the MP and AD curves shift right.

B. The IS curve shifts to the left and the economy moves along the IS curve, the MP curve shifts down, and the net effect on the AD curve cannot be definitely determined.

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." How would you expect the monetary policy curve to be​ affected, if at​ all? A. The MP curve will shift upward because decreasing unemployment results in a loosening of monetary policy. B. The MP curve will shift downward because decreasing unemployment results in a loosening of monetary policy. C. The MP curve will shift downward because decreasing unemployment results in a tightening of monetary policy. D. The MP curve will shift upward because decreasing unemployment results in a tightening of monetary policy. What would be the effect on the aggregate demand​ curve? A. The slope of the AD curve will increase. B. The AD curve will shift to the right. C. The AD curve will not change. D. The AD curve will shift to the left.

B. The MP curve will shift downward because decreasing unemployment results in a loosening of monetary policy. B. The AD curve will shift to the right.

How does an autonomous tightening or easing of monetary policy by the Fed affect the MP​ curve? A. When the Fed decides to lower the real interest rate at any given inflation​ rate, the MP curve shifts upward. Monetary policy​ easing, a decision to raise the real interest rate at any given inflation​ rate, shifts the MP curve downward. B. 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. C. When the Fed decides to raise the real interest rate at any given inflation​ rate, the MP curve shifts downward. Monetary policy​ easing, a decision to lower the real interest rate at any given inflation​ rate, shifts the MP curve upward. D. None of the above are correct.

B. 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.

What is the key assumption underlying the​ Fed's ability to control the real interest​ rate?

Because inflation is relatively sticky in the short​ run, when the Federal Reserve changes the federal funds​ rate, it implies similar changes in real interest rates.

If financial frictions​ increase, how will this affect credit​ spreads? A. The increase in financial frictions will decrease the cost of borrowing and result in lower credit spreads. This will lead to an increase in planned​ investment, causing a movement along the AD curve in the​ south-east direction and increasing aggregate output demanded. B. The increase in financial frictions will increase the cost of borrowing and result in higher credit spreads. This will lead to a decrease in planned​ investment, causing a movement along the AD curve in the​ north-west direction and reducing aggregate output demanded. C. The increase in financial frictions will increase the cost of borrowing and result in higher credit spreads. This will lead to a decrease in planned​ investment, shifting the AD curve to the left and reducing aggregate output demanded. D. The increase in financial frictions will decrease the cost of borrowing and result in lower credit spreads. This will lead to an increase in planned​ investment, shifting the AD curve to the right and increasing aggregate output demanded. How might the central bank​ respond? Why? A. If the central bank wants to avoid a recession due to an increase in financial​ frictions, it needs to reduce the real interest rate for investments through an autonomous easing of monetary policy. B. If the central bank wants to avoid an economic bubble due to an increase in financial​ frictions, it needs to increase the real interest rate for investments by following the Taylor principle. C. If the central bank wants to avoid a recession due to an increase in financial​ frictions, it needs to reduce the real interest rate for investments by following the Taylor principle. D. If the central bank wants to avoid an economic bubble due to an increase in financial​ frictions, it needs to increase the real interest rate for investments through an autonomous tightening of monetary policy.

C. The increase in financial frictions will increase the cost of borrowing and result in higher credit spreads. This will lead to a decrease in planned​ investment, shifting the AD curve to the left and reducing aggregate output demanded. A. If the central bank wants to avoid a recession due to an increase in financial​ frictions, it needs to reduce the real interest rate for investments through an autonomous easing of monetary policy.

Which of the following causes the MP curve to shift​ down? A. a decrease in inflation B. an increase in inflation C. an autonomous tightening of monetary policy D. an autonomous easing of monetary policy

D. an autonomous easing of monetary policy

When r increases​, this causes a movement along​ the________ curve, and shifts the ​_________ curve. A. ​MP; IS B. ​MP; AD C. ​AD; MP D. ​IS; AD

D. ​IS; AD

​"Autonomous monetary policy is more effective at changing output when λ is​ higher." Is this statement​ true, false, or​ uncertain? Explain your answer.

False. For a given IS​ curve, any change in autonomous monetary policy will have the same impact on output.

​"The Fed decreased the fed funds rate in late​ 2007, even though inflation was increasing. This demonstrates a violation of the Taylor​ principle." Is this statement​ true, false, or​ uncertain? Explain your answer.

False. It was the autonomous component of the fed funds rate that was decreased through an autonomous monetary policy easing. The​ Fed's distaste for inflation did not change and remained positive.

​"If f ​increases, then the Fed can keep output constant by reducing the real interest rate by the same amount as the increase in financial​ frictions." Is this statement​ true, false, or​ uncertain? Explain your answer.

False. The Fed would need to reduce the real interest rate by a little bit less than the change in f to keep output constant.

Why can the Fed control the real interest rate in the short run but not in the long​ run?

It adjusts for inflation, and prices are sticky in the short run. Hence, when a change in the Fed's monetary policy causes the nominal interest rate to change, the real interest rate also changes in the same direction. In the long run, actual and expected inflation change in response to changes in monetary policy, leaving the real interest rate unaffected.

Why is it necessary for the MP curve to have an upward​ slope?

So inflation doesn't spin out of control

does a tightening of monetary policy represent a steeper or less steep MP curve?

Steeper

Allowing the real interest rate to rise as inflation rises is said to be driven by the

Taylor principle In order to stabilize​ inflation, monetary policy makers follow the Taylor​ principle, named after John Taylor of Stanford​ University, in which they raise nominal rates by more than any rise in expected inflation so that real interest rates rise when there is a rise in​ inflation, as the MP curve suggests.

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.

The​ Fed's decision to shift the MP curve downward came from its belief that the financial crisis had the potential to drive the economy into a (deep recession / spiraling inflation)

deep recession

if net exports were not sensitive to changes in the real interest​ rate, would monetary policy be more or less effective in changing​ output? Monetary policy would be _____ effective in changing output because net​ exports: A. do not have any significant impact on output. B. are negatively correlated with the real interest rate and output. C. are usually insensitive to changes in the real interest rate. D. represent an additional channel through which interest rate changes can affect output.

less D. represent an additional channel through which interest rate changes can affect output.

When the Fed provides more reserves to the banking​ system, the money banks have to lend to each other _______ and the federal fund rate _____

rises, falls

The Federal Reserve affects the​ short-term nominal interest rate

through adjusting reserves in the banking system

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.