Eco 29 Exam 3

Classify the following situation as a supply or demand​ shock: Steel workers go on strike for 4 weeks.

A negative (temporary) supply shock

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.

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 does not shift the IS curve? A. A decline in government spending B. A fall in the interest rate C. An increase in government spending D. An increase in autonomous consumption

B. A fall in the interest rate

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

B. an autonomous easing of monetary policy

Which of the following best describes the adjustment to​ long-run equilibrium if an​ economy's short-run equilibrium output is belowbelow potential​ output? A. 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 potential output down toward its​ short-run output. B.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. C.Since unemployment is less than its natural​ rate, there will be excessive tightness in the labor market​ and, consequently, pressure on firms to raise their prices at a more rapid rate. This acceleration of inflation shifts the​ short-run aggregate supply curve up​, pushing the​ economy's output down toward its potential output. D.Since unemployment is less 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 up​, pushing the​ economy's output up toward potential output.

B.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.

Which of the following represents a movement along a given AD curve? A. Inflation​ decreases, the real interest rate​ decreases, and aggregate output decreases. B. Inflation​ increases, the real interest rate​ increases, and aggregate output increases. C. Inflation​ decreases, the real interest rate​ decreases, and aggregate output increases. D.Inflation​ increases, the real interest rate​ decreases, and aggregate output increases.

C. Inflation​ decreases, the real interest rate​ decreases, and aggregate output increases.

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

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: The public is moremore likely to believe announcements about future policy changes. Aggregate supply adjusts lessless quickly to policy announcements when compared to another country. Output is moremore stable when compared to another country.

Country A; Country B; Country A

Arguments for adopting a policy rule include: A. policy makers and politicians cannot be trusted. B. discretionary policies pursue overly expansionary monetary policies to boost employment in the short run but generate higher inflation in the long run. C. the timeminus−inconsistency problem can lead to poor economic outcomes. D. all of the above.

D. All of the above

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. D. All of the above are correct.

D. All of the above are correct.

Which of the following is not one of the three basic approaches to establishing​ credibility? A. Appointing a​ "conservative" central banker B. Adopting an inflation targeting framework C. Implementing an exchange rate peg D. By using​ time-inconsistency arguments

D. By using​ time-inconsistency arguments

A negative demand shock will __________ inflation and will ___________ aggregate output in the long run.

Decrease; Not Change

A negative demand shock will ________ inflation and will __________ aggregate output in the short run.

Decrease; decrease

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 can be too rigid because they cannot foresee every contingency. C. discretion enables policy makers to change policy settings when an economy undergoes structural changes. D. policy rules do not easily incorporate the use of judgment. E. all of the above.

E. All of the above

Approaches to establishing central bank credibility include: A. central bank independence. B. appointment of a more conservative central banker. C. exchange rate targeting. D. inflation targeting. E. all of the above.

E. all of the above.

A credible nominal anchor: A. can help overcome the timeminus−inconsistency problem by providing an expected constraint on discretionary policy. B. can help to anchor inflation​ expectations, which leads to smaller fluctuations in inflation. C. is required for a policy rule. D. all of the above. E. both A and B.

E. both A and B.

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

If government spending increases, the ____________ curve shifts ________. In the short fun , inflation __________ and output ____________. This leads to tightness in the labor market, which ___________ inflation expectations and shifts the ______________________ curve _____. When this occurs, the economy moves to a new ____________ equilibrium, output ________________________ and inflation _____________.

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.

A movement to the right along a given MP curve means:

Inflation is increasing

The IS curve shows combinations of:

Interest rates and income that bring equilibrium in the market for goods and services

What relationship does the aggregate supply curve describe?

It describes the relationship between total quantity of output supplies 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.

Inflation targeting can be used to:

Keep inflation under control and increase the credibility of the monetary policymakers' commitment to price stability.

________ 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? (inflation targeting)

Public announcement of the procedural details of using all inflation-related policy variables.

If the interest rate​ falls, other things being​ equal, investment spending will​ ________.

Rise

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

What would be the effect on the aggregate demand curve?

The AD curve will shift to the right.

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.

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.

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?

The MP curve will shift downward because decreasing unemployment results in a loosening of monetary policy.

How do changes in planned expenditures affect the aggregate demand curve?

The aggregate demand curve shifts to the right if autonomous consumption, investment, 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.

"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.

The MP curve is _________ sloping due to the Taylor principle.

Upward

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 rate, the MP curve shifts upward. Monetary policy easing, a decision to lower the real interest rate at any given rate, shifts the MP curve downward.

How is an autonomous tightening or easing of monetary 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.

The short-run aggregate supply curve has:

a positive slope because as the inflation rate increases, so does the quantity of output supplied.

Everything else held​ constant, when output is​ ________ the natural rate​ level, wages will begin to​ ________, decreasing shortminus−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

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

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

In the short run, _____________. In the long run ______________________________.

both inflation and output rise; inflation rises but output does not change

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.

How can establishing an​ exchange-rate target bring credibility to a country with a poor record of inflation​ stabilization?

credible exchange-rate targets can help import another country's law inflation environment to the domestic country.

A temporary positive supply shock will _________ inflation and will ________ aggregate output in the short run.

decrease; increase

In the short run, output _________ and inflation _________. In the long run output ___________ to potential and inflation ______________ to its original level.

decreases; increases; rises; decreases to its original level.

Everything else held​ constant, an increase in the cost of production​ ________ aggregate​ ________.

decreases; supply

An expansionary monetary policy lowers the real interest​ rate, causing the domestic currency to​ ________, thereby​ ________ net exports.

depreciate; raising

Arguments for adopting a policy rule include:

discretionary policies pursue overly expansionary monetary policies to boost employment in the short run but generate higher inflation in the long run.

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 non credible 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 λ>0.

Durring financial crises, financial frictions __________, leading to a ___________ shift of the IS curve.

increase; leftward

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 slopes downward because higher​ ______________ lead to lower​ ___________ and​ ___________.

interest​ rates; investment​ spending; net exports

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

Arguments for discretionary policies include:

policy rules can be too rigid because they cannot foresee every contingency.

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:

real interest rate and the inflation rate

Economic theory suggests that​ ________ interest rates are​ ________ important than​ ________ interest rates in explaining investment behavior.

real; more; nominal

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 shortminus−run aggregate supply curve shifts​ ________.

rises; leftward

If autonomous consumption increases​, then the AD curve:

shifts to the right

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 the 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

When inflation and inflation expectations adjust to move output to​ potential, this is an example of:

the self-correcting mechanism

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 left of the IS​ curve,

there is an excess demand for goods, which leads to 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.

How can use of macroeconomic models that do not assume expectations are rational be problematic for policy analysis?

they are unreliable for evaluating policy options.

The long-run aggregate supply curve is:

vertical because change 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

If taxes decrease and autonomous consumption expenditure increase, the IS curve:

will shift right