Ch.21 Test Bank Output, Inflation, And Monetary Policy

Student name:__________

1) What are the determinants of the potential output for an economy?

2) Use the equation of exchange to show that in the long run, inflation must equal money growth less the growth of potential output.

3) Temporary changes in inflation lead to adjustments in the price level. What causes permanent increases in inflation and why?

4) If changes in the nominal federal funds rate result in equal changes to the expected rate of inflation, how effective would it be for the FOMC to target the nominal federal funds rate?

5) Suppose that, ceteris paribus, the government passes a $2 trillion stimulus package to assist with a slowdown that accompanies a global pandemic. Ignore any monetary policy actions for now. How would this change Aggregate Expenditure in the economy? What impact would this have on potential output and the real interest rate? Include a graph as part of your explanation.

6) Draw a graph of the monetary policy reaction curve (MPRC) and describe what determines its location.

7) When policymakers adjust the real interest rate, they are either moving along a fixed monetary policy reaction curve or shifting the curve. What is the difference? Provide an example of each.

8) Rank the components of aggregate demand by their sensitivity to changes in the real interest rate. Start with the most sensitive to the least sensitive.

9) Why would central bankers have to pay attention to forecasts regarding consumer sentiment and expectations of business owners and managers?

10) What distinguishes the short-run real interest rate from the long-run real interest rate?

11) Why is it necessary to understand fluctuations in investment if we want to understand the fluctuations in the business cycle?

12) If the economy is producing a level of output that is consistent with the potential output level, and government purchases increase, describe what happens in terms of the long-run real interest rate, and why, to keep the economy at its potential output level.

13) Given a central bank's monetary policy reaction curve, if inflation increases by 1% why would policymakers likely have to increase the nominal interest rate by more than the increase in the expected rate of inflation?

14) Discuss what happens to the monetary policy reaction curve if the Fed were to lower their inflation target and why?

15) Is the monetary policy reaction curve applicable only to central banks that have an explicit inflation target? Explain.

16) Can central bankers set short-term interest rate targets and still control inflation in the long run or are these goals mutually impossible? Explain.

17) Explain the impact on the monetary policy reaction curve and the nominal interest rate if the level of government purchases were to decrease and the central bank does not change its inflation target.

18) Assuming the free flow of capital across borders, explain why a country that has a fixed exchange rate cannot have an independent monetary policy reaction curve.

19) Use the monetary policy reaction curve to link a higher inflation rate to lower aggregate demand.

20) Explain the changes that would cause the dynamic aggregate demand curve to shift.

21) Explain why the short-run aggregate supply curve has a positive slope.

22) Explain why changes in expectations of future inflation shift the short-run aggregate supply curve. Provide an example and a graph showing a decrease in SRAS.

23) How would the discovery of a previously unknown large reserve of oil affect the short-run aggregate supply curve and why? What other change could have the same effect?

24) Is the actual amount of output that corresponds to the long-run aggregate supply curve fixed? Explain.

25) Explain the difference between SRAS and LRAS. What happens at the point where they intersect?

26) What are the conditions for long-run equilibrium?

27) Output and inflation movements can arise from either demand or supply shifts. How can we tell them apart?

28) Evidence seems to point out that just before past recessions occurred in the U.S., interest rates rose. Why would monetary policymakers choose to cause recessions?

29) Discuss why many economists maintain that continued deficit spending by government is likely to "crowd out" (decrease) investment spending in the long run.

30) Former Bank of England Governor Mervyn King, commenting on a speech given by then Fed Chairman Greenspan, said "any (coherent) monetary policy can be written as an inflation target plus a response to supply shocks." What do these comments mean and what insight do they provide us to the focus of central banks?

31) Economists usually maintain that policy designed to increase aggregate demand cannot have any long-run real effects. What lies behind this argument?

