Full Test Bank Understanding Business Cycle Chapter 22 6e

Student name:__________

1) Explain why understanding short-run fluctuations in output and inflation requires that we study shifts in dynamic aggregate demand and short-run aggregate supply.

2) Explain why changes in the central bank's inflation target will shift the dynamic aggregate demand curve.

3) Describe the immediate short-run effect to the economy from an increase in government purchases, as well as the self-correcting mechanism that will restore long-run equilibrium.

4) If monetary policymakers do not want the current inflation rate to increase, yet they observe increasing aggregate demand from higher government purchases, will they have to accept a higher inflation target? Explain.

5) Discuss the short- and long-run output responses resulting from an increase in money growth when the economy is producing a current level of output that equals potential output, all other factors constant.

6) Why could it be effectively argued that the temporary increase in inflation from the spending for the Vietnam War was made permanent by the Fed?

7) In 2001, a combination of tax cuts and increased defense spending in the United States did not have the same inflationary effect as the similar policy in the 1960s. Explain the difference.

8) Use the long-run model presented in Chapter 22 to answer this question. If there is a decrease in aggregate demand, and monetary policymakers counter the decrease in aggregate demand, what will be the impact on output and inflation? Explain.

9) Why does it take so long for the declaration of the beginning and end of recessions in the U.S. and why is there a lack of clarity as to what is and is not a recession?

10) Why can monetary policymakers neutralize demand shocks but not supply shocks?

11) Neutralizing demand shocks is easier in theory than in practice. Why?

12) What is meant by saying that automatic fiscal policy is countercyclical?

13) Fiscal policy can act just like monetary policy to offset shifts in the dynamic aggregate demand curve and stabilize inflation and output. Explain how the two policies could have the same effect.

14) Why would most economists usually default first to monetary policy for stabilization before using fiscal policy?

15) What is opportunistic disinflation and what provides the opportunity? Explain how the process works.

16) What explanations have been offered to account for the Great Moderation?

17) Use the long-run AD/SRAS/LRAS model to describe the adjustment process the economy would go through from an increase in potential output.

18) Why do increases in potential output allow monetary policymakers to think "opportunistically" about disinflation?

19) Explain the view called real business cycle theory.

20) Explain why real business cycle theory renders the short-run aggregate supply curve irrelevant.

21) Explain how globalization impacts inflation in both the short run and the long run.

22) Assume the economy is in long-run equilibrium. Use the AD/SRAS/LRAS model to illustrate shifts that occur in the short run and in the long run as the economy opens up to trade with other countries. There is no fiscal or monetary policy implemented as the economy self-adjusts. Explain the results.

23) Assume the economy is in long-run equilibrium. Use the AD/SRAS/LRAS model to illustrate shifts that occur in the short run and in the long run as the economy opens up to trade with other countries. Assume that monetary policymakers do intervene as initial globalization moves the economy away from long-run equilibrium. Explain the results.

24) Does an increase in the rate of inflation always imply that aggregate demand is increasing? Explain.

25) In recent years, discussions of the causes of recessions have focused on monetary policy and higher oil prices as the likely causes. Discuss how we can get insight into the likely cause by focusing on macroeconomic variables.

26) While monetary policymakers cannot shift the short-run aggregate supply curve following inflation shocks, they can minimize the impact that the changes in inflation have on output. Describe how they can do this through the monetary policy reaction curve.

27) Consider the two Monetary Policy Reaction Curves shown below. What does the shape of each MPRC tell us about the views of the central bankers in that country?

28) Suppose monetary policymakers in a small economy are most concerned with keeping output close it its potential level and use interest rates as their primary policy tool. Draw the AD/SRAS/LRAS model illustrating this stance. Explain how aggressively these central bankers are likely to move interest rates in response to an increase in inflation. Why is this the case?

29) Describe two possible contributors to the growth slowdown that occurred in the United States in the decade after 2007 according to conventional supply-oriented theory and two possible contributors according to Lawrence Summers’ secular stagnation, demand-oriented theory.

30) More than once in our history government officials tried to slow rapidly rising inflation by instituting wage and price controls; in essence, making it illegal to raise prices. In terms of the model, which includes aggregate demand, short-run aggregate supply and long-run aggregate supply, describe what the intended result of the officials would be and what the likely result may be.

