ECON 3340 Chapter 9

Suppose T decreases. How must the central bank change the real policy interest rate to maintain the existing​ medium-run equilibrium? A. A decrease in T shifts the IS curve to the​ left, causing a decrease in output below Yn. To return to Yn​, the central bank must decrease the real policy​ rate, causing LM to shift down. B. A decrease in T shifts the IS curve to the​ right, causing an increase in output above Yn. To return to Yn​, the central bank must increase the real policy​ rate, causing LM to shift up. C. A decrease in T shifts the IS curve to the​ right, causing an increase in output above Yn. To return to Yn​, the central bank must decrease the real policy​ rate, causing LM to shift down. D. A decrease in T shifts the IS curve to the​ left, causing a decrease in output below Yn. To return to Yn​, the central bank must increase the real policy​ rate, causing LM to shift up.

A decrease in T shifts the IS curve to the​ right, causing an increase in output above Yn. To return to Yn​, the central bank must increase the real policy​ rate, causing LM to shift up.

Suppose the economy had initially been at potential output where IS crossed LM at . Which of the following events could have caused the output gap that you indicated on the​ graph? ​(Check all that apply​.) A. A decrease in the tax rate B. A decrease in government spending C. An increase in tax rates D. A decrease in the risk premium, x

A decrease in government spending An increase in tax rates

Suppose G increases. How must the central bank change the real policy interest rate to maintain the existing​ medium-run equilibrium? A. An increase in G shifts the IS curve to the​ right, causing an increase in output above Yn. To return to Yn​, the central bank must increase the real policy​ rate, causing LM to shift up. B. An increase in G shifts the IS curve to the​ left, causing a decrease in output below Yn. To return to Yn​, the central bank must decrease the real policy​ rate, causing LM to shift down. C. An increase in G shifts the IS curve to the​ left, causing a decrease in output below Yn. To return to Yn​, the central bank must increase the real policy​ rate, causing LM to shift up. D. An increase in G shifts the IS curve to the​ right, causing an increase in output above Yn. To return to Yn​, the central bank must decrease the real policy​ rate, causing LM to shift down.

An increase in G shifts the IS curve to the​ right, causing an increase in output above Yn. To return to Yn​, the central bank must increase the real policy​ rate, causing LM to shift up.

Which of the following events could have caused the positive output gap that you indicated on the graph? (Check all that apply.) A. An increase in government spending B. A decrease in the tax rate C. A decrease in government spending D. An increase in the risk premium, x

An increase in government spending A decrease in tax rate A decrease in the risk premium, x

If (u − un) is greater than​ zero, then (Y − Yn) is greater than zero.

False

If (u − un) is less than​ zero, the output gap is negative.

False

Okun's law says that if output growth increases by one percentage​ point, the rate of unemployment drops by one percentage point.

False

The IS curve shifts right with an increase in G, right with an increase in T, and right with an increase in x.

False

The central bank can always act to keep output equal to potential output.

False

In the IS−LM−PC ​model, which of the following is assumed to be​ exogenous? A. G B. C C. I D. Y

G

When the policy rate​ increases, A. LM curve shifts upward. B. IS curve does not change. C. LM curve shifts downward. D. IS curve shifts to the right. E. IS curve shifts to the left.

IS curve does not change

When a government reduces its deficits by increasing​ taxes, in the short​ run, A. output returns to potential. B. IS curve shifts inward to the left. C. interest rate is higher. D. output increases.

IS curve shifts inward to the left

During the recent​ recession, several European countries proposed austerity measures that would help shrink the size of the national deficits within the countries. These proposed measures included tax hikes and cuts in government spending. When this happened in the United States in the​ 1990s, there was an accompanying decrease in the policy rate to help avoid slowing the economy down too much. Why was this same policy decision more difficult in​ Europe? A. There is no mechanism in Europe to change the policy rate like there is in the United States. B. Europeans protested against the austerity​ measures, which angered the​ government; it responded by intentionally not taking steps to limit the impact of these measures. C. In response to the​ recession, the policy rate in Europe had already been lowered close to the zero lower​ bound, so additional decreases were not viable. D. European governments had never implemented these types of austerity policies before so they were not aware of the need for monetary policy to limit the impacts.

In response to the recession, the policy rate in Europe had already been lowered close to the Zero Lower Bound, so additional decreases were not viable

Which of the following best characterizes the behavior of inflation in a​ medium-run equilibrium if the level of expected inflation is formed so πe equals π(−1)​? A. Inflation is equal to some constant inflation rate irrespective of what it was the previous year. B. Inflation is decreasing. C. The inflation rate is equal to 0. D. Inflation is not changing.