32) At the conclusion of its meeting on January 27, 2016, the Federal Open Market Committee released a statement that included the following sentence: “Given the economic outlook, the Committee decided to maintain the target range for the federal funds rate at ¼ to ½ percent. The stance of monetary policy remains accommodative, thereby supporting further improvement in labor market conditions and return to 2 percent inflation.” What is the significance of this statement?

33) Use the model of dynamic AD, SRAS, and LRAS to explain the difference between short-run equilibrium and long-run equilibrium. Draw a graph illustrating each situation.

34) Consider the scenario illustrated in the following graph. What situation is occurring in this economy at equilibrium 0? Explain the adjustment process that will move the economy to long-run equilibrium at equilibrium 1.

35) Short-run movements in inflation and output are ultimately attributed to changes in

A) aggregate demand.
B) aggregate supply.
C) foreign policy.
D) aggregate demand and aggregate supply.

36) Modern monetary policymakers work to reduce the volatility created by fluctuations in __________ by adjusting __________.

A) aggregate demand; target interest rate
B) aggregate supply; target monetary aggregate
C) aggregate demand and aggregate supply; target interest rate
D) aggregate demand and aggregate supply; target monetary aggregate

37) The Fed hopes to impact short-run inflation and output by altering

A) the production function.
B) aggregate supply.
C) aggregate demand.
D) fiscal policy.

38) The aggregate demand curve shows the quantity of

A) nominal output demanded at each level of inflation.
B) real output demanded at each level of inflation.
C) output made available at each level of inflation.
D) real output demanded at each level of real interest rate.

39) Aggregate supply is the quantity of

A) real output supplied at each level of inflation.
B) nominal output supplied at each level of inflation.
C) real output supplied at each level of real interest rate.
D) output the country wants at each level of inflation.

40) Business cycles are viewed as

A) movements in the short-run equilibrium.
B) situations where aggregate demand does not equal short-run aggregate supply.
C) inevitable; every economy must experience them.
D) movements in the long-run equilibrium.

41) A characteristic of long-run equilibrium is that the economy is producing its potential output, which is

A) the maximum level of output the economy could produce at any time.
B) the level of output the economy produces when its resources are used at normal rates.
C) defined as using 80 percent of the economy's resources at any time.
D) the level of output consistent with an unemployment rate of 7.5 percent.

42) A slowdown in the pace of inflation is

A) deflation.
B) disinflation.
C) temporary inflation.
D) temporary deflation.

43) In the long run, with %Δ V = 0, we can conclude that the inflation rate equals the

A) rate of money growth.
B) rate of money growth plus growth in potential output.
C) rate of money growth minus growth in potential output.
D) rate of money growth plus change in velocity of money.

44) Potential output of the country when viewed over long periods of time

A) rises in spurts and then starts a downward trend that can last years.
B) is surprisingly constant.
C) always decreases.
D) tends to rise over time.

45) Which one of the following would cause an increase in the potential output of a country?

A) an increase in the capital stock
B) a temporary decrease in exports
C) an increase in the money supply
D) a decrease in the labor force

46) The potential output of a country would increase as a result of each of the following, except which one?

A) an increase in population
B) an increase in capital per worker
C) technological innovation that increases labor productivity
D) depreciation of the capital stock

47) Current output

A) determines potential output.
B) is below potential output when an expansionary gap exists.
C) cannot exceed potential output.
D) is below potential output during a recessionary gap.

48) In the long run, current output will

A) equal potential output.
B) be less than potential output.
C) be above potential output.
D) only equal potential output if unemployment is zero.

49) In the long run, if we ignore changes in velocity, inflation will

A) be zero.
B) equal the rate of money growth.
C) equal money growth less the growth in potential output.
D) equal money growth plus the growth in potential output.

50) Given the equation of exchange, MV = PY, when central bankers control short-term nominal interest rates by adjusting the level of reserves in the banking system, their actions are expected to primarily affect

A) the rate of growth ofV.
B) the value ofV.
C) potentialY as opposed to currentY.
D) the rate of growth ofM.