31) The period 1974–1975 is somewhat unique in U.S. economic history, because

A) the output was growing rapidly and the inflation rate was falling.
B) both the output and the inflation rate were falling.
C) output was falling yet the inflation rate rose dramatically.
D) output and the inflation rate were both rising.

32) Historical evidence shows that, in the United States, the lower the economic growth, the more likely

A) inflation is to fall.
B) output gaps are to fall.
C) unemployment is to fall.
D) government spending is to fall.

33) A "shock" is something that creates a shift in

A) the demand curve only.
B) the supply curve only.
C) either the demand curve or the supply curve.
D) both the demand curve and the supply curve at the same time.

34) Permanent declines in inflation such as those seen in Chile and Sweden must have been a result of

A) an increase in the central bank's monetary target.
B) a decrease in the central bank's inflation target.
C) less independence for their central banks.
D) a change to targeting interest rates instead of inflation rates.

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

A) A fall in the central bank's target inflation rate shifts the monetary policy reaction curve to the left.
B) A decrease in the central bank's inflation target raises the real interest rate policymakers set at each level of inflation.
C) Shifts in the monetary policy reaction curve shift the dynamic aggregate demand curve in the same direction.
D) A fall in the central bank's target inflation rate causes the monetary policy reaction curve to flatten.

36) A reduction in the central bank's inflation target shifts the dynamic aggregate demand curve to the left, resulting in

A) lower current output and higher inflation.
B) higher current output and higher inflation.
C) lower current output and lower inflation.
D) higher current output and lower inflation.

37) A reduction in the central bank's inflation target will result in

A) an increase in potential output.
B) no change in potential output.
C) a decrease in potential output.
D) the long-run aggregate supply curve having an upward slope.

38) If there is an increase in aggregate demand, ceteris paribus, potential output will

A) increase.
B) decrease.
C) increase at first and then decrease.
D) not change.

39) An increase in aggregate demand with no adjustment in monetary policy will result in

A) an increase in potential output and higher inflation.
B) a decrease in potential output and higher inflation.
C) no change in potential output but higher inflation.
D) no change in inflation.

40) If monetary policymakers do not want an increase in government purchases, which increases aggregate demand, to cause an increase in inflation, they would

A) shift the monetary policy reaction curve to the right, raising inflation at every real interest rate.
B) do nothing and let the economy's self-correcting mechanism work.
C) shift the monetary policy reaction function left, increasing the real interest rate at every rate of inflation.
D) increase the growth rate of money.

41) Without a change in target inflation, anything that shifts the aggregate demand curve to the right will cause

A) a temporary increase in output.
B) a permanent reduction in inflation.
C) a temporary decrease in inflation.
D) an increase in output in the long run.

42) If monetary policymakers do not change their inflation target and aggregate demand shifts left,

A) there will be a temporary decrease in output.
B) potential output will decrease.
C) there will be an increase in inflation in the long run.
D) it will result in a permanent reduction in inflation.

43) In response to the deep recession that began in December 2007, U.S. President George W. Bush signed legislation in February 2008 to cut income taxes temporarily. One year later, U.S. President Barack Obama approved a much larger package of temporary tax cuts and increases in government spending to counter the economic slump. Assume that the economy had adjusted back to long-run equilibrium prior to the government interventions taking effect. So, starting from long-run equilibrium, where on the graph below would the economy be after this initial increase in government spending, ceteris paribus, but before any self-adjustment?

A) (Y^p; π^T)
B) (Y^P; π₃)
C) (Y₀; π₂)
D) (Y₁; π₁)

44) Assume that an economy starts from long-run equilibrium, and then there is an increase a sharp increase in oil prices, ceteris paribus. Where on the following graph would the economy be after this initial shock but before any self-adjustment?

A) (Y^p; π^T)
B) (Y^P; π₃)
C) (Y₀; π₂)
D) (Y₁; π₁)

45) Assume that an economy starts from long-run equilibrium, and then monetary policymakers increase their inflation target, ceteris paribus. Where on the following graph would the economy end up after long-run adjustment to this policy change?