Inflation is not changing

Which scenario—that inflation is anchored or that inflation is based on the previous​ year's rate—do you think is more realistic under a positive output​ gap? A. It is more realistic that the central bank will use an expected inflation anchor that is continuously incorrect rather than accept accelerating inflation. B. It is more realistic that the central bank will accept accelerating inflation rather than use an expected inflation anchor that is continuously incorrect. C. Neither are​ likely, as the central bank will not likely accept ever increasing inflation nor will it permanently use an incorrect anchor for inflation. D. Both are equally likely.

Neither are likely, as the central bank will not likely accept ever increasing inflation nor will it permanently use an incorrect anchor for inflation

How will the​ short-run equilibrium in period t+1 compare to the equilibrium in period t​? A. Output will be above potential and inflation will be above expected inflation. B. Output will be unchanged and inflation will be above expected inflation. C. Output will be below potential and inflation will be above expected inflation. D. Both output and expected inflation will decrease.

Output will be above potential and inflation will be above expected inflation

Assume that the central bank does not change the real policy rate. How will the​ short-run equilibrium in period t+1 compare to the equilibrium in period​ t? A. Output will be below potential and inflation will increase. B. Output will be unchanged and inflation will decrease. C. Output will be above potential and inflation will increase. D. Both output and inflation will decrease.

Output will be above potential and inflation will increase.

The​ medium-run equilibrium is characterized by four​ conditions: 1. Output is equal to potential output Y = Yn. 2. The unemployment rate is equal to the natural rate u = un. 3. The real policy interest rate is equal to the natural rate of interest rn where aggregate demand equals Yn. 4. The expected rate of inflation πe is equal to the actual rate of inflation π. The IS relation is Y = C(Y − T) + I(Y, r + x) + G. Suppose rn is​ 2%. If x increases from 4 to 5​%, how must the central bank change rn to maintain the existing​ medium-run equilibrium? A. The central bank should adjust the real policy rate until it also equals 5​%. B. The central bank needs to increase the real policy interest rate by 1​% in order to keep r​ + x unchanged. C. The central bank should adjust the real policy rate until it equals 4​%. D. The central bank needs to decrease the real policy interest rate by 1​% in order to keep r​ + x unchanged

The central bank needs to decrease the real policy interest rate by 1​% in order to keep r​ + x unchanged

At the natural rate of​ unemployment, inflation is neither rising nor falling.

True

If (u − un) is equal to​ zero, the output is at potential.

True

If the output gap is​ positive, inflation is higher than expected inflation.

True

In a​ medium-run equilibrium, the rate of inflation is stable.

True

It is easier for the central bank to keep output at potential output if expectations of inflation are anchored.

True

A large increase in the price of oil increases the natural rate of unemployment.

Uncertain

Professor Blanchard discusses two key risks to the​ IMF's outlook that could slow growth in 2012 and in 2013. Which of the following is NOT one of these key​ risks? A. increase in oil prices B. another Euro crisis C. a monetary tightening D. all of the above

a monetary tightening

Under anchored​ expectations, there was​ _________, and under lagged​ expectations, there was​ _________. A. a permanently higher level of​ inflation; the same permanently higher level of inflation B. an acceleration of​ inflation; the same acceleration of inflation C. a permanently higher level of​ inflation; an acceleration of inflation D. an acceleration of​ inflation; a permanently higher level of inflation

a permanently higher level of inflation; an acceleration of inflation

For this​ question, assume that the economy is initially operating at the natural level of output. An increase in the price of oil will cause which of the following in the medium​ run? A. a reduction in output and an increase in the aggregate price level B. a reduction in the interest rate C. a reduction in​ unemployment, an increase in the nominal wage and an increase in the aggregate price level D. a reduction in the aggregate price level and no change in output E. a reduction in output and a reduction in the interest rate

a reduction in output and an increase in the aggregate price level

How does the zero lower bound on nominal interest rates make a fiscal consolidation more​ difficult? When facing a zero lower​ bound, fiscal consolidation can lead to __________ output and ___________, which will __________ tax​ revenue, making it harder to reduce the deficit.

decreasing; deflation; lower

The wage setting relation is A. horizontal. B. vertical. C. upward sloping. D. downward sloping.