51) To an economist, the term "inflation" refers to

A) any price increases.
B) a continually rising price level.
C) a one-time change in the average price level.
D) increases in prices of critical goods like food and energy.

52) If inflation is very high, say 50 or 100 percent a year, monetary policymakers wishing to lower it will shift their focus to controlling

A) the long-term interest rate.
B) the short-term interest rate.
C) the exchange rate.
D) money growth.

53) Recent policy statements by the FOMC announce and explain its

A) decisions for long-term interest rates.
B) targets for money growth with no mention of interest-rate targets.
C) decisions for money-growth targets but also mentioning short-term interest-rate decisions.
D) short-term interest-rate and balance-sheet adjustments with no mention of money growth targets.

54) The FOMC targets the federal funds rate, and if they are going to alter the course of the economy this must influence the

A) real interest rate.
B) long-term nominal interest rate.
C) real exchange rate.
D) nominal exchange rate.

55) For central bankers to alter the real interest rate by changing the nominal interest rate,

A) the rate of inflation has to remain constant.
B) inflation expectations should be quite stable.
C) the expected rate of inflation has to change.
D) the change in the expected rate of inflation must equal the change in the nominal interest rate.

56) Empirical evidence suggests that over the last several decades,

A) the nominal and real federal funds rates are related inversely.
B) the nominal and real federal funds rates are highly positively correlated.
C) while the FOMC has had a lot of influence over the nominal federal funds rate, they have been less successful at changing the real federal funds rate.
D) there is no correlation between the nominal and real federal funds.

57) Which one of the following is not a part of aggregate expenditure?

A) consumption
B) nominal interest rate
C) government purchases
D) net exports

58) Which one of the following would not be included in aggregate expenditures?

A) new military equipment purchased by the federal government
B) new computers purchased by a law firm
C) social Security payments made by the government to retirees
D) tuition payments made by college students

59) Which one of the following would not be included in aggregate expenditures?

A) your purchase of a new car
B) your purchase of new textbooks for the semester
C) the value of 100 shares of Microsoft stock you purchased
D) the value of blue jeans produced in the United States and exported to Japan

60) Of all of the components of aggregate demand, the most interest sensitive is

A) investment.
B) government purchases.
C) consumption.
D) net exports.

61) Which component of aggregate expenditures is the least sensitive to changes in the real interest rate?

A) investment
B) consumption
C) net exports
D) government purchases

62) Consumption can be sensitive to changes in the real interest rate because

A) higher interest rates can increase the cost of durable goods like automobiles.
B) higher interest rates will result in less saving.
C) lower real interest rates will decrease spending on durable goods and increase spending on non-durable goods.
D) lower interest rates increase savings.

63) When the real interest rate

A) increases, the reward for saving decreases.
B) decreases, current consumption becomes less expensive and the reward for saving decreases.
C) decreases, the cost of current consumption increases.
D) increases, the level of saving always decreases.

64) Increases in the real interest rate in the United States will cause net exports to

A) decrease because the dollar depreciates.
B) increase because the dollar depreciates.
C) decrease because the dollar appreciates.
D) increase because the dollar appreciates.

65) A decrease in the real interest rate in the United States will cause net exports to

A) increase, because exports will remain constant but imports will decrease.
B) decrease, because exports will decrease and imports will increase.
C) decrease, because exports will increase but imports will increase.
D) increase, because exports will increase and imports will decrease.

66) An increase in the real interest rate should cause aggregate expenditures to

A) increase.
B) decrease.
C) remain constant.
D) change in an indeterminate direction.

67) Which one of the following would not shift the aggregate expenditures curve?

A) a change in the real interest rate
B) changes in consumer or business confidence
C) fiscal policy changes
D) changes in net exports that result from exchange rate changes

68) If the level of current output suddenly falls below the potential level of output, central bankers would typically

A) lower the real interest rate.
B) raise the real interest rate.
C) keep the real interest rate constant and focus on only changing the nominal interest rate.
D) attempt to shift the aggregate expenditures curve.