A) (Y^p; π^T)
B) (Y^P; π₃)
C) (Y₀; π₂)
D) (Y₁; π₁)

46) During the Vietnam War, monetary policy officials reacted to the increases in aggregate demand resulting from military expenditures by

A) not shifting the monetary policy reaction function.
B) dramatically slowing money growth.
C) shifting the monetary policy reaction curve to the left.
D) keeping the same inflation target and raising the real interest rates.

47) The 2008 and 2009 tax cuts and the increase in government spending that occurred at the same time did not have the same inflationary impact as the similar policy in the 1960s because, in the 2000s,

A) the fiscal stimulus came at a time when the economy was already overheated.
B) monetary policymakers, having perceived the inflation risk, responded appropriately.
C) aggregate demand was already above potential output.
D) consumer and business confidence in the economy was already high.

48) If inflation increases, ceteris paribus, this could be illustrated as a

A) rightward shift of the long-run aggregate supply curve.
B) leftward shift of the short-run aggregate supply curve.
C) rightward shift of the short-run aggregate supply curve.
D) movement down along the short-run aggregate supply curve.

49) Which one of the following would be classified as a negative supply shock?

A) an increase in the legal minimum wage
B) a decrease in the price of oil
C) an increase in government purchases
D) an increase in demand for exports

50) Which one of the following would be classified as a negative supply shock?

A) an increase in the price of oil
B) an increase in government purchases
C) an increase in export demand
D) a decline of investor optimism

51) An increase in the price of oil should cause the short-run aggregate supply curve to

A) shift to the right.
B) become vertical.
C) become horizontal.
D) shift to the left.

52) Negative supply shocks cause shifts in

A) only the short-run aggregate supply curve.
B) the dynamic aggregate demand curve.
C) the monetary policy reaction curve but only if policymakers do not change their inflation target.
D) the short-run aggregate supply curve and, possibly, the long-run aggregate supply curve.

53) Stagflation is a term that usually describes an economy experiencing

A) low inflation.
B) low inflation coupled with low growth.
C) high inflation coupled with low growth.
D) low unemployment rates and low inflation rates.

54) Which one of the following would shift the short-run aggregate supply curve to the right?

A) an increase in oil prices
B) a reduction in the minimum wage
C) a change in the law requiring overtime pay for anyone working more than 30 hours a week
D) an increase in payroll taxes

55) Stagflation occurs when the inflation rate

A) decreases and current output decreases.
B) increases and current output decreases.
C) decreases and current output increases.
D) increases and current output increases.

56) An increase in the rate of inflation

A) can only result from increases in aggregate demand.
B) can only result from leftward shifts in the short-run aggregate supply curve.
C) will result only if the long-run aggregate supply curve is vertical.
D) can result from shifts in either the dynamic aggregate demand curve or the short-run aggregate supply curve.

57) An inflation shock that shifts the short-run aggregate supply curve leftward and leaves the long-run supply curve unchanged means the economy's potential level of output will

A) increase.
B) not change.
C) decrease.
D) decrease only if monetary policymakers do not respond.

58) Which one of the following statements is most correct?

A) A recession is officially defined as two consecutive quarters where the real growth rate is negative.
B) A recession officially begins when unemployment exceeds 5.0 percent.
C) There is no hard and fast definition of a recession.
D) The official date of a recession is determined by the Federal Reserve Board, but usually with at least a three-month delay.

59) "Official" recessions in the United States are declared by

A) the Federal Reserve.
B) the U.S. Department of the Treasury.
C) the National Bureau of Economic Research.
D) Congress.

60) Almost all recessions identified by the NBER are characterized by

A) declining real GDP.
B) higher interest rates.
C) durations exceeding two years.
D) higher rates of inflation.

61) Which one of the following is not correct, with regard to the definition of a recession as used by the NBER?

A) A recession occurs whenever there is a dip in the growth rate.
B) The exact length of time needed for a downturn to be declared a recession is not specified.
C) Many key economic indicators are used, some of which may move in opposite directions.
D) A recession is characterized by lower levels of economic activity.

62) According to the NBER, a severe decline in economic activity that lasted fewer than two quarters

A) could not be considered a recession.
B) could still be considered a recession.
C) would not be called a recession until more than two years had passed.
D) would immediately be called a recession.