downward sloping

Suppose in period t+4​, the central bank decides to raise the real policy rate high enough to return the economy immediately to potential output and to the period t rate of inflation. Explain the difference between central bank policies using the two assumptions about expected inflation. Under anchored inflation​ expectations, the central bank would have to raise the policy rate __________. This __________ rate will cause ___________. Once the inflation goal has been​ achieved, the central bank ____________. Under lagged inflation​ expectations, the central bank would have to raise the policy rate ____________. This ___________ rate will cause ___________. Once the inflation goal has been​ achieved, the central bank ____________.

enough to eliminate the output gap higher; inflation to return to the anchored rate; will not need to make any further changes significantly higher than if expectations were anchored significantly higher; a recession, causing large reductions in inflation; can return the policy rate to its original level

Suppose in period t+4​, the central bank decides to raise the real policy rate high enough to return the economy immediately to potential output and to the period t rate of inflation. Explain the difference between central bank policies using the two assumptions about expected inflation. Under anchored inflation​ expectations, the central bank would have to raise the policy rate __________. This __________ rate will cause _______________. Once the inflation goal has been​ achieved, the central bank ____________. Under lagged inflation​ expectations, the central bank would have to raise the policy rate _____________. This _________ rate will cause _________. Once the inflation goal has been​ achieved, the central bank ___________.

enough to eliminate the output gap higher; inflation to return to the anchored rate; will not need to make any further changes significantly higher than if expectations were anchored significantly higher; a recession, causing large reductions in inflation; can return the policy rate to its original level

The government policy to reduce the deficit has caused output from period t to period t + 1 to ________ and the change in inflation rate over this period has ________.

fall; become negative

Consider the period t+2 equilibrium under the assumption that πet+2 = πt+1. If the central bank leaves the real policy rate​ unchanged, how does actual inflation in period t+2 compare to inflation in period t+1​? ​ Similarly, how does actual inflation in period t+3 compare to inflation in period t+2​? Actual inflation in period t+2 will be __________ inflation in period t+1​, and actual inflation in period t+3 will be __________ inflation in period t+2.

greater than; greater than

If the central bank leaves the real policy rate​ unchanged, how does actual inflation in period t+2 compare to inflation in period t+1​? ​Similarly, how does actual inflation in period t+3 compare to inflation in period t+2​? Actual inflation in period t+2 will be _____________ inflation in period t+1​, and actual inflation in period t+3 will be _____________ inflation in period t+2.

greater than; similar to

Consider the period t+2 equilibrium under the assumption that πet+2 = πt+1. If the central bank leaves the real policy rate​ unchanged, how does actual inflation in period t+2 compare to inflation in period t+1​? To keep the real policy rate​ unchanged, the central bank would need to __________ the nominal policy rate. Actual inflation in period t+2 will be _________ than inflation in period t+1.

increase greater than

Continue to period t+3. Making the same assumption about the level of expected inflation and the real policy​ rate, how does actual inflation in period t+3 compare to inflation in period t+2​? To keep the real policy rate unchanged in period t+3​, the central bank would need to _________ change the nominal policy rate. Actual inflation in period t+3 will be _______ than inflation in period t+2.

increase greater than

If expected inflation depends on past​ inflation, then in period t + 2​, the real policy rate will​ _________. This will cause output in period t + 3 to​ _________. A. ​decrease; fall further B. increase; rise back to potential C. increase; fall further D. decrease; rise back to potential

increase; fall further

From 1970 to the mid−​1990s, the relative price of crude petroleum A. increased​ dramatically, then decreased dramatically. B. decreased​ dramatically, then increased dramatically. C. steadily decreased. D. remained more or less the same. E. steadily increased.

increased dramatically, then decreased dramatically

If the output is too​ high, to achieve the medium run​ equilibrium, the central bank will A. increase money supply. B. increases inflation rate. C. increases policy rate. D. reduces policy rate.

increases policy rate

The Phillips curve shows that when the unemployment rate is lower than the natural​ rate, A. policy rate is higher than expected. B. policy rate is lower than expected. C. inflation is lower than expected. D. inflation is higher than expected.

inflation is higher than expected

For this​ question, assume that the economy is initially operating at the natural level of output. An increase in consumer confidence will cause A. an increase in the real wage in the medium run. B. no change in the real wage in the medium run. C. ambiguous effects on the real wage in the medium run. D. a reduction in the real wage in the medium run.