69) If government purchases increase and as a result push current output above potential output, monetary policymakers are likely to

A) lower the real interest rate.
B) raise the real interest rate.
C) keep the real interest rate constant and focus on only changing the nominal interest rate.
D) purchase Treasury securities.

70) The relationship between the long-run real interest rate and potential output

A) is direct.
B) is inverse.
C) is constant since the long-run real interest rate is primarily determined by risk.
D) depends on the actions of central bankers.

71) With the economy at its potential level of output, the federal government undertakes a large military buildup. All other things equal, the long-run real interest rate will

A) increase.
B) decrease.
C) remain constant since output is at its potential level.
D) change at the same rate as inflation.

72) It has been argued that the information technology age has greatly increased productivity and potential output. If this is true, then the

A) the long-run real interest rate is also higher as a result.
B) nominal long-run interest rates should have increased.
C) we should have seen lower short-run interest rates than we have seen.
D) the long-run real interest rate is lower as a result.

73) The long-run real interest rate varies

A) directly with changes in non-interest-sensitive components of aggregate demand and inversely with potential output.
B) inversely with changes in non-interest-sensitive components of aggregate demand and inversely with potential output.
C) directly with changes in non-interest-sensitive components of aggregate demand and directly with potential output.
D) directly with changes in non-interest-sensitive components of aggregate demand and does not vary with potential output.

74) In the United States, most of the recessions are associated with

A) ill-timed fiscal policy.
B) decreasing net exports.
C) decreases in investment.
D) large decreases in consumption.

75) In the United States, most of the recessions are associated with fluctuations in investment, which are caused by changes in

A) inflation.
B) ill-timed fiscal policy.
C) net exports and changes in consumption.
D) the real interest rate and changes in expectations about future business conditions.

76) The monetary policy reaction curve

A) is the guideline the Fed publishes in setting their interest rate target.
B) approximates the behavior of central bankers.
C) has remained fairly constant over the years.
D) is set by Congress and given to the Fed as a guideline to follow.

77) A monetary policy reaction curve requires the central bank to have a(n)

A) money growth target.
B) inflation target.
C) unemployment target.
D) economic growth target.

78) If the axes in the model for the monetary policy reaction curve are the real interest rate (vertical axis) and the rate of inflation (horizontal axis), then the monetary policy reaction curve would

A) have a positive slope.
B) have a negative slope.
C) have a zero slope.
D) be vertical.

79) The point where the central bank's target inflation rate is consistent with the long-run real interest rate lies

A) above the monetary policy reaction curve.
B) below the monetary policy reaction curve.
C) on the monetary policy reaction curve.
D) on the horizontal (inflation) axis.

80) If policymakers are aggressive in keeping current inflation near the target inflation rate, then the monetary policy reaction curve will

A) be steep.
B) be flat.
C) have an undefined slope.
D) be vertical.

81) If a point lies on the monetary policy reaction curve, and at this point the inflation rate equals the target rate of inflation, we know that the real interest rate corresponding to this point is

A) above the long-run real interest rate.
B) equal to the long-run real interest rate.
C) below the long-run real interest rate.
D) equal to current output and above potential output.

82) The slope of the monetary policy reaction curve is determined by

A) how strongly the economy reacts to changes in the nominal interest rate.
B) how strongly the inflation rate impacts peoples' decisions.
C) how aggressively policymakers change interest rates in response to deviations between current and target inflation rates.
D) people's expectations for inflation.

83) If policymakers are not aggressive about keeping inflation close to the target rate, the slope of the monetary policy reaction curve would be

A) steep.
B) relatively flat.
C) vertical.
D) negative.

84) If the slope of the monetary policy reaction curve is relatively flat, it means that central bankers are

A) very concerned about keeping inflation close to the target rate.
B) not concerned at all about inflation.
C) less concerned about keeping inflation close to its short-run target.
D) not going to let inflation deviate from its target at all.