63) Business cycles

A) vary in the length of recessions but not the time in between recessions.
B) vary in the time between recessions but not in the length of recessions.
C) vary in both the length of recessions and the time between recessions.
D) are by definition recurring waves that rise and fall in a periodic and predictable pattern.

64) A review of economic data suggests that

A) expansions are shorter than recessions.
B) business cycles are recurrent and periodic.
C) over the last 50 years, recessions are becoming more common.
D) recessions are shorter in duration than expansions.

65) As of the beginning of 2020, the longest recession since the 1940s began in

A) 1952.
B) 1973.
C) 1981.
D) 2007.

66) Stabilization policy refers to the use of

A) only fiscal policy.
B) only monetary policy.
C) either fiscal or monetary policy.
D) policy to shift the long-run aggregate supply curve.

67) Policymakers can stabilize the economy by shifting

A) the short-run aggregate supply curve.
B) the dynamic aggregate demand curve.
C) the long-run aggregate supply curve.
D) neither the short-run aggregate supply curve nor the dynamic aggregate demand curve.

68) Policymakers can

A) eliminate the effects of negative supply shock.
B) neutralize movements in aggregate demand.
C) shift the short-run aggregate supply curve.
D) shift the monetary policy reaction function to stabilize the economy.

69) What tool is available to monetary policymakers to shift the short-run aggregate supply curve to the left following a positive inflation shock?

A) A rightward shift of the monetary policy reaction curve
B) A leftward shift of the monetary policy reaction curve
C) Open market purchases of government securities
D) None since the actions of monetary policymakers affect the dynamic aggregate demand curve

70) Suppose that consumer and business confidence fall. Also, monetary policymakers respond to keep inflation on an unchanged target. If monetary policymakers respond, output would

A) remain close to potential output.
B) fall below potential output.
C) rise above potential output.
D) remain close to potential output but inflation would still rise despite their actions.

71) In practice, it is difficult to keep inflation and output from fluctuating when aggregate expenditures change because

A) policymakers respond too quickly to the shifts that have occurred.
B) changes in interest rates have an immediate impact on the economy.
C) changes in consumer or business confidence can be very difficult to recognize as they are occurring.
D) monetary and fiscal policymakers work too closely together.

72) Unemployment insurance and the proportional nature of the tax system are examples of

A) discretionary fiscal policy.
B) automatic fiscal policy.
C) both discretionary and automatic fiscal policy.
D) expansionary fiscal policy.

73) The dynamic aggregate demand curve shifts as a result of

A) discretionary fiscal policy.
B) automatic fiscal policy.
C) either discretionary or automatic fiscal policy.
D) fiscal policy but only when it's used in conjunction with monetary policy.

74) Tax cuts would have the same directional effect on the dynamic aggregate demand curve as

A) decreases in government purchases.
B) the Federal Reserve selling U.S. treasury securities.
C) the Federal Reserve buying U.S. treasury securities.
D) temporary tax increases.

75) Comparing monetary and fiscal policy,

A) fiscal policy has an advantage because it is faster to implement than monetary policy.
B) fiscal policy is easier to implement.
C) monetary policy is easier to implement.
D) history has shown fiscal policy to be more effective at stabilization.

76) Fiscal policy suffers from the problem of being

A) formulated and implemented by politicians subject to short-run incentives.
B) implemented too quickly.
C) influenced only by nonpolitical interests.
D) global instead of domestic in the effects.

77) When compared to fiscal policy, monetary policy

A) is influenced more by politics.
B) can be implemented faster.
C) cannot usually be fine-tuned.
D) is global instead of domestic in the effects.

78) Monetary policymakers can respond to the impact that positive inflation shocks have on output by shifting the

A) monetary policy reaction curve left.
B) monetary policy reaction curve right.
C) short-run aggregate supply curve to the left.
D) short-run aggregate supply curve to the right.

79) If a positive inflation shock occurs and monetary policymakers do not change the inflation target, output will eventually

A) return to potential output and inflation will equal the inflation target.
B) rise above potential output while inflation will equal the inflation target.
C) fall below potential output while inflation will equal the inflation target.
D) return to potential output but inflation will exceed the inflation target.