no change in the real wage in the medium run

For this​ question, assume that the economy is initially operating at the natural level of output. An increase in unemployment benefits will​ cause: A. an increase in the real wage in the medium run B. ambiguous effects on the real wage in the medium run C. a reduction in the real wage in the medium run D. no change in the real wage in the medium run

no change in the real wage in the medium run

Now consider the period t+2 equilibrium making the assumption that πet+2 = π. If the central bank leaves the real policy rate​ unchanged, how does actual inflation in period t+2 compare to inflation in period t+1​? To keep the real policy rate​ unchanged, the central bank would need to ________ the nominal policy rate. Actual inflation in period t+2 will be ________ than inflation in period t+1.

not change equal to

Okun's law shows that when the unemployment rate is above the natural​ rate, A. output is below potential. B. output is above potential. C. inflation is higher than expected. D. inflation is lower than expected.

output is below potential

In this chapter we discussed the policy decisions that central banks can make to return an economy back to a stable equilibrium whenever there is an outside shock. The policy choices are straightforward and can be decided on directly by the central bank. Why then do central banks not do a better job of keeping economies near a stable equilibrium all the​ time? One issue that arises is that in real life it is very hard to know the true level of ____________. Since this is hard to​ observe, we need to rely on inflation to get an idea of where the economy is. When doing​ this, we focus on the change in ______________ as our guide.

potential output change in inflation

How did the inflation and output outcomes differ when expected inflation was anchored ​(πet+2 = π​) relative to when it was lagged ​(πet+2 = πt+1​)? Under anchored​ expectations, output _________ and there was ________ of​ inflation, and under lagged​ expectations, output __________ and there was _________ of inflation.

remained the same; a permanently higher level; remained the same; an acceleration

Continue to period t​ + 3. Making the same assumption about the level of expected inflation and the real policy​ rate, how does actual inflation in period t​ + 3 compare to inflation in period t​ + 2? Actual inflation in period t+3 will be ________ than inflation in period t+2.

similar to

The change in the unemployment rate is approximately equal to A. the negative policy rate. B. the negative inflation rate. C. the negative of the growth rate of money supply. D. the negative of the growth rate of output.

the negative of the growth rate of output

The central bank can have a hard time adjusting the economy appropriately because​ ________. A. even though central banks can determine the state of the economy​ easily, they usually do not have the​ long-run health of the economy as their main goal. B. the economy usually responds too quickly to policy decisions and there is a lot of​ "noise" in the​ economy, making it hard to know precise relationships between variables. C. even though central banks can determine the state of the economy​ easily, and the economy responds to policy decisions​ quickly, the policy decisions made by central banks are consistently incorrect. D. there is a lag in how long it takes the economy to respond to policy decisions and there is a lot of​ "noise" in the​ economy, making it hard to know precise relationships between variables.

there is a lag in how long it takes the economy to respond to policy decisions and there is a lot of "noise" in the economy, making it hard to know precise relationships between variables

The IMF examined a scenario in which uncertainty in the Middle East would cause oil prices to increase by​ 50%. The IMF predicted that this increase in oil prices would cause the level of output over the next two​ years: A. to decrease by​ 2% in the United States and Europe and by​ 2.5% in Japan. B. to decrease by​ 1% in the United States and Europe and by​ 1.5% in Japan. C. to decrease by​ 3% in the United​ States, Europe and in Japan. D. to decrease by​ 3% in the United States and Europe and by​ 0.5% in Japan.

to decrease by 1% in the United States and Europe and by 1.5% in Japan

If instead, the level of expected inflation is π​, what is the level of actual inflation in the​ medium-run equilibrium? A. The same as rn. B. π. (pi with the line above it) C. 0 D. It cannot be determined

π. (pie with the line above it)

Is it true that in the medium​ run, a fiscal expansion leads to an increase in the natural rate of​ interest? A. ​No, when the central bank increases the real policy rate to address a fiscal​ expansion, the natural rate reacts by moving in the opposite​ direction, resulting in a decrease in rn. B. No, the central bank will decrease the real policy rate to address a fiscal​ expansion, so the new lower rate results in stable inflation and a return to Yn​, thus lowering rn. C. Yes, when the central bank decreases the real policy rate to address a fiscal​ expansion, the natural rate reacts by moving in the opposite​ direction, resulting in an increase in rn. D. ​Yes, when the central bank increases the real policy rate to address a fiscal​ expansion, the new rate results in stable inflation and a return to Yn​, thus making the new​ rate, rn.

​Yes, when the central bank increases the real policy rate to address a fiscal​ expansion, the new rate results in stable inflation and a return to Yn​, thus making the new​ rate, rn.