85) The effect on the monetary policy reaction curve resulting from policymakers decreasing their inflation target would be

A) the monetary policy reaction curve shifting to the left.
B) a movement up the existing monetary policy reaction curve.
C) a movement down the existing monetary policy reaction curve.
D) the monetary policy reaction curve shifting to the right.

86) When the monetary policymakers raise the target inflation rate, they

A) raise the current real inflation rate at every level of current inflation.
B) lower the current real interest rate at every level of current inflation.
C) in effect, shift the monetary policy reaction curve to the left.
D) in effect, move up along the current monetary policy reaction curve.

87) What would be the impact on the monetary policy reaction curve if the Fed were to raise the target inflation rate?

A) The monetary policy reaction curve shifts to the left.
B) There is a movement up the existing monetary policy reaction curve.
C) There is a movement down the existing monetary policy reaction curve.
D) The monetary policy reaction curve shifts to the right.

88) The dynamic aggregate demand curve illustrates that the relationship between inflation and real output is

A) direct.
B) inverse.
C) independent.
D) undefined.

89) An inflation rate above the target rate will result in a movement

A) up along the monetary policy reaction curve and a movement up the dynamic aggregate demand curve.
B) down along the monetary policy reaction curve and a movement down the dynamic aggregate demand curve.
C) up along the monetary policy reaction curve and a leftward shift of the dynamic aggregate demand curve.
D) up along the monetary policy reaction curve and a rightward shift of the dynamic aggregate demand curve.

90) An inflation rate below the target rate will result in a movement

A) up along the monetary policy reaction curve and a movement down the dynamic aggregate demand curve.
B) down along the monetary policy reaction curve and a movement down the dynamic aggregate demand curve.
C) up along the monetary policy reaction curve and a rightward shift of the dynamic aggregate demand curve.
D) up along the monetary policy reaction curve and a leftward shift of the dynamic aggregate demand curve.

91) Each of the following factors contribute to the slope of the dynamic aggregate demand curve, except the

A) strength of the effect of inflation on real balances.
B) current level of technology.
C) extent to which monetary policymakers react to a change in current inflation.
D) size of the response of aggregate expenditures to changes in the interest rate.

92) The fact that central bankers tend to respond to higher rates of inflation by increasing the real interest rate is one reason why the

A) dynamic aggregate demand curve shifts left.
B) dynamic aggregate demand curve slopes downward.
C) dynamic aggregate demand curve shifts right.
D) monetary policy reaction curve has a negative slope.

93) One of the ways inflation reduces aggregate demand is by

A) increasing nominal GDP.
B) increasing velocity.
C) reducing real balances.
D) increasing wealth.

94) The dynamic aggregate demand curve has a negative slope for all the following reasons except which one?

A) reduction in real wealth caused by inflation
B) the fact that high rates of inflation are good for the stock market
C) redistribution that occurs as inflation has a greater impact on the poor than on the wealthy
D) higher current inflation leading policymakers to increase the real interest rate, which depresses various components of aggregate expenditures.

95) A rightward shift in the dynamic aggregate demand curve could result from

A) a decrease in government purchases.
B) an increase in imports.
C) a rightward shift of the monetary policy reaction curve.
D) an increase in business pessimism about future prospects.

96) A decrease in taxes would cause

A) the dynamic aggregate demand curve to shift to the left.
B) a movement down and along the existing dynamic aggregate demand curve.
C) a movement up and along the existing dynamic aggregate demand curve.
D) the dynamic aggregate demand curve to shift to the right.

97) A decrease in the inflation target by the central bank would

A) have no impact on the positioning of the dynamic aggregate demand curve.
B) cause the dynamic aggregate demand curve to shift to the left.
C) cause a movement down the dynamic aggregate demand curve to.
D) be reflected by a movement down and along the existing dynamic aggregate demand curve.