80) During the Great Moderation experienced in the United States during the 1990s, the volatility of inflation and growth

A) moved in opposite directions.
B) both dropped significantly.
C) both increased but only slightly.
D) disappeared.

81) Most economists attribute the Great Moderation experienced in the United States during the 1990s mainly to

A) good fortune.
B) slowing productivity growth.
C) aggressive fiscal policy.
D) better understanding and use of monetary policy.

82) Possible explanations that have been offered for the Great Moderation experienced in the United States include all of the following except which one?

A) good fortune
B) economies that have become more flexible in absorbing shocks
C) calm financial markets
D) better understanding and use of monetary policy

83) Higher potential output levels without any monetary policy intervention will lead to

A) higher real interest rates.
B) lower real interest rates and higher inflation rates.
C) higher real interest rates and lower inflation rates.
D) lower real interest rates and lower inflation rates.

84) Increases in potential output shift

A) the long-run aggregate supply curve.
B) the short-run aggregate supply curve.
C) both the long-run aggregate supply curve and the short-run aggregate supply curve.
D) the long-run aggregate supply curve, the short-run aggregate supply curve, and the dynamic aggregate demand curve.

85) Disinflation occurs when

A) the inflation rate is negative.
B) the inflation rate is 2 percent or less.
C) the inflation rate goes above 10 percent.
D) the rate of inflation declines.

86) Opportunistic disinflation occurs when policymakers

A) leave the target inflation rate unchanged.
B) take advantage of negative supply shocks.
C) are able to permanently lower inflation.
D) are able to shift LRAS to the left.

87) Since 1950, the U.S. economy has likely experienced

A) more periods of deflation than disinflation.
B) more periods of disinflation than deflation.
C) an equal number of periods of deflation and disinflation since they are synonymous.
D) no periods of either deflation or disinflation.

88) During the period from 1995 to 1999, the U.S. economy

A) experienced the great productivity slowdown.
B) experienced increases in productivity that allowed the Fed the opportunity to raise the inflation rate.
C) experienced increases in productivity that allowed the Fed the opportunity to let the inflation rate fall.
D) saw its potential level of output decrease.

89) Which one of the following statements best describes the level of potential output in the United States?

A) It never changes year to year.
B) It is very erratic year to year.
C) It usually increases year to year.
D) It has been decreasing since 1999.

90) Real business cycle theory seeks to explain business cycle fluctuations by focusing on

A) shifts in potential output.
B) the inflexibility of prices and wages.
C) aggregate demand.
D) changes in monetary policy.

91) The key part of the real business cycle theory model is

A) the importance of monetary policy.
B) the short-run aggregate supply curve.
C) changes in aggregate demand.
D) changes in potential output.

92) Real business cycle theory explains fluctuations in output through

A) changes in aggregate demand.
B) changes in productivity.
C) shifts of the short-run aggregate supply curve.
D) changes in monetary policy.

93) Increases in productivity result in

A) higher inflation as output increases.
B) lower inflation as output decreases.
C) opportunities for policymakers to reduce their inflation target without inducing a recession.
D) increases in production possibilities.

94) The assumption that prices and wages are flexible implies that the

A) short-run aggregate supply curve is irrelevant.
B) short-run aggregate supply curve shifts slowly in response to deviations of current output from potential output.
C) long-run aggregate supply curve is irrelevant.
D) long-run aggregate supply curve could not shift.

95) Globalization and trade

A) increase inflation in the short run.
B) shift both the short-run and long-run aggregate supply curves to the right.
C) reduce policymakers’ opportunities to reduce inflation permanently.
D) break the link between domestic inflation and domestic monetary policy.

96) Globalization and trade reduce inflation in the

A) short run but not in the long run.
B) short run and in the long run.
C) long run but not in the short run.
D) short run but increase inflation in the long run.

97) In an economy like the United States, the impact of a decrease in import prices on overall inflation can be best described as

A) nonexistent.
B) a modest increase.
C) a modest decrease.
D) a significant decrease, particularly as globalization and trade increase.

98) Policymakers can neutralize

A) supply shocks, but only in the short run.
B) supply shocks, but only in the long run.
C) supply shocks in both the short run and the long run.
D) only demand shocks.

99) In which situation would policymakers be unable to neutralize the effect on the economy?

