Exam 16: The Dynamics of Inflation and Unemployment

Evidence shows that the more independent a central bank is, the higher the inflation the country experiences.

Suppose that the government collects $500 in taxes and borrows $1000 from the public. If the government prints $200 in new money to finance its budget deficit, how large is the government deficit?

The theory of rational expectations suggests that the forecasts made using the rational expectations model:

Figure 16.1 -Refer to Figure 16.1 to answer this question. Suppose the economy is initially at Point A. If labor leaders successfully negotiate a wage increase and the Fed does nothing, then the economy will experience a/n

One of the main insights of monetarism is that:

Figure 16.1 -Refer to Figure 16.1 to answer this question. Suppose the economy is initially at Point A. Labor leaders will only choose to demand a wage increase if:

Real wages are wages expressed in U.S. dollars.

The quantity equation is derived from:

The ratio of nominal GDP to the money supply is the:

The growth version of the quantity equation can be expressed as:

Suppose the public expects money supply and money demand to increase by 10 percent this year. If the Fed decided to allow money supply to increase by only 8 percent, explain what will happen to the real interest rates and investments in the long run.

Economists believe that Alan Greenspan's credibility in his determination to fight inflation has helped the U.S.:

An increase in the nominal GDP, holding all else constant will cause:

Recall Application 2, "Increased Political Independence for the Bank of England Lowered Inflation Expectations," to answer the following questions: -According to the application, if the bonds that were not adjusted for inflation and the inflation adjusted bonds had the same yield after the Bank of England's announced its increased political independence, then:

Alan Greenspan was not credible in his determination to fight inflation during the 1990s.

According to the growth version of the quantity equation, if the money supply increases by 10 percent while velocity stays constant and real GDP increased by 2 percent, then the price level:

INFLATION-INDEXED BONDS IN THE UNITED STATES Are there bonds that can protect your investments from inflation? In 1997, the U.S. Department of the Treasury created a new financial instrument called the Treasury Inflation-Protected Security, or TIPS. The key feature of TIPS is that the payments to investors adjust automatically to compensate for the actual changes in the Consumer Price Index. Therefore, TIPS provide protection to investors from inflation. Like other government bonds, TIPS make interest payments every six months and a payment of the original principal when the bond matures. However, unlike other Treasury bonds, these payments are automatically adjusted for changes in inflation. Despite their obvious attractions, the market for TIPS is still rather small. As of 2005, there were about $200 billion in TIPS outstanding, compared to a total volume of about $4 trillion ($4,000 billion) total Treasury obligations. Because TIPS compensate for actual inflation, the interest rate on these bonds differs from conventional bonds by the expected inflation rate. By comparing the interest rates on TIPS to other government bonds of similar maturity, economists can estimate the public’s expectations of inflation. SOURCE: Simon Kwan, "Inflation Expectations: How the Market Speaks," Federal Reserve Bank of San Francisco Economic Letter, October 7, 2005. -According to the application, if the interest rates on TIPS are higher than the interest rates on non- inflation indexed securities, then:

Define the Phillips Curve. Graphically illustrate the relationship between the inflation rate and the unemployment rate.

The Phillips curve is a graph showing the relationship between the rate of inflation and the unemployment rate.

The faster you spend your money, the higher the velocity.