98) If monetary policymakers fear a recession resulting from increased pessimism on the part of businesspeople and they want to avoid the recession, they would

A) shift the monetary policy reaction curve to the right.
B) shift the monetary policy reaction curve to the left.
C) likely lower their target rate for inflation.
D) encourage fiscal policymakers to act.

99) In the short run, the point on the aggregate demand curve where an economy will end up in equilibrium depends on

A) the money supply.
B) the long-run rate of inflation.
C) potential output.
D) the short-run aggregate supply curve.

100) In the short run, the aggregate supply curve is

A) vertical.
B) horizontal.
C) upward-sloping.
D) downward-sloping.

101) If most people expect the inflation rate will increase, the

A) long-run aggregate supply curve would shift right.
B) aggregate demand curve would shift right.
C) short-run aggregate supply curve would shift to the right.
D) short-run aggregate supply curve would shift to the left.

102) If output and inflation are unrelated in the long run, the long-run aggregate supply curve must be

A) horizontal.
B) vertical.
C) upward-sloping.
D) the same as short-run aggregate supply.

103) The long-run aggregate supply curve intersects the horizontal axis at the

A) potential level of output.
B) current level of output.
C) expected rate of inflation.
D) actual rate of inflation.

104) At any point along the long-run aggregate supply curve,

A) expected inflation equals current inflation and current output is below potential output.
B) the economy is moving toward its potential output level.
C) current output equals potential output and expected inflation equals current inflation.
D) expected inflation is moving toward current inflation.

105) Which one of the following statements is not correct?

A) The point where the short-run and long-run supply curves intersect corresponds to the potential level of output.
B) Any point on the short-run aggregate supply curve reflects current inflation equaling target inflation.
C) Inflation and output are unrelated in the long run.
D) In the long run, inflation is determined by monetary policy.

106) The intersection of the aggregate demand curve and the short-run aggregate supply curve determines

A) current inflation, but not current output.
B) potential output.
C) current output, but not current inflation.
D) current output and current inflation.

107) The economy is in both a short- and long-run equilibrium if

A) current inflation equals expected inflation and current output equals potential output.
B) the aggregate demand curve intersects the short-run aggregate supply curve.
C) the long-run aggregate supply curve is at potential output.
D) the short-run aggregate supply curve intersects the long-run aggregate supply curve at potential output.

108) If the economy is in long-run equilibrium, then

A) inflation should be accelerating.
B) current output should be greater than potential output.
C) current inflation should equal expected inflation.
D) current inflation should be less than expected inflation.

109) The self-correcting mechanism to return the economy to potential output from output gaps is the change in

A) potential output.
B) aggregate demand.
C) short-run aggregate supply.
D) the real interest rate by the central bank.

110) The conditions that hold in long-run equilibrium include each of the following, except which one?

A) Imports equal exports.
B) Current inflation is steady and equals target inflation.
C) Current output equals potential output.
D) Current inflation equals expected inflation.

111) Suppose an economy is currently operating at point 0 in the following graph. This economy is experiencing a(n)

A) recessionary gap.
B) expansionary gap.
C) long-run equilibrium.
D) inflation rate below expected inflation.

112) The debate over the causes of recessions in the United States in recent years has included arguments about

A) monetary policy, but not higher oil prices.
B) decreases in exports.
C) higher oil prices, but not monetary policy.
D) both monetary policy and higher oil prices.

113) If a recession were the result of monetary policy, we should observe

A) inflation increasing as output decreases.
B) potential output decreasing.
C) inflation slowing as output falls.
D) a high rate of money growth.

114) Evidence points out that since the mid-1950s just about every recession was preceded by

A) low interest rates.
B) rising interest rates.
C) falling interest rates.
D) negative real interest rates.

115) Evidence points out that since the mid-1950s just about every recession was preceded by rising interest rates. This suggests that the recessions were

A) caused in part by the actions of the Federal Reserve.
B) the result of changes in consumer confidence.
C) due to increases in oil prices and other production costs.
D) caused by simultaneous shifts in aggregate demand and aggregate supply.