A) federal government deficit
B) increase in the price of oil
C) imports exceeding exports
D) decline in consumer confidence

100) Policymakers could neutralize all of the following except which one?

A) an increase in federal government spending on defense
B) an increase in the price of oil
C) a trade deficit
D) a decrease in business confidence

101) Estimates of gross domestic product (GDP) are revised

A) quickly and often.
B) for many years after the fact.
C) only in the following quarter.
D) each month.

102) If the economy's output response to changes in current inflation is small, the slope of the dynamic aggregate demand curve will be

A) flat.
B) steep.
C) positive.
D) zero.

103) If the monetary policy reaction curve has a relatively flat slope, the dynamic aggregate demand curve is likely to have a

A) relatively steep slope.
B) relatively flat slope.
C) positive slope.
D) zero slope.

104) If the monetary policy reaction curve has a relatively steep slope, the dynamic aggregate demand curve is likely to have a

A) relatively steep slope.
B) relatively flat slope.
C) positive slope.
D) zero slope.

105) If monetary policymakers respond aggressively to current inflation above the target inflation rate, the

A) monetary policy reaction curve would be flat.
B) dynamic aggregate demand curve would have a steep slope.
C) monetary policy reaction curve would have a positive and steep slope.
D) dynamic aggregate demand curve would shift rightward.

106) Central bankers with a relatively steep monetary policy reaction curve will move interest rates

A) more aggressively when inflation rises, leading to more volatility in output.
B) more aggressively when inflation rises, leading to less volatility in output.
C) less aggressively when inflation rises, leading to more volatility in output.
D) less aggressively when inflation rises, leading to less volatility in output.

107) Central bankers with a relatively flat monetary policy reaction curve will move interest rates

A) more aggressively when inflation rises, leading to more volatility in output.
B) more aggressively when inflation rises, leading to less volatility in output.
C) less aggressively when inflation rises, leading to more volatility in output.
D) less aggressively when inflation rises, leading to less volatility in output.

108) A flat dynamic aggregate demand curve corresponds to a

A) steep monetary policy reaction curve and means that supply shocks will create large changes in current output.
B) flat monetary policy reaction curve and means that supply shocks will create large changes in current output.
C) steep monetary policy reaction curve and means that supply shocks will create small changes in current output.
D) flat monetary policy reaction curve and means that supply shocks will create small changes in current output.

109) In which situation will inflation fall the fastest?

A) A negative supply shock occurs, the dynamic aggregate demand curve is steep, and so is the monetary policy reaction curve.
B) A negative supply shock occurs, the dynamic aggregate demand curve is flat, and so is the monetary policy reaction curve.
C) A negative supply shock occurs, the dynamic aggregate demand curve is flat, and the monetary policy reaction curve is steep.
D) A negative supply shock occurs, the dynamic aggregate demand curve is steep, and the monetary policy reaction curve is flat.

110) If monetary policymakers are more concerned about output fluctuations than inflation fluctuations,

A) they will choose a relatively steep monetary policy reaction curve in which movements in the real interest rates are small.
B) they will choose a relatively flat monetary policy reaction curve in which movements in the real interest rates are small.
C) they will choose a relatively steep monetary policy reaction curve in which movements in the real interest rates are large.
D) they will choose a relatively flat monetary policy reaction curve in which movements in the real interest rates are large.

111) Monetary policymakers face a tradeoff between

A) the level of output and the rate of inflation.
B) the volatility in output and the volatility in inflation.
C) low unemployment and high inflation.
D) high unemployment and low inflation.

112) When faced with negative supply shocks, policymakers

A) will stabilize both inflation and output.
B) will always focus on stabilizing output.
C) cannot stabilize output, so they tend to focus on inflation.
D) face a trade-off because they cannot simultaneously stabilize both output and inflation.

113) In the decade after 2007, the U.S. economy grew at a modest pace. Former Treasury Secretary Lawrence Summers has offered a hypothesis for this that differs from the conventional explanation that potential output slowed sharply. Summers’ secular stagnation shifts the focus on to ______ and argues that the real interest rate that prevails in long-run equilibrium is ______.

A) supply; positive
B) supply; negative
C) demand; positive
D) demand; negative